Opposition — Commissioner v. Texaco Inc.

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MAR 14 {997

No. 96-1107 99

SEER

IN THE

Supreme Cot of the United States ~~

OCTOBER TERM, 1996

COMMISSIONER OF INTERNAL REVENUE.

. Petitioner,

TEXACO INC. AND SUBSIDIARIES,

Respondents.

On Petition for Writ of Certiorari te the

United States Court of Appeals

for the Fifth Circuit

RESPONDENTS’ PRIEF IN OPPOSITION

BUFORD P. BERRY

Counsel of Record

EMILY A. PARKER

DENNIS J. GRINDINGER

Mary A. MCNULTY

R. DAVID WHEAT

THOMPSON & KNIGHT

A Professional Corporation

1700 Pacific Avenue, Suite 3300

Dallas, Texas 75201

(214) 969-1700

JOSEPH M. INCORVAIA

TEXACO INC.

Attorneys for Respondents

Texaco Inc. and Subsidiaries

ACE UR. SEY ERIN

WILSON - EPES PRINTING Co., INC. - 789-0096 - WASHINGTON, D.C. 20001

QUESTION PRESENTED

During the “second oil crisis” over the period 1979-

1981, the Saudi Arabian Government prohibited the re-

sale of Saudi crude at prices higher than those charged

purchasers by the Saudi Government. This restriction on

the resale price of Saudi crude was authorized by the King

of Saudi Arabia and was unilaterally imposed by the

Saudi Government, as part of its price moderation pol-

icy adopted at the urging of the U.S. Government and

other consuming country governments. Was the Saudi

Government restriction a legal restriction within the scope

of Commissioner v. First Security Bank, 405 U.S. 394

(1972), thus barring the Commissioner’s allocation of

additional income to Texaco on sales of Saudi crude under

26 U.S.C. § 482?

LIST OF PARTIES, PARENT COMPANIES,

AND SUBSIDIARIES

The names of all parties appear in the case caption.

Respondent Texaco Inc. has no parent company or pub-

licly held subsidiaries.

TABLE OF CONTENTS

Page

QUESTION PRESENTED ................ i

LIST OF PARTIES, PARENT COMPANIES, AND

SAT a ii

TABLE OF AUTHORITIES .............00. iv

STATUTE AND REGULATION INVOLVED ____.. 1

STATEMENT OF THE CASE........0.0 2

I. COUNTER STATEMENT OF FACTS ...._. 2

II. THE PROCEEDINGS BELOW ............. 7

STE a 7

RESIS ae eT 11

REASONS FOR DENYING THE WRIT... 14

oo ot ESET ATT 27

(iii)

TABLE OF AUTHORITIES

Cases Page

Building & Constr. Trades Council v. Associated

Builders & Contractors, 507 U.S. 218 (1998) ...... 22

Commissioner v. First Security Bank, 405 U.S. 394

TUITE ncsccicensiipenenthienateiaiiddeasdeiissiantiinaisenhinaialieiaieisl bende passim

Estate of Bailey v. Commissioner, 741 F.2d 801

(he | RR Sree ire er ene 16

L. E. Shunk Latex Products, Inc. v. Commissioner,

SEE Ee, Bae Fe pase dinccntediecinssiacanchcteaecteatanitotaitiancnn 24-25

Lehman v. Commissioner, 25 T.C. 629 (1955) ........ 24

Merrion v. Jicarilla Apache Tribe, 455 U.S. 130

CITT <sccniasistacsednnsieesidetinteiidaediphebaaiiadiataaatiieh scien dueacigaindaniai 15, 20

Poe v. Seaborn, 282 U.S. 101 (1930) ................2....... 19

Procter & Gamble Co. v. Commissioner, 961 F.2d

anne ae 8-9, 23, 25

Remington Rand Corp. v. Business Sys., Inc.,

S00. F.2n. Tee (6 CHE. IB8!) ewe, 16

Republic of Argentina v. Weltover, Inc., 504 U. S.

| RSS es ne 20-21

Saudi Arabia v. Nelson, 507 U.S. 349 (1998) .......... 21

South-Central Timber Dev., Inc. v. Wunnicke, 467

Ri Ae: ED ‘adesiencdianintncteceeeabenniandideciisasodiuaaiaal 21, 22

United States v. Basye, 410 U.S. 441 (1973) ...8, 12, 14, 17

United States v. Lulac, 793 F.2d 686 (5th Cir.

DI visa sivichdicdai lips hamish ddsaeeetlateattataindaceinanaimincces 16

United States v. Winstar Corp., 116 S. Ct. 2432

TIED itn sits ihc daceaala a ass Noiss nk ccansstiencdianaaaantalnaiaitcnstamatens 15, 20

Statutes, Regulations, and Other

es iar a eacnre eneebeaconmuaaaeantan 7-8, 11-12

26 U.S.C. § 482 (amended 1986) ................................. passim

Be ee iii cts asin Ninotastcscuecyeanioiacobiad 5

te PD giciacchaciaisanercticreniscenscataneciblintcenens 5

26 C.F.R. §§ 1.482-1(a), (b) (1994) -......-22002... 2

26 C.F.R. § 1.482-1(b) (1) (redesignated 1993) ...... 1

ae ee EO CED citeenccaneseeas 1-2, 13, 17

26 C.F.R. §§ 1.482-1(h) (2), (j) (1) (1994) -....0....... 23

26 C.F.R. §§ 1.482-1T (a), (b) (1993) (amended

EE sbiectiiaidicedinnieacenhbeaiiiciccanibiarsemaieieti baits 2

TABLE OF AUTHORITIES—Continued

Page

26 C.F.R. § 1.901-2(a) (2) (i) (1983) (amended

| oe seeintecialieamiladdeuiicatsiadlahaiaiitaciat ced es 20

Pe ae |) | Pe eee eee ene 20-21

IN THE

Supreme Court of the United States

OCTOBER TERM, 1996

No. 96-1107

COMMISSIONER OF INTERNAL REVENUE,

. Petitioner,

TEXACO INC. AND SUBSIDIARIES,

Respondents.

On Petition for Writ of Certiorari to the

United States Court of Appeals

for the Fifth Circuit

RESPONDENTS’ BRIEF IN OPPOSITION

STATUTE AND REGULATION INVOLVED

The controlling law in this case is section 482 of the

Internal Revenue Code of 1954 and the Treasury regula-

tion issued under section 482, as in effect during the

years in issue (1979-1981). 26 U.S.C. § 482 (amended

1986); 26 C.F.R. § 1.482-1A(b)(1).22. The Commis-

sioner properly quotes the text of section 482 and the

Treasury regulation that defines the scope and purpose

of section 482, as in effect during the years in issue.”

126 C.F.R. § 1.482-1A(b) (1) was redesignated from 26 C.F.R.

§ 1.482-1(b) (1) in 1998. This regulation applies to taxable years

beginning on or before April 21, 1993. T.D. 8470, 58 Fed. Reg.

