DOJ Urges Court to Affirm Mineral Lease, Fuel Credit Holdings

EXXON MOBIL CORPORATION,
Plaintiff-Appellant/Cross-Appellee
v.
UNITED STATES OF AMERICA,
Defendant-Appellee/Cross-Appellant

IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT

ON APPEAL FROM THE JUDGMENT OF
THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF TEXAS

BRIEF FOR THE APPELLEE/CROSS-APPELLANT

DAVID A. HUBBERT
Acting Assistant Attorney General
BRUCE R. ELLISEN (202) 514-2929
CLINT A. CARPENTER (202) 514-4346
Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

Of Counsel:
CHAD E. MEACHAM
Acting United States Attorney

STATEMENT REGARDING ORAL ARGUMENT

Oral argument should be heard in this case because it presents important questions of federal tax law.

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TABLE OF CONTENTS

Statement regarding oral argument

Table of contents

Table of authorities

Glossary

Statement of jurisdiction

Statement of the issues

Statement of the case

Summary of argument

Argument:

I. The district court correctly held that Exxon was not entitled to deduct, as a “cost” of fuel that it sold, fuel-excise taxes that Exxon neither owed nor paid

Standard of review

II. The district court correctly found that Exxon's foreign oil and gas transactions were leases, not sales, because Qatar and Petronas retained economic interests in the oil and gas

Standard of review

III. The district court erred in holding that Exxon had a “reasonable basis” for its position that the transactions were sales

Standard of review

Conclusion

Certificate of service

Certificate of compliance

TABLE OF AUTHORITIES

Cases:

Affiliated Foods, Inc. v. Commissioner, 128 T.C. 62 (2007)

Albritton v. Commissioner, 248 F.2d 49 (5th Cir. 1957)

Allen v. C&H Distribs., L.L.C., 813 F.3d 566 (5th Cir. 2015)

Anderson v. Helvering, 310 U.S. 404 (1940)

Chemtech Royalty Assocs. v. United States, 766 F.3d 453 (5th Cir. 2014)

Chemtech Royalty Assocs. v. United States, 823 F.3d 282 (5th Cir. 2016)

Christie v. United States, 436 F.2d 1216 (5th Cir. 1971)

Commissioner v. Sw. Expl. Co., 350 U.S. 308 (1956)

Delek US Holdings, Inc. v. United States, 515 F. Supp. 3d 812 (M.D. Tenn. 2021)

U.S. ex rel. Doe v. Dow Chem. Co., 343 F.3d 325 (5th Cir. 2003)

Gray v. Commissioner, 183 F.2d 329 (5th Cir. 1950)

Guzman v. Hacienda Recs. & Recording Studio, Inc., 808 F.3d 1031 (5th Cir. 2015)

Hart Furniture Co. v. Commissioner, 12 T.C. 1103 (1949)

Irvine v. United States, 729 F.3d 455 (5th Cir. 2013)

Kirby Petroleum Co. v. Commissioner, 326 U.S. 599 (1946)

Maines v. Commissioner, 144 T.C. 123 (2015)

NPR Invs. LLC v. United States, 740 F.3d 998 (5th Cir. 2014)

Palmer v. Bender, 287 U.S. 551 (1933)

Parsons v. Smith, 359 U.S. 215 (1959)

Rutledge v. United States, 428 F.2d 347 (5th Cir. 1970)

Schaeffler v. United States, 889 F.3d 238 (5th Cir. 2018)

State Farm Fire & Cas. Co. v. United States ex rel. Rigsby, 137 S. Ct. 436 (2016)

Sunoco v. United States, 129 Fed. Cl. 322 (2016)

Sunoco v. United States, 908 F.3d 710 (Fed. Cir. 2018)

Taniguchi v. Kan Pac. Saipan, Ltd., 566 U.S. 560 (2012)

Thomas v. Perkins, 301 U.S. 655 (1937)

TIFD III-E Inc. v. United States, 604 F. App'x 69 (2d Cir. 2015)

TIFD III-E Inc. v. United States, 666 F.3d 836 (2d Cir. 2012)

Vest v. Commissioner, 481 F.2d 238 (1973)

Estate of Weinert v. Commissioner, 294 F.2d 750 (5th Cir. 1961)

Weiss v. Commissioner, 129 T.C. 175 (2007)

Wells Fargo & Co. v. United States, 957 F.3d 840 (8th Cir. 2020)

Whitehead v. United States, 555 F.2d 1290 (5th Cir. 1977)

Wood v. United States, 377 F.2d 300 (5th Cir. 1967)

Statutes:

28 U.S.C.:

American Jobs Creation Act of 2004, Pub. L. No. 108-357, 118 Stat. 1418

Internal Revenue Code (26 U.S.C.):

Protecting Americans from Tax Hikes Act of 2015, Pub. L. 114-113, Div. Q, Title II, § 209(c)(1), 129 Stat. 3040, 3085 (2015)

Other Authorities:

5 Mertens Law of Federal Income Taxation:

Black's Law Dictionary (8th ed. 2004)

Black's Law Dictionary (11th ed. 2019)

Ernst & Young's Oil and Gas ¶ 301.01 (John R. Braden ed., 1997)

Federal Rule of Appellate Procedure 4(a)(3)

Federal Rule of Civil Procedure 11

Joint Committee on Taxation, Tax Expenditures for Energy Production & Conservation, JCX-25-09R (2009)

Maule & Van Loo, Principles of Income Tax Credits, Tax Mgmt. Portfolios No. 506 (2019)

Notice 2015-56, 2015-35 I.R.B. 235

Notice 2016-05, § 2, 2016-6 I.R.B. 302

Priv. Ltr. Rul. 9728010, 1997 WL 381980 (July 11, 1997)

Priv. Ltr. Rul. 9728038, 1997 WL 382008 (July 11, 1997)

Rev. Rul. 79-315, 1979-2 C.B. 27

Rev. Rul. 84-41, 1984-1 C.B. 130

Rev. Rul. 85-30, 1985-1 C.B. 20

Tech. Adv. Mem. 199918002, 1999 WL 283075 (May 7, 1999)

Treasury Regulations (26 C.F.R.):

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GLOSSARY

Abbreviation	Definition
AJCA	American Jobs Creation Act of 2004, Pub. L. No. 108-357, 118 Stat. 1418
Br.	Appellant/Cross-Appellee's opening brief
C.B.	IRS Cumulative Bulletin
Exxon	Exxon Mobil Corporation
I.R.B.	Internal Revenue Bulletin
I.R.C.	Internal Revenue Code (26 U.S.C.)
IRS	Internal Revenue Service
Priv. Ltr. Rul.	IRS Private Letter Ruling
Tech. Adv. Mem.	IRS Technical Advice Memorandum
Treas. Reg.	Treasury Regulation (26 C.F.R.)

STATEMENT OF JURISDICTION

Exxon commenced this action for refunds of income tax and penalties on October 18, 2016, after the IRS disallowed its timely filed administrative claims for refunds of income tax on May 5, 2016. (ROA.53-56.) See I.R.C. §§ 6511(a), 6532(a)(1), 7422(a). The district court had jurisdiction under 28 U.S.C. § 1346(a)(1).

On February 19, 2021, the district court entered a final judgment resolving all claims of all parties. (ROA.5776-5777.) Exxon timely filed a notice of appeal on April 9, 2021, and the United States timely filed a notice of cross-appeal on April 19, 2021. (ROA.5814-5817.) See 28 U.S.C. § 2107(b); Fed. R. App. P. 4(a)(3). This Court has jurisdiction under 28 U.S.C. § 1291.

STATEMENT OF THE ISSUES

1. Whether the district court correctly held that Exxon may not deduct, as a “cost” of fuel that it sold, the amount of a fuel-excise tax that it neither incurred nor paid because it received a credit “against” that excise tax.

2. Whether the district court correctly found that Exxon's transactions with Qatar and Petronas were mineral leases, rather than sales, because Qatar and Petronas retained economic interests in the oil and gas in place.

3. Whether the district court erred in holding that Exxon had a “reasonable basis” for its position that the transactions were sales and was therefore not liable for penalties under I.R.C. § 6676.

STATEMENT OF THE CASE

Exxon seeks refunds of income taxes and penalties totaling more than $1.5 billion for the years 2006-2009. Exxon claimed none of those refunds on it original 2006-2009 income tax returns; rather, its original returns took the tax positions that the Government argues, and the district court held, were the correct positions. But in 2014 and 2015, Exxon reversed course by filing amended returns that took the opposite positions and claimed income-tax refunds totaling more than $1.3 billion. Of that amount, about $1 billion is based on Exxon's amended position that certain oil and gas exploration contracts in Qatar and Malaysia should be recharacterized as sales of minerals in place instead of mineral leases. And about $317 million is based on Exxon's amended position that its “cost of goods sold” for 2008 and 2009 could include not only the excise tax it actually paid on gasoline that it sold, but also the excise tax it would have had to pay if it had not claimed excise-tax credits under I.R.C. § 6426 for blending its gasoline with alcohol.

The IRS disallowed Exxon's refund claims and later assessed penalties of about $207 million under I.R.C. § 6676 after determining that Exxon lacked a “reasonable basis” for its position that the foreign oil and gas transactions should be recharacterized as sales. Exxon paid the penalties, and then brought this action for refunds of both the penalties and the taxes.

The district court rejected Exxon's claims as to the taxes, holding in essence that Exxon had gotten it right the first time in its original returns. Specifically, the court held on summary judgment that Exxon could deduct only the fuel excise taxes that it had actually paid. And the court found after a bench trial that Exxon's foreign oil and gas transactions were properly characterized as leases because under the contracts, the landowners who were Exxon's counterparties had retained “economic interests” in the oil and gas in place. As to the §6676 penalties, however, the court granted summary judgment to Exxon, holding that Exxon had a reasonable basis for its erroneous position that the transactions should be treated as sales.

A. Exxon's transactions with Qatar and Petronas

Of the more than $1.5 billion that Exxon seeks in this case, about $1.2 billion relates to Exxon's oil and gas ventures in Qatar and Malaysia. Starting in the 1980s, Exxon entered into a series of exploration and production agreements with the government of Qatar and with Malaysia's state-owned oil company, Petronas. (ROA.7240-7242.) And until 2014, Exxon treated those agreements as mineral leases for federal tax purposes. (ROA.5757.) Although their terms are not identical, the gist of the agreements is that Qatar and Petronas, as the owners of offshore oil and gas deposits, granted Exxon rights to extract and sell oil and gas from those deposits in exchange for a share of the production (cash royalties and/or in-kind oil and gas). (ROA.5165-5167.)

