                                           CALTEX OIL VENTURE, CALTEX MANAGEMENT CORPORATION,
                                             TAX MATTERS PARTNER, PETITIONER v. COMMISSIONER
                                                     OF INTERNAL REVENUE, RESPONDENT

                                                        Docket No. 3793–08.                    Filed January 12, 2012.

                                                   C, an accrual-basis partnership, entered into a turnkey con-
                                                tract under which it paid $5,172,666 by cash and note in
                                                December 1999 for the drilling of two oil and gas wells.
                                                Although some site preparation required under the contract
                                                occurred in 1999, no drill penetrated the ground for purposes
                                                of drilling a well by or on behalf of C within 90 days after the
                                                end of 1999. C claimed a full deduction for the $5,172,666 as
                                                intangible drilling costs (IDCs) on its 1999 Federal tax return.
                                                R issued a notice of final partnership administrative adjust-
                                                ment to P, C’s tax matters partner, determining, inter alia,
                                                that C was not entitled to deduct the IDCs because the eco-
                                                nomic performance requirement of I.R.C. sec. 461(h) was not
                                                satisfied. Held: For purposes of I.R.C. sec. 461(i)(2)(A),
                                                ‘‘drilling of the well commences’’ when there is actual penetra-
                                                tion of the ground surface in the act of drilling for purposes
                                                of spudding a well. Mere site preparation is insufficient.
                                                Under this special timing rule, C did not satisfy the economic
                                                performance requirement of I.R.C. sec. 461(h). Held, further,
                                                the 31⁄2-month rule of sec. 1.461–4(d)(6)(ii), Income Tax Regs.,
                                                does not enable C to treat any of the services due under the
                                                contract as having been economically performed in 1999,
                                                because, in the case of an undifferentiated, non-severable con-

                                      18




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                                                tract, the 31⁄2-month rule contemplates that all of the services
                                                called for must be provided within 31⁄2 months of payment.
                                                Held, further, in the alternative, if C is able to invoke the 31⁄2-
                                                month rule and treat some of the services due under the con-
                                                tract as having been economically performed in 1999, then
                                                deductions under the 31⁄2-month rule are limited to payments
                                                of cash or cash equivalents and do not include payments made
                                                by notes.

                                        Bernard Stephen Mark and Richard Stephen Kestenbaum,
                                      for petitioner.
                                        Halvor N. Adams III, Margaret Burow, and James P.A.
                                      Caligure, for respondent.

                                                                                  OPINION

                                         GUSTAFSON, Judge: On November 13, 2007, the Internal
                                      Revenue Service (IRS) issued a notice of final partnership
                                      administrative adjustment (FPAA) for taxable year ending
                                      December 31, 1999, to Caltex Management Corp., the tax
                                      matters partner (TMP) of Caltex Oil Venture. (It is the latter
                                      entity—Caltex Oil Venture—to which we refer herein as
                                      ‘‘Caltex’’.) This case is a partnership-level action based on a
                                      petition filed by the TMP pursuant to section 6226. 1 The
                                      matter is currently before the Court on the IRS’s motion for
                                      partial summary judgment filed pursuant to Rule 121, which
                                      asks us to hold that Caltex is not entitled to deduct the
                                      $5,172,666 that it reported in 1999 as nonproductive intan-
                                      gible drilling costs (IDCs). 2 As explained below, we will grant
                                      partial summary judgment in the IRS’s favor as to most of the
                                      issues addressed in its motion, but we find that other
                                      issues—e.g., under the general rule of section 461(h), the
                                      amount, if any, of IDCs that was incurred in 1999—may
                                      remain for trial.



                                         1 Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986

                                      as in effect for the year in issue (codified in 26 U.S.C., and referred to herein as ‘‘the Code’’),
                                      and all Rule references are to the Tax Court Rules of Practice and Procedure.
                                         2 IDCs are drilling cost outlays associated with oil and gas drilling operations. IDCs range

                                      from amounts paid for the clearing of ground, draining, road-making, and surveying work to all
                                      amounts paid for labor, fuel, repairs, hauling, and supplies (e.g., drilling muds, chemicals, and
                                      cement) incident to and necessary in the drilling and preparation of wells for the production
                                      of oil and gas. See 26 C.F.R. sec. 1.612–4, Income Tax Regs.




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                                                                                Background
                                         The following facts are not in dispute and are derived from
                                      the pleadings, the stipulations of fact, the parties’ motion
                                      papers, and the supporting exhibits attached thereto.
                                         Caltex was organized in 1999. For Federal income tax pur-
                                      poses, Caltex is a partnership that uses the accrual method
                                      of accounting and has a taxable year ending December 31.
                                      On December 31, 1999, Caltex entered into a turnkey con-
                                      tract with Red River Exploration, Inc. Under the contract,
                                      Red River assigned to Caltex a 74.33-percent interest in a
                                      well in Louisiana designated ‘‘J.O. Kimbrell 2–8#1’’ and a 90-
                                      percent interest in a well in Oklahoma designated ‘‘NW Sul-
                                      phur #2’’. Red River agreed to ‘‘commence or cause to be com-
                                      menced’’ the drilling of wells at the two sites ‘‘[a]s soon as
                                      practicable after the execution of * * * [the contract] but in
                                      no event later than March 31, 2000’’. ‘‘[T]hereafter * * *
                                      [Red River would] continue or cause to be continued the
                                      drilling [of the wells] with due diligence and in a
                                      workmanlike manner to a depth to adequately test the objec-
                                      tive formation.’’ For purposes of the IRS’s motion for partial
                                      summary judgment, we assume (as Caltex asserts) that ‘‘a
                                      typical well will take two years to grow from concept to
                                      commencement to production for the purpose of selling
                                      hydrocarbons.’’ 3
                                         The contract called for Caltex to pay to Red River by the
                                      close of business on December 31, 1999, $4,123,333 in cash
                                      and note ‘‘as Turnkey Drilling Costs’’ and ‘‘$1,049,333 for the
                                      Intangible Completion Costs’’, for a total of $5,172,666.
                                      Caltex paid Red River with two checks dated December 27,
                                      1999, in the amounts of $308,293.50 for ‘‘drilling’’ and
                                      $119,892 for ‘‘completion’’, 4 totaling $428,185.50, and
                                      executed a note in favor of Red River for approximately $4.8
                                      million. 5
                                         3 Steps in this process may overlap, but they include: (i) collecting data, acquiring leases, se-

                                      curing access roads, staking and permitting the well (one to two years); (ii) designing the proce-
                                      dures and getting estimates from various service companies (three to four months); (iii) negoti-
                                      ating contracts for subcontract services, equipment, rigs, and specialists, as appropriate (three
                                      to four months); (iv) location work, including site operations, equipment delivery, and installa-
                                      tion (four weeks); (v) actual drilling operations (four to eight weeks); (vi) completion and testing
                                      operations (four weeks); (vii) buying and building surface facilities (four weeks); and (viii) negoti-
                                      ating gas sales, saltwater disposal, and field supervision.
                                         4 The record also reflects that on December 27, 1999, Caltex paid Red River an additional

                                      $30,481 for ‘‘Int’’, presumably interest.
                                         5 The record does not include any note executed by Caltex in favor of Red River, but for pur-




