Tidewater Inc. v. United States

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT United States Court of Appeals

Fifth Circuit

FILED

April 13, 2009

No. 08-30268 Charles R. Fulbruge III

Clerk

TIDEWATER INC. AND SUBSIDIARIES; TIDEWATER FOREIGN SALES

CORPORATION

Plaintiffs - Appellees

v.

UNITED STATES OF AMERICA

Defendant - Appellant

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TIDEWATER INC. AND SUBSIDIARIES

Plaintiffs - Appellees

v.

UNITED STATES OF AMERICA

Defendant - Appellant

Appeal from the United States District Court

for the Eastern District of Louisiana

Before JOLLY, DAVIS, and DeMOSS, Circuit Judges.

W. EUGENE DAVIS, Circuit Judge:

The United States of America appeals from the district court’s grant of

summary judgment in favor of Tidewater Inc. and its related entities. The issue

in this tax case is whether Tidewater, which owns and operates a fleet of vessels

No. 08-30268

serving the energy industry, is entitled to certain FSC tax benefits under the

Internal Revenue Code. The resolution of this issue depends on whether the

time charter of Tidewater’s vessels to energy industry customers should be

considered a “lease” or a “service agreement.” We agree with the district court

that the time charters should be considered more like a lease or sublease than

a service agreement and affirm the district court’s judgment.

I. Facts and Prior Proceedings

Tidewater Inc. and its subsidiaries (“Tidewater”) own and operate ocean-

going vessels serving the offshore energy industry in foreign and domestic

waters. For the years in question, 1998-2000, Tidewater structured its vessel

operations as a two-step transaction. It first bareboat chartered a vessel to a

Tidewater operating company. The operating company then time chartered that

vessel to the customer, usually an oil company (the “Time Charter”).1 Under the

Time Charter, the Tidewater operating company yielded significant control over

the vessel to the customer and also provided a crew to operate the vessel.

The operating company allocated the income received under the Time

Charter between the leasing component and the service component of the Time

Charter. The Time Charter was silent as to any such allocation.2 Tidewater

entered into hundreds of these Time Charters, five of which are in the record.

Tidewater Foreign Sales Corporation (“Tidewater FSC”) acted as a commission

agent for these transactions and Tidewater paid Tidewater FSC a commission

on the amount allocated to the leasing component of the Time Charter.

1

The Time Charters are on the “Uniform Time Charter Party for Offshore Service

Vessels, Code Name: Supplytime 89” form. This form is issued by The Documentary

Committee of The Baltic and International Maritime Council (BIMCO), Copenhagen. The first

edition was published in 1975, and this version of the form was revised in 1989.

2

The amount attributed to the leasing component was paid by the Tidewater operating

company to the vessel owner as charter hire on the bareboat charter.

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The provisions of the I.R.C. relating to Foreign Sales Corporations (“FSC”)3

allow qualified taxpayers to deduct commissions paid to a FSC. The income

derived from these commissions is then taxable to the FSC at a favorable rate.

To qualify for these tax benefits, the FSC must derive the commissions from

income generated by the sale or lease of “export property.” Based on its

conclusion that the Time Chartered vessels qualified as “export property,”

Tidewater deducted the commissions paid to Tidewater FSC on its 1998 - 2000

tax returns, and Tidewater FSC claimed the favorable rate on the commissions

on its returns.

The IRS contended that the vessels were not “export property” under the

FSC provisions, and that therefore the favorable tax treatment was inapplicable.

For this reason, the IRS disallowed Tidewater’s commission deductions for 1998

- 2000. Tidewater paid the calculated deficiencies and filed this suit. Tidewater

FSC filed protective refund claims and joined in this suit. It argued in the

alternative, that if Tidewater was not allowed to deduct the commissions paid

to Tidewater FSC, Tidewater FSC was not required to include those commissions

in its taxable income.

The parties filed cross-motions for summary judgment. Tidewater argued

that the Time Charter has attributes of both a service contract and a lease, and

that the lease aspects of the contract are sufficient to allow the vessels to be

classified as export property. The government argued that the Time Charter is

a service contract. The district court agreed with Tidewater and granted its

summary judgment motion. The district court reasoned that the FSC provisions

contemplated hybrid contracts, and that having both elements of a lease and a

service contract did not prevent the Time Charter from being characterized as

3

26 U.S.C. §§ 921-927. The provisions were repealed in November 2000.

3

No. 08-30268

a lease. It concluded that the vessels met the definition of export property, and

that Tidewater’s deductions were proper. The United States now appeals.