In Qatar, the relevant agreements are a series of “Development and Fiscal Agreements” that were executed in the 1990s and 2000s. (ROA.7240-7242.) The transferee under each agreement (i.e., Qatar's counterparty) is not Exxon itself, but rather one of several joint-stock companies in which Exxon and Qatari state-owned entities are the shareholders. (ROA.5165.) Thus, Qatar effectively is on both sides of these transactions and shares Exxon's obligations as transferee. For simplicity, however, we will follow Exxon's lead (Br. 6) and ignore the distinctions between the joint-stock companies, Exxon's state-owned partners therein, and Exxon itself by referring to them all as “Exxon.”

Under the Qatar agreements, Exxon has the right (and obligation) to develop and extract gas from Qatar's North Field and to build, own, and operate the transportation, storage, processing, liquefaction, and marketing facilities for the manufacture and marketing of liquefied natural gas (“LNG”), condensate, and liquefied petroleum gas (“LPG”). (ROA.5165.) In exchange, Exxon is obligated to pay Qatar: (1) a minimum amount per unit of gas delivered to the LNG plant or a percentage of the market value of LNG at the delivery point to the buyer, whichever is greater; (2) a percentage of the proceeds from the sale of condensate; and (3) a percentage from the sale of LPG. (ROA.5165-5166, 62348-62350.)

The agreements are for fixed terms, typically twenty years, and at the end of the term, the facilities built by Exxon revert to Qatar. (ROA.5166.) In the event of a breach, the injured party may seek damages in arbitration or, if both parties agree, in a Qatari court. (E.g., ROA.40741-40743, 40773-40778.)

In Malaysia, the relevant agreements are a series of “Production Sharing Contracts” that Exxon entered into with Petronas beginning in the 1980s. (ROA.5166.) There are few differences between these agreements and the Qatari agreements that are material here. Petronas granted Exxon the right to produce oil and gas in parts of an offshore field known as the Malay Basin, and both the right and the obligation to construct the necessary facilities for doing so. (ROA.5166.) In exchange, Petronas is entitled both to an in-kind share of the oil and gas produced and to substantial cash payments based on the production. (ROA.5185, 62353-62355.) Some of the agreements also require Exxon to make annual “abandonment cess” payments to Petronas, regardless of production, “to cover the costs of plugging the wells at the end of their useful lives,” but the amounts of those payments are “de minimis.” (ROA.5166-5167, 5185-5186.)

Exxon's agreements with Petronas are for fixed terms, and at the end of the term, the facilities built by Exxon revert to Petronas. (ROA.5166.) Evidence at trial showed that Malaysian law recognizes a right to damages for breach of contract. (ROA.59630-59634.)

B. Exxon's “alcohol fuel mixture” credits

From 2005 to 2011, Congress allowed gasoline producers like Exxon to claim a refundable “credit . . . against the [excise] tax imposed [on sales of gasoline] by [I.R.C. §] 4081” for each gallon of alcohol that the producer blended into gasoline it sold. I.R.C. §§ 6426(a)(1), (b), 6427(e)(1), (3), (6)(A). This “alcohol fuel mixture” credit under § 6426 is part of an integrated statutory scheme that Congress enacted in the American Jobs Creation Act of 2004 (“AJCA”), Pub. L. No. 108-357, 118 Stat. 1418, to increase the flow of § 4081 excise-tax revenues to the Highway Trust Fund without eliminating incentives for producers to blend their gasoline with alcohol. See Sunoco v. United States, 908 F.3d 710, 713 (Fed. Cir. 2018); I.R.C. § 9503.

In 2008 and 2009, Exxon produced and sold a qualifying mixture of gasoline blended with alcohol, thus becoming liable for the excise tax under § 4081 while also qualifying for the “credit against” that tax under § 6426. The amounts Exxon sold were substantial, enabling Exxon to claim more than $960 million in “alcohol fuel mixture” credits against the excise tax it otherwise would have owed for the years 2008 and 2009. (ROA.58, 1249-1250.) Exxon's entitlement to those credits is not in dispute.

C. Exxon's income tax reporting for the years 2006-2009

In general, the characterization of a mineral transaction as a lease instead of a sale means that the transferee will not be taxed on the transferor's share of the production and must share with the transferor the statutory deduction for depletion of the minerals. See 5 Mertens Law of Federal Income Taxation §§ 24:19, 24:22 (discussing tax consequences of lease vs. sale). But the lease/sale determination can also have other income-tax effects, depending on the taxpayer's circumstances.

The § 4081 excise tax has income-tax consequences too. Excise taxes are part of the “cost of goods sold” that a taxpayer subtracts, or deducts, from its total sales to determine its gross income from sales of inventory. Treas. Reg. § 1.61-3(a); see I.R.C. § 263A(2)(B). So “including the gasoline excise tax in the cost of goods sold, results in a decrease in income tax liability.” Sunoco, 908 F.3d at 714 n.4.

For decades, Exxon treated its transactions with Qatar and Petronas as mineral leases for both financial reporting and federal income tax purposes, and Exxon continued to do so in its original income tax returns for the years 2006-2009. (ROA.5757, 6330-6333, 6349-6352.). Exxon's original returns for 2008 and 2009 also deducted, as a “cost of goods sold,” the § 4081 excise taxes that Exxon had owed and paid after application of the § 6426 mixture credits it had claimed. (ROA.1250.)

In 2014 and 2015, however, Exxon filed amended returns for 2006-2009 that took much different positions and claimed refunds in excess of $1.3 billion as a result. The amended returns treated Exxon's transactions with Qatar and Petronas as sales of minerals in place and asserted that this treatment had a series of collateral tax effects that allowed Exxon to use excess foreign tax credits (which would have otherwise expired unused), resulting in refunds totaling over $1 billion. (ROA.7267-7271; see ROA.60, 61-62, 5185, 6334-6335.)

In addition, Exxon's amended returns for 2008 and 2009 increased its claimed “cost of goods sold” by more than $960 million, reflecting the excise tax that Exxon would have owed for those years if it had not claimed more than $960 million in mixture credits “against” that tax. (ROA.1250.) And on that basis, the amended returns claimed additional refunds for 2008 and 2009 totaling about $317 million. (ROA.7269-7271.)

D. The IRS proceedings and assessment of § 6676 penalties

The IRS disallowed Exxon's refund claims. It determined that the transactions with Qatar and Petronas must be treated as leases not sales, and that, in any event, the change to sale treatment that Exxon sought would be an impermissible change in accounting method for which Exxon had failed to secure the IRS's consent, as required by I.R.C. § 446(e). The IRS further determined that Exxon was not entitled to increase its “cost of goods sold” for 2008 and 2009 by the amount of excise tax that it would have owed (but did not) if it had not claimed any mixture credits. (ROA.5757-5758, 7267-7271.)

The IRS later imposed penalties under I.R.C. § 6676 (2012) with respect to the $1 billion of Exxon's refund claims that is attributable to the Qatar and Petronas transactions. (ROA.5758.) As in effect for those refund claims, § 6676(a) provided that if an income tax refund claim is made for an excessive amount, then “the person making such claim shall be liable for a penalty in an amount equal to 20 percent of the excessive amount,” unless “the claim for such excessive amount has a reasonable basis.” The IRS concluded that Exxon did not have a reasonable basis for its position that the transactions should be treated as sales, nor for its position that such a change in treatment was not a change in accounting method. Exxon paid the penalties, which totaled over $207 million. (ROA.702.)

E. The district court proceedings

Exxon brought this suit seeking refunds of the income taxes attributable to the excise-tax issue, the income taxes attributable to the lease/sale issue, and the § 6676 penalties. (ROA.53-65, 700-711.) Addressing those claims seriatim, the district court held for the government as to the income taxes and for Exxon as to the penalties.

1. Summary judgment for the Government on the excise-tax issue

First addressing Exxon's attempt to deduct, as a “cost of goods sold,” nearly a billion dollars of excise taxes that it neither owed nor had paid, the district court granted summary judgment to the Government. (ROA.1249.) The court explained that “the Court of Federal Claims recently answered this very question” in Sunoco v. United States, 129 Fed. Cl. 322 (2016), where it held that the § 6426 mixture credit “operates 'as a reduction of the taxpayer's excise tax liability' and the taxpayer therefore 'correctly use[s] its net excise taxes paid in calculating its cost of goods sold.'” (ROA.1250 (quoting Sunoco, 129 Fed. Cl. at 324).) The district court stated that it “agrees with Sunoco and thus adopts its reasoning in full.” Accordingly, the court held “that Exxon's cost of goods sold must include only its fuel excise tax liability actually paid after subtracting the Mixture Credit.” (ROA.1250.)

The Federal Circuit later affirmed the decision of the Court of Federal Claims, holding: “Sunoco asks this court to permit it to deduct, as a cost of goods sold, an excise-tax expense that it never incurred or paid. Neither the text of the [AJCA] nor its legislative history supports such a reading of the Internal Revenue Code.” Sunoco v. United States, 908 F.3d 710, 715 (Fed. Cir. 2018), cert. denied, 140 S. Ct. 46 (2019).

2. Decision for the Government on the lease/sale issue

After a bench trial on the lease/sale issue, the district court issued an opinion holding for the Government and rejecting Exxon's attempt to recharacterize its transactions with Qatar and Petronas as sales. (ROA.5164.) The parties agreed that the question whether the transactions were leases or sales for tax purposes turns on whether the transferors (Exxon's counterparties, Qatar and Petronas) retained an “economic interest” in the minerals in place. And the court had “no difficulty” finding that standard was met here. (ROA.5185.)

As the district court explained, Qatar “retains an economic interest in the minerals” because it is entitled to compensation that “is dependent on extraction of minerals; if there is no extraction, Qatar receives no compensation.” (ROA.5183.) Likewise, “Petronas retained an economic interest in the minerals in place” because “[t]he vast majority of its return on the projects derived from extraction. If there was no extraction, Petronas received virtually nothing.” (ROA.5186.)

Relying on its reading of Anderson v. Helvering, 310 U.S. 404 (1940), Exxon argued that an economic interest exists only if the transferor looks “solely” to extraction for all of its compensation. Exxon contended that, because Qatar and Petronas received royalties (and other compensation) that reflected, in part, value added after the wellhead, they did not look to payments solely from the production of oil and gas and, therefore, did not retain an economic interest in the minerals. (ROA.5175.)

But the district court rejected that argument, concluding that it “tries to load 'solely' with more freight than it can bear by arguing for an extension of Anderson beyond [its] facts.” (ROA.5176.) The court reasoned that “Anderson is factually different from this case”; that Exxon's “construction of Anderson conflicts with subsequent — and binding — Fifth Circuit precedent” and “does not make sense”; and that Exxon's argument “reflects a fundamental confusion between (a) what Qatar and Petronas provide to Exxon Mobil and (b) how the royalty is calculated.” (ROA.5175-5177.) Recognizing that “'[u]nder the economic interest test, the critical consideration is whether payment is dependent upon extraction, not the method by which that payment is calculated,'” the court found that “[p]ayment to Qatar and Petronas is dependent upon extraction.” (ROA.5178 (quoting Wood v. United States, 377 F.2d 300, 306 (5th Cir. 1967)).).

