Amicus Curiae Brief — Commissioner v. Texaco Inc.

W

No. 96-1107 \_ MAR 14 997

CLER!

IN THE «

3 ee ete a

ee. ep

Supreme Court of the United States

OCTOBER TERM, 1996

COMMISSIONER OF INTERNAL REVENUE,

Petitioner,

Vv.

TEXACO INC. AND SUBSIDIARIES,

Respondents.

On Petition for Writ of Certiorari to the

United States Court of Appeals

for the Fifth Circuit

BRIEF FOR EXXON CORPORATION AND

SUBSIDIARIES AS AMICI CURIAE

IN SUPPORT OF RESPONDENTS

ROBERT L. MOoRE, II

Counsel of Record

JAY L. CARLSON

ALAN I. HoROWITz

J. BRADFORD ANWYLL

LAURA G. FERGUSON

MILLER & CHEVALIER,

Chartered

Metropolitan Square

655 Fifteenth Street, N.W.

Washington, D.C. 20005

(202) 626-5800

WILSON - Eres Printine Co., Inc. - 789-0096 - WASHINGTON, D.C. 20001

QUESTION PRESENTED

Whether the Commissioner is empowered under 26

U.S.C. § 482 to tax Texaco’s crude oil trading company

as if it had earned income from reselling Saudi Arabian

crude oil when in fact the company was prohibited by

Saudi Arabian law from reselling that crude oil at an

amount higher than the purchase price.

(i)

TABLE OF CONTENTS

B. The Consuming Countries’ Role in the Saudi

Resale Price Restriction —......................

C. The Fifth Circuit Correctly Concluded That the

Principles of First Security Govern This Case...

1. Applying the Principles of First Security,

the Fifth Circuit Correctly Held That the

Commissioner Could Not Allocate Income to

the Offtakers That They Were Prohibited

From Receiving by Reason of the Saudi

Resale Price Restriction .............0..................

. The Government’s Proffered Distinctions of

First Security Are Insubstantial .............__....

. The Commissioner’s Proposed Section 482

Allocation Is Improper Under the Regula-

tion’s Tax Parity Standard .............

D. United States v. Basye Has No acai to

This Case edibles

i eC aT aE

(iii)

10

15

16

18

iv

TABLE OF AUTHORITIES

CASES Page

Bank of Coushatta v. United States, 650 F.2d 75

CO ne SS visccsccnccicccimcdeenveeiaattindinisariscticeate 9

Bank of United States v. Planters’ Bank of Geor-

gia, 22 U.S. (9 Wheat.) 904 (1824) —.........-....... 13

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

| RRR RRC Oe... EOI ork AL Bem, ew Eee Ie passim

Eli Lilly & Co. v. Commissioner, 856 F.2d 855

(Tit Cie ROR) igi. ence hei 15

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

I a i 11-12

Lufkin Foundry & Machine Co. v. Commissioner,

468 F.2d 805 (Sth Cir. 1972) ............................... 15

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

SS Gee : Se Sa a a 9-11

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

ee ee ee Cs Pe ee 13

United States v. Basye, 410 U.S. 441 (1978) ......... 3, 16-17

STATUTES AND REGULATIONS

ee a acrid icteecinetinieteontereceianonnse 2, 8-9

26 C.F.R. § 1.482-1(h) (2) (1994) .........-..202 2... 10

26 C.F.R. § 1.482-1A(b) (1) (1981) -.......-...0... 9-10, 15

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

BRIEF FOR EXXON CORPORATION AND

SUBSIDIARIES AS AMICI CURIAE

IN SUPPORT OF RESPONDENTS

INTEREST OF THE AMICI CURIAE

The factbound issue presented in this case affects only

two taxpayers, Texaco and Exxon. As noted in the

petition, the Commissioner issued similar notices of defi-

ciency to Texaco and Exxon with respect to the Saudi

pricing issue, and the two cases were consolidated for

trial and decision by the Tax Court on this issue. Pet. 9.

Exxon’s case' remains in the Tax Court because other,

unrelated issues for the tax years in question have not

yet been resolved. Exxon has a strong interest in the

Court's resolution of this case because it potentially would

have equal application to Exxon.

