Four giant American oil companies dealing with Saudi Arabia (the Aramco partners Exxon, Texaco, Mobil and Socal) paid no U.S. taxes on $2.8 billion in profits derived from their Saudi oil operations in 1975
But under a 1975 tax law that was intended to tighten up on credits taken by the multinational oil companies for "foreign income taxes," the Internal Revenue Service could claim $336 million in tax payments from the Aramco partners, informed officials say.
Influential Capitol Hill officials, it was learned, are urging the IRS to adopt a tough audit policy that will yield those taxes to the Treasury.
An Aramco spokesman conceded that no U.S. taxes had been paid on 1975 income from Saudi operations "because Saudi taxes exceeded U.S. taxes.
"This thing has been beaten to death for years," he said. "If someone tried to figure out the best way of driving American companies out of the Middle East, and turning it over to the Dutch, the French, and others, they couldn't find a better way. The whole thing astounds me."
This is the way the arthmetic works: Aramco, according to Treasury sources, claims it paid the Saudis $2.1 billion taxes on its $2.8 billion 1975 income. Since U.S. taxes, at a 48 per cent rate, would have been less than $1.4 billion, Aramco had a Saudi tax "credit" that more than wiped out its U.S. obligation.
But was the $2.1 billion a genuine Saudi tax on Aramco's income, or was it really the sum of royalties and all other charges paid to the Saudis? If the latter, $2.1 billion would not be "creditable" against U.S. taxes, but merely a cost of doing business, leaving $700 million taxable. At a 48 per cent rate, that would require the Aramco companies to fork over $336 million in taxes to Uncle Sam.
Using a slightly different approach, based on an average 22-cent per barrel profit admitted by Aramco, the four companies made a $547 million profit on sales of 2.5 billion barrels, which if taxes at a 48 per cent rate would have yielded the Treasury $263 million.
"This debate is not over peanuts," affirms a Treasury lawyer.
The question of "creditability" of foreign oil taxes is an old one, but has surfaced again under pressure from Frank Church's Senate Subcommittee on Foreign Economic Policy. Church wants the Carter administration to limit incentives for multinational oil corporations to develop oil in the oil cartel countries, and to boost the incentives to explore for oil elsewhere, especially in the North Sea.
For years, oil companies have maintained that much or all of the payments they made to the producing governments in the Persian Gulf constituted an income tax. Since taxes paid another government can be deducted dollar for dollar from the U.S. tax bill, it is obviously to the companies benefit to have their payments labeled taxes, rather than royalties. Royalties would simply be a cost of doing business. At a tax rate of 48 per cent, one dollar's worth of royalities takes only 52 cents off the tax bill.
The main gimmick was the use of a "posted price" several dollars below the market price, the difference being a paper profit on which a "tax" would be levied. Thus, the companies could buy at a low figure, say $6 a barrel, then sell to one of their own subsidiaries or to someone else, for example, $9. They would then pay a tax, of say, $2 per barrel on the $3 profit, giving the oil cartel country $8 a barrel.
But $8 a barrel would just about match the selling price that the producing nation wanted from the start, and the company would have a $2 per barrel "tax credit" to use for lowering its U.S. income taxes. These "taxes" and "credits" as the Organization of Petroleum Exporting Companies fixed steadily higher prices.
Tax lawyers say that the system obviously is not based on a market price, which produces a taxable profit, but on a rigged price, designed openly to create the best mix of a maximum take for the producing country, and the most favorable tax situation for the companies.
Once OPEC nationalized oil, and the Aramco partners were clearly customers rather than oil producers, says lawyer Jerome Levinson of the Church subcommittee, it was more evident than ever that OPEC set prices in terms of fixed costs per barrel, and that there was no "real transaction" between the companies and the countries that constituted a sale, hence a profit.
Even with nationalization there have been various sorts of gimmicks, some relating to "management fees" that are designed to yeild a "profit" hence a tax credit. The British Inland Revenue Service, according to Levinson, is considering disallowing such fees paid by British Petroleum and Shell, against United Kingdom income taxes, but is waiting for the United States to take a stand first.
In 1975. Congress tried to spell out the difference between a tax and a royalty, but - although many observers and students of the oil tax problem thought that legislation in that year settled the issue once and for all - it didn't.