Having found that Qatar and Petronas retained economic interests, and that the transactions were therefore leases for tax purposes, the district court found it unnecessary to address the Government's alternative argument that recharacterizing the transactions as sales would be an impermissible change in accounting method. (ROA.5188.)

3. Summary judgment for Exxon on the penalties

Although the district court held for the Government on the merits, it later granted summary judgment to Exxon as to the § 6676 penalties on the ground that Exxon had a “reasonable basis” for its unavailing positions on the lease/sale issue. (ROA.5764-5769.) Because “reasonable basis” is not defined in § 6676, the court agreed with the parties (ROA.63707-63708, 64604, 68843-68844, 69098, 69588, 70331) that it should look to the meaning of “reasonable basis” in I.R.C. § 6662, as defined by the regulations thereunder. (ROA.5759-5760.) Those regulations provide that the reasonable-basis standard is generally satisfied if the taxpayer's position “is reasonably based on one or more of the authorities set forth in [Treas. Reg.] § 1.6662-4(d)(3)(iii),” including statutes, regulations, cases, and various IRS publications. Treas. Reg. § 1.6662-3(b)(3).

The district court held that “Exxon Mobil's sale vs. mineral lease position was reasonably based on one or more of the authorities set forth in Treas. Reg. § 1.6662-4(d)(3)(iii). . . .” (ROA.5764.) The court did not cite any authorities, however, but stated that this was “an extremely complex case, both factually and legally,” and that its rejection of the merits of Exxon's lease/sale position had required “considerable analysis.” (ROA.5764.)¹

SUMMARY OF ARGUMENT

1. Contrary to Exxon's claims, it is not entitled to deduct — as a “cost of goods sold” — an excise-tax liability that it never paid or even incurred. As the Federal Circuit correctly held on this exact issue, “Neither the text of the [AJCA] nor its legislative history supports such a reading of the Internal Revenue Code.” Sunoco, Inc. v. United States, 908 F.3d 710, 715 (Fed. Cir. 2018), cert. denied, 140 S. Ct. 46 (2019). This Court should hold likewise.

The gravamen of Exxon's argument is that the § 6426 mixture credit does not merely reduce, but rather pays the § 4081 excise-tax liability to which the credit is applied, and that Exxon is entitled to claim that “payment” as a cost of goods sold on its income tax returns. But the plain language of the statute is to the contrary. Mixture credits are credits, not payments, which reduce the taxpayer's excise-tax liability. Indeed, § 6426(a)(1) explicitly states that the mixture credit is applied “against” the § 4081 excise tax. And by expressly distinguishing the “payment” allowed under § 6427(e) from the § 6426 “credit,” the text confirms that the AJCA treats “credits” differently than “payments.”

2. Exxon's position that its transactions with Qatar and Petronas must be treated as sales for tax purposes rests on the erroneous premise that a transferor's reservation of any right to income that is not derived from extraction means that the transfer is a sale. No such “rule” exists. Neither this Court nor the Supreme Court has ever denied lease treatment to a mineral transaction — or otherwise held that the transferor lacked an “economic interest” in the minerals in place — merely because the transferor had rights to non-extraction income.

To the contrary, both Courts have held in multiple cases that transferors did retain the requisite economic interest in that very circumstance. If a right to non-extraction income somehow “destroys” a transferor's otherwise-valid economic interest, as Exxon claims, then all of those cases were wrongly decided. Thus, Exxon's newly discovered “rule” cannot be and is not the law.

The actual rule adopted by the Supreme Court and applied by this Court is much narrower: a transferor's reservation of a right to deferred payments is an economic interest only if the payments are to be derived solely from the production of oil and gas. Here, there can be no serious dispute that Qatar and Petronas both reserved rights to payments that depend “solely” on oil and gas production; if production is zero, the payment is zero. And because Qatar and Petronas thus retained economic interests in the oil and gas in place, the transactions must be characterized as leases.

That Qatar and Petronas also have additional and separate rights to income based on something other than oil and gas production is immaterial. Again, if that were not so, then many of the Supreme Court and Fifth Circuit cases holding that transferors did retain economic interests were wrongly decided. And this Court has consistently rejected arguments that separate rights to non-extraction income negated a transferor's economic interest. The Court should do likewise here.

3. The district court was unequivocal in its rejection of the merits of Exxon's position that the transactions should be treated as sales, concluding that it relies on factually distinguishable authority, conflicts with binding precedent, does not make sense, and reflects fundamental confusion about the facts. But when the court turned to the § 6676 penalties, it concluded that Exxon's position had a “reasonable basis.” In this regard, the district court erred.

The mere fact that a case is complex and requires considerable analysis to unravel does not satisfy the reasonable-basis standard. This Court and others have upheld penalties in cases involving tax-shelter transactions that were much more complex. Rather, a tax position has no reasonable basis if no identifiable authority supports it.

That is precisely the situation here. Although the district court offered a bare assertion that Exxon's position “was reasonably based on one or more of the authorities set forth in Treas. Reg. § 1.6662-4(d)(3)(iii),” the court failed to actually cite any such “authorities” because there are none. Exxon's position rests on a purported “rule” that it derives from a misreading of case law. That case law is materially distinguishable on its facts. And Exxon's misreading of it is inconsistent with numerous binding authorities. That is not a reasonable basis. The judgment for Exxon on its claims for refunds of the penalties should be reversed and remanded with instructions to enter judgment for the Government.

ARGUMENT

I. The district court correctly held that Exxon was not entitled to deduct, as a “cost” of fuel that it sold, fuel-excise taxes that Exxon neither owed nor paid

Standard of review

This Court reviews a grant of summary judgment de novo. Irvine v. United States, 729 F.3d 455, 460 (5th Cir. 2013).

A. The Court should follow the Federal Circuit's decision in Sunoco

Exxon's exegesis of statutory text and structure (Br. 44-54) elides the fundamental implausibility of its position. Exxon claims that it is entitled to deduct — as a “cost of goods sold” — an excise-tax liability that it never paid or even incurred. It should come as no surprise to anyone that the Tax Code does not allow that. As the Federal Circuit correctly held on this exact issue, “Neither the text of the [AJCA] nor its legislative history supports such a reading of the Internal Revenue Code.” Sunoco, Inc. v. United States, 908 F.3d 710, 715 (Fed. Cir. 2018), cert. denied, 140 S. Ct. 46 (2019).²

Exxon calls the Federal Circuit's reading of the statutory text “strained.” (Br. 45.) But it is hard to imagine how it could be more strained than Exxon's reading, which infers a right to deduct “costs” that the taxpayer neither paid nor incurred from the language of tax provisions that do not expressly grant such an incongruous right. Congress certainly could have allowed taxpayers to do what Exxon seeks to do here, but the unambiguous text of the AJCA shows that it did not.

Instead, the AJCA combines with the applicable income-tax provisions to give fuel producers a choice: they can claim § 6426 mixture credits against their § 4081 excise-tax liability and then deduct whatever remains of that liability as a cost of goods sold, or they can forgo mixture credits and deduct their entire excise-tax liability as a cost of goods sold. What they cannot do is both, which is precisely what Exxon seeks to do here. Exxon wants to enjoy both the excise-tax benefits of claiming mixture credits and the income-tax benefits of forgoing mixture credits. As the Federal Circuit recognized in Sunoco, 908 F.3d at 718, “such double-dipping was not intended by Congress.” By claiming mixture credits for 2008 and 2009, Exxon made its choice and will have to make do with only the $960 million excise-tax benefit it received as a result.

This Court should decline Exxon's invitation to create a split with the Federal Circuit and should instead affirm the district court's rejection of Exxon's claims that supposed “costs” it neither paid nor incurred entitle it to refunds of $317 million.

B. Section 6426 allows a “credit against” Section 4081 excise-tax liability; it does not pay that liability

Though presented in several variations, the gravamen of Exxon's argument is that the § 6426 mixture credit pays — or, as Exxon vaguely puts it, “satisfies” — the § 4081 excise-tax liability to which the credit is applied, and that Exxon is entitled to claim that payment as its own when calculating its “cost of goods sold.”³ The district court correctly rejected that argument (ROA.1250), as did the Federal Circuit when Sunoco made the very same argument: “The plain meaning of the statute is clear — the Mixture Credit is a credit, not a payment, which must first be used to decrease a taxpayer's gasoline excise tax liability. . . .” Sunoco, 908 F.3d at 718; cf. Schaeffler v. United States, 889 F.3d 238, 248-49 (5th Cir. 2018) (rejecting argument that foreign tax credit is a payment under the Internal Revenue Code).

1. To be included in the cost of goods sold, a tax liability must be paid, not just “satisfied”

Exxon makes a superficial effort to distinguish its argument from the argument rejected in Sunoco by scrupulously characterizing the § 6426 mixture credit as “satisf[ying]” (Br. 1, 5, 44-56), rather than paying, the excise-tax liability. Exxon appears to use “satisfied” merely as a mushier (and equally erroneous) synonym for “paid.” For example, Exxon asserts that the Federal Circuit in Sunoco “perceived a 'windfall' for a blender if the credit was treated as satisfying, rather than altering, the amount of the blender's excise-tax liability” (Br. 50 (emphasis added)), when the Federal Circuit actually used the phrase “as a payment,” 908 F.3d at 719.

But to the extent that Exxon is using “satisfied” to mean something less than “paid,” its argument fails at the threshold because an excise tax must be paid to be included in “cost of goods sold.” A taxpayer's gross income from sales of inventory in its business includes “the total sales, less the cost of goods sold.” Treas. Reg. § 1.61-3(a); see I.R.C. §§ 263A, 471. So in calculating its gross income from sales, an accrual-method taxpayer such as Exxon (ROA.4822) may subtract any properly allocable costs that the taxpayer actually incurred. See Treas. Reg. §§ 1.61-3(a), 1.446-1(c)(1)(ii). But unlike many other types of liabilities, tax liabilities are not “incurred” unless and until “the tax is paid to the governmental authority that imposed the tax.” Treas. Reg. § 1.461-4(g)(6) (emphasis added); see id. § 1.461-4(a)(1), (g)(1).⁴

Thus, it is not enough for an excise-tax liability merely to be “satisfied”; the taxpayer must have paid the liability for it to be included in the cost of goods sold. We will therefore assume that by “satisfied,” Exxon means “paid.”