5263, 5271 (1993).

* The Commissioner properly quotes section 482 as in effect dur-

ing 1979-1981, except that the asterisks at the end of the Commis-

sioner’s quotation of section 482 are not appropriate. Petition for

The controlling law in this case is identical to the statute

and regulations considered by the Supreme Court in Com-

missioner v. First Security Bank, 405 U.S. 394 (1972)—

the controlling precedent in this case.* Unless otherwise

indicated, Respondents, Texaco Inc. and Subsidiaries

(“Texaco”), will refer hereafter only to the Internal Reve-

nue Code of 1954 and the Treasury regulations in effect

during 1979-1981.

STATEMENT OF THE CASE

I. COUNTER STATEMENT OF FACTS

Texaco disagrees with the Commissioner’s statement of

facts. Rather than point out each omission of fact and

resulting mischaracterization made by the Commissioner,

Texaco will properly state the facts found by the Tax

Court in this case.

The period 1979 through 1981 has been referred to as

the “second oil crisis.” * Pet. App. 41a. Over this period,

crude oil prices almost tripled 23 a result of supply uncer-

a Writ of Certiorari (‘‘Pet.”) 2. Another sentence was added

to section 482, but it did not become effective until after 1986.

3 The Commissioner also cites temporary regulations 26 C.F.R.

§§ 1.482-1T(a) and (b) (effective for taxable years beginning after

April 21, 1993), which were replaced with final regulations 26

C.F.R. §§ 1.482-1(a) and (b) (effective for taxable years beginning

after October 6, 1994). Pet. 2 n.1. These temporary and final regu-

lations are not applicable in this case. Furthermore, the Commis-

sioner’s statement that the 1993 temporary regulation “‘does not

alter the provisions of relevance to this case” is incorrect. Jd. The

second sentence in the applicable regulation (26 C.F.R. § 1.482-

1A(b)(1)) is deleted from the 1993 temporary regulation. The

Supreme Court relied, in part, on this sentence in First Security.

405 U.S. at 404-05. The Fifth Circuit and the Tax Court similarly

relied on this provision of the regulation. Appendix to the Petition

for a Writ of Certiorari (“Pet. App.”) 8a, 105a.

4The “first oil crisis’ occurred when world crude oil prices

increased fourfold over a three-month period following the out-

break of the Arab-Israeli war on October 7, 1973. Pet. App. 33a-35a.

tainties caused by the Iranian Revolution, the takeover of

the U.S. Embassy in Iran, the U.S. trade embargo against

Iran, and the Iran-Iraq war. Pet. App. 40a-41a, 65a. In

an effort to relieve the crisis, the U.S. Government and

the governments of the other consuming countries re-

peatedly urged the Saudi Government to moderate crude

oil prices. Pet. App. 42a, 68a-75a, 113a n.35, 114a. In

response to these requests, the Saudi Government both

increased its production and set its official selling price

(“OSP”) of Saudi crude lower than the selling prices set

by other oil-producing countries for crude oils of similar

grade or quality. As part of this price moderation policy,

the Saudi Government, with the approval of the King,

mandated that purchasers of its crude not resell Saudi

crude for more than the OSP. Pet. App. 42a-45a, 120a-

122a. The Tax Court found that “[p]rominent U.S. offi-

cials believed that the [Saudi Government’s] price mod-

eration policies were designed to obtain the defense and

foreign policy support of the United States and to meet

the need for stability in the world economy.” Pet. App.

68a.

The Saudi Government sold its crude by way of the

Arabian American Oil Company (“Aramco”) to the

Aramco shareholders, including Texaco, and to Petromin,

the Saudi Arabian national oil company. The Aramco

poration (“Exxon”), Chevron Corporation (“Chevron”), and Mobil

Oil Corporation (“Mobil”) (or their predecessor corporations)

owned all of the stock of Aramco. Pet. App. 19a. In 1933, Aramco

acquired the oil concession for Saudi Arabia from the Saudi Gov-

ernment. Pet. App. 18a. By 1977, however, the Saudi Government

had taken over 100 percent ownership of Aramco’s oil-producing

assets, and Aramco merely provided services to the Saudi Govern-

ment for a fee. Pet. App. 33a. The Saudi Government’s takeover

of Aramco was an exercise of its “sovereign power” and “was

forced upon the Aramco shareholders against their will.” Pet. App.

142a. The Saudi Government’s actions followed similar actions by

other oil-exporting countries, who terminated concessions and

nationalized or expropriated producing operations in their countries

during the 1970s. Pet. App. 29a-31la.

shareholders and Petromin then marketed Saudi crude to

customers who transported the crude to refineries located

throughout the world. Pet. App. 19a & n.4, 22a-23a, 25a,

32a-33a, 145a. The Saudi Government mandated that the

Aramco shareholders and purchasers from Petromin not

resell Saudi crude at prices higher than the OSP. Pet. App.

123a-124a. This restriction was initially communicated to

the Aramco shareholders by a letter, dated January 23,

1979, from the Petroleum Ministry of Saudi Arabia, signed

by Minister Ahmed Zaki Yamani (referred to as “Letter

103/Z”). Pet. App. 3a, 42a-44a. Letter 103/Z was

unilaterally issued, and the Aramco shareholders did not

negotiate, solicit, urge, or even influence the issuance of

Letter 103/Z. Pet. App. 114a, 148a-149a. The Saudi

Government restriction applied to all sales 0. Saudi crude

by the Aramco shareholders, whether to related or

unrelated customers. Pet. App. 133a. Texaco and the

other Aramco shareholders were required to comply with

the restriction by the Saudi Government and by the gov-

ernments of the consuming countries, including the U.S.

Government. Pet. App. 68a-75a, 124a-127a, 134a-155a.

The Tax Court found that, “[a]fter the [Saudi Govern-

ment] restriction was issued, official U.S. policy was

strongly in favor of enforcing the restriction and seeing

that the Saudi policy toward moderation was carried out.”

Pet. App. 68a. The Tax Court concluded that the Saudi

Government restriction was “the virtual equivalent of

law.” Pet. App. 158a; accord Pet. App. 6a.

The Saudi Government restriction applied to the sale

of Saudi crude and thus assured delivery of Saudi crude

into consuming countries at the OSP. The restriction did

not apply to the sale of products refined from Saudi crude,

and the Saudi Government recognized that it “could not

control product prices” in the consuming countries. Pet.

App. 16la. In public statements, however, Minister

Yamani stressed that the consuming country governments

were responsible for controlling refined product prices.

Pet. App. 45a-46a, 48a, 52a-53a, 94a-95a, 161a-162a.

anette

osasae

Many consuming countries had product price controls in

effect during 1979-1981, and certain countries directly

established the price of refined products by reference to

the import price of crude. Officials of consuming country

governments—including the United States, the United

Kingdom, Germany, France, Italy, the Netherlands, and

Japan—understood that the restriction was imposed to

ensure that Saudi crude reached the consuming countries

at the lower Saudi price. Pet. App. 68a-75a, 124a-127a.

