Rev. Rul. 80-182

ISSUE

When may a taxpayer using the accrual method of accounting deduct the cost of removing offshore platforms and well fixtures installed pursuant to a long-term oil and gas lease with the federal government?

FACTS

Situation 1

X is a corporation that files its federal income tax return on a calendar year basis using the accrual method of accounting. During 1978 X entered into offshore oil and gas leases with the federal government. The leases provide that X is obligated to remove offshore platforms and well fixtures used in the drilling operation upon X's abandonment of the wells or on termination of the leases. The typical offshore lease has a duration of 20 years or more. X installed the offshore platforms and well fixtures in 1978 and in its federal income tax return for the year deducted the estimated cost of removing them. X will perform all services incidental to removing the offshore platforms and well fixtures.

Situation 2

The facts are the same as Situation 1 except that instead of X performing the removal services it contracts with Y, an unrelated corporation, to perform them.

LAW AND ANALYSIS

Section 461 of the Internal Revenue Code provides that the amount of any deduction shall be taken for the taxable year that is the proper taxable year under the method of accounting used in computing taxable income.

Section 1.461-1(a)(2) of the Income Tax Regulations provides that under an accrual method of accounting an expense is deductible for the taxable year in which (1) all the events have occurred that determine the fact of the liability and (2) the amount thereof can be determined with reasonable accuracy. If the taxpayer is to be entitled to a deduction in 1978 for the cost of removing the platforms and fixtures, both of these conditions must be satisfied.

The specific question is whether the existence during a taxable year of a contractual obligation requiring a taxpayer to incur a deductible expense at some time in the future is sufficient to permit the accrual of such expenditure under section 1.461-1(a)(2) of the regulations even though the contractually mandated services have not been rendered by either the taxpayer or a third-party contractor at the end of the taxable year.

An accrual basis obligor is not permitted to deduct an expense stemming from a bilateral contractual arrangement, that is, mutual promises, prior to the performance of the contracted for services by the obligee. See Levin v. Commissioner, 21 T.C. 996 (1954), aff'd 219 F.2d 588 (3rd Cir. 1955) and Amalgamated Housing Corporation v. Commissioner, 37 B.T.A. 817 (1938), aff'd per curiam, 108 F.2d 1010 (2nd Cir. 1940). The taxpayer obligor, through the vehicle of a bare contractual obligation, has incurred no liability but has merely agreed to become liable to pay in the event the future services called for are performed. The liability under the contract is contingent upon performance. All events are not fixed within the meaning of section 1.461-1(a)(2) of the regulations until the required performance is rendered.

In National Bread Wrapping Machine Co. v. Commissioner, 30 T.C. 550 (1958), the taxpayer was denied a deduction for guaranteed installation services for machines sold but uninstalled. The court held that although the taxpayer was obligated to render installation services, until the installation services were rendered there was no definite liability on the part of the taxpayer to pay any amount to any person. The liability was contingent until performance occurred. See also Spencer, White and Prentis Inc. v. Commissioner, 144 F.2d 45 (2nd Cir. 1944), cert. denied, 323 U.S. 780 (1944), in which the taxpayer was denied a deduction for the estimated cost of future restoration work that the taxpayer was obligated to perform under a construction contract.

In both Situation 1 and 2, X has a contractual obligation under its lease with the federal government to remove the platforms and fixtures. In Situation 1, as X's employees perform the services required to remove the platforms and fixtures the fact of the liability will become fixed. In Situation 2, X's liability to Y for removing the platforms and fixtures is contingent on Y's performance. As Y performs the actual removal services the fact of the liability will become fixed and X will be entitled to deduct the cost of the removal services actually performed by Y. The fact that X is contractually liable for the cost of the entire removal services does not entitle it to deduct the cost of such services before they are performed.

HOLDING

A taxpayer using the accrual method of accounting may deduct the costs of removing offshore platforms and well fixtures installed pursuant to a long-term oil and gas lease with the federal government in the taxable years during which the removal services are performed. This same conclusion results whether the removal services are performed by the taxpayer or a third-party contractor.