Texaco May Face Only a Fraction of Its $6.5-Billion Tax Bill, Experts Say

Texaco could escape its purported $6.5-billion tax liability for 10 cents on the dollar or less, tax experts said Thursday, and Wall Street yawned at reports that the Internal Revenue Service was planning such a huge claim against the company.

That didn’t prevent Texaco’s partners in the Arabian-American Oil Co.--who appear to be subject to similarly large levies for back taxes--from demanding an explanation from the IRS. But IRS officials still refused to discuss the matter, at least publicly.

“If they caught Texaco cheating or something, I can understand that they can’t talk about it publicly,” said an executive at one of the Aramco partners. “But in a situation like this, they owe us the courtesy of at least explaining what the underlying concept is.”

Texaco disclosed Wednesday that it was notified by the IRS that it might owe $6.5 billion in back taxes, much of it dating to purchases of crude oil from Saudi Arabia in 1979-81. The company said its Aramco partners, Chevron, Exxon and Mobil, probably face the same problem.

Aramco produces virtually all of Saudi Arabia’s oil. The IRS apparently intends to explore the byzantine economic system under which oil was bought from the Saudis at the time and sold under a promise not to profit from it.

The whopping tax problem arose as Texaco prepares to pay Pennzoil $3 billion in settlement of their long, bitter court battle and to emerge from bankruptcy, where it has been mired since last April.

But however the tax issue is resolved, Texaco bankruptcy lawyer Harvey Miller said he and Pennzoil hope to keep the tax matter--which could take years to settle--apart from the Chapter 11 bankruptcy case. Observers agreed that the IRS probably wouldn’t object.

“In a case like Texaco, where no creditors are suffering and they’re not proposing to liquidate the company and walk off with the pieces, I don’t think the IRS would object,” said Alan May, manager of the international oil and gas committee at the Houston office of Coopers & Lybrand, a big accounting firm. “This will be very time-consuming to settle.”

On the New York Stock Exchange, Texaco was the second-most active stock and Exxon and Mobil were also heavily traded. Each was down a fraction, while Chevron stock rose $1.125.

Meanwhile, Texaco Chairman James W. Kinnear said in a letter to shareholders that the company will ask them to approve an “anti-greenmail” provision at the annual meeting this spring. The provision, which would prevent a stockholder from demanding a higher price for his shares than the price obtainable by other shareholders, is aimed at financier Carl C. Icahn.

Icahn, Texaco’s largest single shareholder, is fighting Texaco’s proposed reorganization plan. Among other things, he wants a plan that would force a new shareholder vote on Texaco’s anti-takeover defenses.

Texaco said it has set aside enough money to cover sizable back taxes, but not the sum that would apparently be due on the Saudi matter. The company would only say that the Saudi issue accounts for a “significant” portion of the $6.5 billion.

In any case, the figure was widely believed to be an extreme estimate of the total IRS claim, a typical government approach in a bankruptcy case. As attorneys and others explained it, the agency was just staking out its potential territory.

In a case with some parallels, the IRS claimed in early 1986 that then-bankrupt Storage Technology owed $640 million in taxes but later settled for $37 million, said Los Angeles attorney Bruce Specter of Stutman, Treister & Glatt, who represented the big Colorado computer equipment company.

“If the claim wasn’t 10 times what the IRS expects to settle for, I’d be very surprised,” said accountant May. “The government tends to claim big numbers and settle for small ones.”

Texaco said the Saudi-related claim is based on an IRS theory about the proper tax treatment of crude oil that Texaco bought from Saudi Arabia during the period of skyrocketing oil prices that followed the Iranian revolution in early 1979.

Oil executives professed themselves to be “bewildered” by the IRS theory, which Texaco said hinges on the difference between the official oil prices charged by the Saudis at the time and the prevailing market prices, which were much higher.

Would Have Paid Taxes

The Saudis, seeking to restrain the sharp rise in oil prices, maintained official prices that averaged about $5 per barrel below the prices on the fast-moving spot market. At one point, an oilman recalled, the spot price hit $35 a barrel when the Saudis were still charging $18.

The IRS contends that Texaco, and presumably the other Aramco partners, should have been taxed on the assumption that they ultimately received the higher prices for its products.

But the Saudis insisted that its customers--primarily the Aramco partners--not profit on the discounted crude by reselling it in the spot market. In addition, an Aramco executive said, the Energy Department, administering the U.S. price controls in effect at the time, similarly required that savings be passed to customers.

“There was the fear of the U.S. government, and the even bigger fear of being cut off by the Saudis,” this executive recalled, describing the climate of scarce oil that prevailed. “We were taking all the oil we could get, and the vast majority of it stayed within our own system.”

This official calculated a hypothetical, maximum tax burden of $3.5 billion for Texaco if every barrel it bought from the Saudis during that period had been resold at the higher spot price. Even so, it presumably would have already been taxed for the profit.

“Let’s assume that the IRS is correct, and that we defied the authorities and made that kind of profit. That would have been recorded as income, and we would have paid taxes on it. It’s hard to figure out how this transaction could mean an additional tax liability, or how we could have hidden the profits if we’d wanted to. Whatever we sold it for, we booked.”

But accountant May said the complicated sales arrangements in the oil industry, and the flexibility that multinationals have to record their profits in nations with more advantageous tax rates, naturally attract the skepticism of the IRS.

Lose Track of Source

It is common, for example, for a company that bought $20 oil from Saudi Arabia to return and ask to be compensated for a subsequent market reversal. The Saudis might then agree to sell the next barrel for $16, or to let the customer delay payments and be compensated by the interest earned. Meanwhile, the crude makes its way through refineries and into petrochemical plants around the world.

“You lose track of where the oil came from to begin with, and the companies do whatever they can to put their profits where the tax liability is lowest,” May said. “The IRS is very sensitive to this.”

Theoretically, Texaco could pay Pennzoil and Uncle Sam in full by dismantling itself. From its current net worth of about $13 billion, says Salomon Bros. analyst Paul D. Mlotok, the world’s third-largest oil company would be reduced to $3 billion or $4 billion.

“That’s quite a haircut,” Mlotok said.