Texaco had to comply with the Saudi Government re-

striction to have access to Saudi crude. Pet. App.

57a, 142a-143a. Continued access to Saudi crude was

critical to Tewaco, because Saudi crude made up more

than seventy-five percent of its international crude oil

supply during the years in issue. Pet. App. 4la. If Tex-

aco had violated the restriction, the Saudi Government

could have cut off Texaco’s access to Saudi crude, ex-

cluded Texaco from Saudi Arabia, or nationalized Tex-

aco’s assets in Saudi Arabia. Pet. App. 57a-60a, 142a-

144a & n.46. In addition, the consuming countries had

established an elaborate worldwide system for monitoring

the prices at which crude was bought and sold, and this

monitoring ensured compliance with the Saudi Govern-

ment restriction. Pet. App. 153a-154a.

Texaco International Trader Inc. (“Textrad”), a

domestic subsidiary of Texaco Inc., was the international

trading company for the Texaco group during the period

at issue. Pet. App. 23a. Textrad acquired Saudi crude

® Texaco Inc. is the parent corporation of a group of domestic

and foreign corporations engaged in the production, refining, trans-

portation, and marketing of crude oil and refined products in the

United States and foreign countries. Respondents are the members

of the Texaco group that joined in Texaco’s U.S. consolidated

income tax return. Pet. App. 18a. In general, foreign corporations

cannot join in a consolidated return (26 U.S.C. § 1504(b) (3)) and

are not directly subject to U.S. tax on their foreign income, but

the foreign income of controlled foreign corporations is indirectly

subject to U.S. tax under 26 U.S.C. §§ 951-964.

from Aramco at the OSP and, in compliance with the

Saudi Government restriction, resold Saudi crude to Tex-

aco’s affiliates and to unrelated customers at prices not

higher than the OSP. Texaco’s foreign and domestic affili-

ates refined Saudi crude and other crude into products

for sale in the countries where they operated. Pet. App.

2a, 23a-25a, 187a. Texaco’s affiliates reported profits

from the sale of products refined from Saudi crude in their

tax returns for the consuming countries in which they

operated, including the United States, the United King-

dom, Belgium, Germany, Italy, and Sweden.” Pet. App.

24a-25a, 72a-74a nn.14-18, 94a.

During the period at issue, Textrad sold approximately

thirty-four percent of its Saudi crude (780 million bar-

rels) to Texaco’s refining affiliates. Pet. App. 3a, 24a.

Of this amount, approximately 275 million barrels were

sold to Texaco’s domestic refining company and 505 mil-

lion barrels were sold to Texaco’s foreign refining affiliates.

Pet. App. 3a-4a. In addition, Textrad sold approximately

twenty-two percent (494 million barrels) of its Saudi

crude to Caltex Petroleum Corporation (“Caltex”).®

Textrad also sold almost twenty percent (444 million

barrels) of its Saudi crude to customers that were com-

pletely unrelated to Texaco.® Pet. App. 4a, 24a. The

7 One of Texaco’s foreign affiliates was Texas Overseas (Bermuda)

Limited (“TOBL’”), a Bermuda corporation that refined crude

at a refinery located in Bahrain. TOBL was not subject to tax in

Bermuda or in Bahrain. The Tax Court found that this arrange-

ment was unrelated to the Saudi Government restriction because

TOBL’s operations commenced in 1976. Pet. App. 179a-18la. The

Commissioner made an alternative adjustment allocating TOBL’s

income to Textrad, and the parties settled that adjustment.

8 Caltex is a domestic corporation owned fifty percent by Texaco

Inc. and fifty percent by Chevron. Pet. App. 23a.

® Textrad purchased and sold 367 million barrels of Saudi crude

to unrelated customers at the OSP. Textrad purchased and sold

77 million barrels of Saudi crude to unrelated customers expressly

designated by the Saudi Government to receive “war relief” crude.

Pet. App. 24a, 65a-66a.

volume and pattern of Textrad’s sales and other disposi-

tions of Saudi crude during 1979-1981 were consistent

with its sales and other dispositions in prior years.” Pet.

App. 4a, 64a, 85a-86a, 91a.

The Commissioner increased Textrad’s income for

1979-1981 on its sales of Saudi crude to Texaco’s foreign

affiliates under sections 61 and 482 of the Internal Reve-

nue Code.“ The Commissioner alleged that Textrad

shifted profits attributable to the lower cost of Saudi crude

out of Texaco’s U.S. taxable income by selling Saudi

crude at the OSP to Texaco’s foreign affiliates. Pet. App.

2a, 98a. The Commissioner made a similar adjustment

with respect to Exxon. Pet. App. 99a-100a. The Tax

Court consolidated Texaco’s and Exxon’s cases for trial

of this adjustment. Pet. App. 14a n.1.

Il. THE PROCEEDINGS BELOW

A. Tax Court. Following a five-week trial, the Tax

Court issued a detailed opinion numbering almost 200

pages. The Tax Court held that “[uJnder the rule of

Commissioner v. First Security Bank, 405 US. 394

(1972), its assignment of income predecessors, and its

progeny,” the Saudi Government restriction “precluded a

section 61 or section 482 adjustment to the income of

10 In addition to selling Saudi crude, consistent with its historical

business practices, Textrad also refined Saudi crude and exchanged

Saudi crude for non-Saudi crude in order to facilitate Texaco’s

refining operations. Pet. App. 88a-86a, 89a-91a. Textrad realized

Textrad could not have changed its operations in order to capture

additional profits from Saudi crude because “deviations from his-

11 The Commissioner also increased Textrad’s income on its sales

of Saudi crude to Caltex, but that adjustment was only a small

portion of the total adjustment at issue in this case.

[Textrad] in this case.” Pet. App. 187a. The Tax Court

noted that First Security and related cases “stand for the

proposition . . . that ‘in order to be taxed for income, a

taxpayer must have complete dominion over it.’” Pet.

App. 111a-112a, citing First Security, 405 U.S. at 403.

If, as in First Security, “the receipt of income is prohibited

by law, the Commissioner is prohibited from allocating

such income pursuant to section 482.” Pet. App. 106a.

Addressing the Commissioner’s adjustment under sec-

tion 61, the Tax Court recognized that United States v.

Basye, 410 U.S. 441, 449 (1973), and other assignment

of income cases hold that “ ‘income must be taxed to him

who earns it.”” Pet. App. 115a. It noted, however, that

in applying the assignment of income doctrine, this Court

“has consistently distinguished between taxpayers who

voluntarily relinquish the right to receive income and

taxpayers who are denied the right to receive income by

operation of law.” Jd. Relying on First Security, the Tax

Court concluded that “a taxpayer who is legally pro-

hibited from receiving income and who does not in fact

receive such income, cannot be said to have ‘earned’ the

income under a section 61 analysis.” Pet. App. 116a.

