Standard Oil Subsidiary Argues Interest Expenses Paid by Affiliates Are Allowable Deductions of Subsidiary

BP Exploration & Oil Inc., previously known as Sohio Petroleum Company, was a wholly owned subsidiary of The Standard Oil Company of Ohio, and was included in the consolidated federal income tax return for the affiliated group of corporations of which Standard Oil was the common parent. The company itself was engaged in the business of finding and producing crude oil and gas, and owned interests in properties that produced crude oil subject to the windfall profit tax (WPT). BP timely filed and paid its WPT for 1984 and 1985 and later timely filed claims for refund for those same periods. During the IRS's examination of BP's refund request, the company amended its claims, taking the position that an allocable portion of the net interest expense that was paid by its affiliates should be taken into account in determining net income limitation for WPT purposes.

BP subsequently filed a suit for refund in the U.S. Court of Federal Claims on the same grounds that it had raised with the IRS in its amended claims for refund. The Court of Federal Claims granted the government's motion for summary judgment motion and held that the interest expense paid or incurred by Standard Oil and its affiliates could not be taken into account in determining BP's WPT liability. (For a summary of that opinion, see Tax Notes, May 8, 2000, p. 780; for the full text, see Doc 2000-12245 (10 original pages) or 2000 TNT 85-5 .)

BP argues that under the section 4988 regs that control the determination of the net income limitation for WPT purposes and for income tax purposes, taxpayers must reduce gross income by all "allowable deductions." BP contends that these "allowable deductions" include interest expense, which may be deductible either under section 163 or under section 162 as an ordinary and necessary business expense. In this case, BP insists the interest in issue was paid by Standard Oil and other members of the affiliated group for the benefit of BP.

The company also contends that under Revenue Ruling 84-68, 1984- 1 C.B. 31, and Transamerica Corp. v. United States, 7 Cl. Ct. 119 (1984), when a parent corporation pays an expense for the benefit of its wholly-owned subsidiary, that payment is recharacterized for income tax purposes. Under this recharacterization, the parent corporation has made a capital contribution to the subsidiary, and the subsidiary has paid an expense the subsidiary may deduct as an ordinary and necessary business expense under section 162. The oil company further asserts that interest expense on borrowings by other members of the affiliated group that were, in part, for the benefit of and provided to BP are recharacterized for income tax purposes as well. BP insists that this expense is recharacterized as a constructive distribution by the other members of the group to Standard Oil, followed by a contribution to the capital of BP by Standard Oil, and payment by BP. Therefore, the company maintains all the interest in issue in this case is an "allowable deduction" of BP for federal income tax purposes and must be taken into account in determining BP's net income limitation for WPT purposes.

[1] No other appeal in or from the same civil action or proceeding in the Court of Federal Claims was previously before this Court or any other appellate court. We are unaware of any pending case which will directly affect this Court's decision in the instant appeal.

STATEMENT OF JURISDICTION

[2] The appellant timely filed a claim for refund with the Internal Revenue Service (the "IRS") for taxes that it alleged were erroneously collected. That claim was not allowed by the IRS and the appellant filed a timely suit for refund in the United States Court of Federal Claims. That court had jurisdiction over the appellant's action pursuant to 28 U.S.C. section 1491(a)(1).

[3] On April 28, 2000, the United States Court of Federal Claims entered a final judgment disposing of all claims with respect to all parties. (A1-9)

[4] This Court has jurisdiction over appeals from final decisions of the Court of Federal Claims pursuant to 28 U.S.C. section 1295(a)(3). The appellant filed a notice of appeal on July 5, 2000. (A205-206) The notice was timely under 28 U.S.C. sections 2107 and 2522.

STATEMENT OF THE ISSUE

[5] Whether expenses paid or incurred by affiliates for the benefit of the taxpayer are "allowable deductions" of the taxpayer to be taken into account in determining the taxpayer's net income?

STATEMENT OF THE CASE

[6] The appellant, BP Exploration & Oil Inc., seeks refunds of windfall profit tax ("WPT") for the four taxable quarters of 1984 and for the taxable quarters of 1985 ending on June 30, September 30, and December 31. (A3, Add. 46) ¹ During the periods in issue, the appellant's name was Sohio Petroleum Company ("SPC"), but as a result of a merger and a name change, BP Exploration & Oil Inc. is the successor in interest to SPC. (A3, 62-63, Add. 46) For purposes of clarity and consistency with references in the Court below, the appellant will hereafter be referred to as "SPC."