2

Counsel for the parties have consented to the filing of

this brief in letters filed with the Clerk of the Court.

ARGUMENT

The Commissioner does not contend that the Fifth Cir-

cuit committed error in stating any broadly applicable

legal principle or that its decision conflicts with that of

cther courts. Rather, the Commissioner seeks certiorari

here based on the allegation that the lower courts incor-

rectly applied settled legal principles to the unique facts

cf this case. In order to justify this unusual request, the

Commissioner characterizes the decision below as “a blue-

frint for the evasion of United States taxes.” Pet. 12.

The Commissioner’s support for this characterization, how-

ever, is an incomplete and distorted version of events that

is incompatible with the trial court’s findings of fact.

A. Introduction

Texace International Trader, Inc. (Textrad), a US.

sibsidiary of Texaco Inc., served as Texaco’s international

crude oil trading company. As an offtaker, Textrad pur-

chased Saudi crude oil at the Saudi government’s official

slling price and then, as required by a resale price restric-

ton imposed by the Saudi government, sold the oil to

Texaco’s domestic and foreign refining affiliates and un-

rlated parties at the same official selling price. Pet. App.

23a-24a. Invoking 26 U.S.C. § 482, the Commissioner

seks to allocate to Textrad income that it “would have

received if it had sold the Saudi crude oil to its foreign

efiliated refineries at its true economic value, rather than

a the stipulated Saudi price.” Pet. 8. The Commissioner

froposed a similar section 482 reallocation with respect

tb Exxon’s offtakers, three U.S. affiliates of Exxon that

purchased and resold Saudi crude oil at the official selling

price. Pet. App. 19a, 99a-100a.

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

(1972), this Court held that section 482 does not author-

——

3

ize the Commissioner to allocate income to a party that

is prohibited by law from receiving it. Applying the

principles of First Security, both the Tax Court and the

Fifth Circuit concluded that the Commissioner lacked the

authority to make the proposed allocation because the

Saudi resale price restriction prohibited Textrad from

earning a profit on the sale of the crude oil. Both courts

also rejected the Commissioner’s reliance on United States

v. Basye, 410 U.S. 441 (1973), a case involving a medical

partnership that, as a result of bargaining with a health

plan, agreed to have a portion of its compensation di-

verted to a trust fund.

After exhaustively examining the record developed at

a lengthy trial, the Tax Court made the following findings

regarding the Saudi resale price restriction: (1) it was

“not a negotiated contract term” but rather was issued

unilaterally by the Saudi government “without discussion

or negotiation” (Pet. App. 145a); (2) the Saudi govern-

ment did not issue the restriction as a result of pressure

from-the offtakers, nor was there any evidence of collusion

between the offtakers and the Saudi government (id. at

114a); and (3) the “restriction was not commercial in

nature” but instead was the cornerstone of a price mod-

eration policy adopted by the Saudi government “to

obtain the defense and foreign policy support of the

United States and to meet the need for stability in the

world economy” (id. at 68a, 144a). See also id. at 134a-

155a.

The petition portrays a set of facts that is entirely

at odds wtih the Tax Court’s key findings. For example,

the Commissioner characterizes the Saudi resale price re-

striction as a “consensual, commercial arrangement” (Pet.

19) and implies that the Saudi resale price restriction

was designed to shelter the oil companies’ profits from

taxation (id. at 24-25). According to the Commissioner,

the Saudi resale price restriction “poured extensive profits

into respondent’s accounts and also gave it a basis for

4

contending that a portion of those profits is immune from

United States tax.” Jd. at 25 n.14. After reading the

Commissioner’s petition, one would assume that the sole

purpose of the Saudi pricing policy was to confer a tax-

free “windfall” on U.S. oil companies. See id. at 18. In

particular, the petition obscures the sovereign underpin-

nings of the resale price restriction by virtually ignoring

the restriction’s central role in the Saudi government’s price

moderation policy and the role of the consuming countries,

notably the United States, in urging the Saudi govern-

ment to adopt and enforce that policy.

The reason for these omissions is obvious. The Com-

missioner’s legal theory (that Basye rather than First

Security controls) rests on the factual premise that the

resale price restriction was a consensual arrangement nego-

tiated by the oil companies. The Tax Court, however,

made findings to the contrary. When the facts of this case

are fully and fairly related, it is apparent that the lower

courts correctly resolved this case by applying the princi-

ples of First Security.

