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Baker Hughes Inc. v. United States

United States District Court, S.D. Texas, Houston Division

June 18, 2018



          Stephen Wm Smith, United States Magistrate Judge.

         This is a dispute over a disallowed income tax deduction. Although the parties to this litigation are an American company and the U.S. Government (for taxes collected on its behalf by the Internal Revenue Service), the facts giving rise to the claim involve a Russian subsidiary company and the Russian Ministry of Finance. Pending before the court are the parties' cross motions for summary judgment seeking a determination whether a payment made by a U.S. parent company, through a Cypriot entity, to a Russian subsidiary is deductible either as a bad debt (Dkts. 29 & 31[1]) or as an ordinary and necessary business expense (Dkts. 43 & 44).


         The following facts are largely undisputed.[2] During the relevant time period, BJ Services Company (“BJ Parent”) was the parent company of an affiliated group of corporations and subsidiaries throughout the world. Through a series of foreign and domestic holding companies, BJ Parent conducted fracking services in Russia through a Russian subsidiary, ZAO Samotlor Fracmaster Services (“BJ Russia”). (Dkt. 29-2, 21-4). Plaintiff, Baker Hughes Incorporated, is the successor to BJ Parent.

         In August 2006, BJ Russia contracted with OJSC TNK-Management (“TNK-BP”), a joint venture between a Russian company and British Petroleum. (Dkt. 44, p. 5). Under the contract, BJ Russia agreed to provide pressure pumping services to TNK-BP in the Siberian oil fields. (Id.). The agreement guaranteed a minimum number of jobs for BJ Russia over the three years of the contract at a fixed rate, and was valued at approximately $44 million. (Id. at p. 6; depo of Brett Wells, Dkt 44-3, p. 14). The contract required BJ Parent to extend a “performance guarantee:” if BJ Russia was unable to perform all of its obligations under the contract, BJ Parent would, upon demand by TNK-BP, be responsible to perform or to take whatever steps necessary to perform, as well as be liable for any losses, damages, or expenses caused by BJ Russia's failure to complete the contract. (Dkt. 29-6).

         The contract was not as profitable as BJ Russia had forecast, and it sustained net losses in 2006 and 2007. (Dkt. 44, p. 9). In September 2008, BJ Russia informed TNK-BP that it would not renew the contract and would exit the Russian market at the conclusion of the contract in 2009. (Dkt. 44, p. 9; depo. of Brett Wells, Dkt. 44-3, p. 32). On October 21, 2008, the Russian Ministry of Finance sent a letter to BJ Russia advising the company it was in violation of articles 90 and 99 of the Civil Code of the Russian Federation and in danger of forced liquidation. (Dkt. 44-14). Those provisions require a joint stock company to maintain “net assets” in an amount at least equal to the company's chartered capital. (Dkt. 44-14). A company may reduce its chartered capital to match the level of its net assets, but the Civil Code sets a minimum level for chartered capital. If, at the end of year, the net assets fall below that minimum level, the company must be liquidated. (Dkt. 44-14).

         The Ministry of Finance informed BJ Russia that, by its calculations, the company's net assets cost for 2006 was -228, 277, 00 Rubles, and -570, 683, 000 Rubles for 2007. Since the net assets cost were below the chartered capital minimum, [3] the Russian tax authority had the right to liquidate the company through the courts, a point it repeated three times in the letter. (Dkt. 44-14). The company was given until November 14, 2008 to “improve [the company's] financial performance and increase the net assets.” (Dkt. 44-14). BJ Parent considered this to be a credible threat, and analyzed the ramifications if BJ Russia was liquidated. (Dkt. 44, p. 10-11). It believed that if BJ Russia was liquidated, TNK-BP would force BJ Parent to finish the contract pursuant to the Performance Guarantee, and BJ Parent would have to pay a third party to complete the work. (Dkt 44, 11-12). BJ Parent estimated its potential exposure exceeded $160 million, and worried about the potential damage to its reputation if one of its subsidiaries defaulted. (Dkts. 44, p. 12; 44-18).

         On November 13, 2008, BJ Russia assured the Ministry of Finance that it was “taking steps to improve the financial and economic activities of the company and to increase the net assets in 2008.” (Dkt. 29-9). After considering the options available in the limited time given, BJ Parent chose to transfer funds from BJ Parent to BJ Russia under article 251(11) of the Tax Code of the Russian Federation, Federal law No. 117-FZ. (Dkt. 43-2). That provision allows a majority shareholder to transfer assets to a company without tax consequences for the receiving company. (Dkt. 43-2, 8-9). To comply with the statute, it was necessary to change the ownership structure of BJ Russia from two owners with equal shares of stock to a single majority shareholder. (Dkt. 43, p. 6). BJ Holding (Russia) Limited sold 1, 050 shares of BJ Russia stock to a Cypriot entity, Samotlor Holding Limited, making Samotlor the majority shareholder of BJ Russia. (Dkt 43-2).