[7] During 1984 and 1985, SPC was engaged in the business of finding and producing crude oil and natural gas, and SPC owned interests in properties that produced crude oil subject to the WPT. (A4, Add. 47) SPC timely filed its quarterly federal excise tax returns regarding its WPT for the periods in issue and later timely filed claims for refund for those same periods. (Id.) During the IRS's examination of the claims for refund, SPC amended its claims, taking the position that an allocable portion of the net interest expense that was paid by its affiliates should be taken into account in determining SPC's net income limitation for WPT purposes. (A4, Add. 47)

[8] SPC filed a suit for refund in the United States Court of Federal Claims on September 26, 1997, raising the same grounds it had raised in the amended claims for refund. The United States (the "defendant") filed a Motion for Summary Judgment on April 8, 1999, and SPC filed a Cross-Motion for Partial Summary Judgment on June 8, 1999. (A4, Add. 47) On April 28, 2000, the Court granted the defendant's Motion for Summary Judgment, denied SPC's Cross-Motion for Partial Summary Judgment, and entered a Judgment for the defendant. (A1-9, Add. 45-52) BP Exploration & Oil Inc. v. United States, 46 Fed. Cl. 526 (2000). (A2-9, Add. 45-52) SPC filed a timely Notice of Appeal on July 5, 2000. (A205-206)

STATEMENT OF THE FACTS

A. FACTS

[9] During 1984 and 1985, SPC was a wholly-owned subsidiary of The Standard Oil Company of Ohio ("Standard Oil"). (A3, Add. 46) SPC was included in the consolidated federal income tax returns for the affiliated group of corporations (the "Sohio group") of which Standard Oil was the common parent. (Id.)

[10] Although it carried on some limited refining, marketing, and other activities, Standard Oil was primarily a holding company. Its main responsibility was to provide management services, including financial services, to the Sohio group. (A3, 64, Add. 46) As part of those services, Standard Oil actively directed and controlled the day-to-day and long-term cash management system (including the financing structure) of the entire Sohio group. (A3, Add. 46) Specifically, Standard Oil was responsible for determining both the short-term and long-term cash needs of the Sohio group. (A3, 188-190, Add. 46) Based upon those needs, Standard Oil would decide whether it was necessary to issue debt to fund those needs and, if so, whether to issue the debt in the name of Standard Oil or in the name of one of the other members of the Sohio group. (A190-191)

[11] Most of the long-term debt for the entire Sohio group was issued in the name of Standard Oil, because Standard Oil was able to borrow money at lower interest rates due to its financial strength and excellent credit rating. (A75-76, 193) The amounts of Standard Oil's indebtedness in 1984 and 1985 (over $1 billion and over $1.3 billion, respectively) were much more than the amounts of funds Standard Oil needed for its limited active businesses. (A190-191) Standard Oil borrowed so that it would have enough cash to fund the anticipated cash needs of its subsidiaries, in addition to Standard Oil's own needs. (A190) Standard Oil borrowed for the general corporate purposes of the Sohio group, including SPC's business of finding and producing oil and gas, and paid or incurred interest expense on those borrowings. (A3, 64, 190, Add. 46)

[12] Standard Oil sometimes used its subsidiaries for the issuance of long-term debt for the benefit of the Sohio group, but Standard Oil unconditionally guaranteed that debt. (A76-79, 192-193) Standard Oil's guarantee reduced the interest rate otherwise payable on the debt because of Standard Oil's financial strength and excellent credit rating. (A193) Standard Oil's subsidiaries paid or incurred interest expense on amounts borrowed by the subsidiaries. (A3, 67, Add. 46) However, for the debts of certain small subsidiaries, Standard Oil itself would make the principal and interest payments on debts that were issued in the name of the subsidiary. (A193)

[13] Under this centralized financing system, Standard Oil borrowed (or used its subsidiaries to borrow) the funds necessary to satisfy the cash needs of all members of the Sohio group, including SPC. (A3, 64, 67, 190-192, Add. 46) These borrowings (1) benefited Standard Oil as a stockholder of its subsidiaries, (2) made Standard Oil's subsidiaries more profitable, and therefore more valuable to Standard Oil, (3) were not intended to, and did not, provide any direct benefit to Standard Oil's own active businesses, and (4) were not entered into to protect Standard Oil's own business standing or credit rating. (A193)

[14] The proceeds of these borrowings were deposited into a Master Funding Account that Standard Oil maintained in Cleveland, Ohio. (A191) All available cash of nearly the entire Sohio group, ² including the proceeds of nearly all borrowings by any member of the group, was "swept" on a daily basis into the Master Funding Account. (A182-183, 188-191) The Master Funding Account was then used to fund the cash requirements of the entire Sohio group (including SPC) by transferring cash on a daily basis to fund each member's cash needs. (A3,182, 188-191, Add. 46) As a result of this centralized funding through the Master Funding Account, funds that were technically borrowed in the name of any member of the Sohio group or for any stated purpose were generally used for the benefit of ALL members of the Sohio group, including SPC. (A191-192)