Therefore, under the assignment of income doctrine, “the

Commissioner cannot allocate income to a taxpayer who

is legally prohibited from receiving it.” Pet. App. 118a.

The Tax Court then determined whether the principle

of First Security applied under the facts in this case.”

12 The Tax Court initially addressed the Commissioner’s concern

that “[i]ndiscriminate deference to foreign law [in applying section

482] would open the door to wide-scale collusion between taxpayers

and foreign sovereigns engaged in commercial activity.” Pet. App.

114a. Because of the potential for collusion, the Tax Court applied

“a ‘heightened scrutiny’ of the evidence” of the Saudi Government

restriction and found “no evidence” of collusion. Pet. App. 113a-

114a & n.36. The Tax Court also rejected the Commissioner’s argu-

ment that the principle ~ /. st Security did not apply where

receipt of the income in je on was precluded by foreign as

opposed to domestic law. Fe: App. 1lla-114a, citing Procter &

The Tax Court examined “whether the [Saudi Govern-

ment] restriction constituted a valid and binding pro-

hibition imposed by the [Saudi Government] against the

sale of Saudi crude oil for an amount in excess of Saudi

OSP.” Id. The Tax Court found that the Saudi Govern-

ment restriction was unilaterally imposed on Texaco and

other resellers of Saudi crude and “was authorized by the

King.” ** Pet. App. 119a-122a. The Tax Court also

found that Texaco was required to comply with the restric-

tion by both the Saudi Government and consuming country

governments. Pet. App. 153a-155a.

In response to the Commissioner’s argument that the

restriction was merely a contract term, the Tax Court

stated:

We agree with [the Commissioner] that, if the restric-

tion was a mere contract term, negotiated by [Texaco

and Exxon] in the context of a commercial relation-

ship, then the facts in First Security and Procter &

Gamble would be distinguishable from the facts in

this case. In such a circumstance, the restriction

would not have deprived [Texaco and Exxon] of the

power to control the location of income, and the rule

of First Security and subsequent cases would not

apply. If, on the other hand, the restriction required

[Texaco and Exxon] to price Saudi crude as they

did, then [the Commissioner’s] allocation cannot

stand.

Gamble Co. v. Commissioner, 961 F.2d 1255 (6th Cir. 1992). The

Commissioner did not make that argument on appeal to the Fifth

Circuit and does not make that argument in her petition. See

infra note 23.

18 The Tax Court found that the Saudi Government restriction

“applied to all sales of Saudi crude”; was “in effect during the

period at issue”; applied to “all four Aramco shareholders”; and

“was imposed upon other than the Aramco shareholders.” Pet.

App. 128a, 124a, 188a, 158a. The Tax Court found “no evidence

that certain purchasers were not required to resell Saudi crude

at Saudi OSP.” Pet. App. 124a.

Pet. App. 134a. The Tax Court found that “the restric-

tion was not a negotiated contract term that [Texaco and

Exxon] had the option of taking or leaving; the Saudis

issued the restriction without discussion or negotiation,”

in “language of a mandatory, nonnegotiable, admonish-

ing nature.” Pet. App. 145a, 146a. The Tax Court

found “no evidence that [Texaco and Exxon] urged the

[Saudi Government] to issue the resale price restriction

at issue here,” or that the restriction was even the result

of Texaco’s and Exxon’s “influence.” Pet. App. 149a.

The Saudi Government issued the restriction with “an

underlying warning that failure to comply with Saudi

requirements would have serious repercussions.” Pet.

App. 146a.

The Tax Court also rejected the Commissioner’s argu-

ment “that the restriction was merely a commercial term

consented to in the context of a commercial relationship.”

Pet. App. 137a. The Tax Court examined the “historical

relationship” and “the specific facts leading up to the

[Saudi Government] restriction.” Pet. App. 143a. While

the Tax Court recognized that “the relationship between

{Texaco and Exxon] and the [Saudi Government] was in

part commercial in nature in the sense that it involved the

purchase and sale of crude oil,” it found that the Saudi

Government restriction itself “was not commercial in

nature.” Pet. App. 143a-144a. Based on all the facts,

the Tax Court concluded that the Saudi Government

restriction was not “a ‘commercial’ contract pricing term

in which [Texaco and Exxon] made a negotiated, calcu-

lated concession.” Pet. App. 149a. In addition, the Tax

Court reasoned that “the Saudi power over the pricing of

its crude was sovereign in nature from the inception of

its relationship with [Texaco and Exxon]”; that “the sub-

sequent takeover of Aramco by the [Saudi Government]

was another exercise of the [Saudi Government’s] sover-

eign power”; that the setting of crude prices by member

countries of the Organization of Petroleum Exporting

Countries (“OPEC”) “was inherently sovereign in na-

ture”; and that the penalties for violating the restriction

(cut off of crude supplies, nationalization of assets, and

exclusion from Saudi Arabia) were not the type of pen-

alties “that would have existed in a normal contractual

relationship between private parties.” Pet. App. 142a,

143a, 144a n.46.

The Commissioner also argued that the Saudi Govern-

ment restriction was consensual because Texaco and

Exxon “were not compelled to purchase Saudi crude

on the terms and conditions sought by the Saudis.” Pet.

App. 147a. The Tax Court found that Texaco’s and

Exxon’s relationship with the Saudi Government “went to

the very heart of [Texaco’s and Exxon’s] livelihood as

international marketers of crude oil to third parties and

to their refining affiliates.” Id. Texaco and Exxon did

not have the “choice” whether to buy Saudi crude, be-

cause “to choose to cut off a significant percentage of

their crude supply was not a realistic option.” Pet. App.

148a.

Based on all the facts, the Tax Court concluded that

“the Saudi restriction was the virtual equivalent of law

and constituted a valid and binding prohibition against

the sale of Saudi crude for an amount in excess of Saudi

OSP.” Pet. App. 158a. The Tax Court then found that

“[Texaco and Exxon] complied with the restriction in

all material respects.” Pet. App. 187a. Therefore, the

Tax Court held that the Saudi Government restriction

“precluded a section 61 or section 482 adjustment” to

Textrad’s income. Id.

B. Fifth Circuit. The Commissioner appealed to

the Fifth Circuit, which unanimously affirmed the Tax

Court. The Fifth Circuit reviewed the Tax Court’s

14 The Tax Court has not entered a final decision in Exxon’s

case, due to other issues not yet resolved. Any appeal of Exxon’s

case likely would be to the Second Circuit.

factual findings and determined that they were “not

clearly erroneous.” Pet. App. 6a. The Fifth Circuit

concluded that “[t]he Tax Court’s findings of fact fully

support[ed]” its conclusions that the Saudi Government

restriction “had the effect of a legal restriction in Saudi

Arabia” and “should be given the effect of law for pur-

poses of §§ 482 and 61.” Id.