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                                         By December 31, 1999, drilling permits were secured for
                                      the two well sites identified in the contract, and we assume
                                      that in early 2000 Red River engaged in activities to prepare
                                      to drill the wells. However, the parties have stipulated that
                                      ‘‘[n]o drill penetrated the ground for purposes of drilling a
                                      well by or on behalf of Caltex Oil Venture during 1999 or
                                      2000.’’
                                         Caltex timely filed, for 1999, a Form 1065, ‘‘U.S. Partner-
                                      ship Return of Income’’. On the Form 1065, Caltex claimed
                                      a deduction of $5,172,666 for nonproductive IDCs.
                                         In November 2007 the IRS issued its FPAA determining that
                                      Caltex was not entitled to deduct any portion of the IDCs
                                      because, among other things, the economic performance
                                      requirement of section 461(h) was not satisfied. The IRS also
                                      disallowed $744,241 in other deductions claimed by Caltex on
                                      its 1999 return and determined that Caltex was liable for
                                      accuracy-related penalties under section 6662(a) and (b)(1)
                                      and (2).
                                         On February 12, 2008, Caltex, through its TMP, timely filed
                                      a petition pursuant to section 6226 seeking a readjustment
                                      of the IRS’s determinations in the FPAA. Caltex asserted,
                                      among other things, that the IRS erred in determining (i)
                                      ‘‘that the deduction for non-productive intangible drilling
                                      costs in the amount of $5,172,666.00 is improper’’; (ii) that
                                      economic performance was not met by Caltex under Section
                                      461(h)’’; and (iii) that they ‘‘are subject to penalties under
                                      Section 6662(a), 6662(b)(1) and in 6662(b)(2).’’ In doing so,
                                      Caltex asks us to find that there ‘‘are no adjustments to
                                      Partnership items for the year in question’’ and that ‘‘no pen-
                                      alties are properly asserted against any investor of Caltex’’.
                                      At the time the petition was filed, the principal place of busi-
                                      ness for both Caltex and its TMP was Pennsylvania.
                                         On September 18, 2009, the IRS moved for partial sum-
                                      mary judgment on the issue of whether the economic
                                      performance requirement of section 461(h) was satisfied with
                                      respect to the $5,172,666 deduction claimed by Caltex in
                                      1999 for IDCs. In particular, the IRS asks us to narrow the
                                      issues of the case by holding that the economic performance
                                      requirement of section 461(h), if satisfied at all, limits
                                      poses of the IRS’s motion we assume (in Caltex’s favor) that Caltex satisfied its payment obliga-
                                      tions under the contract by executing a note in favor of Red River on or before December 31,
                                      1999.




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                                      Caltex’s maximum potential deduction for 1999 for IDCs to
                                      amounts paid in 1999 for work actually performed in 1999. 6
                                      Caltex opposes the IRS’s motion.
                                        For purposes of deciding this motion, we will consider to
                                      what extent, if any, the services attributable to the
                                      $5,172,666 in IDCs were economically performed during 1999
                                      or within a time that the Code and regulations allow the
                                      services to be treated as if performed in 1999.

                                                                                 Discussion
                                      I. Standard for summary judgment
                                         Under Rule 121 (the Tax Court’s analog to Rule 56 of the
                                      Federal Rules of Civil Procedure) the Court may grant full
                                      or partial summary judgment where there is no genuine
                                      issue of any material fact and a decision may be rendered as
                                      a matter of law. The moving party bears the burden of
                                      showing that no genuine issue of material fact exists, and the
                                      Court will view any factual material and inferences in the
                                      light most favorable to the nonmoving party. Dahlstrom v.
                                      Commissioner, 85 T.C. 812, 821 (1985); cf. Anderson v. Lib-
                                      erty Lobby, Inc., 477 U.S. 242, 255 (1986) (same standard
                                      under Fed. R. Civ. P. 56). ‘‘The opposing party is to be
                                      afforded the benefit of all reasonable doubt, and any
                                      inference to be drawn from the underlying facts contained in
                                      the record must be viewed in a light most favorable to the
                                      party opposing the motion for summary judgment.’’ Espinoza
                                      v. Commissioner, 78 T.C. 412, 416 (1982).
                                         The issue presented in the IRS’s motion—i.e., whether the
                                      economic performance requirement of section 461(h) is satis-
                                      fied with respect to the $5,172,666 deduction claimed by
                                      Caltex in 1999 for IDCs—can be largely resolved on the basis
                                      of the undisputed facts. As a result, we will grant the IRS’s
                                      motion in part.
                                      II. Statutory and regulatory framework
                                        The issue before us is an accounting question: What is the
                                      proper year for claiming deductions for costs that are related
                                         6 On the basis of a stipulation agreed to by Caltex, the IRS asserts that this maximum poten-

                                      tial deduction is $7,072.80. We hold that summary judgment is not appropriate as to the precise
                                      amount (see section V of the argument below), but we hold in favor of the IRS on the interpreta-
                                      tion and application of the economic performance requirement.




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                                      to the drilling of oil wells? 7 As we will show, Caltex is
                                      allowed deductions for 1999 only to the extent that the
                                      performance of the drilling-related services was timely under
                                      one of several alternative rules.
                                           A. ‘‘All events test’’
                                         Section 461 of the Code and its accompanying regulations
                                      provide general rules that govern the timing of deductions.
                                      For a taxpayer (like Caltex) that uses the accrual method of
                                      accounting, an expense is generally allowed as a deduction
                                      for the year the taxpayer incurred the expense, irrespective
                                      of the date of payment. Whether a business expense has been
                                      ‘‘incurred’’ is determined by the ‘‘all events test’’ as set forth
                                      in 26 C.F.R. section 1.461–1(a)(2)(i), Income Tax Regs., which
                                      provides:
                                      Under an accrual method * * * a liability * * * is incurred, and generally
                                      is taken into account for Federal income tax purposes, in the taxable year
                                      in which all the events have occurred that establish the fact of the
                                      liability, the amount of the liability can be determined with reasonable
                                      accuracy, and economic performance has occurred with respect to the
                                      liability. * * * [Emphasis added.]

                                      See United States v. Gen. Dynamics Corp., 481 U.S. 239,
                                      242–243 (1987). The IRS does not dispute that Caltex satis-
                                      fied the first two requirements of the ‘‘all events test’’ (i.e.,
                                      (1) that all the events occurred to establish the liability; and
                                      (2) that the amount of the liability was determinable with
                                      reasonable accuracy). Rather, the IRS contends that Caltex
                                      failed to satisfy the third ‘‘all events’’ requirement, namely,
                                      ‘‘economic performance’’.




                                         7 Apart from the special allowances of the Code, IDCs would be capital expenditures. Since

                                      they benefit future periods, they would have to be capitalized and recovered over those periods
                                      for income tax purposes, rather than being expensed for the period the costs are incurred. See,
                                      e.g., 26 C.F.R. sec. 1.461–1(a)(2)(i), Income Tax Regs. Notwithstanding this general rule, section
                                      263(c) grants taxpayers the option to currently expense IDCs. See Keller v. Commissioner, 725
                                      F.2d 1173, 1178 (8th Cir. 1984), aff ’g 79 T.C. 7 (1982). However, ‘‘this option applies only to
                                      expenditures for those drilling and developing items which in themselves do not have a salvage
                                      value. For the purpose of this option, labor, fuel, repairs, hauling, supplies, etc., are not consid-
                                      ered as having a salvage value, even though used in connection with the installation of physical
                                      property which has a salvage value.’’ 26 C.F.R. sec. 1.612–4(a), Income Tax Regs.