         Samotlor then signed an agreement to provide “Free Financial Aid” in the amount of $52 million to BJ Russia. (Dkt 44-15). The funds would be transferred by BJ Parent, on behalf of Samotlor, by December 31, 2008. (Dkt. 44-15). It was agreed that the “stated cash assets shall be used by the Company to execute its activities as stipulated by the Company's Charter” and that Samotlor “confirms hereby that its financial assistance is free and that it does not expect the company to return the funds to the shareholder.” (Id.). BJ Parent then made a series of transfers in amounts between $2, 000.00 and $6, 000.00 to BJ Russia.[4] (Dkt. 44-16). BJ Parent (now Baker Hughes Incorporated) claimed a deduction on its tax return of $52 million, but that deduction was disallowed by the IRS. Baker Hughes now seeks a refund of $17, 654, 000 in federal income taxes it paid on the $52 million, plus interest. Baker Hughes contends the payment is deductible as a bad debt under Section 166 of the Tax Code, or as an ordinary and necessary trade or business expense under Section 162. See 26 U.S.C. §§ 162 and 166.


         Summary judgment is appropriate if no genuine issues of material fact exist, and the moving party is entitled to judgment as a matter of law. Fed.R.Civ.P. 56(c). The party moving for summary judgment has the initial burden to prove there are no genuine issues of material fact for trial. Provident Life & Accident Ins. Co. v. Goel, 274 F.3d 984, 991 (5th Cir. 2001). Dispute about a material fact is genuine if the evidence could lead a reasonable jury to find for the nonmoving party. In re Segerstrom, 247 F.3d 218, 223 (5th Cir. 2001). “An issue is material if its resolution could affect the outcome of the action.” Terrebonne Parish Sch. Bd. v. Columbia Gulf Transmission Co., 290 F.3d 303, 310 (5th Cir. 2002).

         If the movant meets this burden, “the nonmovant must go beyond the pleadings and designate specific facts showing that there is a genuine issue for trial.” Littlefield v. Forney Indep. Sch. Dist., 268 F.3d 275, 282 (5th Cir. 2001) (quoting Tubacex, Inc. v. M/V Risan, 45 F.3d 951, 954 (5th Cir. 1995)). If the evidence presented to rebut the summary judgment is not significantly probative, summary judgment should be granted. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 249-50 (1986). In determining whether a genuine issue of material fact exists, the court views the evidence and draws inferences in the light most favorable to the nonmoving party. Id. at 255. Where, as here, the evidentiary facts are not disputed, a court may grant summary judgment if trial would not enhance its ability to draw inferences and conclusions. Nunez v. Superior Oil Co., 572 F.2d 1119, 1124 (5th Cir. 1978).

         1. Section 166 - Bad Debt

         Baker Hughes contends the $52 million payment to BJ Russia is deductible under Section 166(a), which applies to “any debt which becomes worthless within the taxable year.” 26 U.S.C. § 166(a) (1). It argues that courts have defined the term “debt” broadly, and have allowed payments that were made to discharge a guarantee to be deducted as bad debt losses. Baker Hughes further insists that Treasury Regulation § 1.166-9 allows it to deduct this payment because “a payment of principal or interest made . . . by the taxpayer in discharge of part or all of the taxpayer's obligation as a guarantor . . . is treated as a business debt becoming worthless in the taxable year in which the payment is made.” Id. Baker Hughes argues that it made the payment to discharge its obligation to guarantee performance on the BJ Russia contract, and therefore satisfies this regulation. Baker Hughes' argument proceeds as follows:

1) The Russian Ministry was threatening to liquidate BJ Russia because it did not have sufficient capital;
2) Liquidation of BJ Russia would have caused it to default on the contract with TNK-BP);
3) That default would have made TNK-BP a judgment-creditor and BJ Russia a judgment-debtor;
4) BJ Russia would have been obligated to pay TNK-BP a fixed and determinable sum of money potentially in excess of $160 million;
5) BJ Parent guaranteed BJ Russia's performance, creating a creditor-debtor relationship between them and making BJ Parent ...

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