Shell Wins $19M Refund
A district court in Texas allowed Shell Petroleum to carry back capital losses and receive a nearly $19 million refund. The losses were generated by a restructuring transaction involving an exchange of high-basis property for new subsidiary stock followed by loss-generating dispositions of the stock. In 1992, Shell Oil was facing serious financial difficulties. Oil prices had dropped significantly, causing serious declines in Shell's net income and net cash flow at the same time that its debt was increasing. In reaction, Shell and its affiliated oil companies (the Shell Group) restructured to improve cash flow while preserving assets, especially offshore leases and oil shale rights that were currently nonproducing but that Shell thought could eventually yield profitable oil discoveries. (Shell had learned its lesson decades earlier, when it had abandoned its holdings on the North Slope of Alaska and the region then became home to the biggest oil field in North America.) The Shell Group transferred the properties to a new subsidiary, Shell Frontier Oil & Gas Inc., in a section 351 transaction. In such a transaction, shareholders receive a basis in the stock of the new corporation equal to the basis of the property they transfer to acquire that stock. In this case, the basis of much of the transferred property was far greater than its value. As a result, subsequent disposal of the stock in Shell Frontier created losses exceeding $350 million for tax year 1992. The Shell Group in 2004 carried back the consolidated net capital loss to 1990, which resulted in an overpayment for that tax year of $18.9 million. The IRS disallowed these losses on various grounds. It claimed that since many of the transferred properties were nonproducing, they had no value and thus should not be considered section 351 property However, the district court found that even though the properties were nonproducing, they did in fact have value and thus were considered property for section 351 purposes. Noting that the provision does not define "property," the court said Shell's interests "fit the classical--indeed, paradigmatic--definition of 'property' in that they are identifiable and transferable real property interests." The IRS also asserted that the transfer was a sham transaction intended to artificially inflate tax basis. While the Shell Oil tax department was involved in the restructuring plan, it did not discuss any of the plan's tax benefits with management, so that the restructuring decisions would be based on economic factors. …