Emil Sunley, deputy assistant treasury secretary for tax policy, says: "Congress threw up its hands and said: "It's too hard. We can't tell the difference between taxes and royalties. We'll assume that you pay enough taxes abroad, but we'll stop you from using excess credits from oil extraction as a credit against non-oil income."
But Levinson has a different interpretation of the 1975 law. What COngress did, he says, was leave it up to the IRS to decide what is a "creditable" tax payment, and what is a royalty.
Many private practioners agree. "I think the 1975 law was explicit," says one, "when it said that no company could take credit for foreign taxes unless it had an 'economic interest' in the oiL. How can they have an 'economic interest' when it's been nationalized?"
On the question "economic interest," the Aramco spokesman said "there is no question about Aramco's 'economic interest' in Middle East oil. The Saudis haven't gotten to a point of 100 per cent ownership. Aramco is a Delaware corporation, 100 per cent owned by the four corporate shareholders, and it has a concession agreement inside Saudi Arabia at the present time.
"Anyone who says that Aramco does not have an 'economic interest' in Saudi oil doesn't know the facts."
Privately, Treasury tax experts concede that it is becoming increasingly difficult, as Levinson maintains, to define the Aramco payments to the Saudis as income taxes.
Last year, in respose to a request from Mobil to carry forward its claimed tax credits, the IRS put out a press release saying that "income taxes which are part of a scheme to collect a fixed charge per barrel and thus are not arms length transactions, may, in the future, not be eligible to be credited against U.S. corporate income tax liability."
This reversed an IRS position first taken in 1956 (some say under pressure from the State Department), and reaffirmed in 1966, when the divergence between the posted price and the market price highlighted the potential for avoidance of U.S. income tax liabilities.
But despite what some tax lawyers thought was the thrust of the IRS' 1976 press release, the multinational oil companies are continuing to claim their payments to the Saudis as income taxes. Levinson said that Carter administration officials, if they intend to reduce the power of OPEC, should push IRS for a strict interpretation of the law.
A spokesman for Mobil oil said that 1975 tax returns had been filed in accordance with the law, "which introduces major changes affecting the ability of oil companies to claim credit for foreign taxes paid." The Mobil spokesman said tha the 1975 returns, along with 1974's, are just now being audited by IRS.
he Aramco spokesman also said that the $2.8 billion income and $2.1 billion Saudi tax figures cited by government sources are far less than gross sales and gross taxes "by tenfold." Government sources refer to the $2.8 billion and $2.1 billion figures as net figures.
Church is trying to get the Treasury to encourage IRS to take a tough stand. The key Treasury official now is Under Secretary for Monetary Affairs Anthony Solomon. When the 1975 tax law was passed, the man in that role was Jack Bennett, an Exxon official on leave who since has returned to his company. Church subcommittee staff aides say bluntly that Ford administration officials, notably Treasury Secretary William E. Simon and Bennett, were not about to take on the oil companies.
Solomon told The Washington Post that the situation is still being reviewed, "and the tax lawyers have to make an objective judgment." One official who will be involved is Assistant Secretary for Tax Policy Laurence Woodworth, who as a Capitol Hill technician helped draft the 1975 law. Another key policymaker will be IRS Commissioner Jerome Kurtz, known as a tax reformer in private practice.
Solomon said that the Treasury had not yet concluded that reducing tax incentives in the Middle East was necessarily the right way to approach the problem. Weakening incentives to produce Middle East oil, for example, he said, might merely cut production and result in higher prices.
Solomon, on the other hand, privately concedes that the Aramco partners are probably merely purchasers of Middle East oil, and as such are entitled only to charge off the cost of the oil as a raw material, and not to a credit for taxes. Many Treasury officials suggest that the issue ultimately may have to be settled by President Carter.
There are delicate foreign policy issues involved. The Saudis, as Levinson admits, would probably claim that disallowing tax creditability status to Aramco would "impair peace prospects in the Middle East." He also concedes "there is no alternative in sight" to reliance on the multi-national companies as the chief providers of foreing oil.
Even one severe critic of the "chicancery" of the companies in claiming foreign payments as tax credits acknowledges that what he sees as a correct interpretation of the 1975 "would severely limit their profitability."
Meanwhile, the Treasury seems to be looking more favorably at a collateral part of the Church argument. That is a suggestion that payments to the United Kingdom under the Petroleum Revenue Tax, be considered income taxes, and therefore creditable against U.S. taxes. Solomon said a treaty is being negotiated with the British government.