In Attempt To Deny Oil and Gas-Related Deductions, IRS Reads Language Into the Code That Isn’t There – Tax Court Not Biting

Section 167(h) of the I.R.C. says that a taxpayer can write-off (over 24 months) “geological and geophysical expenses paid or incurred in connection with the exploration for, or development of, oil or gas.”  I.R.C. §167(h)(1) retains that language and then adds that the expenses must be incurred in the United States and that the write-off period begins when the expense was incurred.  Nowhere in the statute is it required that the taxpayer actually own the oil and gas interests with which the expenses are associated.  But, in a recent Tax Court case, the IRS argued that the statutory phrase “geological and geophysical expenses” is a “term of art” referring only to expenses incurred by taxpayers that own mineral interests who incur the expenses in connection with the taxpayer's oil and gas exploration or development.  That position, if true, would deny deductions of expenses that a taxpayer incurs associated with the oil and gas exploration done on behalf of another taxpayer that actually owns the minerals.  Think survey costs here.   

Under the facts of the case, the taxpayer didn’t own any oil or gas interests, but did conduct marine surveys of the outer continental shelf of the Gulf of Mexico in an attempt to detect where oil and gas deposits were located. The taxpayer gathered the data, and then licensed its use to customers on a non-exclusive basis. Those customers then used the data identifying deposits to drill for oil and gas. The taxpayer deducted the cost associated with the surveys under I.R.C. §167(h) as geological and geophysical expenses incurred in connection with the exploration for, or development of, oil and gas. The IRS disallowed the deduction because the plaintiff did not own the oil and gas interests, but the Tax Court allowed the deduction. The Tax Court determined that the deduction under I.R.C. §167(h) is not limited to taxpayers that own the oil and gas interests being surveyed because all that I.R.C. §167(h) requires is that the expenses were incurred in connection with the exploration for, or development of, oil and gas.  The Tax Court noted that the Congress could have put an ownership requirement in the Code if it wanted to, but didn’t.  Indeed, the committee reports behind the provision indicate rather clearly that the taxpayer might not ever choose to own the property.  Also, the provision allows a uniform method of writing off the costs, even if the project is abandoned.  But, in that event, the taxpayer would no longer get an I.R.C. §165 loss.

So, the taxpayer was entitled to the two-year write off provision for the survey costs.  It’s nice to see the Tax Court hold the IRS to the language of the Code – at least this time.  CGG Americas, Inc. v. Comr., 147 T.C. No. 2 (2016).