B. The Consuming Countries’ Role in the Saudi Resale Price

Restriction

In the late 1970s, the United States government “under-

took numerous diplomatic efforts to affect or moderate

OPEC crude oil price increases, urging the [Saudi Arabian

government] as well as other OPEC Governments to

moderate crude oil prices and to-increase-crude Oil pro-

duction.” Pet. App. 68a. Because Saudi Arabia had the

“largest supply of crude oil of all the OPEC countries

and was a prominent player in OPEC” (id. at 28a) the

U.S. government placed principal emphasis on the Saudi

government. /d. at 68a. As a result of the Saudi govern-

ment’s “close relationship with the U.S. Government” (id.

at 114a) and its desire to “obtain the defense and foreign

policy support of the United States” (id. at 68a), the Saudi

government agreed to moderate its prices and increase its

5

production during this period. On two different occasions

(1977 and 1979), the Saudi government imposed a resale

price restriction to ensure that Saudi oil reached the

major industrialized countries at the lower Saudi price.

Id. at 35a-49a. With respect to the 1979 restriction at

issue here, the Tax Court found that “official U.S. policy

was strongly in favor of enforcing the restriction and

seeing that the Saudi policy toward moderation was carried

out.” Id. at 68a.

The first resale price restriction was imposed in 1977,

when the Saudi government declined to follow significant

price increases voted by OPEC. As a necessary com-

ponent of its price moderation program, the Saudi govern-

ment mandated that the prices charged by the offtakers for

Saudi crude oil be no higher than the Saudi official selling

price. Id. at 35a-38a. According to the Saudi Petroleum

Minister, the Saudi government wanted to “make sure that

the oil companies do not take one cent from the cheap

Saudi crude and put it in their pockets. We want the

lowest price for the benefit of the consumers.” Id. at 36a.

To enforce the resale price restriction, the Saudi govern-

ment imposed auditing and reporting requirements (id.

at 37a) and sought the help of the consuming countries

in monitoring the oil companies’ compliance and “ensuring

that no party other than the final consumer benefits from

the low prices.” Id. at 38a.

A second resale price restriction was imposed in 1979,

during the “Second Oil Crisis.” The Iranian Revolution,

followed by the U.S. embargo of Iranian oil and the Iran-

Iraq war, led to a significant drop in Middle East crude oil

production and sky-rocketing oil prices. Jd. at 40a-4la.

65a-67a. During 1979-1981 (the tax years at issue here),

world crude oil prices nearly tripled. Jd. at 41a. The

Sccond Oil Crisis led not only to long lines at gas stations

but also to severe economic disruptions in the major oil

consuming countries, including spiraling inflation and mas-

sive balance of payment deficits. Given the Saudi gov-

6

ernment’s prior willingness to assist the consuming coun-

tries, the United States and other oil consuming countries

again looked to Saudi Arabia for price moderation.

As in 1977, the Saudi government agreed to exercise

price restraint by ensuring that the official selling price

for its crude oil lagged behind that imposed by other

OPEC members. Id. at 45a, 66a-67a. In furtherance of

its policy to deliver cheaper oil to the consuming countries,

the Saudi government again imposed a resale price restric-

tion. Issued by the Saudi Petroleum Minister and author-

ized by the King (id. at 122a), the restriction required

the offtakers to resell the Saudi crude oil at the

same Official selling price at which they purchased it. The

restriction applied to all sales of Saudi crude oil, whether

made to related or unrelated buyers. Jd. at 133a.

The U.S. government and the governments of the major

oil consuming countries fully supported the Saudi govern-

ment’s imposition of the resale price restriction and mon-

itored its enforcement. Dr. James Schlesinger, then U.S.

Secretary of Energy, testified that he understood that “the

1979 restriction fulfilled the common U.S. and [Saudi

Arabian government] objectives to have the lower-priced

Saudi crude reach the consuming countries at the lower

price.” /d. at 71a. The Tax Court found that “[o]fficials

of the Governments of the United Kingdom, Italy, the

Federal Republic of Germany, the Netherlands and

France understood the Saudi objective to be the same.”