II. Analysis

A. Statute and Regulation

The central issue in this appeal is whether the vessels Tidewater time

chartered to its customers qualify as “export property.” We turn first to the

relevant provision of the I.R.C. and the relevant treasury regulation that control

our analysis. The FSC provisions define export property as follows:

§ 927(a) Export property. For purposes of this subpart

(1) In general. The term “export property”means property

(A) manufactured, produced, grown, or extracted in the

United States by a person other than a FSC,

(B) held primarily for sale, lease, or rental in the ordinary

course of trade or business, by, or to, a FSC, for direct use,

consumption, or disposition outside the United States, and

(C) not more than 50% of the fair market value of which is

attributable to articles imported into the United States.

26 U.S.C. § 927(a) (2000). In this case, the parties agree that the vessels meet

the requirements of § 927(a)(1)(A) and (a)(1)(C). Only § 927(a)(1)(B) is in

question, as the definition of export property goes on to state:

(2) Excluded property. The term “export property” shall not

include

(A) property leased or rented by a FSC [or through a

commission FSC] for use by any member of a controlled group

of corporations of which such FSC is a member . . . .

Id. The Tidewater entities that own the vessel and operate the vessel are

members of a controlled group of corporations with Tidewater FSC. Therefore

this provision excludes the Tidewater vessels as “export property.”

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No. 08-30268

However, a gloss in the treasury regulations on this statutory exclusion

provides Tidewater with a basis for an argument that these vessels are indeed

export property:

(2) Property leased to a member of controlled group- (I) In

general. Property leased to a person (whether or not the FSC)

which is a member of the same controlled group as the lessor

constitutes export property for any period of time only if during the

period

(A) The property is held for sublease or is subleased, by the

person to a third person for the ultimate use of the third

person.

(B) The third person is not a member of the controlled group;

and

(C) The property is used predominantly outside the United

States by the third person.

Temp. Treas. Reg. § 1.927(a)-1T(f)(2) (1998). The bareboat charter of the vessel

from the vessel owner to the Tidewater operating company amounts to a lease,

so if the Time Charter to the customer is a sublease, Tidewater is entitled to the

deduction. Therefore, the question narrows to whether the Time Charter to the

customer is a sublease.

B. Standard of Review

We review the district court’s grant of summary judgment de novo.

Patterson v. Mobil Oil Corp., 335 F.3d 476, 485 (5th Cir. 2003). Summary

judgment is proper if it can be shown “that there is no genuine issue as to any

material fact.” F ED. R. C IV. P. 56(c). “On cross-motions for summary judgment,

we review each party’s motions independently, viewing the evidence and

inferences in the light most favorable to the nonmoving party.” Ford Motor Co.

v. Tex. Dep’t of Transp., 264 F.3d 493, 499 (5th Cir. 2001). The parties agree

that no question of fact is presented in this case and that the sole issue

presented is legal.

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C. Criteria to Use in Determining Status of Vessels

In determining whether the vessels qualify as “export property,” we look

to the governing statute, § 927, and the regulation interpreting the statute. On

its face, the governing regulation allows Tidewater and Tidewater FSC the

benefit of the FSC deduction if “the property is held for sublease or is subleased,

by the person to a third person for the ultimate use of the third person.” Temp.

Treas. Reg. § 1.927(a)-1T(f)(2)(A)(1998). The statute, § 927(a)(1)(B), requires

that the property be held “primarily” for lease in order to qualify as export

property. While the language of the treasury regulation does not contain the

word “primarily,” the regulation cannot change the terms of the statute. See

Nalle v. Comm’r, 55 F.3d 189, 193 & n.11 (5th Cir. 1995) (“[I]f a regulation

obviously altered the scope of the relevant statute, the Commissioner should

have known that such a regulation was invalid.” (citing Comm’r v. Acker, 361

U.S. 87, 92-94 (1959) (parenthetical omitted))). The definition of export property

carried forward in the regulations implicitly retains the word “primarily.”