2. A credit that is allowed “against the tax imposed” reduces the tax liability by the amount of the credit

Like Sunoco's arguments to the Federal Circuit, Exxon's arguments to this Court turn on the fatally flawed premise that “[t]he alcohol [fuel mixture] credit satisfies [i.e., pays] a fuel blender's excise-tax liability; it does not alter the amount of liability imposed.” (Br. 5 (emphasis added).) That is wrong, as the Federal Circuit correctly held in Sunoco: “Section 6426(a)(1) explicitly provides that the 'credit,' i.e., the Mixture Credit, is applied 'against' the gasoline excise tax imposed under § 4081. In other words, the Mixture Credit works to reduce the taxpayer's overall excise-tax liability. . . . [It] is a credit, not a payment.” Sunoco, 908 F.3d at 716-17.

In rejecting the argument that the credit is instead “a 'payment' of [the taxpayer's] § 4081 excise-tax liability,” the Federal Circuit explained that the AJCA “treats 'credits' differently from 'payments,' as evidenced by the language in § 6427(e)(1), which grants payment to a taxpayer in the same amounts as the Mixture Credit, to the extent the taxpayer's excise-tax liability is zero.” Id. at 716. That limitation on the payment exists, the court added, because § 6427(e)(3) states: “'No amount shall be payable under paragraph (1) . . . with respect to which an amount is allowed as a credit under section 6426.'” Sunoco, 908 F.3d at 716. “The plain language of § 6427(e)(3) therefore distinguishes the § 6426 'credit' from the 'payment' allowable under § 6427(e)(1).” Id.

This understanding of the credit as reducing, rather than paying, the excise-tax liability is consistent with the settled principle that taxpayers may deduct from gross income, or include in their cost of goods sold, only an expense for which they bore the economic burden. If (for example) a taxpayer receives a “price rebate” on goods that it purchased for resale, it cannot treat as an expense the original unreduced price for such goods, but must instead treat the rebate “as a reduction in the cost of the goods sold.” Affiliated Foods, Inc. v. Commissioner, 128 T.C. 62, 80 (2007); see Rev. Rul. 84-41, 1984-1 C.B. 130; Rev. Rul. 85-30, 1985-1 C.B. 20.

That a tax credit is refundable to the extent it exceeds the taxpayer's tax liability — that is, that any part of the credit that exceeds the tax liability may be received as a payment — does not change the fundamental principle that tax credits that reduce tax liability produce a corresponding reduction in the amount of the taxpayer's allowable deduction. For example, in Revenue Ruling 79-315, 1979-2 C.B. 27, the IRS determined that the portion of a tax rebate that was used to “reduc[e]” a tax liability was not “deductible under section 164(a)(3),” even if part of the rebate was paid to the taxpayer. See also Maines v. Commissioner, 144 T.C. 123, 135-36 (2015) (portion of refundable credit that reduced taxpayer's state-tax liability was not taxable income because it merely “reduce[d]” state-tax liability); Hart Furniture Co. v. Commissioner, 12 T.C. 1103, 1107-08 (1949) (federal tax credit “allowed against” a federal excise tax reduced taxpayer's deductible tax expense; taxpayer had “no actual or apparent liability” for the unreduced amount), rev'd on other grounds by joint stipulation, 188 F.2d 968 (5th Cir. 1950) (per curiam).

3. The plain language of § 6426 shows that its excise-tax credit reduces the amount of § 4081 excise-tax liabilities

As the Federal Circuit held in Sunoco, the “plain meaning of the statute is clear — the [§ 6426] Mixture Credit is a credit, not a payment, which must first be used to decrease a taxpayer's gasoline excise-tax liability.” 908 F.3d at 717. Section 6426(a)(1) is most naturally read as providing that the excise-tax credit is part of the calculation of a taxpayer's § 4081 excise-tax liability and, as such, reduces the amount of that liability. For the years at issue here, § 6426(a)(1) provided that “[t]here shall be allowed as a credit . . . against the tax imposed by section 4081 an amount equal to the sum of the credits” described in §6426(b), (c), and (e), including (as relevant here) the “alcohol fuel mixture credit.” When a statutory credit is allowed “against” a tax, the “commonly accepted definition” is that the credit “is allowable as a subtraction from tax liability for purposes of computing the tax due.” Maule & Van Loo, Principles of Income Tax Credits, Tax Mgmt. Portfolios No. 506 at 15 (2019). Under that approach, a “[c]redit is a direct reduction of tax liability.” Id. at 11; accord Sunoco, 908 F.3d at 716 (citations omitted).

Nothing in § 6426 or § 4081 suggests that Congress intended to deviate from that common understanding of the phrase “credit . . . against the tax imposed.” Accordingly, the plain meaning of § 6426 is that the excise-tax credit reduces a taxpayer's excise-tax liability — just as a rebate reduces the effective price of an item purchased for resale — and thus reduces the taxpayer's “cost of [the] goods sold” that were subject to excise tax.

That interpretation coheres with the ordinary meaning of “tax credit.” Because the Internal Revenue Code does not define that term, courts should look to its ordinary meaning in this context. See Taniguchi v. Kan Pac. Saipan, Ltd., 566 U.S. 560, 566 (2012). The ordinary meaning of a “tax credit” is “[a]n amount subtracted directly from one's total tax liability, dollar for dollar, as opposed to a deduction from gross income.” Black's Law Dictionary 1501 (8th ed. 2004); Black's Law Dictionary (11th ed. 2019). Applying that definition here, the §6426 mixture credit is “subtracted directly from” the § 4081 excise-tax liability, “dollar for dollar,” thereby reducing the taxpayer's § 4081 excise-tax liability. Id.

Exxon's reliance (Br. 51-52) on § 9503(b) is misplaced. If, as Exxon contends, mixture credits do not reduce the amount of excise-tax liability, then “there would be no reason to explicitly state that the amount to be deposited in to the Highway Trust Fund 'shall be determined without reduction for credits under section 6426.'” Sunoco, 908 F.3d at 717 (quoting I.R.C. § 9503(b)(1)).

4. Statutory and administrative language concerning different contexts does not render the mixture credit a payment

To bolster its argument that the mixture credit is a payment (not a reduction) of the § 4081 excise-tax liability, Exxon erroneously equates (Br. 46, 48) the §6426 mixture credit with credits provided in other statutory contexts, such as paycheck withholding. Under I.R.C. §31(a)(1), the “amount withheld as tax” from wage income is “allowed to the recipient of the income as a credit against the [income] tax imposed by this subtitle.” Exxon argues that § 31(a)(1)'s use of the phrase “credit against” supports its interpretation of that same phrase in § 6426 because “withholding satisfies, but does not reduce, that amount of an employee's income tax liability.” (Br. 46.)

But the statutory context is completely different. Exxon ignores I.R.C. § 6211(b)(1), which expressly requires that income tax be computed “without regard to the credit under section § 31.” Like estimated tax payments, which are likewise excluded from the computation under § 6211(b)(1), the § 31 credit for wage withholding is just an expedient way for individuals to prepay their own income-tax liabilities. Given § 6211(b)(1)'s express exclusion of § 31 credits from the income tax computation, Congress's omission of any similar provision excluding mixture credits from the computation of a taxpayer's excise-tax liability strongly suggests that Congress intended to include mixture credits in the computation, thereby reducing the liability. See State Farm Fire & Cas. Co. v. United States ex rel. Rigsby, 137 S. Ct. 436, 442 (2016) (“Congress' use of explicit language in one provision cautions against inferring the same limitation in another provision”) (cleaned up).

Exxon also points (Br. 48) to I.R.C. §§ 45H and 280C(d), but the Federal Circuit correctly rejected that comparison in Sunoco, 908 F.3d at 717. Section 280C(d) provides that “deductions otherwise allowed . . . shall be reduced by the amount of the credit determined . . . under section 45H(a).” That provision was necessary because the § 45H credit, unlike the § 6426 credit, does not by itself reduce the amount of a deductible liability. Section 45H provides an income-tax credit, not an excise-tax credit, see I.R.C. §§ 45H(a), 38, and federal income taxes, unlike excise taxes, are not deductible, I.R.C. § 275(a)(1). By enacting §280C(d), Congress prevented taxpayers from effectively receiving “a double benefit” from the § 45H credit. Sunoco, 908 F.3d at 717. There was no need to enact a similar provision with respect to the § 6426 mixture credit because that credit does apply against a deductible liability — i.e., the § 4081 excise tax liability. There is no double benefit with § 6426 because by reducing the amount of excise tax owed, mixture credits also reduce the amount of excise tax that can be deducted.

Exxon also argues that the excise-tax form itself (Form 720) treats the mixture credit “as satisfying the '[t]otal tax,' just like a payment of estimated tax, rather than altering the amount of that tax.” (Br. 53-54.) But tax forms “cannot affect the operation of the tax statutes.” Weiss v. Commissioner, 129 T.C. 175, 177 (2007). While Form 720 does use the term “Total tax” to label Part III, line 3, that sum is merely an interim computation prior to the application of the “Claims” reflected in Part III, line 4, which include mixture credits. IRS Form 720, Part III; id., Schedule C, lines 12, 13. To compute the taxpayer's actual excise-tax liability, one must subtract Part III, line 4 (Claims), from Part III, line 3 (Total tax). Thus, Form 720 is fully consistent with the statutory language establishing that the mixture credit reduces the tax liability.

C. Sections 6426 and 6427(e) do not allow producers to “choose” between a mixture credit or a payment

Exxon argues (Br. 5, 49-50) that the AJCA treats the mixture credit as a payment because “the AJCA gives fuel blenders a choice between the credit or cash” — i.e., to claim the mixture credit as a credit under § 6426 against the § 4081 excise tax or as a cash payment under §6427(e). But that is not so. As the Federal Circuit recognized, the “plain meaning of the statute” is that mixture credits “must first be used to decrease a taxpayer's gasoline excise-tax liability before receiving any payment under § 6427(e).” Sunoco, 908 F.3d at 717. Section 6427(e) unambiguously provides that the Secretary “shall pay . . . an amount equal to the alcohol fuel mixture credit” to the extent that amount exceeds the amount that “is allowed as a credit under section 6426.” I.R.C. §§ 6427(e)(1), (3); see also Joint Committee on Taxation, Tax Expenditures for Energy Production & Conservation, JCX-25-09R, at 24 (2009) (“alcohol fuel mixture credit must first be taken to reduce excise tax liability for gasoline” and “[a]ny excess credit may be taken as a payment or income tax credit”); Notice 2015-56, 2015-35 I.R.B. 235; Notice 2016-05, § 2, 2016-6 I.R.B. 302.