Id. To ensure that the offtakers complied with the Saudi

resale price restriction, the consuming countries shared

information about the prices at which Saudi crude oil was

imported into their countries. Id. at 71a-75a. According

to the Tax Court, the “transparency [in oil pricing] cre-

ated by the information-sharing was important in ascer-

taining compliance with the restriction” and “ensured that

all consuming member countries were being treated the

same.” Id. at 72a.

5

When the Saudi crude oil arrived at the refineries, the

consuming countries had different approaches to capturing

the benefit of the lower price. Some, such as the United

States, France, the Netherlands, and Japan, imposed price

controls to ensure that the consumers benefited direct:

from the lower prices and that the refiners’ profits were

capped. /d. at 68a, 72a-73a. Other countries, such as the

Federal Republic of Germany and the United Kingdom,

declined to impose price controls, but rather encouraged

pricing restraint through more informal means. See, e.g.,

id. at 74a nn.17, 18. To the extent that the refiners made

additional profits as a result of the Saudi pricing advan-

tage, they were subject to tax on those profits.

The petition emphasizes that the resale price restriction

did not preclude the oil companies from earning profits on

the sale of refined petroleum products. Pet. 6, 9-11,

14-18, 24. For example, the Commissioner repeatedly

refers to the following statement by the Saudi Petroleum

Minister: “the oil companies are definitely making higher

profits in the downstream by refining Saudi crude and

selling the products at higher prices. This we cannot con-

trol.” See id. at 6n.5, 15, 19 n.11 (emphasis added by the

Commissioner). The Commissioner, however, omits the

final sentence from the Petroleum Minister’s statement:

“It is the consumers’ responsibility.” See Pet. App. 48a.

By omitting this sentence, the Commissioner suggests that

the Saudi government was indifferent to the level of profits

earned by the refiners. Elsewhere, the Commissioner im-

plies that the Saudi government “planned” for the profits

to end up in the oil companies’ “pocketls].” Pet. 24.

While it is true that the Saudi Petroleum Minister recog-

nized the limits of Saudi power to control the refined prod-

uct prices charged in other countries, there is no support in

the record for the Commissioner’s suggestion that the Saudi

government intended for the oil companies to reap the

benefit of the Saudi price moderation policy. To the con-

trary, that policy was designed to benefit the consuming

8

countries. Pet. App. 71a. The Saudi government rightly

acknowledged, however, that “once the oil was delivered

to the refineries, it was beyond Saudi jurisdiction” and

the regulation of product prices was the consuming coun-

tries’ responsibility. 7d. at 95a.

C. The Fifth Circuit Correctly Concluded That the Prin-

ciples of First Security Govern This Case

The Commissioner argues that Basye rather than First

Security controls this case. The Commissioner’s position

is irreconcilable with the Tax Court’s explicit findings that

the resale price restriction was neither consensual nor the

product of collusion between the oil companies and the

Saudi government. Rather, as a key element of the Saudi

government’s contribution to an international effort to hold

down the price that consuming countries would pay for

oil, the Saudi resale price restriction clearly is encom-

passed within the rule of First Security.

1. Applying the Principles of First Security, the Fifth

Circuit Correctly Held That the Commissioner Could

Not Allocate Income to the Offtakers That They Were

Prohibited From Receiving by Reason of the Saudi

Resale Price Restriction

Although the Commissioner seeks certiorari on the

ground that the court of appeals “misapplie[d]” First

Security (Pet. 12, 24), the petition neglects to discuss this

Court’s rationale in that case, which the Fifth Circuit in

fact faithfully applied. In First Security, the Commis-

sioner invoked section 482 to try to reallocate income tc

certain banks that an affiliated insurance company had

received as reinsurance premiums. The Commissioner’s

theory was that the income really reflected commissions

“earned” by the banks for referring customers to the com-

panies that paid for the reinsurance. See 405 US. at

396-400. Because banks were prohibited by law from

receiving commissions as a result of their customers’ pur-

chase of life insurance, this Court held that the Com-

9

missioner’s proposed reallocation exceeded the authority

conferred by section 482.