Therefore, our analysis will focus on whether the vessels were held by the

Tidewater operating company primarily for sublease to a third party.

Although the relationship of the parties in this case is controlled by the

contracts between the parties, we begin with a consideration of the generally

accepted definitions of the terms in play. “As a general matter, the term ‘lease’

means a transfer of the right to possession and use of goods for a term in return

for consideration.” 19 W ILLISTON ON C ONTRACTS § 53:18 (4th ed. 1991). A service

contract is defined simply as “a contract to perform a service . . . .” B LACK’S L AW

D ICTIONARY 324 (7th ed. 1999). A time charter is defined generally as “[a] charter

for a specified period, rather than for a specific task or voyage; a charter under

which the shipowner continues to manage and control the vessel, but the

charterer designates the ports of call and the cargo carried.” Id. at 229. As

opposed to a voyage charter, which is for one voyage from point A to point B, a

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No. 08-30268

time charter is “an arrangement of some permanency.” G RANT G ILMORE &

C HARLES L. B LACK, J R., T HE L AW OF A DMIRALTY, § 4-14, at 229 (2d ed. 1975).

While these general definitions are a logical starting point, the terms of

the Time Charter itself controls the critical question as to whether the Time

Charter is more like a lease or a service agreement. Under the Tidewater Time

Charter, the customer can direct the vessel to undertake any voyage permitted

by the terms of the agreement. The Time Charter covers a named vessel with

specified capabilities, and while Tidewater has the right to provide a substitute

vessel at any time, the customer must give its reasonable consent.4 If the

substitute vessel is not acceptable, the customer can refuse to accept it. The full

capacity of the vessel is placed at the customer’s disposal for use as it sees fit,

and the customer can require special towing or anchor handling equipment or

modify the vessel. In sum, the customer is given the full use of the vessel and

the right to direct the vessel in all respects: when and where the vessel should

go, the cargo it should carry, the passengers to be transported, and in other ways

as set forth in the Time Charter.

The government argues that the provisions of 26 U.S.C. § 7701(e) provide

the proper framework for determining if the Time Charter is more like a lease

or a service contract. Section 7701 is entitled “Definitions,” and §7701(e)

provides criteria for determining when a contract should be treated as a lease.

Based on legislative history, Tidewater argues that § 7701(e) does not apply to

the FSC provisions and that it only applies to investment tax credit issues.

Tidewater’s argument is inconsistent with the plain language of the statute.

which states that the provisions apply for purposes of chapter 1. When the plain

language of a statute is unambiguous, there is no need to resort to legislative

4

“The Owners shall be entitled at any time, whether before delivery or at any other

time during the Charter Period, to provide a substitute vessel, subject to the Charterer’s prior

approval, which shall not be unreasonably withheld.” Part II, Clause 18, Time Charter.

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No. 08-30268

history for aid in its interpretation. See Peavy v. WFAA-TV, Inc., 221 F.3d 158,

169 (5th Cir. 2000). Here, the prefatory language of § 7701 clearly requires its

application to all parts of Chapter 1, which includes the FSC provisions. Section

7701(e) reads:

§ 7701 (e) Treatment of certain contracts for providing services,

etc. For purposes of chapter 1

(1) In general. A contract which purports to be a service contract

shall be treated as a lease of property if such contract is properly

treated as a lease of property, taking into account all relevant

factors, including whether or not

(A) the service recipient is in physical possession of the

property,

(B) the service recipient controls the property,

(C) the service recipient has a significant economic or

possessory interest in the property,

(D) the service provider does not bear any risk of substantially

diminished receipts or substantially increased expenditures

if there is nonperformance under the contract,

(E) the service provider does not use the property

concurrently to provide significant services to entities

unrelated to the service recipient, and

(F) the total contract price does not substantially exceed the

rental value of the property for the contract period.

(2) Other arrangements. An arrangement (including a

partnership or other pass-thru entity) which is not described in

paragraph (1) shall be treated as a lease if such arrangement is

properly treated as a lease, taking into account all relevant factors

including factors similar to those set forth in paragraph (1).

