943 F.3d 255
5th Cir.2019Background
- BJ Services ("BJ Parent") guaranteed performance of its Russian subsidiary ZAO Samotlor Fracmaster Services ("BJ Russia") to TNK-BP under a 2006–2009 fracking contract. TNK-BP could terminate if BJ Russia became bankrupt or a liquidator was appointed.
- In 2008 the Russian Ministry of Finance warned BJ Russia that its net assets were below the legal minimum, exposing it to liquidation if not remedied.
- To avert liquidation, BJ Parent wired $52 million to BJ Russia as "Free Financial Aid" (FFA) under Russian tax law; the FFA expressly imposed no repayment obligation and was treated as a capital contribution under Russian law.
- IRS denied BJ Parent's U.S. tax deduction claim (claimed as a bad-debt under 26 U.S.C. §166 and alternatively as an ordinary and necessary business expense under 26 U.S.C. §162), treating the transfer as a capital contribution.
- Baker Hughes (successor to BJ Parent) sued for a refund; district court granted summary judgment to the Government, and the Fifth Circuit affirmed.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| §166: Is the $52M FFA a deductible bad debt? | Payment discharged guarantor obligation and is deductible under Treas. Reg. §1.166-9 even without a right of repayment | No bona fide debtor-creditor relationship; payment was a voluntary capital contribution and did not discharge a guarantor obligation | No. Payment created no debt nor discharged a guarantor obligation; not deductible under §166 |
| §162: Is the $52M FFA an ordinary and necessary business expense? | Payment was made to protect/promote parent’s business interests (avoid liquidation and large losses) and fits the Lohrke exception | Payment was a capital contribution to recapitalize subsidiary, not an expense; no underlying expense was paid | No. FFA was a capital contribution, not an ordinary and necessary business expense; §162 deduction disallowed |
Key Cases Cited
- Putnam v. Comm'r, 352 U.S. 82 (1956) (guarantor who pays may "step into the creditor's shoes," supporting bad-debt characterization when underlying debt exists)
- Comm'r v. Fink, 483 U.S. 89 (1987) (contribution to capital is not deductible; resembles investment)
- United States v. Vaughan (In re Vaughan), 719 F.2d 196 (6th Cir. 1983) (guarantor payments deductible as bad debts where underlying bona fide debt exists)
- Stratmore v. United States, 420 F.2d 461 (3d Cir. 1970) (similar: guarantor payments treated as bad debts when discharging bona fide obligations)
- Lohrke v. Comm'r, 48 T.C. 679 (1967) (exception allowing deduction when payment protects taxpayer's business and is tied to an actual expense)
- Myers v. Comm'r, 42 T.C. 195 (1964) (advances deductible as bad debts where they create a debtor-creditor relationship and were required by guarantee)
- Schleppy v. Comm'r, 601 F.2d 196 (5th Cir. 1979) (shareholder's voluntary payments to bolster corporation are non-deductible capital contributions)
- Comm'r v. Lincoln Sav. & Loan Ass'n, 403 U.S. 345 (1971) (elements for §162 ordinary and necessary expense)
- Black Gold Energy Corp. v. Comm'r, 99 T.C. 482 (1992) (Tax Court treating guarantor loss as bad debt when based on debtor's obligation to guarantor)
- Baker Hughes, Inc. v. United States, 313 F. Supp. 3d 804 (S.D. Tex. 2018) (district court decision granting summary judgment to government on same issues)