The United States has urged the Fifth Circuit to reverse a district court's decision to spare Exxon Mobil Corp. from $200 million in penalties in a dispute over its $1.3 billion tax refund claim.
Exxon has no reasonable basis for treating its oil and gas ventures with Qatar and with Malaysian state oil company Petronas as sales rather than leases, and the U.S. District Court for the Northern District of Texas was wrong to hold otherwise, according to the government’s opening brief in Fifth Circuit proceedings in Exxon Mobil v. United States. The complexity of the case doesn’t help Exxon’s reasonable basis argument, the government asserted, adding that penalties have been upheld in disputes concerning far more complicated transactions.
The government’s brief defends the district court’s conclusion that Exxon’s offshore exploration and development transactions were mineral leases and that the company's cost of goods sold includes only fuel excise tax liabilities that it paid after accounting for fuel mixture credits. The district court roundly rejected Exxon’s position on the merits and should not have found that it had a reasonable basis for purposes of section 6676 penalties, the government argued.
Exxon appealed the decision on the characterization of the mineral transactions to the Fifth Circuit, arguing in a July 21 brief that the district court erroneously failed to apply a bright-line economic interest test in determining whether the risk of nonproduction was retained by the transferors of the mineral interest — in this case, Qatar and Petronas. A transferor isn’t considered to bear risks of nonproduction if it has rights to non-extraction income, Exxon said. Because Qatar and Petronas derive non-extraction income from the parties’ transactions, the transactions should be treated as sales, it said.
Exxon also appealed the district court’s decision on the alcohol fuel mixture credit issue, insisting that it is entitled to a deduction of excise taxes without a reduction for the credit amount. The IRS’s treatment of fuel mixture credits is a hot-button issue being litigated by other energy companies, including Valero Energy Corp. and Delek US Holdings Inc.
The government filed a notice of cross-appeal in the Fifth Circuit in April, objecting to the district court’s grant of summary judgment to Exxon regarding section 6676 penalties. “A tax position has no reasonable basis if no identifiable authority supports it,” and the district court failed to substantiate its conclusion that Exxon’s position was based on authorities in reg. section 1.6662-4(d)(3)(iii), the government argued. “The court failed to actually cite any such ‘authorities’ because there are none,” it said.
The government reiterated its position that Exxon should be permitted to deduct only fuel excise taxes that it actually paid. Exxon is claiming that its COGS includes not only excise taxes paid on gasoline sales “but also the excise tax it would have had to pay if it had not claimed excise tax credits" under section 6426, it said.
The government noted the district court’s reliance on Sunoco Inc. v. United States, 129 Fed. Cl. 322, in which the U.S. Court of Federal Claims found that the credit reduces a taxpayer’s excise tax liability and that taxpayers should use net excise taxes in the calculation of COGS.
Exxon’s claim that its Qatar and Petronas transactions were sales “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,” the government said. Neither the Fifth Circuit nor the Supreme Court has denied lease treatment just because the transferor in a mineral transaction was entitled to non-extraction income, it said. “Exxon’s newly discovered ‘rule’ cannot be and is not the law,” it argued.
Exxon is represented before the Fifth Circuit in Exxon Mobil Corp. v. United States, No. 21-10373, by attorneys from Paul, Weiss, Rifkind, Wharton & Garrison LLP and Holland Knight LLP. The United States is represented by attorneys with the Justice Department Tax Division.