26 U.S.C. § 7701(e) (2000). Although the Time Charter in this case does not

“purport[] to be a service contract,” the factors set forth in § 7701(e)(1) are

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No. 08-30268

relevant because § 7701(e)(2) requires the same analysis for other contractual

arrangements that may be “properly treated as a lease,” such as the Time

Charter. Both § 7701(e)(1) and (e)(2) state that the factors are not exclusive and

that “all relevant factors” must be considered.

Before applying these individual factors to the Time Charter and

considering any other relevant factors, we observe that § 7701(e) establishes a

balancing test. This requires us to consider all pertinent information and

determine whether, on balance, the Time Charter is more like a lease or a

service contract. Section 7701(e) gives no guidance as to the weight to be given

to these factors: that determination is left to the court’s discretion.

D. Application of §7701(e)

1. Was the customer in physical possession of the vessel?

Under the Time Charter, Tidewater delivered the vessel to the customer

at a specified port within a certain time period.5 At the end of the charter period,

the vessel was redelivered to Tidewater “free of cargo and with clean tanks” at

a specified port.6 While Tidewater provided a crew that manned the vessel at all

times,7 the vessel and crew were under the general direction and control of the

customer. The government argues that the Tidewater crew operated the vessel

and therefore it remained in Tidewater’s possession. While the crew had

physical possession of the vessel, the customer had significant control over the

5

The Time Charter refers to the Tidewater operating company as “Owner” and the

third party customer as “Charterer.” “[T]he Vessel shall be delivered by the Owners free of

cargo and with clean tanks at any time between the date stated in Box 5 and the date specified

in Box 6 at the port or place stated in Box 7 where the Vessel can safely lie always afloat.”

Part II, Clause 2(a), Time Charter.

6

“The Vessel shall be redelivered on the expiration or earlier termination of this

Charter Party free of cargo and with clean tanks at the port of place as stated in Box 8(I) or

such other port or place as may be mutually agreed.” Part II, Clause 2(d), Time Charter.

7

“The Owners shall provide and pay for all provisions, wages and all other expenses

of the Master, Officers and Crew. . . .” Part II, Clause 7, Time Charter.

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No. 08-30268

vessel and the crew, particularly as to when and where the vessel traveled. This

control was sufficient to give the customer constructive possession of the vessel.

Although Tidewater’s crew was in physical possession of the vessel, this fact is

relatively unimportant in light of the customer’s constructive control of the

vessel.

2. Did the customer control the vessel?

During the charter periods, the vessel and its crew were at the beck and

call of the customer. The customer directed the movement of the vessel, cargo,

and passengers. So long as these directives were safe and within the vessel’s

capabilities, the master and crew were required to fulfill them.8 The customer

could, at its own discretion, lay up the vessel at a safe port for all or any portion

of the charter period,9 or terminate the Time Charter at any time.10 The

customer also had the right to sublet, assign, or loan the vessel to other entities

so long as they were not competitors of Tidewater.11 Furthermore, the customer

8

Part II, Clause 5(a), Time Charter (“The Vessel shall be employed in offshore activities

which are lawful in accordance with the law of the place of the Vessel’s flag and/or registration

and of the place of operation”), Part II, Clause 6(d), Time Charter (“The Vessel will be operated

and the services hereunder will be rendered as requested by the Charterers, subject always

to the exclusive right of the Owners or the Master of the Vessel to determine whether

operation of the Vessel may be safely undertaken.”), Part II, Clause 20, Time Charter (“The

Vessel shall not be ordered nor bound to enter without the Owners’ written permission” any

dangerous port.).

9

“The Charterers shall have the option of laying up the Vessel at an agreed safe port

or place for all or any portion of the Charter Period in which case the Hire hereunder shall

continue to be paid . . . .” Part II, Clause 5(d), Time Charter. One of the five sample Time

Charters, that for the Regent Seahorse, eliminates this provision, however it retains all other

provisions regarding control of the vessel. The period of this Time Charter was only for three

days. Even if we were to examine only this contract, the elimination of this one provision in

a contract of this duration would not change our conclusion that the contract is a lease.

10

“The Charterers may terminate this Charter Party at any time by giving the Owners

written notice as stated in Box 15 and by paying the settlement statement stated in Box 14

and the demobilisation charge stated in Box 16 . . .” Part II, Clause 26(a), Time Charter.