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                                           B. Economic performance with respect to services provided
                                              to a taxpayer
                                           1. General rule: provision of services
                                         Before the enactment of section 461(h) in the Deficit
                                      Reduction Act of 1984 (DEFRA), Pub. L. No. 98–369, sec.
                                      91(a), 98 Stat. at 598, economic performance was not
                                      required. With its enactment, section 461(h) expanded the
                                      ‘‘all events test’’ by providing that ‘‘in determining whether
                                      an amount has been incurred with respect to any item
                                      during any taxable year, the all events test shall not be
                                      treated as met any earlier than when economic performance
                                      with respect to such item occurs.’’ Sec. 461(h). Section 461(h)
                                      applies to any item allowable as a cost, expense, or deduc-
                                      tion, unless specifically exempted by an alternative timing
                                      rule in the Code. Sec. 461(h)(2).
                                         Generally, if the liability of the taxpayer arises from a
                                      third person’s providing services to the taxpayer, economic
                                      performance occurs as the services are provided. Sec.
                                      461(h)(2)(A)(i); 26 C.F.R. sec. 1.461–4(d)(2), Income Tax Regs.
                                      This general rule is applicable in cases of IDCs under a turn-
                                      key contract for the drilling of an oil or gas well. See 26
                                      C.F.R. sec. 1.461–4(d)(7), Example (4).
                                         Before the enactment of section 461(h), when an accrual-
                                      basis oil or gas enterprise entered into a contract to receive
                                      drilling services, under which the taxpayer was to incur IDCs,
                                      it was proper under the ‘‘all events test’’ for the taxpayer to
                                      claim a deduction in the year in which the obligation for the
                                      IDCs became fixed under the contract, whether or not there
                                      was in that year any economic performance of services called
                                      for by the contract. As compared to a cash-basis taxpayer,
                                      this rule placed an accrual-basis taxpayer in a superior posi-
                                      tion with regard to IDCs, because the cash-basis taxpayer
                                      actually had to prepay its IDCs to be allowed the deduction
                                      while an accrual-basis taxpayer only had to become obligated
                                      to pay in order to be allowed a deduction. However, since the
                                      enactment of section 461(h), the Code has not allowed
                                      accrual-basis taxpayers to claim a deduction for IDCs until
                                      economic performance of the services under the contract has
                                      occurred. Thus, even though the old ‘‘all events test’’ might
                                      be met for one tax year because the taxpayer’s liability for




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                                      payment became fixed and determined in that year, under
                                      the rules now applicable to accrual-basis taxpayers, a deduc-
                                      tion is allowed for that year only if the economic performance
                                      test of section 461(h) is satisfied as well.
                                         As a result, unless an exception to this general rule
                                      applies, the IDCs at issue here satisfy the economic perform-
                                      ance requirement of section 461(h) for 1999 only to the
                                      extent the corresponding services were actually performed in
                                      1999.
                                           2. The two pertinent exceptions in dispute 8
                                        Caltex does not contend that Red River performed more
                                      than $5 million in services on the last day of 1999 (i.e., the
                                      day the contract was executed). 9 Rather, Caltex claims its
                                      deduction is warranted under two possible exceptions to the
                                      general rule:
                                           a. The 90-day rule
                                         The 90-day rule of section 461(i)(2)(A) allows a taxpayer to
                                      deduct IDCs in full prior to economic performance if ‘‘drilling
                                      of the well commences’’ within 90 days after the close of the
                                      tax year in which the taxpayer prepaid the IDCs and for
                                      which the taxpayer is seeking to claim the deduction. The IRS
                                      maintains that Caltex is not entitled to the special timing
                                      provision of the 90-day rule because no drill penetrated the
                                      ground for the purpose of beginning Caltex’s wells before the
                                      close of the 90th day after the close of 1999 (i.e., by March
                                      30, 2000). In so arguing, the IRS contends that the phrase
                                      ‘‘drilling of the well commences’’ as used in section
                                      461(i)(2)(A) requires actual penetration of the ground by a
                                      drill bit for purposes of starting the well.
                                        8 A third exception is the recurring item exception of section 461(h)(3)(A)(iii), which allows a

                                      taxpayer to claim a deduction in advance of economic performance if certain requirements are
                                      met. In its motion the IRS argues that Caltex is not entitled to the recurring item exception
                                      because, inter alia, the liability under the contract is not recurring in nature. Caltex does not
                                      counter the IRS’s argument or explicitly argue that it is entitled to invoke the recurring item
                                      exception of section 461(h)(3)(A)(iii). We therefore infer that Caltex concedes this issue and does
                                      not invoke the recurring item exception.
                                        9 Caltex does contend that, even if all its other arguments fail, it is still entitled to a deduction

                                      for the cost of any services that Red River actually performed in 1999 under the terms of the
                                      contract. The IRS acknowledges that entitlement but argues that Caltex’s maximum possible de-
                                      duction under that theory should be $7,072.80 because Caltex stipulated that ‘‘it incurred
                                      $7,072.80 of intangible drilling costs relating to Exhibit 5–J (the document entitled ‘Turnkey
                                      Contract’ between Caltex Oil Venture and Red River Exploration, Inc.) during 1999.’’ We ad-
                                      dress this issue briefly in section V below.




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                                         In contrast, Caltex contends that it is entitled to a full
                                      deduction for the IDCs for 1999 because it commenced drilling
                                      operations, i.e., by securing drilling permits and beginning
                                      site preparation, within 90 days of the close of 1999 in satis-
                                      faction of section 461(i)(2)(A). Caltex challenges the IRS’s
                                      interpretation that the 90-day rule requires that a drill bit
                                      actually penetrate the ground. Caltex argues that actual
                                      drilling is not necessary and that acts normally required to
                                      be done before the commencement of actual drilling are suffi-
                                      cient to constitute the commencement of a well or drilling
                                      operations.
                                           b. The 31⁄2-month rule
                                         In the alternative, Caltex argues that, even if it is not enti-
                                      tled to a full deduction under the 90-day rule, it is entitled,
                                      at least, to a partial deduction of IDCs for 1999 under the
                                      31⁄2-month rule of 26 C.F.R. section 1.461–4(d)(6)(ii), Income
                                      Tax Regs., which allows a taxpayer to treat a liability as
                                      having been economically performed at the time of payment
                                      if that taxpayer ‘‘reasonably expect[ed] the * * * [provider of
                                      services] to provide the services * * * within 31⁄2 months
                                      after the date of payment’’. The IRS maintains that Caltex
                                      may not invoke this special timing rule because the 31⁄2-
                                      month rule contemplates that, under a non-severable con-
                                      tract, all of the services called for must reasonably be
                                      expected to be performed within the required time. Caltex
                                      disputes the IRS’s interpretation of the regulation and con-
                                      tends that it is entitled to a deduction for the portion of the
                                      contracted services that it reasonably expected to be per-
                                      formed within 31⁄2 months of payment.
                                         We now address these disputed issues.
                                      III. The special 90-day rule for oil and gas tax shelters under
                                           section 461(i)(2)(A): ‘‘if drilling of the well commences’’
                                         Section 461(i)(2)(A) provides a special rule for economic
                                      performance as it relates to the drilling of oil and gas wells.
                                      This special rule is limited to ‘‘tax shelters’’ as defined in sec-
                                      tion 461(i)(3). For purposes of this motion, we will assume
                                      (favorably to Caltex) that Caltex is such a tax shelter so that
                                      it may invoke section 461(i)(2)(A), which provides:




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                                      In the case of a tax shelter, economic performance with respect to amounts
                                      paid during the taxable year for drilling an oil or gas well shall be treated
                                      as having occurred within a taxable year if drilling of the well commences
                                      before the close of the 90th day after the close of the taxable year.
                                      [Emphasis added.]

