## Facts

- Texaco, Inc. operated a worldwide, vertically integrated oil business through subsidiaries, including Texaco International Trader, Inc. (Textrad), its international trading company.
- During 1979–1981, Textrad purchased Saudi crude oil through the Arabian American Oil Company (Aramco) and resold the crude to Texaco affiliates and unrelated customers.
- Saudi Arabia permitted Aramco participants to acquire Saudi crude at below-market prices, creating significant economic rents.
- A 1979 Saudi Oil Minister directive, Letter 103/z, required Aramco participants to resell Saudi crude at specified below-market prices under a prescribed pricing formula.
- Textrad resold Saudi crude to Texaco refining affiliates at the mandated below-market prices; most crude went to non-U.S. refining affiliates.
- Letter 103/z constrained crude resale prices but did not directly constrain prices for refined products, allowing refining affiliates to earn substantial profits on refined-product sales.
- The Commissioner concluded Texaco had shifted income to foreign affiliates via non-arm’s-length transfer prices and increased Textrad’s U.S. taxable income under I.R.C. §§ 482 and 61 for 1979–1981.
- The Tax Court found Letter 103/z was the “virtual equivalent of law” for Texaco and held the Commissioner’s reallocations were precluded; the Commissioner appealed.

## Issues

1. Whether the Commissioner may reallocate income under I.R.C. §§ 482 and 61 when a binding foreign sovereign pricing directive dictates controlled-transaction prices and constrains arm’s-length pricing.
2. Whether, on the record, Letter 103/z effectively compelled Texaco’s crude resale prices so that § 482 adjustments premised on different prices rested on an unrealizable counterfactual.

## Decision

- The Fifth Circuit affirmed the Tax Court’s judgment for Texaco.
- The court accepted the Tax Court’s finding that Letter 103/z required Texaco and other Aramco members to resell Saudi crude at specified below-market prices.
- Because the foreign directive effectively fixed the relevant prices, the Commissioner could not reallocate income under §§ 482 and 61 based on the assumption Texaco could have used different prices inconsistent with that mandate.
- The Commissioner’s proposed § 482 allocation was rejected for the 1979–1981 tax years.

## Legal Principles

- I.R.C. § 482’s arm’s-length allocation authority must be applied in a manner consistent with genuine, binding external constraints on pricing, including foreign sovereign directives.
- Where a foreign mandate effectively fixes prices as the “virtual equivalent of law,” an arm’s-length analysis cannot assume the taxpayer could lawfully charge inconsistent prices in the same circumstances.
- Appellate review gives substantial deference to the Tax Court’s factual findings regarding the existence, binding effect, and practical compulsion of a foreign pricing requirement.

## Conclusion

The Fifth Circuit held that, given the Tax Court’s supported findings that Letter 103/z effectively compelled Texaco’s below-market crude resale prices, the Commissioner could not use §§ 482 and 61 to reallocate income on a hypothetical pricing structure that assumed Texaco could disregard the Saudi directive.


Texaco, Inc. v. Commissioner, 98 F.3d 825 (5th Cir. 1996)