11

“The Charterers shall have the option of subletting, assigning or loaning the Vessel

to any person or company not competing with the Owners, subject to the Owners’ prior

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had the right to make structural alterations to the vessel and to install

additional equipment as it saw fit.12 While the rights to sublet and alter the

vessel were both subject to Tidewater’s prior consent, such consent was not to be

unreasonably withheld.

Thus under the Time Charter, the customer had control of the vessel in the

most important sense of the word. While the crew retained control over the

details of routine operation and maintenance of the vessel, this type of control

is far less important than the type of control exercised by the customer.

Therefore, this factor weighs in favor of the Time Charter being a lease.

3. Did the customer have a significant economic or possessory

interest in the vessel?

Under the Time Charter, Tidewater was responsible for costs of the

vessel’s maintenance, insurance, and all costs associated with the crew.13

Tidewater bore the risk of loss if anything happened to the vessel. The

customer’s only risk of loss was limited to its cargo 14 and any special towing or

anchor handling equipment it required on the vessel.15 The customer did share

approval which shall not be unreasonably withheld. . . .” Part II, Clause 17(a), Time Charter.

12

“The Charterers shall have the option of, at their expense, making structural

alterations to the Vessel or installing additional equipment with the written consent of the

Owners which shall not be unreasonably withheld . . . .” Part II, Clause 23, Time Charter.

The Time Charter for the Gulf Squall eliminates this provision, however, the elimination of

this one provision does not, in our view, lessen the control of the customer over the vessel. See

supra note 10.

13

“The Owners shall provide and pay for all other expenses of the Master, Officers and

Crew; all maintenance and repair of the Vessel’s hull . . .; also, except as otherwise provided

in this Charter Party, for all insurance on the Vessel.” Part II, Clause 7, Time Charter.

14

“Owners shall not be responsible for loss of, damage to, or any liability arising out

anything towed by the Vessel, any cargo laden upon or carried by the Vessel or her tow, the

property of the Charterers or of their contractors and sub-contractors.” Part II, Clause 12(b),

Time Charter.

15

Upon request by the customer, the equipment was placed on the vessel at Tidewater’s

expense. If the equipment was damaged or unusable due to any reason other than Tidewater’s

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No. 08-30268

in some of the benefits of any reduction in operating costs, as the customer paid

many of the day to day operating costs of the vessel, such as fuel and dock fees.16

While the customer shared in these limited savings, the primary economic and

possessory interest in the vessel remained with Tidewater. This factor weighs

against the Time Charter being a lease.

4. Did Tidewater bear the risk of substantially diminished receipts

if there was nonperformance under the Time Charter?

The Time Charter required the customer to “pay Hire for the Vessel . . .

per day or pro rata for part thereof from the time that the Vessel is delivered to

the Charterers until the expiration or earlier Termination of the Charter Party.”

Part II, Clause 10(a), Time Charter. The payment of hire was suspended for

any period the vessel was unable to function “as a result of any deficiency of

Crew or of the Owners’ stores, strike of Master, Officers and Crew, breakdown

of machinery, damage to hull or other accidents to the Vessel.” Part II, Clause

11(a), Time Charter. If the vessel could not perform due to the customer’s

actions, such as damage caused by transporting dangerous or hazardous cargo

or caused by directing the vessel through ice, the payment of hire was not

negligence, “the Charterers shall either provide, or direct the Owners to provide, an equivalent

replacement at the Charterers’ expense.” Part II, Clause 7(b), Time Charter.

16

While the Vessel is on hire the Charterers shall provide and pay for all fuel,

lubricants, water, dispersants, firefighting foam and transport thereof, port

charges, pilotage and boatmen and canal steersmen (whether compulsory or

not), launch hire (unless incurred in connection with the Owners’ business),

light dues, tug assistance, canal, dock, harbour, tonnage and other dues and

charges, agencies and commissions incurred on the Charterers’ business, costs

for security and other watchmen, and of quarantine (if occasioned by the nature

of the cargo carried or the ports visited whilst employed under this Charter

Party but not otherwise.

Part II, Clause 8(a), Time Charter.

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suspended.17 Therefore, Tidewater bore most of the risk of vessel

nonperformance under the Time Charter, and Tidewater has conceded that this

factor weighs in favor of the Time Charter being more like a service contract.

5. Did Tidewater use the vessel concurrently to provide services to

other customers?

