Hawaii Attorney General Releases Report on ChevronTexaco Investigation

[2] Shortly after taking office, Governor Linda Lingle directed the Attorney General's office⁴ to work in cooperation with Winston & Strawn to determine if the professors' allegations had merit. If at the end of the process, it was determined that there were viable claims to pursue, Governor Lingle directed the Attorney General's office to aggressively pursue the claims.

[3] Winston & Strawn, along with attorneys from the Attorney General's office and Department of Taxation, had full access to previously confidential internal company documents, including oil production/importation, transfer pricing, and market share data, documents filed with the Internal Revenue Service (IRS) during the course of its audit, transcripts of proceedings before the IRS, the so-called "fraud" documents identified in the course of the IRS litigation relating to Chevron, sworn testimony by ChevronTexaco executives, data from third parties, such as the Asian Petroleum Price Index (APPI), Platts, RIM, IRS adjustments and settlements, and amended Hawaii income tax returns filed by ChevronTexaco. In addition, Winston & Strawn participated in a series of conferences with representatives from ChevronTexaco, and requested and received additional documentary evidence from ChevronTexaco.

[4] Based on its review of the evidence, Winston & Strawn has advised the State that no evidence supports Hawaii's tax fraud claim against ChevronTexaco, and has recommended against suing ChevronTexaco, indicating that it would not participate in any such suit, regardless of the nature of the fee arrangement. The team of lawyers from the Attorney General's office and Department of Taxation also concluded that the professors' claims are without merit, and have recommended to Governor Lingle that the State not sue ChevronTexaco.

[5] To summarize, the professors alleged (1) that Chevron has been paying more than fair market value (the government set price or "GSP") for oil purchased through Caltex and/or Chevron's Indonesian affiliates; (2) by doing so, Chevron inflated its cost of goods sold for Federal and state income tax purposes, thereby reducing its taxable income; (3) Caltex received a "kickback" called the Western Hemisphere Allowance ("WHA") from the Indonesian government in the form of free oil; and (4) that the WHA, together with foreign tax credits and special dividends essentially reimbursed Chevron for paying more than fair market price for the Indonesian oil. The amount that ChevronTexaco allegedly defrauded the states in income taxes has been variously reported by the professors at figures as low as $471.2 million, and as high as $1.7 billion.

B. THE PROFESSORS REACHED INCORRECT CONCLUSIONS

[7] The portion of business income subject to Hawaii taxation in this case is determined under the Uniform Division of Income for Tax Purposes Act, section 235-29, Hawaii Revised Statutes. See Appendix 1. This formula, which is used in many states, divides a business's income among the states in which it operates.

[8] Chevron acquired 458,013,734 barrels of Indonesian oil during the period 1980 through 2001. The professors alleged that ChevronTexaco inflated the cost of goods sold by as much as $4.55 per barrel. If that were true, Chevron's total oil cost would have been inflated by $2.08 billion. Even if one were to assume not just that, but also that all of the professors' allegations had merit (something that is refuted later in this report), and give the benefit of every doubt to the State's claim, applying Chevron's highest apportionment factor for the entire 21 year period and the Hawaii income tax rate, the State's claim against Chevron would total only $3.65 million.

[9] Texaco's figures are even less significant. Texaco imported 167,599,445 barrels of crude during the years 1983 through 2001 (much less than Chevron). Similarly assuming that the cost of goods sold was inflated by as much as $4.55 per barrel, Texaco's total oil cost would be inflated $762.5 million. Using Texaco's highest apportionment factor for this entire period and applying the tax rate, Hawaii's damage claim against Texaco would be $396,540.

2. The Professors Are Wrong on the Merits.

[10] Due probably to the fact that the professors did not have access to the information and evidence that Winston & Strawn had in conducting its review, we now know that the professor's theories of liability also do not hold up to the evidence.

a. Western Hemisphere Allowance (WHA)

[11] The sworn testimony of ChevronTexaco executives show that ChevronTexaco received the WHA only during the period April 1, 1983 to January 31, 1986, and did not receive the allowance for any other year -- contrary to the professors' assumption. The ChevronTexaco affidavits are fully supported by ChevronTexaco internal documents.

• 1990 to Present. Separate schedules provided to Winston & Strawn compared the Indonesian government set price of oil to the actual prices Chevron paid in the marketplace for crude oil and the prices that Chevron charged third parties when it sold the oil. For the period 1990 through 2002, the government set price was close to, but generally somewhat less than, the price that Chevron received in Chevron's third party sales. In other words, the evidence supports Chevron's claim that the government set price is not higher than the fair market value.

• Independent market indices, such as the Asian Petroleum Price Index also fully supports Chevron's claim that it paid fair market value.

• 1980 to 1989. The IRS crack petroleum pricing task- force ("PIP") looked at prices paid by Chevron and made adjustments for 1980 through 1989. The IRS made adjustments to Texaco's prices for 1983 through 1988. For both companies, adjustments were made relating to the WHA only in years 1983 through 1986:

• • Chevron reported these adjustments on amended Hawaii income tax returns and paid the additional taxes due.

  • The adjustments had no impact on Texaco's Hawaii income because Texaco was in a net loss position in Hawaii.

  • c. ChevronTexaco Paid More to the IRS to Settle the IRS Audit Than it Reserved for the Transfer Pricing Issues.

d. Chevron 2003 Press Release: Smoking Gun?

[14] The professors speculated that a 2003 Chevron press release was a "smoking gun," demonstrating that Chevron continued to receive the WHA into the present day. The professors theorized that as the spread between the government price and the fair market price narrowed, Chevron received less WHA oil.

[15] The text of the press release at issue, however, refers to the net effect of higher oil prices on Chevron's share of net production under production sharing agreements, not WHA oil. Chevron's Indonesian Production Sharing contracts permit it to recover its cost of production in oil first. As the price of oil increased, it took fewer barrels of net production to reimburse Chevron for its costs. There is nothing in the Press Release that supports the argument that the decline in production of oil (67,000 barrels per day) related to the receipt of WHA oil.

²Senate Standing Committee Report No. 1216 (Mar. 28, 2003).

³Senate Standing Committee Report No. 1676 (Apr. 29, 2003).

⁴Because of a possible conflict of interests, Attorney General Mark Bennett recused himself from any participation or involvement in this matter.