The Fifth Circuit “agree[d] with the Tax Court’s legal

conclusion that the teaching of Commissioner v. First

Security Bank, 405 U.S. 394 (1972), bars the Com-

missioner from allocating income to Textrad on its sales

of Saudi crude under § 482. Because the sales price of the

crude is governed by [the Saudi Government restriction],

Texaco did not have the power to control the sales price

of the oil.” Pet. App. 6a (parallel citations omitted). The

Fifth Circuit pointed out, as the Supreme Court did in First

Security, that “the Commissioner’s own regulations for

implementing § 482 contemplate that the controlling in-

terest ‘must have “complete power” to shift income among

its subsidiaries.’” Pet. App. 8a. The Fifth Circuit held:

It is precisely this ability to control the flow of its

income that Texaco lacked. The Tax Court found,

and we agree, that [the Saudi Government restric-

tion] had the force and effect of law, that Textrad

was obligated to comply with its requirements, and

that it did so comply. Because Textrad lacked the

power to sell Saudi crude above the OSP, reallocation

under § 482 is inappropriate.

Pet. App. 10a.

The Fifth Circuit rejected the Commissioner’s assign-

ment of income argument and reliance on the Supreme

Court’s decision in United States v. Basye, 410 US.

441 (1973). The Fifth Circuit concluded that “nothing

in Basye is contrary to the principles discussed above.”

Pet. App. lla. The Fifth Circuit examined the Court’s

reasoning in Basye and concluded that it “turned on the

consensual nature of the agreement and is entirely con-

sistent with the principles of control expressed in the

regulations adopted under § 482 and in First Security.”

Id. By contrast, “where, as here, the taxpayer lacks the

power to control the allocation of the profits, reallocation

under § 482 is inappropriate.” Pet. App. 12a.

The Fifth Circuit also stated that the Commissioner’s

proposed allocation would not “be consistent with § 482’s

goal of achieving tax parity between controlled and un-

controlled taxpayers.” Jd. The standard of tax parity

as reflected in the Commissioner’s regulations is “an un-

controlled taxpayer dealing at arm’s length with another

uncontrolled taxpayer.” J/d., citing 26 C.F.R. § 1.482-1A

(b)(1). The Fifth Circuit reviewed the record evidence

and concluded that it “fully supports the Tax Court’s

findings that Textrad sold significant amounts of Saudi

crude to unrelated customers at the same OSP it sold

to its affiliates, that the volume of Textrad’s sales of

Saudi crude to unrelated customers during this period

remained generally consistent with historic levels, and

that any changes in Textrad’s sales to its affiliates and

its unrelated customers during this period had no

nexus with the restrictions imposed by [the Saudi

Government].” Pet. App. 12a-13a. Therefore, the Fifth

Circuit concluded, “the Tax Court did not err in con-

cluding that the Commissioner failed to demonstrate any

disparity between Texaco’s treatment of its affiliates and

its unrelated customers as a result of the Saudi price

restrictions. Thus, under the regulation’s tax parity stand-

ard, the Commissioner’s allocation of Texaco’s income

under § 482 is improper.” Pet. App. 13a.

REASONS FOR DENYING THE WRIT

The issue in this case—whether the Saudi Government

restriction was a legal restriction or a consensual agree-

ment—is narrow, largely fact-based, of no general impor-

tance, and correctly decided by the courts below. The

courts below found that, during the period 1979-1981,

the Saudi Government required Texaco to charge below-

market prices on all sales of Saudi crude, whether to

related or unrelated customers. In compliance with that

mandate, Textrad actually sold 367 million barrels of

Saudi crude to unrelated customers at the Saudi-mandated

price. Applying the principles established in Commis-

sioner v. First Security Bank, 405 U.S. 394, 404 (1972),

the courts below found that the Saudi Government restric-

tion deprived Texaco of the “ ‘complete power’ to shift

income among its subsidiaries.” Pet. App. 8a, 10a, 106a,

158a. The courts below also found that recognition of

the restriction achieved “tax parity” since there was no

“disparity between Texaco’s treatment of its affiliates and

its unrelated customers as a result of the Saudi price

restrictions.” Pet. App. 13a; accord 186a-187a.

The Commissioner primarily urges review on the ground

that the Saudi Government restriction was a “consensual

commercial arrangement,” thereby allegedly making the

principles of United States v. Basye, 410 U.S. 441 (1973),

controlling. The courts below thoroughly considered the

Commissioner’s argument and found that there was “no

evidence” that the price restriction was a product of

“collusion” or “negotiations” between Texaco and the

Saudi Government, or that Texaco solicited or even

“influence[d]” issuance of the restriction. Pet. App. 114a,

148a, 149a; accord Pet. App. 5a. Rather, they deter-

mined that the restriction was “a valid and binding prohi-

bition” authorized by the King and unilaterally imposed on

Texaco and other resellers of Saudi crude oil to ensure de-

livery of Saudi crude to refiners at the Saudi OSP, as part

eS Oe —

of the Saudi Government’s price moderation policy adopted

at the urging of the U.S. Government and other consuming

country governments. Pet. App. 3a, 6a, 122a, 158a.

Under these facts, there is no support for the Commis-

sioner’s argument that the Saudi Government restriction

was a consensual agreement because Saudi Arabia was

also the supplier of Saudi crude oil. This Court, in other

contexts, has frequently made clear that governments

engaged in commerce retain their sovereign power to

regulate in the public interest. See, e.g., United States v.

Winstar Corp., 116 S. Ct. 2432, 2458, 2465-67 (1996);

Merrion v. Jicarilla Apache Tribe, 455 U.S. 130, 145-47

(1982). The Tax Court expressly found that the Saudi

Government restriction itself “was not commercial in

nature.” Pet. App. 144a. The Commissioner offers no

good reason for this Court to second-guess this determina-

tion under the facts in this case.

The Commissioner also fails to demonstrate that this

case is of any broad or continuing significance. The proper

characterization of the Saudi Government restriction is of

importance to only two taxpayers and, then, only for the

years 1979-1981. The Commissioner’s assertion that the

result in this case will encourage collusion between tax-

payers and foreign governments, at the expense of the

U.S. Treasury, is simply not justified. The Tax Court

properly addressed this concern and applied “heightened

scrutiny” of the Saudi Government restriction due to its

foreign origin and Texaco’s commercial relationship with

the Saudi Government. There is no reason for this Court

to disturb the Tax Court’s finding that there was no evi-

dence of collusion between Texaco and the Saudi Govern-

ment in this case. Pet. App. 113a-114a. Thus, the peti-

tion should be denied.

1. The decision below rests upon the established legal

principle that the Commissioner is not free “to allocate

income to a party prohibited by law from receiving it.”