Thus, the cash payment under § 6427(e) is available only to the extent that a taxpayer's § 6426 mixture credits exceed its § 4081 excise-tax liabilities.⁵ Sunoco, 908 F.3d at 716-18. “If Congress intended the credit against excise tax under Section 6426(a) and the payment of any excess under Section 6427(e) to both be treated as payments, it could have provided as much without the need for the distinctions provided.” Delek US Holdings, Inc. v. United States, 515 F. Supp. 3d 812, 818 (M.D. Tenn. 2021), appeal pending, No. 21-5257 (6th Cir.).

Exxon's argument that fuel producers may choose between a credit and a payment rests on Congress's use of the term “allowed” (as opposed to “allowable”) in § 6427(e). (Br. 49-50.) But Exxon ignores the fact that both § 6427(e) and § 6426 use the term “allowed.” The term must mean the same thing in both places. If Exxon is correct that “allowed” means the “credits actually taken” by the taxpayer (Br. 49), then § 6426's mandate that mixture credits “shall be allowed . . . against the tax imposed by section 4081” must mean that the credits shall “actually [be] taken” by the taxpayer against its § 4081 excise-tax liabilities.

Read either way, § 6427(e) serves only one function: to provide a cash payment for any mixture credit exceeding the taxpayer's § 4081 liabilities. There is no option or choice. The statute is clear: fuel producers who elect to claim mixture credits must first use them to reduce their § 4081 excise-tax liabilities, before claiming a cash payment under § 6427(e) in the amount of any excess credits. Exxon's argument that the different treatment of § 6426 credits and § 6427(e) cash payments leads to an “absurd” result (Br. 20, 50) rests on its erroneous premise that producers have a choice to take a credit or cash.

II. The district court correctly found that Exxon's foreign oil and gas transactions were leases, not sales, because Qatar and Petronas retained economic interests in the oil and gas

Standard of review

The district court's findings of fact are reviewed for clear error, and its conclusions of law are reviewed de novo. Guzman v. Hacienda Recs. & Recording Studio, Inc., 808 F.3d 1031, 1036 (5th Cir. 2015). The determination that a transferor of mineral rights retained an economic interest in the minerals in place (and that the transaction was therefore a lease for tax purposes) is a finding of fact. See Vest v. Commissioner, 481 F.2d 238, 242 (1973).

This Court may affirm the district court's judgment on any grounds supported by the record. E.g., U.S. ex rel. Doe v. Dow Chem. Co., 343 F.3d 325, 330 (5th Cir. 2003).

A. Exxon misconstrues the “economic interest” test

According to Exxon, the Supreme Court and this Court have prescribed a “bright-line rule” that “a transferor's right to any non-extraction source of income means that a transfer is a sale, not a mineral lease.” (Br. 27.) Exxon contends that under this rule, even if the transferor retained an economic interest in the minerals-in-place, “the right to income derived from sources besides extraction destroys the transferor's economic interest.” (Br. 36.) Exxon's position that its transactions with Qatar and Petronas must be treated as sales for tax purposes hinges on the existence of this purported “bright-line rule.” 

But Exxon is wrong. There is no such rule. Neither the Supreme Court nor this Court has ever denied lease treatment to a mineral transaction — or otherwise held that the transferor failed to retain an “economic interest” in the minerals in place — merely because the transferor had a right to a non-extraction source of income.⁶

To the contrary, both Courts have held in multiple cases that transferors did retain the requisite economic interest where they also had rights to income that was not derived from extraction, beginning with the Supreme Court's seminal “economic interest” decision in Palmer v. Bender, 287 U.S. 551 (1933). There, the transferors not only had rights to the extraction-based royalties by which they “retained . . . an economic interest in the oil, in place, identical with that of a lessor,” id. at 558, but they also had rights to upfront cash payments irrespective of extraction, id. at 553-54. And so did the transferors in Thomas v. Perkins, 301 U.S. 655, 657 (1937), Kirby Petroleum Co. v. Commissioner, 326 U.S. 599, 601 (1946), and Albritton v. Commissioner, 248 F.2d 49, 50 n.5 (5th Cir. 1957).⁷ The transferor in Albritton also had a right to periodic payments of a minimum amount ($200/month) regardless of extraction, id., as did the transferors in Wood v. United States, 377 F.2d 300, 302 n.3 (5th Cir. 1967) ($15,000/year), and Rutledge v. United States, 428 F.2d 347, 348-49 & n.3 (5th Cir. 1970) ($416.66/month). The transferor in Gray v. Commissioner, 183 F.2d 329, 330 (5th Cir. 1950), had a right to a 20-percent interest in any gas-processing plant that the transferee elected to construct.

If Exxon were correct that “a transferor's right to any non-extraction source of income” (Br. 27) somehow “destroys” (Br. 36) the transferor's retention of an economic interest in the minerals (and thus transforms a lease into a sale), then all of these cases were wrongly decided. In all of them, the transferors were held to have retained an economic interest in the minerals in place by virtue of their rights to extraction-based income (such as royalties or “production payments”), notwithstanding their additional rights to non-extraction income.

Thus, the rule proposed by Exxon — that any right to non-extraction income “destroys” an otherwise-valid economic interest — cannot be and is not the law. And without the foundational premise that there is such a rule, Exxon's arguments for treating the transactions as sales crumble because there is otherwise no dispute that Qatar and Petronas retained economic interests in the oil and gas. See infra pp. 41-43. Accordingly, the district court's findings that Qatar and Petronas retained economic interests in the oil and gas in place, and that the transactions are therefore leases for tax purposes, should be affirmed.

It is telling that Exxon only recently discovered the purported rule on which it now relies. For decades, Exxon itself treated the transactions as leases for tax purposes and only reversed course when it concluded that treating them as sales would save it over $1 billion in taxes. That does not square with Exxon's argument that sale treatment is compelled by a “bright-line rule” that was supposedly established more than 80 years ago in Anderson v. Helvering, 310 U.S. 404 (1940), and followed by this Court 50 years ago in Christie v. United States, 436 F.2d 1216 (5th Cir. 1971).

There are, to be sure, broadly worded dicta in Christie and other cases that, if read in isolation and without regard for what the courts actually held in those cases, might appear to support the rule proposed by Exxon. See infra pp. 48-51. But neither the Supreme Court nor this Court has ever adopted, much less applied such a rule. To the contrary, a decision here that Qatar and Petronas's economic interests were somehow “destroyed” by the other rights they bargained for — and that their transactions with Exxon were therefore sales for tax purposes — would upend long-settled principles and contravene this Court's binding precedent. See infra pp. 43-48, 51-65.

1. Exxon does not dispute that Qatar and Petronas retained rights to share in the oil and gas produced

The parties agree, and it is “well established,” that a “transaction constitutes a mineral lease and not a sale if the landowner retains an 'economic interest' in the minerals subject to the agreement.” Whitehead v. United States, 555 F.2d 1290, 1292 (5th Cir. 1977). Since the Supreme Court's decision in Palmer almost 90 years ago, the economic-interest test has asked whether the transferor “has acquired, by investment, any interest in the oil in place, and secure[d], by any form of legal relationship, income derived from the extraction of the oil, to which he must look for a return of his capital.” Palmer, 287 U.S. at 557; accord Treas. Reg. § 1.611-1(b)(1).

And for just as long, one rule has been settled: “It is enough if, by virtue of the leasing transaction, [the transferor] has retained a right to share in the oil produced. If so he has an economic interest in the oil, in place. . . .” Palmer, 287 U.S. at 557; see Parsons v. Smith, 359 U.S. 215, 221 & n.7 (1959) (quoting this language as one of “[t]he principles declared in the Palmer case [that] have been recognized and applied by every subsequent decision of this Court that has treated with the subject”). Thus, for example, “[t]he holder of a royalty interest — that is, a right to receive a specified percentage of all oil and gas produced during the term of the lease — is deemed to have 'an economic interest' in the oil in place.” Anderson, 310 U.S. at 409 (citations omitted).

Here, Exxon does not and cannot dispute that Qatar and Petronas, by virtue of their agreements with Exxon, both retained rights to share in the oil and gas produced thereunder. Each of the agreements gives Qatar or Petronas at least one right to a payment or share of oil and gas that is dependent entirely on the production of oil or gas: if there is extraction, it is owed; if there is no extraction, it is not. (See, e.g., ROA.6449, 6452, 47620, 47651-47653, 48570, 48616-48629.) Indeed, Exxon's own expert and summary witnesses both testified that under the agreements, Qatar and Petronas have each received billions of dollars in cash payments or in-kind oil and gas, which they would not have received but for Exxon's extraction of oil and gas. (ROA.6688-6690, 6815-6816, 6833-6835.)

Thus, there can be no serious argument that Qatar and Petronas did not retain economic interests in the oil and gas. Indeed, Exxon appears to concede as much, arguing instead that Qatar and Petronas have rights to non-extraction income “which destroy[ ] their economic interests.” (Br. 36.) But that argument is meritless because it rests on a “rule” that does not exist, as we explain more fully below.

2. Exxon's argument that other rights Qatar and Petronas bargained for somehow “destroy” their economic interests in the oil and gas rests on a misreading of Anderson

Among the myriad cases cited by Exxon, not a single one holds that an otherwise-valid economic interest must, or even can, be disregarded if the transferor also has separate, additional rights to income from non-extraction sources. In none of them did the courts even articulate such a rule, much less hold that a transferor lacked an economic interest on that basis. The “rule” on which Exxon's entire argument rests does not exist.

a. Exxon contends that the purported rule was established by the Supreme Court in Anderson and applied by this Court in Christie, but that is not so. Although the transferors in both of those cases were held to lack an economic interest, it was not because of any rule that a transferor cannot have an economic interest in the minerals if it also has rights to non-extraction income. Again, multiple Supreme Court and Fifth Circuit decisions, both before and after Anderson, have held that transferors retained an economic interest in that very circumstance. See supra pp. 38-39.

The rule actually established in Anderson and applied in Christie is much narrower: a transferor's reservation of a right to deferred payments is an economic interest only if “the reserved payments are to be derived solely from the production of oil and gas.” Anderson, 310 U.S. at 413 (emphasis added). Or as the rule is restated in the depletion regulations: “A right to mineral in place which can be required to be satisfied by other than the production of mineral from the burdened mineral property is not an economic interest in mineral in place.” Treas. Reg. § 1.636-3(a)(1) (emphasis added). Thus, the transferor in Anderson lacked an economic interest because it had no right to deferred payments that was “dependent entirely upon the production of oil”; the only deferred payments to which it was entitled could also “be derived from sales of the fee title to the land.” Anderson, 310 U.S. at 412; accord Kirby Petroleum, 326 U.S. at 605-06. Likewise, the right to deferred payments in Christie was not an economic interest because the payments could be derived not only from oil production, but also from the proceeds of salvaging certain equipment. Christie, 436 F.2d at 1218, 1220-21.