                                      Thus, accrual-basis oil and gas tax shelters (such as Caltex)
                                      may deduct their IDCs in advance of drilling as long as the
                                      ‘‘drilling of the well commences’’ within 90 days after the
                                      close of the tax year for which the taxpayer is seeking to
                                      claim the deduction.
                                         The question that this provision prompts is: When does the
                                      ‘‘drilling’’ of a well ‘‘commence’’?
                                         The IRS maintains that the drilling of a well commences
                                      when the well is ‘‘spudded’’, meaning at the beginning of sur-
                                      face drilling (i.e., when the drill bit penetrates the ground),
                                      while Caltex argues that drilling is commenced when activi-
                                      ties such as site preparation begin.
                                           A. The plain language of the statute: ‘‘drilling * * *
                                              commences’’
                                         To construe a statute, we consult first the ordinary
                                      meaning of its language, see Perrin v. United States, 444 U.S.
                                      37, 42 (1979), and we apply the plain meaning of the words
                                      used in a statute unless we find that those words are ambig-
                                      uous, United States v. James, 478 U.S. 597, 606 (1986). Since
                                      the 90-day rule was added to the Code in 1984, see DEFRA
                                      sec. 91(a), and has remained relatively unchanged, these are
                                      not antiquated words or terms that would need special
                                      interpretation. According to Webster’s Third New Inter-
                                      national Dictionary 690 (2002), to ‘‘drill’’ means ‘‘to make (a
                                      rounded hole or cavity in a solid) by removing bits with a
                                      rotating drill’’, while to ‘‘commence’’ means ‘‘to begin’’. Id. at
                                      456. Giving effect to the plain meaning of these words, we
                                      find it unambiguous that ‘‘drilling of the well commences’’
                                      when the boring of a hole for the well begins. Therefore, we
                                      find that the plain language of section 461(i)(2)(A) dictates
                                      that, as a matter of law, ‘‘drilling of the well commences’’
                                      when the drill bit penetrates the ground to start the hole for
                                      the well. Our interpretive task could stop there, with our
                                      conclusion based on the plain language of section 461(i)(2)(A).




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                                           B. The title of section 461(i)(2): ‘‘spudding’’
                                         However, we need not look far to see strong corroboration
                                      of this interpretation—or, if the language were thought
                                      ambiguous, resolution of that ambiguity. The title of section
                                      461(i)(2)—‘‘Special rule for spudding of oil or gas wells’’
                                      (emphasis added)—shows the intended meaning of the term
                                      ‘‘drilling of the well commences’’. While the title of an act will
                                      not limit the plain meaning of the text, see Strathearn S.S.
                                      Co. v. Dillon, 252 U.S. 348, 354 (1920); Caminetti v. United
                                      States, 242 U.S. 470, 490 (1917), it may be of aid in resolving
                                      an ambiguity, Fla. Dept. of Revenue v. Piccadilly Cafeterias,
                                      Inc., 554 U.S. 33, 47 (2008). 10 In the case of section 461(i),
                                      the heading is not at any variance with the text. This is an
                                      instance in which the heading is ‘‘of some use for interpreta-
                                      tive purposes’’, 11 Wallace v. Commissioner, 128 T.C. 132,
                                      140–141 (2007), and it confirms our reading of the text of the
                                      statute:
                                         To ‘‘spud’’ means ‘‘to begin to drill (an oil well) by alter-
                                      nately raising and releasing a spudding bit with the drilling
                                      rig’’. Webster’s Third New International Dictionary 2212
                                      (2002). 12 As a result, we find that a well is ‘‘spudded’’ when
                                          10 See also Graves v. Commissioner, 89 T.C. 49, 51 (1987); Keeble v. Commissioner, 2 T.C.

                                      1249, 1252–1253 (1943). The Court of Appeals for the Third Circuit, to which an appeal of this
                                      case would lie, follows this principle: ‘‘ ‘[T]he title of a statute and the heading of a section are
                                      tools available for the resolution of a doubt about the meaning of a statute.’ ’’ Gay v.
                                      CreditInform, 511 F.3d 369, 385 (3d Cir. 2007) (quoting Almendarez-Torres v. United States, 523
                                      U.S. 224, 234 (1998)); see also United States v. Thayer, 201 F.3d 214, 221 (3d Cir. 1999) (‘‘the
                                      title of a [statutory] section can assist in resolving ambiguities’’).
                                          11 The word ‘‘spudding’’ was used not only in the title of the statute but several times in the

                                      legislative history. See S. Rept. No. 100–445, at 100–101 (1988), 1988 U.S.C.C.A.N. 4515, 4618
                                      (‘‘When the special spudding rule for economic performance was adopted by Congress * * * eco-
                                      nomic performance was deemed to occur at the time of spudding of an oil or gas well where
                                      the taxpayer had paid for the drilling costs prior to the close of the taxpayer’s year. * * * the
                                      special spudding rule * * * in order for spudding to be considered as economic performance’’
                                      (emphasis added)); H.R. Conf. Rept. No. 98–861, at 884–885 (1984), 1984–3 C.B. (Vol. 2) 1, 138
                                      (‘‘economic performance is deemed to occur with respect to all intangible drilling expenses of a
                                      well when the well is ‘spudded.’ * * * [If] the spudding of the well commenced within 90 days
                                      after the close of the taxable year, the entire amount of the prepaid intangible drilling expense
                                      would be deductible’’ (emphasis added)). Thus, if there were any doubt, the legislative history
                                      could be cited to confirm the interpretation we have found.
                                          12 If ‘‘spudding’’, as a specialized term, should be defined by reference to oil and gas sources,

                                      then such sources only confirm the dictionary meaning. See Marathon Oil Co. v. FERC, 68 F.3d
                                      1376, 1377 (D.C. Cir. 1995) (spudding occurs ‘‘where surface drilling had commenced’’); Amer-
                                      ican Petroleum Institute, Glossary of Oilfield Production Terminology (1988) (citing API Bulletin
                                      D11, ‘‘Glossary of Drilling-Fluid and Associated Terms’’ (2d ed. 1979) (defining ‘‘spudding in’’ as
                                      ‘‘[t]he starting of the drilling operations of a new hole’’)) (available at http://www.occeweb.com/
                                      og/api-glossary.pdf); Howard R. Williams & Charles J. Meyers, Manual of Oil and Gas Terms
                                      1084 (12th ed. 2003) (defining ‘‘spudding in’’ as ‘‘[t]he first boring of the hole in the drilling of
                                      an oil well’’). In addition, an abridged version of the Dictionary of Petroleum Terms provided