Pet. App. 7a, citing First Security, 405 U.S. at 404. As

this Court observed more than two decades ago, “[iJn

cases dealing with the concept of income, it has been

assumed that the person to whom the income was attrib-

uted could have received it.” First Security, 405 U.S. at

403. In applying section 482, the central question is

whether the controlling taxpayer has “complete dominion”

over the income that the Commissioner seeks to allocate—

that is, it must have “ ‘complete power’ to shift income

among its subsidiaries.” Jd. at 403, 404. “It is only

where this power exists, and has been exercised in such a

way that the ‘true taxable income’ of a subsidiary has

been understated, that the Commissioner is authorized

to reallocate under § 482.” Jd. at 404-05. Applying

those standards, the Fifth Circuit agreed with the Tax

Court that, given the legal, mandatory nature of the

restriction imposed by the Saudi Government, “it [was]

precisely this ability to control the flow of its income

that Texaco lacked.” Pet. App. 10a; see First Security,

405 U.S. at 405 (power to control income “hardly in-

cludes the power to force a subsidiary to violate the

law”).

The Fifth Circuit also stated that, in this case, reallo-

cation would not “be consistent with § 482’s goal of

achieving tax parity between controlled and uncontrolled

15 According to the Commissioner, “[t]he court of appeals erred

in implying that whether the resale price restriction in Letter

103/Z was a Saudi ‘law’ was a question of fact to be reviewed

under the clearly erroneous standard.” Pet. 20 n.12. But this

is an obvious misreading of the Fifth Circuit’s opinion. That

court plainly stated: “Based on the Tax Court’s factual findings,

which are not clearly erroneous, we agree that Letter 103/z had

the effect of a legal restriction in Saudi Arabia.” Pet. App. 6a

(emphasis added). That analysis is entirely correct. The Fifth

Circuit reviewed the legal conclusions of the Tax Court for error

and the factual findings on which they were based for clear error.

See United States v. Lulac, 793 F.2d 636, 642 (5th Cir. 1986) ;

Estate of Bailey v. Commissioner, 741 F.2d 801, 803-04 (5th Cir.

1984); Remington Rand Corp. v. Business Sys., Inc., 830 F.2d

1260, 1268-65 (8d Cir. 1987).

taxpayers.” Pet. App. 12a, citing First Security, 405 U.S.

at 407. The governing regulation establishes that “[t]he

purpose of section 482 is to place a controlled taxpayer

On a tax parity with an uncontrolled taxpayer.” 26 C.F.R.

§ 1.482-1A(b)(1); see Pet. App. 12a. In compliance

with the Saudi Government restriction, Textrad sold 367

million barrels of Saudi crude “to unrelated customers

at the same OSP it sold to its affiliates.” Pet. App. 12a.

These transactions establish a benchmark of “arm’s length”

sales against which the sales of Saudi crude to affiliated

buyers can be measured. Thus, there is no basis to con-

clude that Texaco was improperly shifting income by

selling Saudi crude to its own subsidiaries at the OSP.2®

2.A. Relying on Basye, the Commissioner’s principal

argument is that the holding of First Security does not

apply to a “consensual agreement.” ” See Pet. 12, quoting

Basye, 410 U.S. at 453 n.13. Both courts below agreed

with this proposition but rejected-the Commissioner’s con-

tention that the Saudi Government restriction was a con-

sensual agreement. Pet. App. 10a-12a, 134a, 146a-149a.

The Commissioner continues to argue that the Saudi

Government restriction was consensual. Pet. 19 (“the

Saudi resale price restriction represents a consensual, com-

16 The Tax Court found that the volume of Textrad’s sales of

Saudi crude to unrelated customers during the years at issue re-

mained consistent with historic levels and that any changes in

Textrad’s pattern of sales were not related to the Saudi Government

restriction. Pet. App. 64a.

17In Basye the deflection of income did not result from a legal

restriction imposed by a government. Rather, Basye involved an

agreement between a partnership of doctors and a health mainte-

nance organization to provide medical services in return for a base

compensation plus the payment of retirement benefits to a trust.

This Court expressly distinguished First Security on the basis

that it “involved a deflection of income imposed by law, not an

assignment arrived at by the consensual agreement of two parties

acting at arm’s length as we have in the present case.” 410 U.S.

at 453 n.138.

mercial arrangement”); see also Pet. 17 (“consensual ar-

rangement”), 18 (“consensual commercial arrangement”).

But the contrary conclusion of the courts below is fully

supported, and compelled, by the record. Furthermore,

the characterization of one particular restriction, of nar-

row application at the time and long since defunct, does

not merit review by this Court. While the Commissioner

argues that her view “finds support not only in the facts

of this case but also in a long and consistent line of

decisions of this Court concerning governmental immu-

nity,” a review of the relevant facts and law leads to the

opposite conclusion. Pet. 19-20 (citation omitted).

The Tax Court concluded that “there is no evidence

that would support [the Commissioner’s] claim that the

price restriction was a product of voluntary negotiations

between [Texaco and Exxon] and the [Saudi Govern-

ment].” Pet. App. 148a. To the contrary, it found “that

the restriction was not a negotiated contract term that

[Texaco and Exxon] had the option of taking or leaving;

the Saudis issued the restriction without discussion or

negotiation.” Pet. App. 145a; see also id. at 146a (noting

that the language of Letter 103/Z was “of a mandatory,

non-negotiable, admonishing nature”). The Tax Court

also reviewed in detail the historical background of the

dealings between Texaco and Saudi Arabia. In particular,

it pointed out that Saudi Arabia, in a prior “exercise of

[its] sovereign power,” had taken over Aramco against

the will of its shareholders (including Texaco). Pet. App.

142a. Observing that Saudi Arabia “possessed the ulti-

mate weapon of nationalization,” the court found that

“[t]here was an aspect of control by the Saudis here that

went far beyond a private party’s contractual power to

negotiate and enforce a contract term.” Pet. App. 142a,

143a. That degree of control, likewise, supported the

conclusion that the Saudi Government restriction “was not

a ‘commercial’ contract pricing term in which [Texaco

and Exxon] made a negotiated, calculated concession.”

Pet. App. 149a.

Since there is no evidence that Texaco solicited, nego-

tiated, or influenced the restriction, the Commissioner

argues that Texaco consented to the restriction by “con-

senting to purchases of oil subject to the Saudi restric-

tion.” Pet. 18. The issue under section 482 is not

whether Texaco could have avoided the restriction by not

purchasing Saudi oil. The issue is whether Texaco could

have purchased the oil and resold it at a price higher

than the restricted price, thus earning on those sales the

profit that the Commissioner seeks to allocate. See First

Security, 405 U.S. at 404-05. The courts below found

that, as a result of the Saudi Government restriction,

Texaco did not have the choice to sell Saudi crude for

more than the restricted price. Pet. App. 6a, 12a, 158a.

Further, under the Commissioner’s argument, every deflec-

tion of income that results from a legal restriction would

be consensual. For example, the banks in First Security

chose to offer credit life insurance to their customers.