Tidewater did not use the vessel for any other customer or its own

purposes during the term of the Time Charter. Under the Time Charter, “[t]he

whole reach and burden and decks of the Vessel shall throughout the Charter

Period be at the Charterer’s disposal.” Part II, Clause 5(c), Time Charter.

Tidewater was allowed only “proper and sufficient space for the Vessel’s Master,

Officers, Crew” and necessary equipment and provisions. Id. Thus the customer

had the full use and enjoyment of the vessel during the period of the Time

Charter, and this factor supports finding that the Time Charter is more like a

lease.

17

“Hire shall not cease in the event of the Vessel being prevented from working as

aforesaid as a result of:

(i) the carriage of cargo as noted in Clause 5(c)(iii) and (iv);

(ii) quarantine or risk of quarantine unless caused by the Master, Officers or Crew

having communication with the shore at any infected area not in connection with the

employment of the Vessel without the consent or the instructions of the Charterers;

(iii) deviation from her Charter Party duties or exposure to abnormal risks at the

request of the Charterers;

(iv) detention in consequence of being driven into port or to anchorage through stress

of weather or trading to shallow harbours or to river or ports with bars or suffering an

accident to her cargo, when the expenses resulting from such detention shall be for the

Charterers’ account howsoever incurred;

(v) detention or damage by ice;

(vi) any act or omission of the Charterers, their servants or agents

Part II, Clause 11(a), Time Charter.

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6. Did the price of the Time Charter substantially exceed the rental

value of the vessel?

If the amount Tidewater received under the Time Charter substantially

exceeded the rental value of the vessel without any charge for services, it

indicates that payment was made not only for the lease of the vessel but for

services as well. Tidewater conceded that the amount received under the Time

Charter included sums attributable to the crew and other expenses and allocated

those amounts accordingly. Therefore, this factor weighs in favor of the Time

Charter being more like a service contract.

III. Conclusion

Our task is to decide whether the Time Charter between the Tidewater

operating company and its customer is more like a lease or a service contract.

We must make this determination because the Time Charter has attributes of

both a lease and a service contract.18 Section 7701(e) does not specify the weight

to be given to its factors; we must therefore determine the weight each factor

deserves. We conclude that the crucial issue is whether Tidewater or the

customer has control of the vessel. As stated above, a lease provides the use of

property to a customer, while a service contract provides a service. Here, the

charterer customer maintains control over every aspect of the use of the vessel.

In our view this is more important than the operational control exercised by the

18

Tidewater argues that we should look to the previous “two-contract” arrangement

used by Tidewater before it employed the 1989 form of Time Charter as evidence that the Time

Charter is more like a lease. Under the previous system, the customer entered into two

contracts with Tidewater entities: one bareboat charter was entered into between the owning

entity and the customer, and a separate contract for services was entered into between the

customer and the operating entity. Tidewater argues that while the paperwork has changed,

the substance of the arrangement with the customer is unchanged. However, Tidewater and

the customer have modified the structure of the transaction by eliminating the bareboat

charter to the customer. “[W]hile a taxpayer is free to organize his affairs as he chooses,

nevertheless, once having done so, he must accept the tax consequences of his choice.” Comm’r

v. Nat’l Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149 (1974). We must evaluate the

tax consequences of the arrangement as it was structured for the years in question.

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No. 08-30268

vessel’s crew. It is also more important than Tidewater’s risk of loss and risk of

nonperformance.

Thus, under the facts of this case, we are satisfied that control is the most

important criterion enumerated in § 7701(e)(1), and that the significant control

the time charterer exercises makes the Time Charter more like a lease than a

service agreement. If a Tidewater employee leased a vehicle from Avis and

operated it himself, this contract, like a bareboat charter, would be a classic

lease. If, on the other hand, the vehicle was leased with a driver employed by

Avis, and the car and driver were at the beck and call of the lessee, the control

the of lessee over the vehicle in this latter arrangement is reduced very little,

and is still more like a lease than a service agreement. We see very little

difference in principle between the lease of a car with a driver and Tidewater’s

Time Charter.

Therefore, when we weigh the § 7701(e) factors in this light, we conclude

that the Time Charter is more like a lease than a service agreement. The

district court’s order granting summary judgment is therefore

AFFIRMED.

15