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                                      the drill bit penetrates the ground for purposes of drilling an
                                      oil or gas well. That being the case, the title that Congress
                                      gave to this subparagraph—‘‘Special rule for spudding’’—
                                      indicates that when Congress said that the special rule
                                      would apply ‘‘if drilling of the well commences’’, it meant that
                                      the rule would apply if a spudding bit had been raised and
                                      released to begin the actual drilling.
                                           C. Giving effect to every word in the statute
                                         In support of its contrary position, Caltex cites several
                                      State court opinions that interpret similar language in oil
                                      and gas leases but hold that actual drilling is not required.
                                      However, in most of the cases Caltex cites, the language and
                                      the contexts are different from section 461. 13 Caltex cites one
                                      case with language sufficiently close to section 461 to war-
                                      rant discussion: Jones v. Moore, 338 P.2d 872 (Okla. 1959),
                                      which interprets a contract term that required a lessee to
                                      ‘‘commence to drill a well’’ and holds that the contract was
                                      satisfied even without actual drilling. 14 In Jones the
                                      Supreme Court of Oklahoma held that the ‘‘well was com-
                                      menced’’ by certain preparatory acts, e.g., staking the loca-
                                      tion, digging a slush pit preparatory to drilling, and ordering
                                      a machine out to drill the well. Id. at 874–876. In doing so,
                                      the court seems to have ascribed no significance to the pres-
                                      ence of the word ‘‘drill’’ in the lease term at issue (‘‘commence
                                      to drill a well’’ (emphasis added)), and Caltex would evi-
                                      by Petex and the University of Texas Austin (c) Petex 2001 (provided on the Department
                                      of Labor’s website at http://www.osha.gov/SLTC/etools/oilandgas/glossaryloflterms/glos-
                                      sarylofltermsla.html) defines ‘‘spud’’ as ‘‘1. to begin drilling a well; such as, to spud in. 2.
                                      to force a wireline tool or tubing down the hole by using a reciprocating motion’’, where ‘‘spud
                                      in’’ means ‘‘to begin drilling; to start the hole.’’ Caltex does not dispute that ‘‘spudding’’ has this
                                      specific meaning, nor does Caltex cite any sources that give a different definition of ‘‘spudding’’.
                                         13 See Allen v. Cont’l Oil Co., 255 So. 2d 842 (La. App. 1971) (interpreting contract term that

                                      required ‘‘operations for drilling’’ to have commenced); Walton v. Zatkoff, 127 N.W.2d 365 (Mich.
                                      1964) (interpreting contract term requiring commencement of ‘‘operations for the drilling of a
                                      well’’ or ‘‘the commencement of drilling operations’’); Henderson v. Ferrell, 38 A. 1018 (Pa. 1898)
                                      (interpreting contract term that required lessee ‘‘to commence operations on the premises within
                                      30 days’’); Pemco Gas, Inc. v. Bernardi, 5 Pa. D & C.3d 85 (1977) (interpreting lease term that
                                      required ‘‘commencement of operations’’ by a certain date); Petersen v. Robinson Oil & Gas Co.,
                                      356 S.W.2d 217 (Tex. Civ. App. 1962) (interpreting contract term requiring the commencement
                                      of ‘‘operations for drilling’’); Edgar v. Bost, 14 S.W.2d 364 (Tex. Civ. App. 1929) (interpreting
                                      contract term that ‘‘well be commenced’’); Fast v. Whitney, 187 P. 192 (Wyo. 1920) (interpreting
                                      contract term that ‘‘well be commenced’’). None of these sheds any light on the meaning of ‘‘if
                                      drilling of the well commences’’ (emphasis added) in section 461.
                                         14 Caltex also cites, to the same effect, 2 Walter Lee Summers, Oil and Gas, sec. 349 (1959),

                                      cited in Anderson v. Hess Corp., 733 F. Supp. 2d 1100, 1108 (D. N.D. 2010), aff ’d, 649 F.3d 891
                                      (8th Cir. 2011).




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                                      dently have us do the same here. However, we do not face
                                      the question whether, under Oklahoma law, lease terms of
                                      this nature are understood not to require actual penetration
                                      of the ground, despite language literally calling for
                                      ‘‘drill[ing]’’. Instead, we interpret a statute (not a lease), and
                                      we construe it as a provision of Federal law (not under State
                                      law).
                                         In so doing, we follow the ‘‘ ‘elementary rule of construction
                                      that effect must be given, if possible, to every word, clause
                                      and sentence of a statute.’ ’’ Vetco Inc. & Subs. v. Commis-
                                      sioner, 95 T.C. 579, 592 (1990) (quoting 2A Sutherland Statu-
                                      tory Construction sec. 46.06 (1986)). As a result, we will not
                                      ignore or minimize the word ‘‘drilling’’ in section 461(i)(2)(A).
                                      To do so would be at odds with the heading of the section
                                      (discussed above at III.B.) and its intended purpose (see
                                      supra note 11). Therefore, we do not find the cases cited by
                                      Caltex to be persuasive in aiding our interpretation of section
                                      461.
                                           D. Application to Caltex
                                        Caltex has stipulated that ‘‘[n]o drill penetrated the ground
                                      for purposes of drilling a well by or on behalf of Caltex Oil
                                      Venture during 1999 or 2000.’’ Given that fact, Caltex is not
                                      entitled to the special timing rule of section 461(i)(2)(A).
                                      IV. The 31⁄2-month rule of 26 C.F.R. section 1.461–4(d)(6)(ii)
                                         As we have shown, the general ‘‘economic performance’’
                                      rule of section 461(h)(2)(A)(i) provides that economic perform-
                                      ance occurs as services are provided to the taxpayer; but sec-
                                      tion 461(h)(2) conferred on the Secretary the authority to
                                      promulgate regulations that would provide alternative
                                      timing. Acting under this authority, the Secretary promul-
                                      gated 26 C.F.R. section 1.461–4(d)(6)(ii), Income Tax Regs.,
                                      which provides that a taxpayer is allowed to treat services as
                                      having been provided (i.e., thereby satisfying the economic
                                      performance prong of the ‘‘all events test’’) when the tax-
                                      payer makes payment for those services if the taxpayer can
                                      ‘‘reasonably expect the * * * [provider of services] to provide
                                      the services * * * within 31⁄2 months after the date of pay-
                                      ment.’’ This is commonly referred to as ‘‘the 31⁄2-month rule.’’




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                                           A. The parties’ contentions
                                          The IRS maintains that this 31⁄2-month rule does not allow
                                      Caltex to treat the services due under the contract as having
                                      been economically performed in 1999 because the rule
                                      applies only if Caltex could reasonably expect all services due
                                      under the contract to be provided within 31⁄2 months after
                                      the date of payment. The IRS acknowledges a distinction (and
                                      a different outcome) where the contract provides for differen-
                                      tiated or severable services to be performed under a single
                                      contract. The IRS concedes that, in the case of a divisible con-
                                      tract, also known as a severable contract, 15 economic
                                      performance occurs (and any applicable economic perform-
                                      ance exception will apply) separately with regard to each dis-
                                      tinct service that was contracted for as that service is pro-
                                      vided. See 26 C.F.R. sec. 1.461–4(d)(6)(iv), Income Tax Regs.
                                      (‘‘If different services * * * are required to be provided to a
                                      taxpayer under a single contract or agreement, economic
                                      performance generally occurs over the time each service is
                                      provided’’). However, the IRS maintains that the same is not
                                      so if a contract—like, it points out, the turnkey contract 16 at
                                      issue here—does not specifically provide for differentiated
                                      services.
                                          Caltex disagrees and argues that the IRS’s interpretation of
                                      the 31⁄2-month rule must be rejected because if all the serv-
                                      ices called for under a turnkey contract had to be performed
                                      within 31⁄2 months of payment, the rule could never be
                                      applicable to the oil and gas industry. Our record shows that
                                      digging an oil well usually takes over two years from concep-
                                      tion to production and necessarily requires, among other
                                      things, extensive data collection, lease acquisitions, securing
                                      access roads, staking and permitting of the well site, negoti-
                                      ating contracts for subcontract services, buying and building
                                        15 Where several things are to be done under a contract, and the money consideration to be