Likewise, the husband and wife in Poe vy. Seaborn, 282

U.S. 101, 117 (1930), chose to live in Washington state

and thus were subject to Washington law under which

the husband’s wages were the income of the mar’‘al com-

munity. But the choices that subjected the taxpayers to

legal restrictions in these cases did not make the resulting

deflection of income “consensual.” Likewise, Texaco’s

purchase of Saudi crude did not make any deflection of

income resulting from compliance with the Saudi Govern-

ment restriction consensual.

2.B. The Commissioner tries to salvage her position

that the Saudi Government restriction was consensual by

claiming that “when a government undertakes a commer-

cial activity, it acts in a commercial, not sovereign, Capac-

ity.” Pet. 20. If the Commissioner is arguing that some

actions of a sovereign engaged in commerce are treated

as private acis, the Commissioner is correct. The courts

below agreed that not all governmental actions are sover-

eign in nature, but found that this particular edict was a

sovereign act. To the extent that the Commissioner ar-

gues that the restriction must be deemed consensual sim-

ply because Saudi Arabia was the producer and supplier of

Saudi crude oil, the argument runs head-on into the well-

recognized principle that sovereigns engaged in commer-

cial activities nonetheless retain the sovereign power to

regulate in the public interest. See, e.g., United States v.

Winstar Corp., 116 S. Ct. 2432, 2458, 2465-67 (1996);

Merrion v. Jicarilla Apache Tribe, 455 U.S. 130, 145-47

(1982).

This Court has frequently made clear that “[c]on-

tractual arrangements,” including those to which a sover-

eign itself is a party, “remain subject to subsequent legis-

lation by the presiding sovereign.” Jicarilla, 455 U.S. at

147-48 & cases cited therein. Thus, a sovereign engaged

in commerce may operate both as a contractor and as a

sovereign.” See generally United States v. Winstar Corp.,

116 S. Ct. 2432 (1996). Given that dual capacity, it

follows that sovereign governments and U.S. taxpayers

might enter into purely contractual arrangements that,

upon a proper showing, the Commissioner would be en-

titled to disregard for purposes of section 482. But a

sovereign may also exercise its sovereign power wholly

without regard to the “consent” of its contractual partners.

Thus, “[w]hatever place consent may have in contractual

matters and in the creation of democratic governments, it

has little if any role in measuring the validity of an exer-

cise of legitimate sovereign authority.” Jicarilla, 455

USS. at 147.

18In her foreign tax credit regulations, the Commissioner has

recognized that a foreign government may simultaneously act both

as a sovereign and as a commercial party. See 26 C.F.R. § 1.901-

2(a) (2) (i) (1983) (amended 1991). These regulations provide

that, depending on the facts and circumstances, a foreign govern-

ment that has a commercial relationship with the taxpayer may

also, in its sovereign capacity, impose a tax on the taxpayer.

19 Although the Commissioner relies on the Foreign Sovereign

Immunities Act of 1976, 28 U.S.C. §§ 1602-1611, and the decision

in Republic of Argentina v. Weltover, Inc., 504 U.S. 607 (1992),

neither sheds much light on whether the Saudi Government restric-

The record evidence supports the decision below that

the Saudi Government was exercising its sovereign powers

in issuing the restriction. In addition to pointing out the

unilateral nature of the edict and its approval by the

King, the Tax Court found that the Saudi Government

had imposed the restriction as part of its price moderation

policy adopted at the urging of the U.S. Government and

the governments of other consuming countries.” That

policy began with the decision by Saudi Arabia to sell its

oil at a lower price than the price set by other oil-pro-

ducing countries, and the restriction on the resale price

of Saudi crude was intended to ensure that the crude

tion was a legal restriction that Texaco was required to obey.

Nothing in the Act is inconsistent with the basic principle that a

sovereign may engage in an activity both as a commercial entity

and as a sovereign, and this Court has recognized the intermingled

existence of both roles. See Saudi Arabia v. Nelson, 507 U.S. 349,

358 n.4 (1993) (declining to “address the case where a claim

consists of both commercial and sovereign elements”). And, in

Weltover, the Court held only that action by Argentina to change

the terms of its own transactions—that is, extending the period

for repayment of its debt—was sufficiently commercial in nature to

deny it immunity from suits to collect on that debt. Here, by

contrast, the restriction imposed by Saudi Arabia applies not to

its own transactions, but to subsequent transactions between resell-

ers of crude oil and their customers. See South-Central Timber

Dev., Inc. v. Wunnicke, 467 U.S. 82, 99 (1984) (plurality opinion)

(“downstream restrictions have a greater regulatory effect than do

limitations on the immediate transaction”’).

2° The Tax Court found that the price moderation policy was

designed to obtain the defense and foreign policy x ipport of the

United States, to stabilize the world economy, and to protect the

long-term interests of Saudi Arabia in its abundant oil reserves.

Pet. App. 68a, 114a, 124a-127a, 153a n.48. The Tax Court also

found that the consuming country governments, including the

United States, were very. much aware of the terms of the Saudi

Government restriction; that the Saudi Government made public

statements about the scope and nature of the restriction, which

were widely publicized during the period at issue; and that the

nature of the Saudi Government restriction was common knowl-

edge throughout the world. Pet. App. 45a-48a, 52a-53a, 68a-75a,

121a-122a.

reached the consuming countries at the lower Saudi price.

The Fifth Circuit concluded, based on the Tax Court’s

findings, that the Saudi Government imposed the restric-

tion to ensure that its price moderation policy “had its

intended effect.” Pet. App. 3a. Under these facts, the

Saudi Government was acting as a sovereign when it is-

sued the restriction.”

In an attempt to support her argument that the Saudi

Government restriction was nothing more than a com-

mercial arrangement, the Commissioner asserts that the

Saudi Government “planned” and “contemplated” that its

price moderation policy, including the restriction, would

put additional profits into the “pocket” of the Aramco

shareholders. Pet. 14, 24. The facts contradict those

assertions. While Minister Yamani stated publicly that

the Saudi Government would “follow the barrel of Saudi

crude until it lands at a certain refinery and we know

that it is sold at our price,” and that “I cannot do any-

thing after that,” he added that “Jt is the consumers’ re-

sponsibility.” Pet. App. 46a, 48a (emphasis added).

Many consuming countries had product price controls or

other measures in effect during 1979-1981 that limited the

product profits realized by the Aramco shareholders. Pet.

App. 68a-75a & nn.14-18. Further, the Tax Court found

that, in compliance with the restriction, Texaco and Exxon

sold Saudi crude to both affiliated and unaffiliated cus-

tomers at the OSP. Pet. App. 2la, 24a, 185a, 186a.

21 See Building & Constr. Trades Council v. Associated Builders

& Contractors, 507 U.S. 218, 229 (1993) (distinguishing situations

in which a state “acts as a regulator” from situations in which it

“acts as a market participant with no interest in setting policy’) ;

see also South-Central Timber Dev., Inc. v. Wunnicke, 467 U.S.

82, 96 (1984) (plurality opinion) (factors showing that state

acted as regulator included “foreign commerce, a natural resource,

and restrictions on resale’).