B. THE OPINION OF THE COURT BELOW

1. THE STATUTORY AND REGULATORY BACKGROUND

[15] The issue in this case is whether SPC may take an allocable portion of the net interest expense that was paid or incurred by other members of the Sohio group into account in determining SPC's net income limitation for WPT purposes. (A5, Add. 48) The allocable portion of the net interest expense that was paid or incurred by other members of the Sohio group and that is in issue in this case is hereafter referred to as the "Interest in Issue." ³

[16] Under the WPT statutory scheme, the first step in determining the net income limitation on the "windfall profit" on a barrel of crude oil is to determine the "taxable income from the property" for the year attributable to crude oil. See section 4988(b)(2)(A). (Add. 73) Treasury regulation section 51.4988-2(b) explains how to compute the "taxable income from the property." (Add. 91) That regulation first requires a determination of the "taxpayer's gross income from the property" attributable to taxable crude oil. (Id.) The regulation then directs the taxpayer to determine its "taxable income from the property" by subtracting from its gross income from the property "all allowable deductions attributable to the production of taxable crude oil that would be subtracted in determining taxable income from the property under section 613(a) . . . ." (Id.) (emphasis added) ⁴

[17] As the Court below recognized, the crucial issue in this case is the determination of SPC's "taxable income from the property" in computing its WPT net income limitation. (A6, Add. 48) The Court noted that both section 4988(b)(3) and Treasury regulation section 51.4988-2(b) referred to section 613 as the guide for determining the "taxable income from the property." (Id.) Section 613 is an income tax provision which permits certain taxpayers (but not SPC) ⁵ to deduct as a depletion allowance a percentage of their gross income from oil and gas wells and other natural deposits. (Add. 60) Much like the controlling WPT regulation, section 613 also provides for a net income limitation, which "caps" the amount of the percentage depletion deduction at 50 percent of the taxpayer's "taxable income from the property. . . ." (Id.) Treasury regulation section 1.613- 5(a) defines "taxable income from the property" as the gross income from the property less all "allowable deductions . . . which are attributable to mining processes . . . with respect to which depletion is claimed." (Add. 90) (emphasis added.) That regulation also states that "[i]n determining the taxpayer's taxable income from the property, the amount of any particular item to be taken into account shall be determined in accordance with the principles set forth in paragraph (d)(2) and (3) of section 1.613-4." (Id.) Treasury regulation section 1.613-4(d)(2) then states that "only costs actually paid or incurred shall be taken into consideration" in determining the taxpayer's gross income from mining, and further states that the "amount of any particular item to be taken into account shall . . . . be the amount used in determining the taxpayer's income for tax purposes." (Add. 78)

2. THE COURT'S CONCLUSIONS

[18] The Court rejected SPC's position that the Interest in Issue may be taken into account in determining SPC's net income limitation for WPT purposes. The Court began its analysis by assuming SPC contended that federal income tax provisions are irrelevant to the proper interpretation of the WPT net income limitation. Based on this assumption, the Court concluded that SPC's position violated three specific requirements of federal tax law. According to the Court:

1. SPC's position ignores the requirement under section

SUMMARY OF ARGUMENT

[20] The conclusions which are the bases for the adverse decision of the Court below are erroneous, and the Court's judgment should be reversed.

[21] SPC presented two alternative positions to the Court below. One position was that SPC may take the Interest in Issue into account in computing its WPT net income limitation, whether or not SPC would be entitled to deduct that same expense for federal income tax purposes, because Congress intended to provide a true economic limitation on the taxable "windfall profit" subject to the WPT. The Court below rejected this position, and SPC is not pursuing it in this Appeal.

[22] SPC also presented an alternative position to the Court below, which is the subject of this Appeal. Under its alternative position, SPC acknowledges and agrees that federal income tax principles fully apply for purposes of computing its WPT net income limitation, and that the "taxable income from the property" must be computed the same for purposes of the WPT net income limitation as it is computed for purposes of the income tax net income limitation. As support for its alternative position, SPC relies on a 1984 IRS revenue ruling, a 1984 decision of the Claims Court, and other authorities that were issued and rendered under income tax law. Under these controlling income tax precedents, the Interest in Issue is an "allowable deduction" of SPC both for income tax purposes and for WPT purposes. The Court below erred in rejecting SPC's alternative position, because that position is consistent with, and indeed is mandated by, controlling income tax law.

[23] SPC's alternative position may be summarized as follows:

[24] Under the regulations that control the determination of the net income limitation for WPT purposes and for income tax purposes, taxpayers must reduce gross income by all "allowable deductions." Treas. Reg. section 51.4988-2(b); Treas. Reg. section 1.613-5(a). (Add. 91, 90) The term "allowable deductions" is a term of art in the tax law with a well-established legal meaning. The term "allowable deductions" means the deductions which are permitted under the Internal Revenue Code, whether or not they were actually claimed on the taxpayer's return. Virginian Hotel Corp. v. Helvering, 319 U.S. 523 (1943); Sharp v. United States, 27 Cl. Ct. 52 (1992), aff'd, 14 F.3d 583 (Fed. Cir. 1993).

