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Exxon Mobil Avoids $200 Million Penalty for Erroneous Refund Claim

(Parker Tax Publishing February 2021)

A district court held that an oil and gas company that changed its tax treatment of certain transactions from mineral leases to sales and claimed a refund which the IRS disallowed, on the basis that the change in treatment was an impermissible change in accounting method, was not liable for a penalty under Code Sec. 6676 (as in effect before 2015). The court determined that, based on the statutory language and legislative history, the reasonable basis standard for avoiding the penalty did not include a subjective element as the government argued, and the court concluded that taxpayer had a reasonable basis for its contention that the change from lease to sale treatment was not a change in accounting method. Exxon Mobil Corp. v. U.S., 2021 PTC 10 (N.D. Tex. 2021).


Exxon Mobil Corp. was involved in multiple oil and gas ventures in Qatar and Malaysia, which for tax purposes were treated as partnerships, and reported on Exxon Mobil's consolidated tax returns. Exxon Mobil had historically treated those transactions as mineral leases. In June 2014 and April 2015, Exxon Mobil filed amended tax returns treating the transactions as purchases for tax years 2006-2009. The IRS disallowed the refund claims in May 2016, contending that the transactions were mineral leases and that the change in treatment was an impermissible change in accounting method. The IRS later imposed a penalty under Code Sec. 6676 of approximately $200 million, claiming Exxon filed an erroneous refund claim.

Exxon Mobil filed an action for the refund in a district court. The district court held separate proceedings regarding the refund and the penalty. On the refund issue, the court found in favor of the government after determining that the transactions were primarily mineral leases, and thus the court did not need to reach the issue of whether there was an impermissible change in accounting method. Exxon Mobil and the government both filed motions for summary judgment on the penalty issue.

Before being amended in 2015, Code Sec. 6676 imposed a penalty on a taxpayer that claimed a refund for an excessive amount of income tax unless the taxpayer showed that the claim had a "reasonable basis." Neither the statute nor the regulations defined "reasonable basis." In PMTA 2014-15, the IRS advised that the reasonable basis standard in Code Sec. 6676 had the same meaning as reasonable basis in Code Sec. 6662, as defined in Reg. Sec. 1.6662-4(e)(2)(i). That section incorporates by reference the definition in Reg. Sec. 1.6662-3(b)(3). Under the regulation, the reasonable basis standard is satisfied if a return position is reasonably based on one or more of the authorities set forth in Reg. Sec. 1.6662-4(d)(2) (i.e., the Code, regulations, revenue rulings and procedures, and other specified authorities).

Observation: In 2015, Congress amended the statute and replaced the reasonable basis test with a test for whether the refund claim "is due to reasonable cause."

The parties agreed that the "reasonable basis" test applied in this case but disagreed as to its meaning. The IRS argued that the court should overlay a subjective element on "reasonable basis," as the Eighth Circuit did in Wells Fargo & Co. v. U.S, 2020 PTC 132 (8th Cir. 2020). Wells Fargo concerned a negligence penalty under Code Sec. 6662, which also had a reasonable basis defense. The Eighth Circuit found that, in order to base a return position on a particular legal authority, a taxpayer must show that it actually relied on the authority in forming its position.

Regarding the issue of whether Exxon Mobil changed its method of accounting, Exxon Mobil contended that a change in method of accounting deals with when, not whether, an item is includable in income or allowed as a deduction. In support of this argument Exxon Mobil cited Tate & Lyle, Inc. v. Comm'r, 103 T.C. 656 (1994) and Knight-Ridder Newspapers, Inc. v. U.S., 743 F.2d 781 (11th Cir. 1984). According to Exxon Mobil, in a mineral lease, the lessor's share of production never comes into the lessee's income or out as a deduction. In a sale transaction, though, all production comes into the buyer's income. Thus, from Exxon Mobil's perspective, the issue was that production which was not part of its income under a mineral lease treatment became part of its income under sale treatment. It was not an issue of when it was income or a deduction, according to Exxon Mobil, but whether it was income, and therefore was not a change in method of accounting.


The district court granted Exxon Mobil's motion for partial summary judgment regarding the penalty. The court declined the government's proposal to apply a subjective test to the reasonable basis standard. The court noted that Wells Fargo dealt with the negligence penalty which, according to the court, inherently focuses on the taxpayer's subjective conduct. The court found that, by contrast, Code Sec. 6676 focuses on whether a claim had a reasonable basis, not whether the taxpayer had a reasonable basis. The court reasoned that the difference in the statutory texts counseled against importing the Wells Fargo reasoning to Code Sec. 6676. The court further found that the legislative history for Code Sec. 6676 argued against importing a subjective element. In particular, the court noted that the National Taxpayer Advocate 2014 Annual Report to Congress stated that the reasonable basis test in Code Sec. 6676 was an objective test that penalized unsophisticated taxpayers who were doing their best to comply, but may not have had a reasonable basis as defined in the regulations. The court found that the report recommended precisely the language change to Code Sec. 6676 adopted by Congress in 2015 and observed that there would be no reason to amend the statute to provide for a subjective standard if it already embodied such a standard.

Next, the court held that Exxon Mobil had a reasonable basis for its claims. The court noted that when it ruled on the merits, it acknowledged that this was an extremely complex case, both factually and legally, and although it ultimately ruled against Exxon Mobil, it was only with considerable analysis. Thus, the court readily held that Exxon Mobil's sale vs. mineral lease position was reasonably based on one or more of the authorities set forth in Reg. Sec. 1.6662-4(d)(3)(iii). On the change in accounting method issue, the court also found that Exxon Mobil's briefing on the merits reflected a reasonable basis. The court said that Exxon Mobil reasonably cited Tate & Lyle and Knight-Ridder Newspapers for the proposition that a change in accounting method pertains to when, not whether, an item is includable in income or allowed as a deduction. The court further found that Exxon Mobil had colorable support for its legal contention that a change that affects whether, not when, an item comes into income is not an impermissible change in account method, and further, that Exxon Mobil had a factual basis to argue that the change from mineral lease to sale treatment was a "whether, not when," change and thus not an impermissible change in accounting method. The court therefore concluded that Exxon Mobil's return position satisfied the reasonable basis standard.

For a discussion of the penalty for erroneous claims for refund or credit, see Parker Tax ¶262,175.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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