The Court reasoned that Congress did not intend to

authorize a reallocation if the taxpayer itself had no power

to allocate the income in that manner. Such taxation

would violate the principle that, “in order to be taxed for

income, a taxpayer must have complete dominion over

it”; a taxpayer cannot be held to “have taxable income

that he did not receive and that he was prohibited from

receiving.” Jd. at 403. Indeed, the Court observed that

the Commissioner’s own regulation implementing section

482 “expressly recognizes the concept that income implies

dominion or control of the taxpayer.” Jd. at 404. The

premise of a section 482 reallocation is that the con-

trolling interests “have complete power to cause each con-

trolled taxpayer so to conduct its affairs that its trans-

actions and accounting records truly reflect the taxable

income . . . of each of the controlled taxpayers.” Treas.

Reg. § 1.482-1A(b)(1) (1981) (emphasis added). Be-

cause “[t]he ‘complete power’ referred to in the regula-

tions hardly includes the power to force a subsidiary to

violate the law” (405 U.S. at 405), the Court held that

“t]he Commissioner’s exercise of his § 482 authority was

... unwarranted.” Id. at 407.

The lower courts have uniformly understood First Secu-

rity as establishing a general principle that bars a section

482 allocation if a governmental restriction deprives the tax-

payer of the requisite degree of control. See, e.g., Procter

& Gamble Co. v. Commissioner, 961 F.2d 1255, 1259

(6th Cir. 1992); Bank of Coushatta v. United States, 650

F.2d 75, 76-77 (Sth Cir. 1981). Thus, the court of

appeals here was following settled law when it refused to

allow the section 482 adjustment because the Saudi resale

price restriction denied Texaco “the power to control the

sales price of the oil” and the “ability to control the flow

of its income.” Pet. App. 6a, 10a.

10

2. The Government’s Proffered Distinctions of First

Security Are Insubstantial

The petition argues that First Security is inapplicable

because it is limited to a “rare” and “narrow factual con-

text.” Pet. 16. Specifically, the Commissioner advances

three factual differences between this case and First Secu-

rity as grounds for reaching a different result here. These

proposed distinctions, however, are either nonexistent or

immaterial. The rationale of First Security compels rejec-

tion of the proposed section 482 adjustment.

a. Although it does not clearly raise the question or

discuss it in the petition, the Commissioner suggests at

various points (Pet. I, 17 n.10, 25-26 & n.14) that First

Security does not apply to a restriction imposed by foreign

law. This contention was correctly rejected by the Tax

Court, which relied on Procter & Gamble, 961 F.2d 1255.

In that case, the Sixth Circuit held that a Spanish law

prohibiting royalty payments to affiliated corporations pre-

cluded the Commissioner from imputing royalty payments

from a Spanish subsidiary to its Swiss parent company.

Multinational corporations must obey the laws of the

countries in which they do business, and restrictions im-

posed by those laws can deprive them of the requisite

“complete power” (Treas. Reg. § 1.482-1A(b)(1)) to

allocate income among affiliated corporations just as surely

as the restrictions imposed by federal or state law spe-

cifically addressed by this Court in First Security. See 405

U.S. at 406 n.22 (noting that Local Finance Corp. v.

Commissioner, 407 F.2d 629 (7th Cir. 1969), which

allowed a section 482 reallocation of income in a manner

prohibited by state law, “was erroneously decided”).

Indeed, the Commissioner did not dispute this point in the

court of appeals, and the 1994 amendments to the regu-

lations explicitly recognize that “foreign legal restrictions”

are relevant to the section 482 analysis where, as here,

they “affect[ ] the results of transactions at arms length.”

See Treas. Reg. § 1.482-1(h)(2) (1994).

—— ee ee

11

The Commissioner suggests (Pet. 25 & n.14) that U.S.

tax authorities cannot respect foreign law restrictions be-

cause foreign governments have commercial dealings with

U.S. corporations and therefore can be expected to enact

laws for the purpose of helping those corporations avoid

U.S. taxation. But even that cynical view of foreign legis-

lation in no way justifies a blanket rule that would entitle

the Commissioner to ignore all foreign legal restrictions.