[25] Interest expense (such as the Interest in Issue) may be deductible under section 163 of the Code, but may also be an ordinary and necessary business expense that is deductible under section 162 of the Code. McNutt-Boyce Co. v. Commissioner, 38 T.C. 462 (1962), aff'd, 324 F.2d 957 (5th Cir. 1963); Ungerman v. Commissioner, 89 T.C. 1131 (1987). Under these and similar authorities, the Interest in Issue may be tested to determine if it is an "allowable deduction" under section 162.

[26] In this case, the Interest in Issue was paid by Standard Oil and other members of the Sohio group for the benefit of SPC. (A3, 64, 67, 190-192, Add. 46) Both the IRS and the Claims Court have analyzed the income tax effect under section 162 when a parent corporation pays an expense for the benefit of its wholly-owned subsidiary. In Revenue Ruling 84-68, 1984-1 C.B. 31, and in Transamerica Corp. v. United States, 7 Cl. Ct. 119 (1984), the IRS and the Claims Court both concluded that when a parent corporation pays an expense for the benefit of its wholly-owned subsidiary, that payment is recharacterized for income tax purposes. Under that recharacterization:

1. The parent corporation has made a capital contribution to the

[28] Similarly, interest expense on borrowings by other members of the Sohio group which were, in part, for the benefit of and provided to SPC are recharacterized for income tax purposes. That expense is recharacterized as a constructive distribution by the other members of the group to Standard Oil, followed by a contribution to the capital of SPC by Standard Oil, and payment by SPC. See Cox v. Commissioner, 56 T.C. 1270 (1971), modified 58 T.C. 105 (1972) (transfer of funds between corporations under common control was constructive distribution to the parent).

[29] When the authorities outlined above are applied to the facts of this case, the Interest in Issue is an "allowable deduction" of SPC for federal income tax purposes. Under Treasury regulation section 51.4988-2(b)(1)(ii) all "allowable deductions" of SPC must be taken into account in determining SPC's net income limitation for WPT purposes. Accordingly, the Court below erred in rejecting SPC's alternative position. As discussed in more detail below, under SPC's alternative position:

1. The "taxable income from the property" is computed the

B. INTRODUCTION

[31] The judgment of the Court below should be reversed because the Court made two fundamental errors in considering SPC's alternative position. First, the Court erred when it assumed that under SPC's alternative position "federal income tax provisions are irrelevant to the proper interpretation of the WPT [net income limitation]." (A8, Add. 51) As shown below, that assumption is incorrect. SPC's alternative position does not treat federal income tax law as irrelevant, but instead is based upon and fully complies with the requirements of federal income tax law. Second, the Court also erred in concluding that SPC's alternative position does not compute "taxable income from the property" for WPT purposes as it is computed under the income tax net income limitation, that it contravenes the requirements of Treasury regulation section 1.613-4(d)(2), and that it impermissibly ignores the principle that separate companies are separate taxpayers.

C. THE COURT BELOW ERRED, BECAUSE SPC'S ALTERNATIVE POSITION

[33] Treasury regulation section 51.4988-2(b) provides that in computing the WPT net income limitation, the taxpayer's gross income from the property is reduced by "all allowable deductions attributable to the production of taxable crude oil that would be subtracted in determining taxable income from the property under section 613(a) . . . ." (Add. 91) The controlling regulation under section 613(a) likewise provides that in computing the income tax net income limitation, the taxpayer's gross income is reduced by all "allowable deductions." See Treas. Reg. section 1.613-5(a). (Add. 90)

[34] The Interest in Issue is an "allowable deduction" of SPC for federal income tax purposes. Under established federal income tax law, an "allowable deduction" means an expense that COULD HAVE BEEN deducted by SPC for income tax purposes. There is no requirement that SPC ACTUALLY have deducted the expense for income tax purposes. This conclusion is so well settled that it is a matter of hornbook law. For example, under Code section 1016(a)(2), the basis of property is to be reduced by at least the amount of depreciation that is "allowable." In construing this term, a leading hornbook states as follows:

The minimum amount of the downward adjustment of basis

[35] The case law also makes it clear that a deduction is "allowable" if it is permitted under the Code, whether or not the deduction was actually taken. For example:

1. Virginian Hotel Corp. v. Helvering, 319 U.S. 523, 525 (1943):

In at least three cases, all affirmed by three separate

[37] Similarly, in Ungerman V. Commissioner, 89 T.C. 1131, 1137 (1987), the Tax Court held that the deduction claimed by the taxpayer under section 163 for interest expense was also "deductible as an administration expense under section 212," with the result that the taxpayer was therefore not subject to the alternative minimum tax.