Nowhere in Anderson did the Court hold, as Exxon claims (Br. 24), “that a transferor lacks an economic interest if it has a right to receive non-extraction income, even if it also has income that is derived from extraction.” Indeed, the Court was utterly unconcerned that the transferor was entitled to $50,000 in cash regardless of any extraction or any sale of the land. Anderson, 310 U.S. at 405. Rather, the deciding factor was that none of the transferor's rights — including its right to additional, deferred payments totaling $110,000 — was linked inextricably to the extraction of oil. Although the deferred payments could be derived from extraction, they could also be derived from sales of the land. Because of “the reservation of this additional type of security for the deferred payments,” the transferor was “not dependent entirely upon the production of oil for the deferred payments.” Id. at 412 (emphasis added).

Anderson's reference to situations in which “the reserved payments are to be derived solely from the production of oil and gas,” 310 U.S. at 413 (emphasis added), thus plainly refers to situations in which at least one payment obligation comes solely from oil and gas revenue — which would then be an indication that that obligation represented a return on investment. Cf. Kirby Petroleum, 326 U.S. at 604 (“Economic interest does not mean title to the oil in place but the possibility of profit from that economic interest dependent solely upon the extraction and sale of the oil.” (emphasis added)).

That is precisely the case here: Exxon has payment obligations to Qatar and Petronas that depend “solely” on oil and gas production; if production is zero, the obligation is zero. Unlike in Anderson and Christie, there is no “reservation of [an] additional type of security” — unconnected to production — for those payment obligations. Anderson, 310 U.S. at 412. As a result, Qatar and Petronas's rights to those purely production-derived payments are economic interests in the oil and gas in place, compelling the conclusion that the transactions were leases for tax purposes.

That Exxon also has additional and separate obligations to Qatar and Petronas based on something other than oil and gas production is immaterial. If that were not so, then Anderson would have been decided on the much simpler ground that the transferor was entitled to $50,000 in cash regardless of extraction, id. at 405, and many of the Supreme Court and Fifth Circuit cases holding that transferors did retain economic interests would have come out the other way, see supra ap. 38-39. Moreover, as the district court observed (ROA.5184), Exxon's separate obligations easily could have been placed in a separate agreement, which further distinguishes them from the terms that precluded economic interests in Anderson and Christie by providing alternative sources for the deferred payments. The tax treatment of oil and gas payments should not turn on the mere formality or happenstance that severable provisions establishing additional, separate rights were placed in the same agreement as provisions establishing a right to payments derived solely from extraction.

In sum, Qatar and Petronas have economic interests in the oil and gas in place because unlike the transferors in Anderson and Christie, Qatar and Petronas “reserved [rights to] payments [that] are to be derived solely from the production of oil and gas.” Anderson, 310 U.S. at 413. The economic-interest test requires nothing more. As the district court rightly concluded, Exxon's argument to the contrary “tries to load 'solely' with more freight than it can bear by arguing for an extension of Anderson beyond the facts before the Supreme Court in that case.” (ROA.5176.)

b. As Exxon points out (Br. 25), there is dicta in Commissioner v. Southwest Exploration Co., 350 U.S. 308 (1956), suggesting that a transferor “must look solely to the extraction of oil or gas for a return of his capital” in order to have an economic interest. Id. at 314 (second emphasis added); see also Christie, 436 F.2d at 1218 (quoting this language from Southwest). Exxon apparently assumes that every item of compensation received by a transferor, including income that is not derived from extraction, is necessarily “a return of [the transferor's] capital.” And if that were so, then the language of the Southwest dictum would be broader than the rule applied in Anderson — i.e., that the transferor must have a right to payments that look solely to the extraction of oil or gas.

But the Supreme Court appears not to share Exxon's assumption; its cases indicate that the relevant capital investment is the transferor's retention of an economic interest itself. See, e.g., Kirby Petroleum, 326 U.S. at 603 (“Under the leases and our previous decisions, these taxpayers had an economic interest, a capital investment, in so much of the extracted oil as was used by the lessee to pay to the taxpayers the royalties and bonuses.”); id. at 606 (issue is “whether the transferor has made an absolute sale or has retained an economic interest — a capital investment”). Southwest illustrates this perfectly because the transferors there had made no other investment in the oil. Having no rights to oil in place, they instead transferred rights to use their land for slant-drilling into adjacent offshore oil deposits owned by the state of California in exchange for a share of the net profits from production. Southwest, 350 U.S. at 315-16. In holding that this gave the transferors an economic interest in the oil in place, the Court explained:

The owners might have realized th[e] value [of their land] by selling their interest for a stated sum. . . . But instead they chose to contribute the use of their land in return for rental based on a share of net profits. This contribution was an investment in the oil in place sufficient to establish their economic interest. Their income [from that investment] was dependent entirely on production, and the value of their interest decreased with each barrel of oil produced. No more is required. . . .

Id. at 316 (emphasis added).

In this light, any non-extraction income that a transferor receives is not “a return of his capital,” id. at 314, because the transferor's capital investment is the transfer of rights in exchange for payments derived solely from extraction — i.e., the retention of an economic interest in the minerals in place. Only if the transferor retained no economic interest — and thus made no capital investment — is the transaction a sale. And with this understanding of the relevant capital investment, the dictum in Southwest that a transferor “must look solely to the extraction of oil or gas for a return of his capital,” id., is just another way of saying that the transferor must have a right to payments derived solely from extraction — i.e., the rule of Anderson.

In any event, even if the language of the Southwest dictum is, in fact, broader than the rule of Anderson, it is clear when read in context that the dictum was not intended to change the existing rule. The Court recognized in the very same sentence that the dispositive fact in Anderson was that the “payments might have been made from a sale of any part of the fee interest as well as from production.” Southwest, 350 U.S. at 314. So the dictum suggesting that a transferor “must look solely to the extraction of oil or gas for a return of his capital,” id., is at most merely an imprecise summary of the rule of Anderson, as part of a general discussion of the economic-interest test, in a case where greater precision was unnecessary because the issue was not in dispute.

3. This Court has consistently rejected arguments like Exxon's

Although this Court has occasionally quoted the Southwest dictum or used similarly broad-sounding language when describing the economic-interest test, it has consistently declined to hold that rights to non-extraction income precluded economic interests outside of the Anderson/Christie fact pattern. Indeed, when confronted with arguments that separate rights to additional income not derived from extraction somehow negated a transferor's rights to income derived solely from extraction, this Court has rejected them every time.

As only the latest taxpayer to try such an argument, Exxon points to Qatar and Petronas's rights to: certain facilities at the end of the agreements; payments based on the value of marketable petroleum products; breach-of-contract damages; and (in the case of Petronas) certain “abandonment cess” payments. (Br. 35-41.) Those rights are immaterial because the undisputed fact remains that Qatar and Petronas also have rights to payments that are “dependent entirely on the production of oil.” Anderson, 310 U.S. at 412. No authority supports Exxon's premise that such economic interests can be destroyed by other rights that a transferor bargained for, and this Court's binding precedent confirms that the rights cited by Exxon are no exception.

1. It is true that after the agreements end, Qatar and Petronas are to retain certain processing and other facilities. (See, e.g., ROA.6443, 48656.) But it is equally true that their rights to those facilities are completely separate from their additional rights to payments that are dependent solely on extraction. Because Qatar and Petronas retained economic interests in the oil and gas by virtue of the latter rights, the former rights are irrelevant.

This Court rejected the argument that a right to gas-processing facilities precludes an economic interest in Gray, 183 F.2d at 331. There, the transferor bargained not only for “an overriding royalty in the oil and a twenty per cent interest in the net profits from the sale of gas and gas products,” but also “a contingent interest [of 20 percent] in any [gas] processing [and cycling] plant constructed” by the transferee. Id. This Court held that it was “patent” that the transferor's retention of those rights “manifestly resulted in the reservation of an 'economic interest' in the oil and gas in place.” Id.

Like Exxon, the taxpayer in Gray relied on Anderson in arguing to the contrary. And like the district court here (ROA.5175-5176), this Court held in Gray that Anderson was “readily distinguishable under [its] own facts, and in no wise applicable or controlling.” 183 F.2d at 331. The circumstance that was dispositive in Anderson — i.e., the transferor's lack of any right to payments that depended solely on extraction — was not present in Gray, just as it is not present here, because the transferor in Gray, just like Qatar and Petronas, retained completely separate rights to payments that were solely dependent on extraction.

Exxon cites Christie (Br. 37), but as we have shown, supra pp. 43-45, that case did involve the circumstance that was dispositive in Anderson. Christie does not hold, as Exxon claims, “that even the salvage value of equipment destroys an economic interest.” (Br. 37.) Rather, there was no economic interest in Christie for the same reason as in Anderson: there was no right to payments dependent solely on extraction. The only right to payments that could be satisfied from extraction could also be satisfied in Christie from salvaging certain equipment, just as it could also be satisfied in Anderson from land sales.

Here, as in Gray, the transferors' rights to facilities are separate from and in addition to their rights to payments that are dependent solely on extraction. Accordingly, Gray compels the conclusion that Qatar and Petronas's residual interests in facilities are irrelevant to the economic interests they retained.

2. When Exxon says that Qatar and Petronas “have the right to income from post-extraction activities,” it is referring to the fact that the amounts of the cash royalties (or in-kind oil and gas) that they receive are tied to the value of marketable petroleum products — which require processing, transportation, etc. — instead of “raw, unprocessed” oil and gas. (Br. 37-39.) But “[u]nder the economic interest test, the critical consideration is whether payment is dependent upon extraction, not the method by which that payment is calculated.” Wood, 377 F.2d at 306. There is no question here that Qatar and Petronas both have rights to payments that are dependent on extraction; if there is no extraction, then there is no payment.

The fact that the amount of the payments may be indexed to market or sales prices or may otherwise reflect value that was added after extraction is immaterial. Wood, 377 F.2d at 306. Lease payments may take many forms; there is no requirement that they must be calculated based only on the value of the raw minerals. See, e.g., Kirby Petroleum, 326 U.S. at 604 (“The lessors' economic interest in the oil is no less when their right is to share [the lessees'] net profit” than when it is to share “the gross receipts from the sale of the oil extracted by the lessees. . . . In both situations the lessors' possibility of return depends upon oil extraction and ends with the exhaustion of the supply.”). This Court has consistently upheld economic interests where extraction-based payments were calculated on the basis of something other than the value of the raw minerals. See Vest, 481 F.2d at 244-45 (percentage of proceeds from sales of “purchase price water,” which “included but was not limited to water actually extracted from wells situated on the [transferor's] property”); Estate of Weinert v. Commissioner, 294 F.2d 750, 754, 764-65 (5th Cir. 1961) (net profits from half interests in leases and a gas “cycling” plant); Albritton, 248 F.2d at 51 (royalty based on “retail value”); Gray, 183 F.2d at 331 (“twenty per cent interest in the net profits from the sale of gas and gas products”).