                                      paid is apportioned to each of the items, the contract is ordinarily regarded as severable. Mac-
                                      Arthur v. Commissioner, 168 F.2d 413 (8th Cir. 1948), aff ’g 8 T.C. 279 (1947); Canister Co. v.
                                      Wood & Selick, Inc., 73 F.2d 312, 314 (3d Cir. 1934). On the other hand, if the consideration
                                      to be paid is single and entire, the contract will ordinarily be held as entire, see United States
                                      v. U.S. Fid. & Guar. Co., 236 U.S. 512, 524–525 (1915); Traiman v. Rappaport, 41 F.2d 336,
                                      338 (3d Cir. 1930), ‘‘although the subject thereof may consist of several distinct and wholly inde-
                                      pendent items,’’ Fullmer v. Poust, 26 A. 543, 543 (Pa. 1893).
                                        16 ‘‘A turnkey contract has a definite meaning in the oil industry. It is a contract where the

                                      driller undertakes to furnish everything, and to do all the work required to complete the well,
                                      place it on production, and turn it over ready to ‘turn the key’ and start the oil running into
                                      the tanks.’’ Cont’l Oil Co. v. Jones, 177 F.2d 508, 510 (10th Cir. 1949).




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                                      surface facilities, and the actual drilling and production of oil
                                      or gas. Instead, Caltex maintains that the rule permits a tax-
                                      payer to accelerate a deduction for just the allocable cost of
                                      the services that would be provided in the 31⁄2-month period
                                      from payment. In taking this position, Caltex does not
                                      address the IRS’s distinction between a severable and non-
                                      severable contract.
                                        Thus, the questions before us are (i) whether the 31⁄2-
                                      month rule contemplates that all of the services called for
                                      under a contract must be provided within 31⁄2 months of pay-
                                      ment, or whether the rule permits a taxpayer to accelerate
                                      a deduction for just the portion of the services that would be
                                      expected to be provided in the 31⁄2-month period from pay-
                                      ment, and (ii) whether the interpretation and application of
                                      the 31⁄2-month rule changes depending on whether the con-
                                      tract at issue is severable or non-severable.
                                           B. Construing 26 C.F.R. section 1.461–4(d)(6)(ii)
                                           1. The ambiguity of the regulation
                                         The starting point for interpreting a regulatory provision
                                      is, as with a statute, its plain meaning. Walker Stone Co. v.
                                      Sec’y of Labor, 156 F.3d 1076, 1080 (10th Cir. 1998) (‘‘When
                                      the meaning of a regulatory provision is clear on its face, the
                                      regulation must be enforced in accordance with its plain
                                      meaning’’); Intermountain Ins. Serv. of Vail, L.L.C. v.
                                      Commissioner, 134 T.C. 211, 218 (2010), rev’d on other
                                      grounds, 650 F.3d 691 (D.C. Cir. 2011). The 31⁄2-month rule
                                      inquires whether Caltex reasonably expected Red River ‘‘to
                                      provide the services’’ within the relevant time period. See 26
                                      C.F.R. sec. 1.461–4(d)(6)(ii), Income Tax Regs. (emphasis
                                      added). The IRS argues that this rule contemplates that ‘‘the
                                      services’’ called for under a contract—i.e., all of the con-
                                      tracted services—must be provided within 31⁄2 months of
                                      payment, while Caltex maintains that the rule permits a tax-
                                      payer to claim a deduction for just the portion of the services
                                      that would be expected to be provided in the 31⁄2-month
                                      period from payment. The IRS thus contends in effect that
                                      ‘‘the services’’ means ‘‘all of the services’’, and Caltex con-
                                      tends in effect that it means ‘‘any of the services’’.
                                         We think that the IRS’s proffered meaning (i.e., all of the
                                      services) is the more likely. The regulation reads:




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                                      A taxpayer is permitted to treat services or property as provided to the
                                      taxpayer as the taxpayer makes payment to the person providing the serv-
                                      ices or property (as defined in paragraph (g)(1)(ii) of this section), if the
                                      taxpayer can reasonably expect the person to provide the services or prop-
                                      erty within 31⁄2 months after the date of payment. [26 C.F.R. sec. 1.461–
                                      4(d)(6)(ii), Income Tax Regs.]

                                      The regulation thus presumes a correlation between ‘‘the
                                      services’’ and ‘‘payment’’ therefor. Where multiple services
                                      are provided pursuant to a contract that calls for a single
                                      payment, and the single payment is thus not linked to fewer
                                      than all of the contracted services but is instead paid for all
                                      of the contracted services, ‘‘the services’’ that must be pro-
                                      vided within 31⁄2 months would seem to be the services for
                                      which ‘‘payment’’ is made—i.e., all the services.
                                         However, the regulation does not include either the phrase
                                      ‘‘all of ’’ or the phrase ‘‘any of ’’. We cannot say that Caltex’s
                                      interpretation is impossible. Since the meaning of the regula-
                                      tion is thus ambiguous, we will look to other principles and
                                      canons 17 to see whether they confirm or correct our initial
                                      reading of the regulation.
                                           2. Narrow construction of deductions
                                         It is well settled that deductions are a matter of legislative
                                      grace and should be narrowly construed. INDOPCO, Inc. v.
                                      Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co.
                                      v. Helvering, 292 U.S. 435, 440 (1934). Caltex asks us to read
                                      the 31⁄2-month rule expansively—i.e., giving the taxpayer a
                                      greater entitlement to accelerate deductions—whereas the
                                      IRS’s interpretation is narrower. This tends in favor of the
                                      IRS’s interpretation, especially since the 31⁄2-month rule, even
                                      narrowly construed, is already a relaxation of the general
                                      economic performance rule of section 461(h) and expands tax-
                                      payers’ entitlement to a deduction. 18
                                         17 The IRS’s interpretation of 26 C.F.R. sec. 1.461–4(d)(6)(ii) has not been announced in any

                                      published guidance. Because we uphold this interpretation on other grounds, we need not reach
                                      the question whether, as the IRS contends, this is a circumstance in which we should defer to
                                      the agency’s unpublished interpretation of its own regulation.
                                         18 The Secretary showed an intention to limit the relaxation of the economic performance rule.