[38] When the holdings of McNutt-Boyce, the earlier cases cited in the McNutt-Boyce opinion, and Ungerman are applied to the facts of this case, the Interest in Issue is an "allowable deduction" under section 162. More importantly, the Interest in Issue is an "allowable deduction" of SPC. Under both the case law and the IRS's rulings, when a parent corporation (such as Standard Oil) pays an expense to benefit the separate business activities of a subsidiary, that expense is an "allowable deduction" of the subsidiary (in this case, SPC).

[39] A summary of the facts will be helpful in applying the section 162 cases and rulings to this case. First, Standard Oil was primarily a holding company which owned the stock of subsidiaries, and had only limited business activities of its own. (A3, 64, Add. 46) Standard Oil borrowed far more funds than it needed or used in its own business activities. (A190-191) Standard Oil borrowed for the general corporate purposes of the Sohio group, including SPC's business of finding and producing crude oil and natural gas, and Standard Oil paid or incurred interest expense on those borrowings. (A3, 64, 190, Add. 46) Likewise, under Standard Oil's centralized cash management and financing system, subsidiaries borrowed funds (and paid interest thereon) necessary to satisfy the cash needs of all members of the Sohio group, including SPC. (A3, 64, 67, 190-192, Add. 46)

[40] When the interest expense paid or incurred by Standard Oil (as parent) is tested under section 162, that interest expense is not deductible by Standard Oil, but is an "allowable deduction" of its subsidiaries, including SPC. The IRS and the courts have considered similar scenarios in which a parent corporation has paid or incurred an expense which benefits the separate business activities of its subsidiary, but does not benefit the parent's own business activities.

[41] In Revenue Ruling 84-68, 1984-1 C.B. 31, the IRS analyzed and ruled on the issue of whether "a parent corporation [may] deduct as a business expense under section 162 of the Internal Revenue Code cash bonuses it pays to employees of its wholly-owned subsidiary or may the bonuses be deducted by the subsidiary." The IRS stated its legal analysis and holdings as follows:

It is implicit in section 162 that a taxpayer may not

[42] The IRS summarized its conclusions in Revenue Ruling 84-68 as follows:

The parent corporation may not deduct as a business expense

[43] The Claims Court analyzed the same basic issue in Transamerica Corp. v. United States, 7 Cl. Ct. 119 (1984). That case considered whether a parent corporation was entitled to deduct the "spread" between the exercise price and the market price of parent corporation stock that had been issued to employees of a wholly-owned subsidiary. The parent corporation, Transamerica Corporation ("Transamerica") had established a stock option plan under which employees of its wholly-owned subsidiary, Occidental Life Insurance Company ("Occidental"), could acquire Transamerica stock. Transamerica claimed the deductions when Occidental employees made disqualifying dispositions of the Transamerica stock they had acquired under Transamerica's stock option plan. Transamerica claimed the deductions on its SEPARATE corporate income tax return. Transamerica and Occidental were prohibited from filing a CONSOLIDATED income tax return, because Occidental was a life insurance company, and section 1504(b)(2) prohibits insurance companies from joining in the filing of a consolidated income tax return. The IRS disallowed the deductions Transamerica claimed, and Transamerica sued for a refund in the Claims Court.

[44] In denying the deductions and refunds claimed by the parent corporation, the Claims Court stated its legal analysis and conclusions as follows: "It is well established that a stockholder is not entitled to a deduction under section 162 for compensation paid to the officers or other employees of a corporation for services rendered by them to the corporation." 7 Cl. Ct. at 124. The Claims Court cited as supporting authority Deputy v. Du Pont, 308 U.S. 488 (1940), Young & Rubicam, Inc. v. United States, 410 F.2d 1233 (1969), and Berner v. United States, 282 F.2d 720 (1960). The Claims Court went on to conclude that "[a] parent corporation's payment of its subsidiary's business expense, whether in cash, in kind or in stock, is not an expense of the parent's business, but A CONTRIBUTION TO THE CAPITAL OF OR ADDITIONAL INVESTMENT IN THE SUBSIDIARY AND AN EXPENSE OF THE SUBSIDIARY." 7 Cl. Ct. at 125 (emphasis added). The Claims Court cited as supporting authority South American Gold & Platinum Co. v. Commissioner, 8 T.C. 1297, aff'd per curiam, 168 F.2d 71 (2d Cir. 1948), Koppers United Co. v. Commissioner, 2 T.C.M. (CCH) 103, (1943), aff'd per curiam, 141 F.2d 1023 (3d Cir. 1944), and Esmond Mills v. Commissioner, 132 F.2d 753 (1st Cir. 1943).