Weinert is particularly instructive. In rejecting an argument that a right to income that reflects value added by post-extraction processes “destroyed” an economic interest, this Court reasoned:

It seems unreasonable to say that merely because [Lehman] receives the cycling plant income rights . . . in addition to mineral production (leasehold) rights, and merely because one of the [cycling plant] processes included fractionation [(“a refining or manufacturing activity”)], that the entire character of the leasehold rights as an economic interest is destroyed. The arrangement here was predominantly concerned with mineral production and recoupment was recoverable solely from extraction and sale of the minerals. . . . If Lehman had no economic interest in the production, no one had.

Processing plants . . . are as indispensable to the production of gas as the upland drilling sites were indispensable to the production of oil in [Southwest]. To hold that Lehman did not possess an economic interest would be tantamount to holding that the owner of a working interest or any lease owner would lose his right to depletion whenever a cycling plant is needed to process gas. The Law may be a jealous mistress; it is not a fussy old maid.

Weinert, 294 F.2d at 764-65.

Weinert thus stands in stark opposition to the purported “rule” that Exxon derives from its misreading of Anderson. Indeed, Exxon's response to Weinert in the proceedings below was to assert that Weinert “ignored the Supreme Court's mandate in Anderson.” (ROA.63450.) In fact, this Court expressly distinguished Anderson in Weinert, 294 F.2d at 763, 765. But Exxon was right that its interpretation of Anderson and this Court's decision in Weinert cannot both be correct.

As Exxon points out (Br. 39), the Court in Weinert concluded that in the circumstances presented, the revenues from the processing plant “should be apportioned to reflect the amount solely attributable to production” — i.e., to exclude the amount attributable to “fractionation.” Weinert, 294 F.2d at 765. But this Court squarely rejected the argument that the occurrence of fractionation prior to sale of the gas “destroyed” Lehman's economic interest. Id. at 764-65. And Exxon has never asked for any similar apportionment, nor has it challenged the district court's holding (ROA.5184-5185) that no such apportionment is necessary here.

3. Exxon's argument that Qatar and Petronas cannot have economic interests in the oil and gas because they also have rights to damages for breach (Br. 40-41) is silly. Damages are the default remedy for practically every breach of contract. If an economic interest cannot exist unless the transferor has no right to damages in the event of breach, then the economic-interest standard is meaningless.

Citing no authority or evidence, Exxon asserts that “[i]n a typical mineral lease, the transferee is not liable for damages for failure to explore or develop the minerals because it has the option — not the obligation — to do so.” (Br. 40.) But this Court recognized in Wood that, at least in Exxon's home state of Texas (ROA.54, 4822), a “typical” oil and gas lease “gives rise to an implied covenant to produce.” 377 F.2d at 307 n.19 (citations omitted). Exxon's attempt to cast its own obligations to produce as somehow unusual is therefore unavailing.

4. Finally, Exxon's reliance (Br. 41) on Petronas's rights to “abandonment cess” payments, regardless of extraction, is equally misplaced. The district court's unchallenged finding that “[t]he size of the abandonment cess . . . is so small that . . . it is of de minimis importance” (ROA.5186) is reason alone to disregard those payments. In any event, Exxon does not and cannot dispute that they are entirely separate from the extraction-based payments to which Petronas is also entitled. Consequently, Petronas has an economic interest in the oil and gas in place regardless of the abandonment cess payments.

Although the Court has not previously had occasion to consider that specific type of payment, both this Court and the Supreme Court have held that transferors retained economic interests notwithstanding their separate and additional rights to cash payments that were not dependent on extraction. See supra pp. 38-39. And this Court has squarely rejected as “without merit” arguments that even a right to minimum guaranteed royalties defeats an economic interest. Rutledge, 428 F.2d at 351; Wood, 377 F.2d at 307. A guarantee that royalty payments will meet or exceed a specified amount, regardless of extraction, is much more like the alternative sources for the deferred payments in Anderson and Christie than Petronas's completely separate and additional rights to abandonment cess payments. Cf. Anderson, 310 U.S. at 412-13 (reservation of right to payments that can be derived not only from extraction, but also from sale of land, “is similar to the reservation in a lease of oil payment rights together with a personal guarantee by the lessee that such payments shall at all events equal the specified sum”).

B. Even if the Court were not constrained by binding precedent, the reversal of long-settled principles that Exxon seeks would still be unwarranted

The law in this area is settled; the relevant “economic interest” cases were all decided between forty and ninety years ago. And if the law were settled in the direction that Exxon claims, then Exxon would not be unable to cite even one case in which a court actually held that a “right to income derived from sources besides extraction destroy[ed] the transferor's economic interest.” (Br. 36.) Nor would Exxon itself have treated the transactions as leases for decades. Exxon's newly-discovered “rule” makes no sense, which is undoubtedly why this Court has consistently refused to apply such a rule.

Exxon offers no cogent reason why the law should disregard Qatar and Petronas's economic interests in the oil and gas just because they also bargained for additional rights. Claiming a need for predictability, Exxon points (Br. 24-25, 27-28) to the Supreme Court's justification that the rule of Anderson was adopted “[i]n the interests of a workable rule.” Anderson, 310 U.S. at 413. But as we have shown, the rule of Anderson is much narrower than Exxon claims. It is not that any right to income from non-extraction sources destroys an economic interest, but rather that an economic interest requires at least one right to payments that are dependent solely on extraction. See id. at 412-13.

That rule is no less predictable than the novel rule that Exxon asks the Court to adopt here, as evidenced by the dearth of recent litigation. And unlike Exxon's rule, it is narrowly tailored to resolve the “workability” problems that the Supreme Court was actually concerned about in Anderson — namely, the “difficulties to the allocation” of income and depletion “between transferor and transferee” that would arise if a right to payments that can be derived from extraction and from some other source were treated as an economic interest. 310 U.S. at 413.

Exxon frequently refers to the “risk of nonproduction” (e.g., Br. 22-24, 36-40), but it has not shown that there even was such a risk. Exxon is not some mid-century wildcatter drilling speculative oil wells in unproven territory. The fact that Exxon agreed to construct multi-billion-dollar facilities that have no value or purpose without production (and that will revert to Qatar and Petronas) casts serious doubt on the notion that there was any appreciable risk of nonproduction.

To the extent there was any such risk, however, Qatar and Petronas shared the risk by reserving rights to payments that were dependent solely on production. Instead of selling the oil and gas in place for a sum certain, they invested in it by “contribut[ing] the use of their land in return for rental based on a share of [production],” and “[t]heir income [from that investment] was dependent entirely on production.” Southwest, 350 U.S. at 316. Exxon argues that Qatar and Petronas's other rights somehow “mitigated the risk of nonproduction” (Br. 36), but that is not so. Their additional rights have no effect on their rights to payments that depend solely on production. And in any event, Exxon cites no authority supporting its suggestion that a transferor loses its economic interest merely by taking steps to mitigate the risk of nonproduction that it assumed.

Exxon also fails to acknowledge that adopting a broad rule that any right to non-extraction income destroys an economic interest would produce incongruous, if not absurd, results and have consequences that reach far beyond this case. First, disregarding economic interests every time the transferor also has a separate right to non-extraction income would cause transactions that clearly are not sales to be treated as sales anyway. As this Court held in Vest, “a sale results where an agreement purports to transfer within a prescribed time period all or a specific, predetermined quantity of minerals in place in exchange for a fixed consideration.” 481 F.2d at 243 (emphasis added); accord Whitehead, 555 F.2d at 1292; see also Gray, 183 F.2d at 331 (sale occurs only when transferor has “completely divested himself of any interest in the minerals to be recovered”). Under that definition, the transactions here are clearly not sales. Indeed, Exxon does not seriously dispute the district court's findings (ROA.5183, 5186) that the agreements “entitle [Exxon] to produce an undefined amount of gas over a fixed term, instead of conveying to [Exxon] all or a fixed amount of the minerals in place.” But if Exxon's misreading of Anderson were adopted as the rule, then non-sale transactions like these would be treated as sales nonetheless, not because of what the “buyer” acquired, but because of what the “sellers” received in exchange.

Second, as the district court correctly reasoned, adopting Exxon's proposed rule would “exalt[ ] form over substance” and enable parties to manipulate the tax consequences of their oil and gas agreements through trivial formalities by allowing, for example, “a penny of post-production revenue to transform a mineral lease into a sale.” (ROA.5177.) That would contravene “the cardinal principle of income taxation” that “[a] transaction's tax consequences depend on its substance, not its form.” Chemtech Royalty Assocs. v. United States (“Chemtech I”), 766 F.3d 453, 460 (5th Cir. 2014) (citation omitted).

Finally, the Court should bear in mind that the new rule that Exxon is asking it to adopt would be broadly applicable. The determination whether a transaction is a lease or a sale affects the tax consequences for both the transferor and the transferee. And extending the narrow rule of Anderson to preclude economic interests where there is any right to income from a source other than extraction could transform into sales untold numbers of oil and gas transactions that the parties and/or the IRS have been correctly treating as leases under existing precedent.

Moreover, Exxon is asking this Court to unsettle those expectations for reasons having nothing to with its transactions or the interests that were transferred thereunder, but rather with Exxon's desire to use expiring foreign tax credits that Exxon believes will ultimately entitle it to $1 billion in tax refunds. That is far from representative of a typical “economic interest” case. Indeed, it is telling that Exxon is advocating its broadly applicable rule only in a case involving international transactions with foreign counterparties that likely are not U.S. taxpayers and have no reason to care how transactions are characterized for U.S. tax purposes. (See, e.g., ROA.50634.) With more than $1 billion in taxes at stake, Exxon has a powerful incentive to be less than concerned about the implications beyond this case. See 5 Mertens Law of Federal Income Taxation §24:21 (“[W]hen the taxpayer is the party seeking recharacterization, both the [IRS] and the courts tend to closely examine the taxpayer's motives and the underlying transaction.”).

C. Consideration of the agreements' “predominant” character is unnecessary but, in any event, supports their characterization as leases

Exxon's assertions that the district court refused to apply the economic-interest test (Br. 15-16, 22) are baseless. The court correctly refused to apply Exxon's erroneous interpretation of the test as contrary to this Court's binding precedent, but the court discussed the economic-interest test and relevant cases at length (ROA.5167-5178), expressly found that Qatar and Petronas retained economic interests in the minerals (ROA.5183, 5185, 5186), and characterized the transactions as leases accordingly (ROA.5185, 5186).