                                      Some commentators on the Secretary’s initial proposed regulations encouraged the IRS to adopt
                                      final regulations with a ‘‘payment trump’’ rule—i.e., treating the time of payment as full eco-
                                      nomic performance, see T.D. 8408, 1992–1 C.B. 155, 157—and others suggested that the pro-
                                      posed 31⁄2-month rule be extended to six months, see id., 1992–1 C.B. at 157. Rejecting these
                                      suggestions in the final regulations, the Secretary determined that ‘‘the policy of section 461(h)
                                      would be frustrated’’ by adopting the ‘‘payment trump’’ rule and that ‘‘the 31⁄2-month rule appro-
                                                                                                    Continued




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                                           3. The history of the 31⁄2-month rule
                                         It is well settled that where a statute is ambiguous, we
                                      may look to legislative history to ascertain its meaning. Bur-
                                      lington N. R.R. v. Okla. Tax Comm’n, 481 U.S. 454, 461
                                      (1987); Griswold v. United States, 59 F.3d 1571, 1575–1576
                                      (11th Cir. 1995). The rules of statutory construction also
                                      apply to the construction of regulations. See Estate of
                                      Schwartz v. Commissioner, 83 T.C. 943, 952–953 (1984).
                                      Therefore, when a regulation is ambiguous, we may likewise
                                      consult its ‘‘regulatory history’’—i.e., statements made by the
                                      agency contemporaneously with proposing and adopting the
                                      regulation—to ascertain its meaning. See Armco, Inc. v.
                                      Commissioner, 87 T.C. 865, 868 (1986) (‘‘A preamble will fre-
                                      quently express the intended effect of some part of a regula-
                                      tion * * * [and] might be helpful in interpreting an ambi-
                                      guity in a regulation’’); see also Abbott Labs. v. United States,
                                      84 Fed. Cl. 96, 103 (2008) (‘‘the court [is] permitted to consult
                                      the agency’s interpretations or the regulatory history to
                                      determine meaning’’ if the regulation is ambiguous), aff ’d,
                                      573 F.3d 1327 (Fed. Cir. 2009). Proposed regulations under
                                      section 461(h) were issued on June 7, 1990, and adopted on
                                      April 9, 1992. See Notice of Proposed Rulemaking, Economic
                                      Performance Requirement, IA–258–84, 1990–2 C.B. 805; T.D.
                                      9408, 1992–1 C.B. 155. In publishing the proposed regula-
                                      tions, the Secretary explained the origin of the 31⁄2-month
                                      rule:
                                      [I]n the case of a liability of a taxpayer arising from the provision by
                                      another person of property or services to the taxpayer, the statute provides
                                      that economic performance occurs as the property or services are provided
                                      to the taxpayer. The regulations provide rules designed to lessen the bur-
                                      den on a taxpayer incident to determining when property or services are
                                      provided to the taxpayer. For example, the regulations provide that a tax-
                                      payer may treat property or services as provided to the taxpayer as the
                                      taxpayer makes payment for the property or services. However, this treat-
                                      ment is available only if the taxpayer can reasonably expect the property
                                      or services to be provided by the other person within 31⁄2 months after the
                                      payment is made. [1990–2 C.B. 805, 806; emphasis added.]


                                      priately operates to relieve taxpayers of the burdens incident to determining precisely when
                                      services and property are provided, while assuring that economic performance occurs within a
                                      reasonable time following payment.’’ Id.




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                                      In promulgating the final regulations (in which he rejected a
                                      suggestion to lengthen the 31⁄2-month period; see supra note
                                      18), the Secretary repeated—
                                      that the 31⁄2-month rule appropriately operates to relieve taxpayers of the
                                      burdens incident to determining precisely when services and property are
                                      provided, while assuring that economic performance occurs within a
                                      reasonable time following payment. [T.D. 8408, 1992–1 C.B. at 157;
                                      emphasis added.]

                                        Therefore, the history of 26 C.F.R. section 1.461–4(d)(6)(ii)
                                      is emphatic about avoiding the burden of having to deter-
                                      mine precisely when services were provided. It would be
                                      somewhat at odds with such a regime—engineered to avoid
                                      difficulties in determining when services have been pro-
                                      vided—to allow a taxpayer to accelerate deductions for just
                                      the portion of services expected to be provided within 31⁄2
                                      months of payment and, in order to do so, to make ex post
                                      facto valuations of those services—valuations that would
                                      require fact-intensive analyses by both the taxpayer and the
                                      IRS. This is the very difficulty that the regulation sought to
                                      avoid. We hardly think that the Secretary intended this
                                      result when promulgating the 31⁄2-month rule.
                                           4. Difficulty for the oil and gas industry
                                         Caltex argues that the IRS’s interpretation of the 31⁄2-
                                      month rule must be rejected because if all the services called
                                      for under a turnkey contract have to be performed within 31⁄2
                                      months of payment, the 31⁄2-month rule could never be
                                      applicable to the oil and gas industry because of the immen-
                                      sity of its projects, thereby making the rule superfluous.
                                         It is true that, generally speaking, an interpretation that
                                      renders a statutory provision superfluous should be avoided,
                                      since that interpretation would offend ‘‘the well-settled rule
                                      of statutory construction that all parts of a statute, if at all
                                      possible, are to be given effect.’’ Weinberger v. Hynson, West-
                                      cott & Dunning, Inc., 412 U.S. 609, 633 (1973).
                                         However, the 31⁄2-month rule is a general exception to the
                                      economic performance rule of section 461(h). It is not an
                                      exception that is specific to the oil and gas industry. Cf. sec.
                                      461(i)(2)(A). As a result, even if it were true that the 31⁄2-
                                      month rule could not be used in the oil and gas industry,
                                      that fact would not be sufficient by itself to invalidate the




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                                      IRS’s  proposed interpretation, because inapplicability to one
                                      particular industry does not make a provision entirely super-
                                      fluous.
                                         Moreover, we do not find that the IRS’s interpretation of
                                      the 31⁄2-month rule would always make it inapplicable to the
                                      oil and gas industry. For example, if a contract for the
                                      drilling of an oil or gas well were drafted in such a manner
                                      that payments were allocated to specified services, the 31⁄2-
                                      month rule could apply to such oil and gas contracts. See 26
                                      C.F.R. sec. 1.461–4(d)(6)(iv), Income Tax Regs. Or, if some or
                                      all of the preparatory activities were already completed at
                                      the time the taxpayer entered into a turnkey contract and
                                      made payment and the remaining services that were the sub-
                                      ject of the contract could be completed in 31⁄2 months, then
                                      under such a contract all the services under the contract
                                      could be completed within that 31⁄2-month period.
                                         In any event, we do not reject the IRS’s interpretation of
                                      the 31⁄2-month rule simply because the rule might be used in
                                      the oil and gas industry only infrequently.
                                           C. Application to Caltex
                                           1. Caltex is not entitled to the special timing provisions of
                                              the 31⁄2-month rule.
                                         We hold that the 31⁄2-month rule contemplates that all of
                                      the services called for under an undifferentiated, non-sever-
                                      able contract must be provided within 31⁄2 months of pay-
                                      ment. Therefore, a determination of Caltex’s entitlement to
                                      use the 31⁄2-month rule requires (1) a determination of
                                      whether the contract at issue is an undifferentiated, non-
                                      severable contract (see supra note 15), versus a severable
                                      one, and (2) a determination of whether the services called
                                      for thereunder could have reasonably been expected to be
                                      performed within 31⁄2 months of payment. In doing so, we
                                      find that Caltex is not entitled to the special timing provi-
                                      sions of the 31⁄2-month rule.
                                         Caltex’s contract with Red River fits the definition of a
                                      ‘‘turnkey contract’’ (see supra note 16). It did not provide an
                                      exhaustive, itemized list of services to be provided to Caltex
                                      by Red River (or its subcontractors) with particular payments
                                      associated with or allocated to each service. Instead, the con-
                                      tract enumerated some, but not all, of the services to be pro-