22 The Commissioner’s quotations of Minister Yamani conspicu-

ously omit his statements that controlling profits from refined

products is the consuming countries’ responsibility. Pet. 6 & n.3.

Thus, the Saudi Government restriction had its intended

effect: it prevented the Aramco shareholders and others

from reselling Saudi crude for more than the OSP and

it assured delivery of Saudi crude to refineries at the

Saudi-mandated price.

3. The Commissioner seeks to distinguish First Secu-

rity from this case on the grounds that the Saudi Govern-

ment did not prohibit Texaco from profiting from sales of

products refined from Saudi crude and did not prohibit

Texaco from engaging in the business of buying and sell-

ing crude.* Pet. 16-17. The Commissioner contends that

in First Security “the taxpayer could not lawfully engage

in the commerce that produced the income.” Pet. 16.

According to the Commissioner, the present case is differ-

ent because Texaco “was lawfully engaged in the business

of buying and selling crude oil” and could and did profit

from sales of refined products. Pet. 16-17. But the rele-

vant issue under section 482 is not whether the taxpayer

can lawfully engage in a particular business; the issue is

whether it can lawfully earn the income that the Com-

missioner seeks to allocate to it. Here, the Commissioner

Seeks to increase Textrad’s income on sales of Saudi crude

to Texaco’s affiliates. Textrad could not earn that income

because it could not lawfully sell Saudi crude oil at a

higher price than that established by the Saudi Govern-

ment. The Tax Court further found that all Texaco

affiliates were prohibited from selling Saudi crude for

more than the price mandated by the Saudi Government.

*3The Commissioner does not contend that the principle of

First Security does not apply to a foreign government restriction.

The Commissioner merely notes that she “disagrees” with the Sixth

Circuit’s conclusion in Procter & Gamble “that First Security Bank

applies where the law prohibiting the receipt-of income is that of

a foreign country.” Pet. 17 n.10. The Commissioner did not make

that argument before the Fifth Circuit, and she has accepted, in

her own regulation, the premise that a foreign legal restriction may

bar an allocation under section 482 in certain circumstances. See

Treas. Reg. §§ 1.482-1(h) (2), ¢j) (1) (1994), effective for taxable

years beginning after October 6, 1994.

Pet. App. 123a-124a, 158a. In First Security, this Court

barred allocation of a share of insurance premiums to

the banks even though members of the affiliated group

(other than the banks) were allowed to engage in the

insurance business and to receive insurance premiums.

405 USS. at 402.

The artificial nature of the Commissioner’s attempts to

distinguish First Security is readily apparent from the

Court’s reasoning in First Security. There, the Court

relied on the Tax Court’s prior decision in L. E. Shunk

Latex Products, Inc. v. Commissioner, 18 T.C. 940

(1952), which involved a “closely analogous situation.”

405 U.S. at 406. Like the present case, Shunk Latex in-

volved a corporation that could lawfully engage in the

commerce that produced the income but could not law-

fully earn the income at issue because of a governmentally

imposed price ceiling.* 18 T.C. at 959. Further, in

Shunk Latex the profit associated with the higher price

was received and retained by an affiliated person. Id. Yet

this Court quoted with approval the conclusion of the

Tax Court that the Commissioner had “no authority to

attribute to petitioners income which [by virtue of the

price ceiling] they could not have received.” 405 U.S. at

406, quoting 18 T.C. at 961; accord Lehman v. Commis-

sioner, 25 T.C. 629, 633-34 (1955). In this case, the

Commissioner seeks to increase Textrad’s income on sales

of Saudi crude even though all Texaco affiliates were pro-

hibited from selling Saudi crude for more than the re-

24 Although the Commissioner claims that the subsidiary to

which she reallocated the income (Textrad) earned it as a matter

of “economic reality,” that view is mistaken. Pet. 19. The Tax

Court found that Textrad was prohibited from engaging in the

activity—selling Saudi crude for more than the mandated price—

that would have produced the income that the Commissioner seeks

to allocate in this case. Pet. App. 158a. Furthermore, the Tax

Court found that Textrad could not have changed its operations in

order to capture additional profits from Saudi crude because “devia-

tions from historical behavior would have been objected to by the

Saudis.” Pet. App. 180a.

stricted price. Thus, as in First Security and Shunk Latex,

the Commissioner in this case is seeking to allocate to the

taxpayer income that it was prohibited from receiving,

4. The Commissioner appears to acknowledge that

the characterization of the Saudi Government restriction

as a legal restriction or a consensual agreement is of cur-

rent significance to only two taxpayers, Texaco and

Exxon. This narrow application is hardly surprising. The

issue arises out of an oil crisis occurring almost twenty

years ago and an extraordinary price moderation policy

adopted by the Saudi Government at the urging of the

U.S. Government.

To broaden the potential impact of the decision below,

therefore, the Commissioner raises the specter that tax-

payers may “encourage or endure the adoption of profit-

able foreign ‘legal restrictions’” at the expense of the

U.S. Treasury. Pet. 25. But this concern is not justified.

The Tax Court recognized the possibility that a foreign

legal restriction might be the result of collusion with a

private taxpayer, and it subjected the restriction to “height-

ened scrutiny” to assure that collusion was not present.

Pet. App. 113a, citing Procter & Gamble Co. v. Com-

missioner, 961 F.2d 1255, 1259 (6th Cir. 1992). It

found, however, that “despite [the Commissioner’s] ex-

pressed fears, there is no evidence of such collusion in

this case.” Pet. App. 114a; see also id. (noting “sufficient

evidence in the record of Saudi self-interest in issuing

the restriction—particularly in terms of its close relation-

ship with the U.S. Government, which encouraged price

moderation at the time”). Moreover, in order to bring

itself within the facts of this case, a taxpayer would

be required to orchestrate an extraordinary series of global

events and U.S. and foreign government actions and

policies.

Finally, the Commissioner points to the amount of taxes

in dispute.” But the amount in dispute, standing alone,

provides no proper ground for granting review. Section

482 does not authorize the Commissioner to reallocate

income simply because that action will result in more tax

revenue to the U.S. Treasury. Rather, it provides for

reallocation when a taxpayer, by virtue of its “complete

power” over the income, has shifted income between con-

trolled parties so that the “true taxable income” of the

taxpayer has not been clearly reflected. See First Security,

405 U.S. at 404-05. The courts below merely decided

that this particular taxpayer, as the result of a particular

legal restriction imposed by the Saudi Government, did

not have or exercise that power. That conclusion does not

warrant further review.

2% The Commissioner computes the tax due as more than $1 bil-

lion, whereas the actual asserted tax deficiency is approximately

$800 million. Pet. 12. In addition, the Commissioner has assumed

that the amount asserted as the deficiency for Texaco is correct.

But the Tax Court has not ruled on the amount of the adjustment,

only on the Commissioner’s power to make an adjustment at all.

CONCLUSION

The petition for a writ of certiorari should be denied.

Respectfully submitted,