In doing so, however, the district court also considered “a predominant or primary purpose test” that it inferred from this Court's decisions in Weinert, 294 F.2d at 765, and Vest, 481 F.2d at 245 n.15. (ROA.5171-5172, 5174-5178.) Though nowhere stated in either case, the district court inferred from Weinert that “when a project produces income from both production and refining, courts should use a predominance test in determining whether to characterize the transaction as a lease.” (ROA.5172.) This Court's passing mention of the “predominant[ ] concern[ ]” of the “arrangement” in Weinert, 294 F.2d at 765, and the “primary purpose” of the “transaction” in Vest, 481 F.2d at 245 n.15, does not mean, however, that the Court did not apply the economic-interest test. And the same is true of the district court's finding that the agreements here were “primarily” leases. (ROA.5183-5186.) As we have explained, a transferor has an economic interest in the minerals so long as it retained a right to income that is dependent solely on extraction, and the district court found that Qatar and Petronas did precisely that. The court's inquiry into whether the agreements were “predominantly concerned with mineral production,” Weinert, 294 F.2d at 765, was therefore unnecessary, but in any event correctly confirmed its findings that the agreements should be treated as leases for tax purposes.

Exxon argues that “the predominant purpose of the transactions” was “not the extraction of minerals,” but rather “the development of an export natural-gas market (in Qatar) or a domestic natural-gas market (in Malaysia).” (Br. 42.) Without extraction, however, there is nothing to sell. Exxon's suggestion that extraction of the gas was merely incidental to the development of a market for that gas turns the agreements on their heads.

III. The district court erred in holding that Exxon had a “reasonable basis” for its position that the transactions were sales

Standard of review

This Court reviews de novo the question whether, as a defense to penalties, a taxpayer had a “reasonable basis” for its tax position. Chemtech Royalty Assocs. v. United States (“Chemtech II”), 823 F.3d 282, 287 (5th Cir. 2016).

A. Section 6676 penalizes refund claims that are not supported by authority

The version of § 6676 that was in effect when Exxon filed its refund claims with the IRS imposed a penalty of 20 percent of the amount by which any administrative claim for refund of income tax exceeded the amount to which the taxpayer was entitled, “unless it is shown that the claim for such excessive amount has a reasonable basis.”⁸ I.R.C. § 6676(a) (2012). Although the statute does not define “reasonable basis,” that term is defined by regulation in connection with the “reasonable basis” defense to the § 6662 underpayment penalty. See I.R.C. § 6662(d)(2)(B)(ii). Under that definition, which the parties and the district court all looked to below (supra p. 15):

Reasonable basis is a relatively high standard of tax reporting, that is, significantly higher than not frivolous or not patently improper. The reasonable basis standard is not satisfied by a return position that is merely arguable or that is merely a colorable claim. If a return position is reasonably based on one or more of the authorities set forth in § 1.6662-4(d)(3)(iii) (taking into account the relevance and persuasiveness of the authorities, and subsequent developments), the return position will generally satisfy the reasonable basis standard. . . . 

Treas. Reg. § 1.6662-3(b)(3).

The eligible “authorities” that may establish a reasonable basis for the taxpayer's position include, among others, statutes, regulations, court cases, and a wide range of materials issued by the IRS. Treas. Reg. § 1.6662-4(d)(3)(iii). Eligible authorities that are materially distinguishable do not satisfy the reasonable basis standard. Chemtech II, 823 F.3d at 289-92; see Treas. Reg. § 1.6662-3(b)(3); TIFD III-E Inc. v. United States, 604 F. App'x 69, 70 (2d Cir. 2015) (reversing decision that taxpayer's position had a reasonable basis, where district court “relied on various inapposite authorities”).

B. The district court's stated rationale does not support its holding that Exxon established a reasonable basis for its position

On the merits of Exxon's position that its transactions with Qatar and Petronas should be treated as sales, the district court was unequivocal. Recognizing that Exxon's position turned on its reading of Anderson, the court rejected that reading without hesitation, concluding that “Anderson is factually different from this case” (ROA.5175), that Exxon's “construction of Anderson conflicts with subsequent — and binding — Fifth Circuit precedent” (ROA.5176) and “does not make sense” (ROA.5177), and that Exxon's argument “reflects a fundamental confusion between (a) what Qatar and Petronas provide to Exxon Mobil and (b) how the royalty is calculated” (ROA.5177). A position that relies on factually distinguishable authority, conflicts with binding precedent, does not make sense, and reflects fundamental confusion does not have a reasonable basis. See Treas. Reg. § 1.6662-3(b)(3); Chemtech II, 823 F.3d at 289-92; TIFD III-E, 604 F. App'x at 70.

But when the court turned to the § 6676 penalties, it declared “that Exxon Mobil's sale vs. mineral lease position was reasonably based on one or more of the authorities set forth in Treas. Reg. § 1.6662-4(d)(3)(iii).” (ROA.5764.) Which “authorities” those might be, however, is anyone's guess; the court identified none in its penalty opinion or its merits opinion. Instead, the court's single paragraph of analysis stated only that this was “an extremely complex case, both factually and legally,” and that the court's rejection of Exxon's position on the merits required “considerable analysis.” (ROA.5764.)

That is not enough to satisfy the reasonable-basis standard. Section 6676 penalties are tax penalties, and tax issues are often complicated, especially those in large-dollar tax cases involving foreign transactions. Complex facts, without more, do not establish a reasonable basis for a refund claim. This Court and others have upheld §6662 penalties in cases involving tax-shelter transactions much more complex than the transactions in this case. See Wells Fargo & Co. v. United States, 957 F.3d 840, 843 (8th Cir. 2020) (agreeing with district court's observation that transaction “was extraordinarily complicated — so complicated, in fact, that it almost defies comprehension by anyone (including a federal judge) who is not an expert in structured finance”); TIFD III-E, 604 F. App'x at 70 (upholding penalty where prior merits opinion, TIFD III-E Inc. v. United States, 666 F.3d 836, 838 (2d Cir. 2012), described the facts as “extraordinarily complex”); cf. NPR Invs. LLC v. United States, 740 F.3d 998, 1013-14 (5th Cir. 2014) (rejecting “substantial authority” defense to penalties in complex tax shelter case).

Nor does the need to engage in “considerable analysis” of case law establish a reasonable basis, where that analysis leads to only one obvious result. “The reasonable basis standard is not satisfied by a [tax] position that is merely arguable or that is merely a colorable claim.” Treas. Reg. § 1.6662-3(b)(3). That a taxpayer's arguments are difficult to untangle does not make them more than colorable. A complex claim, like a simple claim, has no reasonable basis if no identifiable authority supports it. That is precisely the situation here.

C. No authority supports Exxon's position that its lease agreements with Qatar and Petronas should be recharacterized as sales

As we have shown, supra pp. 36-59, Exxon's position turns on a purported “rule” that has no basis in the case law. Anderson did not establish a rule that a transferor's retention of any “right to income derived from sources besides extraction destroys the transferor's economic interest.” (Br. 36.) Rather, Anderson established (and this Court applied in Christie) a rule that to have an economic interest, the transferor must reserve a right to payments that, under the terms of the agreement, “are to be derived solely from the production of oil and gas.” Anderson, 310 U.S. at 413. That rule precluded economic interests in Anderson and Christie because the transferors there had no rights to payments that could not be derived from another source.

Because Qatar and Petronas, in contrast, do have rights to payments derived solely from production, the Anderson rule is satisfied here. Anderson and Christie are thus materially distinguishable on their facts and cannot provide a reasonable basis for Exxon's position. See Treas. Reg. § 1.6662-3(b)(3); Chemtech II, 823 F.3d at 289-92; TIFD III-E, 604 F. App'x at 70. Moreover, this Court has consistently declined every opportunity to extend the rule of Anderson beyond its facts. Indeed, if the rule proposed by Exxon were actually the law, then many of both this Court's and the Supreme Court's economic-interest cases were wrongly decided. See supra pp. 38-39.

The closest the case law comes to supporting Exxon's position is isolated statements in dicta that phrase the rule of Anderson in arguably broader terms, in cases where the distinction did not affect the outcome. A broadly worded dictum, taken out of context and read in a way that contravenes how binding authority has actually applied the rule that the dictum purports to summarize, is not a “reasonable basis” for a claim. See Treas. Reg. § 1.6662-3(b)(3) (determination whether position is “reasonably based” on authority must “tak[e] into account the relevance and persuasiveness of the authorities, and subsequent developments”). Like factual complexity or analytical difficulty, passing assertions in dicta might be sufficient to survive a challenge under Federal Rule of Civil Procedure 11. But the reasonable-basis standard requires more. See Treas. Reg. § 1.6662-3(b)(3) (standard is “significantly higher than not frivolous or not patently improper”).

Exxon's position fares no better with authorities other than case law. According to Exxon (Br. 26), the “IRS has enforced the [purported] rule in more than fifty administrative rulings.”⁹ But in the only three that Exxon actually cites (Br. 26-27), the IRS did no such thing. In two of them, the IRS correctly (and identically) stated the rule of Anderson: “In order to qualify as an economic interest in mineral in place, an interest must be payable solely from the production of mineral.” Priv. Ltr. Rul. 9728010, 1997 WL 381980 (July 11, 1997); Priv. Ltr. Rul. 9728038, 1997 WL 382008 (July 11, 1997). Accordingly, what mattered in both rulings was what was “payable with respect to the interest.” Id. (emphasis added.)

And in the other cited ruling, the IRS in dicta characterized Anderson and Christie imprecisely as “den[ying] economic interest treatment where there is a possibility of sharing in income not solely derived from extraction.” Tech. Adv. Mem. 199918002, 1999 WL 283075 (May 7, 1999). But that imprecise dictum did not affect the result in that ruling and is belied by Anderson and Christie themselves. Non-binding authorities that are inconsistent with “more apposite” circuit authority “fail[ ] to meet the . . . reasonable-basis standard.” Chemtech II, 823 F.3d at 291-92. And in any event, there was no possibility here of “sharing in income not solely derived from extraction”; the only shared income under the agreements was the income derived from Exxon's extraction of the oil and gas.

Because Exxon can show no reasonable basis for its position that the transactions should be recharacterized as sales, the district court's penalty decision should be reversed and remanded with instructions to enter judgment for the Government.

CONCLUSION

The judgment of the district court should be affirmed as to Exxon's claims for refunds of income taxes based on the mixture-credit/excise-tax issue and the lease/sale issue.¹⁰ But the judgment should be reversed as to Exxon's claims for refunds of the § 6676 penalties.

Respectfully submitted,

DAVID A. HUBBERT
Acting Assistant Attorney General

BRUCE R. ELLISEN (202) 514-2929
CLINT A. CARPENTER (202) 514-4346
Appellate.TaxCivil@usdoj.gov
Clint.A.Carpenter@usdoj.gov
Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

Of Counsel:

CHAD E. MEACHAM
Acting United States Attorney

NOVEMBER 12, 2021