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                                      vided in order for Red River to ‘‘commence or cause to be
                                      commenced’’ the drilling of wells at the two sites, and it
                                      called for lump-sum payments of $4,123,333 for drilling costs
                                      and $1,049,333 for completion costs without any allocation of
                                      those sums to particular services. As a result, we hold that
                                      the contract at issue here is an entire, non-severable con-
                                      tract, as the IRS contends.
                                        Given that the contract is non-severable, Caltex may use
                                      the 31⁄2-month rule only if all the services called for in the
                                      contract with Red River could have been reasonably expected
                                      to be performed within 31⁄2 months of payment. Caltex has
                                      never alleged that it expected all of the services to be pro-
                                      vided within 31⁄2 months of payment. On the contrary, Caltex
                                      concedes that it did not reasonably expect all services to be
                                      performed within 31⁄2 months of payment, since ‘‘turnkey
                                      contract services in the oil and gas industry could never be
                                      completed in such a limited time frame.’’ As a result, we find
                                      that Caltex may not treat any of the services due under the
                                      contract as having been economically performed in 1999 by
                                      operation of the 31⁄2-month rule of 26 C.F.R. section 1.461–
                                      4(d)(6)(ii).
                                           2. Deductions under the 31⁄2-month rule are limited to
                                              payments made by cash or cash equivalents, not notes.
                                        For purposes of the regulation at issue, ‘‘payment’’ has the
                                      same meaning as it has for taxpayers using the cash receipts
                                      and disbursement method of accounting. See 26 C.F.R. sec.
                                      1.461–4(d)(6)(ii), Income Tax Regs. (defining ‘‘payment’’ by
                                      reference to 26 C.F.R. section 1.461–4(g)(1)(ii)). Pursuant to
                                      26 C.F.R. section 1.461–4(g)(1)(ii)(A),
                                      payment includes the furnishing of cash or cash equivalents and the net-
                                      ting of offsetting accounts. Payment does not include the furnishing of a
                                      note or other evidence of indebtedness of the taxpayer, whether or not the
                                      evidence is guaranteed by any other instrument (including a standby letter
                                      of credit) or by any third party (including a government agency).

                                      After this regulation was proposed, see Notice of Proposed
                                      Rulemaking, Economic Performance Requirement, IA–258–
                                      84, 1990–2 C.B. 805, 814, commentators objected to this rule
                                      and, among other things, asked that the regulation provide
                                      that a note or other evidence of indebtedness which bears an
                                      arm’s-length rate of interest be included as ‘‘payment’’. T.D.




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                                      8408, 1992–1 C.B. at 159. The Secretary rejected this sugges-
                                      tion because he ‘‘believe[d] that consistent use of the cash
                                      method definition of payment provides an administrable rule
                                      that is consistent with congressional intent.’’ Id. Therefore,
                                      for purposes of the 31⁄2-month rule, the ‘‘payments’’ made by
                                      Caltex would not include any notes executed in favor of Red
                                      River, but instead would include only the two payments
                                      made by Caltex to Red River via checks in the amounts of
                                      $308,293.50 and $119,892. As a result, even if Caltex were
                                      able to invoke the 31⁄2-month rule, it would be able to deduct
                                      only the amount of its actual payments (i.e., $428,185.50),
                                      not the approximately $5.2 million it attempted to deduct.
                                      V. Economic performance under the general rule of section
                                         461(h)
                                         Even though Caltex does not qualify for the exceptions dis-
                                      cussed above, it may still invoke the general rule of section
                                      461(h). That statute provides that ‘‘the all events test shall
                                      not be treated as met any earlier than when economic
                                      performance with respect to such item occurs’’; and, if the
                                      liability of the taxpayer arises from a third person providing
                                      services to the taxpayer, ‘‘economic performance occurs as
                                      such person provides such services’’. Sec. 461(h)(1), (2)(A)(i).
                                      Thus, Caltex remains entitled to deduct for 1999 the pay-
                                      ments it made in 1999 for services actually performed in
                                      1999.
                                         The IRS acknowledges this principle but argues that eco-
                                      nomic performance with respect to at least $5,165,593.20 of
                                      the claimed IDCs of $5,172,666 did not occur in 1999, because
                                      (it says) Caltex stipulated that only $7,072.80 of the IDCs due
                                      under the contract was incurred in 1999. The actual lan-
                                      guage of the stipulation is: ‘‘Petitioner contends that it
                                      incurred $7,072.80 of intangible drilling costs relating to
                                      * * * [the contract] during 1999.’’ Therefore, reasons the IRS,
                                      Caltex’s maximum potential deduction for IDCs for 1999
                                      under section 461(h) is $7,072.80.
                                         Caltex counters that while it stipulated that it contends
                                      that $7,072.80 of IDCs was incurred in 1999, it did not stipu-
                                      late that it contends that only $7,072.80 of IDCs was incurred
                                      in 1999. As a result, Caltex maintains that the precise
                                      amount of IDCs incurred in 1999 remains in dispute.




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                                         We think the IRS’s reading of the stipulation is the more
                                      likely reading. However, we cannot say that Caltex’s reading
                                      is impossible, and we currently address this question not
                                      after a trial but under Rule 121. In deciding the IRS’s motion
                                      for partial summary judgment, we must draw every inference
                                      in favor of the non-moving party, Caltex. As a result, there
                                      remains a genuine issue of material fact regarding the
                                      amount, if any, of IDCs incurred by Caltex in 1999 (and the
                                      effect, if any, of the parties’ stipulation on Caltex’s ability to
                                      claim deductions in excess of $7,072.80).
                                         Moreover, we note that the IRS does not maintain that, by
                                      way of summary judgment on this point, we can use the
                                      stipulation to avoid a trial on the issue of the amount of
                                      Caltex’s 1999 IDC deductions under the general rule of sec-
                                      tion 461(h). The IRS does not concede that Caltex may actu-
                                      ally deduct $7,072.80 in IDCs for 1999. Instead, the IRS
                                      argues that factual issues relating to the deductibility even
                                      of the $7,072.80 should remain for trial and that such issues
                                      include (i) whether the services to which the $7,072.80 relate
                                      were performed in 1999, and (ii) if so, whether the services
                                      were performed before Caltex acquired interests in the wells.
                                      See Haass v. Commissioner, 55 T.C. 43, 50 (1970) (holders of
                                      interests in oil and gas wells may deduct IDCs only after they
                                      have been granted operating rights to the wells to which
                                      those costs relate). It is not worthwhile for us to attempt
                                      resolve under ‘‘genuine issue of material fact’’ standards a
                                      controversy about the interpretation of a stipulation, only to
                                      then have to address in large part the issue that summary
                                      judgment should resolve. These considerations also tilt this
                                      question in Caltex’s favor, for purposes of the IRS’s motion.

                                                                                Conclusion
                                         The IRS is entitled to summary judgment on two issues: (1)
                                      Caltex is not entitled to the 90-day special timing rule of sec-
                                      tion 461(i)(2)(A); and (2) Caltex is not eligible to treat any
                                      services due under the contract as having been economically
                                      performed in 1999 under the 31⁄2-month rule of 26 C.F.R. sec-
                                      tion 1.461–4(d)(6)(ii), Income Tax Regs. Whether, and to
                                      what extent, Caltex may be entitled to deduct some of its
                                      IDCs for 1999 on the basis of the general economic perform-
                                      ance rule of section 461(h) is still in dispute.




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                                      40                  138 UNITED STATES TAX COURT REPORTS                                        (18)


                                           To reflect the foregoing,
                                                                                 An appropriate order will be issued.
                                                                               f




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