The courts are capable of determining whether a foreign

law is legitimate or a sham enacted at the behest of U.S.

corporations. The court of appeals in Procter & Gamble

Suggested that the Commissioner’s concern could be met

by applying a “heightened scrutiny” standard “to be sure

the taxpayer is not responsible for the restriction on pay-

ment.” 961 F.2d at 1259. The Tax Court in this case

followed that suggestion (Pet. App. 113a) and nonethe-

less concluded that the Saudi government adopted the

restriction in its own “self-interest,” not because of “col-

lusion” or “pressure” from the oil companies. Id. at 114a.

b. The Commissioner also argues that First Security

is inapplicable because the Saudi resale price restriction

did not prevent Texaco affiliates from earning profits

downstream on the sale of refined petroleum products.

Pet. 14-17. This assertion, however, ignores that the usual

Starting point of a section 482 case is that a taxpayer has

earned income somewhere in its corporate family, and the

question is whether the government can shift that income

to another corporation in the family. In First Security,

the restriction on the banks did not prevent another mem-

ber of the corporate family from earning arguably related

income in another manner; the insurance affiliate could

(and did) earn income from reinsurance premiums on the

policies sold to the bank’s customers. The Court none-

theless held that the Commissioner could not reallocate

that income to the particular corporation that was pre-

vented by a legal restriction from earning it.

The facts here are essentially indistinguishable from

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

iio ai

12

18 T.C. 940 (1952), a case that this Court in First

Security approved as “closely analogous.” 405 U.S. at

406. Shunk involved wartime price controls that limited

the price at which a manufacturer could sell condoms,

but allowed an affiliated distributor to resell the product

at a higher price. Just as in this case, the government

niaintained that section 482 permitted the Commissioner

to disregard the government-imposed price controls and

reallocate income from the distributor to the manufacturer |

as if the latter had sold the product at a price higher than |

that permitted by law. Even though the price controls

did not preclude the distributor from earning significant

profits, the Tax Court nonetheless held that section 482

did not authorize the Commissioner’s proposed realloca-

tion of that income to the manufacturer. 18 T.C. at 961.

c. The Commissioner also argues that First Security

does not apply because the resale price restriction was a

“commercial arrangement, as opposed to a ‘law’ enacted

by a foreign ‘sovereign.’” Pet. 19. This contention is

flawed both legally and factually. The argument erro.2-

ously assumes a clear, legal dichotomy between “commer-

cial” and “sovereign” actions. Just because a foreign

government enters into a commercial relationship, it is |

not true that every action bearing in some way on that |

relationship should be regarded as a “private,” rather than

a “sovereign,” action. Nothing in the rationale of First

Security or any other authority suggests that its principles

should not apply to a binding, non-negotiated sovereign

restriction simply because the “underlying activity” (id. at

23) can be characterized as “commercial.”

/

The only support the Commissioner musters for attach- )

ing such overriding significance to a “commercial” label is |

language in cases addressed to the narrow, and very differ-

ent, question of the cir umstances under which a state

gives up its own sovere-s2 immunity. Jd. at 20-22. These

quotations have no bearing on the question presented

here, which arises from the perspective of a private party

that must obey the laws of a sovereign state. When such

13

a State acts in a sovereign, lawmaking capacity, it binds

private parties and constrains their power to act, notwith-

Standing that the sovereign act touches on an area of

commercial activity that might lie outside the state’s

sovereign immunity.

Thus, in Bank of United States v. Planters’ Bank of

Georgia, 22 U.S. (9 Wheat.) 904 (1824), the Court held

merely that, where a state creates a distinct corporation

for business purposes that is explicitly made subject to

suit, the suit is not subject to jurisdictional and Eleventh

Amendment constraints that would attach to a suit directly

against the state. The Commissioner’s invocation of Re-

public of Argentina v. Weltover, Inc., 504 U.S. 607

(1992) (Pet. 21-23), is even farther afield because that

Case construes specific statutory language in the Foreign

Sovereign Immunities Act, which does not apply to the

interpretation of section 482. The other cases cited by

the Commissioner (id. at 20-21) involve the analogous

constitutional question of state immunity from federal

taxation. These cases in no way justify the Commission-

er’s attempt here to ignore the effect on private parties

of an action by a sovereign state that undeniably divested

them of the control required to support a section 482

adjustment.

