## Facts

- Berry Petroleum Company and subsidiaries filed consolidated federal income tax returns for 1987–1989.
- The Commissioner determined income tax deficiencies for 1987, 1988, and 1989; Berry petitioned the U.S. Tax Court for redetermination.
- In a transaction with the same selling interests, Berry acquired 80% of Norris Oil Co. stock and also acquired an “Afex option” to purchase Oklahoma gas leases.
- The Afex option expired unexercised in 1987; Berry claimed a $1.2 million loss deduction based on the option’s expiration.
- After Berry obtained control of Norris, minority shareholders who had sold Norris stock in the public market brought a class action (“Wiegand litigation”) alleging breach of fiduciary duty and related misconduct connected to the acquisition and subsequent events.
- Berry paid legal and related costs to defend the Wiegand litigation and claimed current deductions as ordinary and necessary business expenses.
- Through a subsidiary (Bush), Berry acquired all stock of Tosco Enhanced Oil Recovery Corp. (Teorco), later renamed C.J. Co., which had net operating loss (NOL) carryovers.
- After the acquisition, C.J. advanced cash to Bush for unsecured notes; the notes were later cancelled, and the cancellation was treated as a dividend to Bush.
- Bush transferred the C.J. stock to Berry, and C.J. was later merged into Berry; Berry sought to use C.J.’s NOL carryovers without tightened limitations under I.R.C. § 382.

## Issues

1. Whether Berry could deduct a $1.2 million loss on the Afex option’s expiration, or whether the payment labeled as an option premium was substantively part of the purchase price of Norris stock.
2. Whether Berry could currently deduct Wiegand litigation defense costs under I.R.C. § 162, or whether the costs were capital expenditures because the claim originated in the acquisition of Norris stock.
3. Whether post-acquisition transactions involving C.J. (including cash advances and debt-cancellation treated as a dividend) triggered enhanced I.R.C. § 382 limitations on NOL use due to a “redemption or other corporate contraction” connected to an ownership change, and related § 382 constraints (including continuity of business enterprise, fair market value, and substantial nonbusiness assets).

## Decision

- The court disallowed the claimed $1.2 million Afex option loss, finding the payment was part of the consideration for the Norris stock acquisition rather than a separate, economically substantive option investment.
- The court held the Wiegand litigation defense costs were not currently deductible; they were capital expenditures because the litigation originated in Berry’s acquisition of Norris stock.
- The court applied restrictive § 382 limitations to Berry’s use of C.J.’s NOL carryovers, concluding the post-acquisition steps amounted to a corporate contraction connected with the ownership change and that other § 382 rules further limited utilization.
- Deficiencies were sustained to the extent consistent with the holdings, with remaining amounts to be computed under Rule 155.

## Legal Principles

- Tax consequences follow economic reality; labels applied by the parties may be disregarded where a purported asset or transaction lacks independent economic substance.
- Under substance-over-form principles, consideration paid in an integrated acquisition may be recharacterized as part of stock purchase price (a capital expenditure) rather than as a separately deductible loss item.
- The deductibility of litigation costs depends on the origin of the claim; expenses originating in acquiring, defending, or perfecting title to a capital asset are capital and not currently deductible under § 162.
- I.R.C. § 382 may substantially limit an acquiring group’s use of a target’s NOLs after an ownership change, including when there is a “redemption or other corporate contraction” connected with the change and when the loss corporation’s value and asset composition affect the limitation.

## Conclusion

The Tax Court treated the Afex option payment and Wiegand litigation defense costs as non-deductible current expenses—recharacterizing the option payment as part of stock acquisition cost and requiring capitalization of shareholder-suit defense costs—and it applied § 382 to restrict Berry’s use of acquired NOL carryovers due to post-acquisition transactions viewed as a corporate contraction connected to the ownership change.


Berry Petroleum Co. v. Commissioner, 104 T.C. 584 (1995)