[45] Under the legal reasoning adopted by the IRS in Revenue Ruling 84-68 and the Claims Court in Transamerica, Standard Oil may not deduct under section 162 the interest expense that was paid for the benefit of SPC. Instead, Standard Oil's payment of that expense is treated for income tax purposes as a contribution to SPC's capital, followed by a constructive payment of the expense by SPC. Similarly, the payments of such expenses by other members of the Sohio group are treated for income tax purposes as constructive distributions to Standard Oil, followed by contributions to SPC's capital and constructive payments of the expense by SPC. See Cox v. Commissioner, 56 T.C. 1270 (1971), modified 58 T.C. 105 (1972) (transfer of funds between corporations under common control was constructive distribution to the parent). Accordingly, under section 162 the Interest in Issue is an "allowable deduction" of SPC for federal income tax purposes.

[46] As shown by the analysis outlined above, the Court below erred when it concluded that under SPC's alternative position "federal income tax provisions are irrelevant to the proper interpretation of the WPT [net income limitation]." (A8, Add. 51) Instead, SPC's alternative position is based upon and fully complies with the requirements of federal income tax law under which the Interest in Issue is an "allowable deduction" of SPC for federal income tax and WPT purposes.

D. THE COURT BELOW ERRED IN CONCLUDING THAT SPC'S ALTERNATIVE

1. SPC's position ignores the requirement under section

1. UNDER SPC'S ALTERNATIVE POSITION, THE "TAXABLE INCOME

[49] As outlined in the preceding section, SPC's alternative position follows to the letter the requirements of federal income tax law under section 162 to conclude that the Interest in Issue is an "allowable deduction" of SPC. It is in accordance with federal INCOME tax law, as illustrated by Revenue Ruling 84-68 and Transamerica, that the payment is recharacterized as a contribution by Standard Oil to the capital of SPC, followed by the actual payment of the expense by SPC. It is in accordance with federal INCOME tax law, as illustrated by Virginian Hotel, Sharp, McNutt-Boyce, and other authorities, that the recharacterized expense is an "allowable deduction" of SPC.

[50] Since the Interest in Issue is an "allowable deduction" of SPC for federal income tax purposes, it would be taken into account in computing SPC's "taxable income from the property" for purposes of the income tax net income limitation. The controlling regulation under section 613(a) defines "taxable income from the property" as "gross income from the property . . . less all allowable deductions . . . which are attributable to mining processes." Treas. Reg. section 1.613-5(a). SPC merely contends that the same "allowable deduction" should likewise be taken into account in computing the "taxable income from the property" for purposes of the WPT net income limitation under Treasury regulation section 51.4988-2(b). Thus, under SPC's alternative position, the "taxable income from the property" for purposes of the WPT net income limitation is computed the same as the "taxable income from the property" for purposes of the income tax net income limitation.

[51] The Court below ruled that "[i]t is clear from the plain language of the statute that "taxable income from the property" for WPT [net income limitation] purposes is determined based on federal income tax provisions." (A8, Add. 51) SPC's alternative position fully satisfies that requirement, and the Court below erred in rejecting SPC's alternative position.

2. SPC'S ALTERNATIVE POSITION DOES NOT VIOLATE THE

(a) "In determining the taxpayer's gross income from mining

a. ONLY COSTS ACTUALLY PAID OR INCURRED BY SPC ARE

[54] Instead, the Court below apparently concluded that SPC's alternative position violated the first requirement of Treasury regulation section 1.613-4(d)(2) because "plaintiff [SPC] admittedly did not pay or incur the interest expense at issue . . ." (emphasis added) (A8-9, Add. 51-52) That conclusion is erroneous, however, because it ignores the legal analysis in Revenue Ruling 84-68, Transamerica, and the other authorities that are outlined above. Under that analysis, the Interest in Issue is recharacterized as an expenditure of SPC and is treated for tax purposes precisely as if it had been actually paid or incurred by SPC. This point is particularly well illustrated by Revenue Ruling 84-68. Section 162, like Treasury regulation section 1.613-4(d)(2), requires that the expenditure in issue be "paid or incurred" if it is to be deductible. See section 162(a) ("There shall be allowed as a deduction all the ordinary and necessary expenses PAID OR INCURRED during the taxable year in carrying on any trade or business. . . .") (Add. 53) (emphasis added). The IRS obviously concluded that this requirement was satisfied in Revenue Ruling 84-68, even though the expenditure was actually paid by the parent for the benefit of the subsidiary: "Because the parent's payment of cash bonuses to its subsidiary's employees is treated as a contribution to the subsidiary's capital accompanied by a constructive payment by the subsidiary of the cash bonuses to its employees, the cash bonuses may be deducted by the subsidiary under section 162 of the Code . . . ." (Add. 94) The same conclusion should be reached here. The Sohio group's payment of interest expense for the benefit of SPC is recharacterized as a contribution to SPC's capital and a constructive payment by SPC. Accordingly, the Interest in Issue is paid or incurred BY SPC for income tax (and WPT) purposes.