As a factual matter, there is no basis for the Com-

missioner’s conclusion that the resale price restriction was

not a “sovereign” action by the Saudi Arabian govertn-

ment that implicates the principles of First Security. In

this connection, the Tax Court specifically found:

An examination of the historical relationship and of

the specific facts leading up to the 1979 pricing

restriction at issue here has convinced us that, while

the relationship between [the offtakers] and the

[Saudi Arabian government] was in part commercial

in nature in the sense that it involved the purchase

and sale of crude oil, the 1979 restriction was not

commercial in nature.

14

Pet. App. 143a-144a (emphasis added). The Tax Court

found that the resale price restriction was an integral part

of an oil price moderation policy adopted by the Saudi

government at the behest of the oil consuming countries,

principally the United States. Id. at 68a-7la, 124a-125a.

As part of a worldwide price control system, the restric-

tion was an action that is much more readily associated

with a sovereign than with a private entity. The back-

ground of the restriction also stamps it as sovereign. It

grew out of diplomatic negotiations among sovereign

states, and the critical Saudi interest in those discussions

was quintessentially sovereign; as the Tax Court found,

the Saudi government’s “price moderation 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.” Jd. at 68a. By contrast, the “com-

mercial” partners of the Saudi government were complete

outsiders to the process leading up to the restriction; it

was promulgated “without discussion or negotiation” with

the offtakers. 7d. at 145a. In short, the Saudi restriction

was not the type of action that would occur in a private

commercial arrangement, and there is no basis for chal-

lenging the decision below on the ground that the restric-

tion was not a sovereign action.

The Commissioner’s position here is particularly per-

verse because it ignores the U.S. government’s pivotal role

in the development and enforcement of the Saudi govern-

ment’s oil price moderation policy. The Tax Court spe-

cifically found that, “[a]fter the 1979 restriction was

issued, official U.S. policy was strongly in favor of en-

forcing the restriction and seeing that the Saudi policy

toward moderation was carried out.” Id. at 68a. The goal

of that policy was to deliver lower priced Saudi crude oil

to the consuming countries. The U.S. government under-

stood that the policy it urged inevitably would allow

refiners to earn additional income as a result of their

access to lower priced Saudi crude oil. It was further

contemplated that, while some of the income would be

PO Te

15

subject to U.S. tax, some of the income would be subject

to tax by the other consuming countries. There is no basis

for the U.S. government to do an about-face today and

argue that the Commissioner has the power to disregard

these governmental actions and reallocate to the U.S. off-

takers income that was, in accordance with the Saudi

restriction, earned in and subject to tax by foreign countries.

3. The Commissioner’s Proposed Section 482 Alloca-

tion Is Improper Under the Regulation’s Tax Parity

Standard

As the court of appeals explained, “the purpose of

§ 482 is to place a controlled taxpayer on a tax parity

with an uncontrolled taxpayer.” Pet. App. 12a (internal

quotation marks omitted). Accordingly, the standard ex-

plicitly stated in the regulations for making a section 482

adjustment “‘s that of an uncontrolled taxpayer dealing

at arm’s length with another uncontrolled taxpayer.”

Treas. Reg. § 1.482-1A(b)(1). See also, e.g., Eli Lilly &

Co. v. Commissioner, 856 F.2d 855, 860 (7th Cir. 1988);

Lufkin Foundry & Machine Co. v. Commissioner, 468

F.2d 805, 807-08 (Sth Cir. 1972).

The “tax parity” standard was already satisfied by

Texaco’s sales of Saudi crude oil to its refining affiliates

at the same price at which that crude oil was sold to

unrelated parties. Indeed, the Commissioner’s proposed

adjustment would turn section 482 on its head by destroy-

ing the existing tax parity between controlled and un-

controlled taxpayers and instead forcing Texaco to account

for its sales to affiliated entities at a different price from

the one used in arm’s-length transactions between un-

related parties. Thus, the court of appeals correctly con-

cluded that, “under the regulation’s tax parity standard,

the Commissioner’s allocation of Texaco’s income under

§ 482 is improper.” Pet. App. 13a.

16

D. United States v. Basye Has No Application to This Case

The Commissioner argues that the resale price restric-

tion was a “consensual agreement” that cannot defeat a

section 482 adjustment. It relies upon United States v.

