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Tuesday, July 15, 2008


In 1992, several Shell Oil affiliates transferred various properties to Shell Frontier Oil & Gas Inc. in a Section 351 transaction. As a Section 351 transfer, the shareholders of Shell Frontier received a basis in their Shell Frontier stock equal to the basis of the property transferred to Shell Frontier.

Shell Western E&P Inc. was one of the companies contributing properties to Shell Frontier. As it turned out, the basis of much of the property transferred by Shell Western far exceeded its value. Due to this disparity, when Shell Western later sold some of its shares in Shell Frontier, it realized substantial losses (in the hundreds of millions of dollars) since it received proceeds for that stock in excess of its basis in the stock..

The IRS was not too pleased with these losses, and challenged them on various grounds. The first line of attack was that the assets contributed to Shell Frontier (oil shale rights and offshore leases) were not “property” for Section 351 purposes because they had no value (and thus no tax basis for them should be given to Shell Western). The appellate court made short shrift of this argument, noting that just because the properties were not income producing did not mean they had no value. Further, the court acknowledged that there is no requirement under Section 351 that a positive value is required for an item to be "property" for Section 351 purposes. The court also rejected the IRS attempt to categorize the properties as equivalent to stock in a wholly insolvent corporation that is in receivership (which stock had been previously held not to be "property" under Section 351).

The IRS also attempted to characterize the transfer of the loss properties as a sham transaction. The appellate court found too much substance and non-tax purpose for the transfer for a sham argument to succeed. An interesting aspect of the case was that the structuring plan came from the Shell Oil tax department. However, the department specifically held back from management the tax benefits of the transaction, so that management would base its decision solely on nontax reasons. This worked well to eliminate the punch from the IRS' argument that the purpose of the tax transaction was entirely or substantially tax motivated.

Lastly, the IRS attempted to use Section 482 to deny loss treatment to the taxpayer. However, insufficient evidence to invoke Section 482 was provided at trial. The appellate court also noted that even if Section 482 evidence had been provided, there was insufficient evidence of an improper purpose to evade taxes to allow for a Section 482 adjustment that would override the Congressional purposes of Section 351 transactions.

Thus, in the end, the IRS lost and Shell's losses were respected.

SHELL PETROLEUM INC. v. U.S., 102 AFTR 2d 2008-XXXX, (DC TX), 07/03/2008

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