b. THE AMOUNT TAKEN INTO ACCOUNT IS THE AMOUNT USED

[56] The controlling WPT regulation requires a taxpayer such as SPC to take into account all "allowable deductions" in computing its WPT net income limitation. Treas. Reg. section 51.4988-2(b). The corresponding income tax regulation, section 1.613-5(a), also requires a taxpayer to take into account all "allowable deductions" in computing its income tax net income limitation. The term "allowable deductions" is a term of art in the tax law, with a well- established meaning. The term "allowable deductions" must be construed and applied in accordance with its long-accepted meaning and usage. "Words with a fixed legal or judicially settled meaning must be presumed to have been used in that sense." In re Estate of Nissen v. Commissioner, 345 F.2d 230, 235 (4th Cir. 1965); see also United States v. Merriam, 263 U.S. 179, 187 (1923). Under this well- established meaning, an "allowable deduction" is one that is permitted under the Code, whether or not a taxpayer such as SPC actually claims the deduction. See Sharp v. United States, 14 F.3d 583, 588 ("[A]llowable deductions are those deductions permitted and not otherwise forbidden or limited by the IRC, WHETHER OR NOT THEY ARE ACTUALLY USED and regardless of their lack of tax benefit.") (emphasis added).

[57] Both the controlling WPT regulation and the corresponding income tax regulation require that all "allowable deductions" be taken into account in computing the net income limitation. Applying the well-established meaning of the term "allowable deductions," that means the Interest in Issue must be taken into account whether or not it was ACTUALLY deducted by SPC. In contrast, the Court below interpreted Treasury regulation section 1.613-4(d)(2) to require that the Interest in Issue must ACTUALLY have been deducted by SPC before it may be taken into account in computing the net income limitation. The interpretation of Treasury regulation section 1.613-4(d)(2) adopted by the Court below is misdirected, because it would completely contradict and eviscerate the well-established meaning of the term "allowable deductions." See United States v. Menasche, 348 U.S. 528, 538-539 (1955):

"The cardinal principle of statutory construction is to save and

The amount of any particular item to be taken into account shall

3. SPC's ALTERNATIVE POSITION DOES NOT COMPUTE THE NET

[60] In Revenue Ruling 84-68 and Transamerica, the IRS and the Claims Court did not ignore the principle that separate companies are separate taxpayers. Instead, in both cases, the IRS and the Claims Court recharacterized the expenditure made by the parent for the benefit of the subsidiary in accordance with its substance. In Revenue Ruling 84-68, "the parent's payment of cash bonuses to its subsidiary's employees is treated as a contribution to the subsidiary's capital accompanied by a constructive payment by the subsidiary of the cash bonuses to its employees." (Add. 94) Similarly, in Transamerica, the Claims Court concluded that "[a] parent corporation's payment of its subsidiary's business expense . . . is not an expense of the parent's business, but a contribution to the capital of . . . the subsidiary and an expense of the subsidiary." 7 Cl. Ct. at 125. The same is true under SPC's alternative position. That position respects the principle that separate companies are separate taxpayers, but (like Revenue Ruling 84-68 and Transamerica) recharacterizes the Interest in Issue as a contribution to the capital of SPC, followed by a deductible payment of that expense by SPC.

b. SPC's ALTERNATIVE POSITION DOES NOT HAVE THE

[62] Instead of relying on the consolidated return requirements, both the IRS and the Claims Court recharacterized the parent's payment of the expense in issue as a contribution to the capital of the subsidiary, followed by a deductible payment of the expense by the subsidiary. The same is true here. SPC's alternative position does not rely on any consolidated return requirements as the reason the Interest in Issue is an "allowable deduction" of SPC. In fact, it is completely irrelevant under SPC's alternative position whether SPC and the other members of the Sohio group are either permitted to file or prohibited from filing a consolidated tax return for income tax, excise (WPT) tax, or any other tax. Instead, the Interest in Issue is recharacterized under federal income tax principles, and treated as a contribution to the capital of SPC, followed by a deductible payment of the expense by SPC. It is that recharacterization that makes the Interest in Issue an "allowable deduction" of SPC for purposes of computing the WPT net income limitation, and not any consolidated return requirement.