Basye, 410 U.S. 441 (1973), where this Court rejected

the attempt of a medical partnership to avoid taxation on

its full compensation by agreeing to have a portion of the

compensation paid directly to a retirement trust. In a

footnote, this Court explained that First Security did not

support the taxpayer because it involved “a deflection of

income imposed by law,” whereas Basye involved “an

assignment [of income] arrived at by the consensual agree-

ment of two parties acting at arm’s length.” Jd. at 453

n.13. Seizing on this footnote, the Commissioner charac-

terizes the Saudi resale price restriction as a negotiated,

consensual arrangement between the offtakers and the

Saudi government, which was designed to shelter the oil

companies’ profits from U.S. taxation. Pet. 17-18.

The Commissioner’s legal theory rests on a factual

premise that is fundamentally at odds with the Tax Court’s

findings. After reviewing the evidence, the Tax Court

rejected the Commissioner’s argument that the Saudi re-

striction was consensual, finding instead “that the restric-

tion was not a negotiated contract term” and was issued

“without discussion or negotiation.” Pet. App. 145a. The

Tax Court also rejected the Commissioner’s collusion

theory, finding instead “sufficient evidence in the record

of Saudi self-interest in issuing the restriction—particularly

in terms of its close relationship with the United States,

which encouraged price moderation at the time—that [it

was] unable to conclude that the [Saudi Arabian govern-

ment] issued the restriction as a result of pressure from”

the oil companies. 7d. at 114a (emphasis added).

The Tax Court also found that cempliance with the

Saudi resale price restriction was mandatory. /d. at 134a-

155a. In fact, adherence to the restriction was regarded

as a matter of grave importance to the Saudi government.

17

After imposing the 1977 restriction, the Saudi government

issued a statement cautioning that a violation of the re-

Striction would be considered “a hostile act against Saudi

Arabia” and would “be held to be working against the

interests of the Kingdom.” Jd. at 36a. The 1979 restric-

tion was taken equally seriously. According to the Tax

Court, “there would have been potentially serious conse-

quences if [the oil companies] had violated the 1979

restriction.” Jd. at 5la.

In an attempt to divert attention from the Tax Court's

adverse factual findings (specifically, that the Saudi re-

striction was not promulgated at the behest of the oil

companies), the Commissiorier focuses on the offtakers’

alleged “consent” to purchase the oil. Pet. 17-18. As the

Tax Court found, however, there was no such “consent”

in any meaningful sense because the offtakers had no

realistic option of declining to buy Saudi oil. Pet. App.

147a-148a. “Continued access to Saudi crude was critical

to [the oil companies] during the period at issue, because

it was their largest internationally traded crude oil source.

representing about 50 percent of Exxon’s and 78 percent

of Texaco’s crude oil supply.” Jd. at 5la-52a: see also id.

at 20a n.5.

* * * *

There is no justification for further review by this

Court. The decision below is factbound and presents no

broadly applicable issue that would warrant exercise of

this Court’s discretionary jurisdiction. The court of ap-

peals’ decision is supported by two settled legal principles

under section 482, the rule of First Security and the tax

parity standard. The Commissioner has attempted to cre-

ate an argument that this case involves a “consensual

agrcement” under Basye, but can do so only by distorting

and disregarding the Tax Court’s findings of fact. Although

the Commissioner wants to ignore the role of the U.S.

government, the Tax Court found that the U.S. govern-

ment was instrumental in urging the Saudi government

to adopt its price moderation policy and in enforcing the

———li!

18

Saudi resale price restriction. The Commissioner may not

now recharacterize that very Saudi government restriction

as no more than a “consensual, commercial arrangement”

that can be overridden under section 482.

CONCLUSION

The petition for a writ of certiorari should be denied.

Respectfully submitted,

ROBERT L. Moors, II

Counsel of Record

JAY L. CARLSON

ALAN I. Horow1Tz

J. BRADFORD ANWYLL

LAURA G. FERGUSON

MILLER & CHEVALIER,

Chartered

Metropolitan Square

655 Fifteenth Street, N.W.

Washington, D.C, 20005

MARCH 1997 (202) 626-5800