E. THE CHEVRON CASE DOES NOT CONTROL THE OUTCOME OF SPC'S CASE.

[63] The Court below also cited Chevron U.S.A., Inc. v. United States, 77 AFTR 2d (RIA) 96-1412 (S.D. Tex. 1995), aff'd mem, 81 F.3d 154 (5th Cir. 1996). On the specific facts involved in that case, Chevron held that a wholly-owned subsidiary could not take a portion of the interest expense paid by its parent into account in computing the subsidiary's WPT net income limitation. Chevron does not control the outcome of this case, because the facts and resulting legal analysis in that case are very different from the facts and resulting legal analysis in this case. In Chevron, the parent borrowed over $13 billion to purchase the stock of Gulf Corporation from the shareholders of Gulf Corporation. All of the funds borrowed by the parent went to former Gulf Corporation shareholders. Unlike the facts of this case, none of borrowed funds were used in the business of (and for the benefit of) Gulf Oil Corporation, the oil producing subsidiary of Gulf Corporation that was subject to the WPT.

[64] Because of the very different facts involved in that case, the taxpayer in Chevron could not possibly rely on the same authorities and legal analysis SPC relies on in this case. The crucial distinction is that, unlike the facts of Chevron, some of the funds Standard Oil and the other members of the Sohio group borrowed were used by SPC in its oil and gas business. (A3,64,67,190-192, Add. 46) Under the IRS's analysis in Revenue Ruling 84-68 and the Claims Court's analysis in Transamerica, interest expense Standard Oil and the other members of the Sohio group paid on funds borrowed for the benefit of SPC is recharacterized as a capital contribution to SPC, and the payment by SPC of an expense that is deductible BY SPC for income tax purposes. SPC's alternative position in this case fully respects the legal conclusions the court reached in Chevron. That is, and as discussed above, under SPC's alternative position, principles of income tax law (and not merely cost accounting principles) are respected in computing the WPT net income limitation; the costs taken into account in computing the WPT net income limitation are, under the income tax authorities cited above, treated as having been paid or incurred by SPC, the separate WPT "taxpayer"; and SPC does not rely on any provisions relating to the filing of a consolidated tax return to conclude that the Interest in Issue is an "allowable deduction" of SPC for purposes of the WPT net income limitation.

CONCLUSION AND STATEMENT OF RELIEF SOUGHT

[65] The judgment of the Court below that, as a matter of law, SPC may not include the Interest in Issue as an "allowable deduction" in computing SPC's net income limitation for WPT purposes should be reversed. The case should be remanded to the Court below for the determination of the amount of SPC's WPT refunds for the four taxable quarters of 1984 and for the taxable quarters of 1985 ending on June 30, September 30, and December 31.

Dated September 5, 2000.

[66] This is to certify that two copies of the Brief for the Appellant have been served upon opposing counsel by mailing the same in the United States mail, postage prepaid, on September 5, 2000, addressed to:

Charles Bricken

[67] The undersigned certifies that the foregoing brief complies with the type-volume limitations of Federal Rule of Appellate Procedure 32(a)(7)(B). Excluding those portions of the brief listed in Federal Rule of Appellate Procedure 32(a)(7)(B) and Federal Circuit Rule 32(b), the brief contains less than 11,000 words.

Dated September 5, 2000

² The one exception to this general rule was Sohio Pipe Line Company. That company's cash was not commingled with the cash of Standard Oil and the other members of the Sohio group, because Sohio Pipe Line Company was regulated by the Federal Energy Regulatory Commission, and was required to maintain segregated records and accounts. (A3, 189, Add. 46)

³ SPC determined the Interest in Issue as follows: (a) a portion of the net interest expense of Standard Oil and its subsidiaries other than SPC was allocated to SPC based on SPC's capital expenditures in relation to the total capital expenditures of the Sohio group for the year; (b) the portion allocated to SPC was allocated among SPC's oil and gas producing, non-producing, and other activities based on the relative modified direct expenses of the activities; (c) the portion allocated to SPC's oil and gas producing activities was allocated among SPC's producing properties on the basis of their relative gross income; and (d) the portion allocated to a producing property was allocated between the crude oil and the natural gas produced from the property based on the relative gross income from the oil and from the natural gas. (A70-71)

⁴ Under the WPT statutory scheme, the taxpayer's "taxable income from the property" is divided by the number of barrels of taxable crude oil sold for the year to derive the net income limitation per barrel. See section 4988(b)(2)(B). (Add. 73) The resulting net income limitation acts as a "cap" on the amount of windfall profit subject to the WPT. Under the WPT statute and regulations, the amount of "windfall profit" subject to the WPT cannot exceed 90% of the net income attributable to a barrel of taxable crude oil. This final step in determining the WPT net income limitation is not in controversy in this appeal.

⁵ Because other members of the Sohio group, including Standard Oil, were "retailers" and/or "refiners," under section 613A(d)(2) and (4) (Add. 70), SPC was not eligible to claim any deduction for percentage depletion on its income from oil and gas. (A63)