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Will BP's Tax Benefit Disappear?

Under IRS rules, BP is entitled to a deferred tax benefit for the loss it will incur related to the Deepwater Horizon drilling rig explosion. But there is more at play than tax and accounting rules.
Robert Willens, CFO.com | US
July 30, 2010

This week BP announced it is taking a second-quarter pretax charge of $32.2 billion related to future costs associated with the ongoing cleanup of the Deepwater Horizon oil spill in the Gulf of Mexico. BP also plans to offset those future losses with a deferred tax benefit, which is a somewhat standard business practice, and allowed under current Internal Revenue Service rules.

Indeed, if a corporation sustains a loss, it is permitted to establish a deferred tax asset in an amount equal to the loss multiplied by the company's tax rate. In addition, the company gets to record a deferred tax benefit in its income statement, and for BP that benefit amounts to $9.9 billion.

In practical terms, instead of having a $32 billion charge on an aftertax basis, BP's charge will be "only" $22 billion. What's more important, however, is whether the expenses that comprise the $32 billion charge (most notably the $20 billion escrow fund that BP has established) are all tax-deductible.

Keep in mind that BP hasn't actually expended $32 billion yet. It has paid out only a small fraction of that amount, although it is "probable" that it will be called upon to spend all of it. That probability allows BP to expense the entire $32 billion this period.

We believe that the expenses are all tax-deductible, but there's a hitch. The wild card is whether the U.S. Congress will decide to write a special rule that denies BP the right to deduct these outlays. In the recent Goldman Sachs settlement, a special clause was written into the agreement in which Goldman agreed not to deduct any portion of the settlement, even though by law it would have been able to.

So although the accounting in the BP situation is pretty standard, the imponderables are twofold: will Congress allow BP to deduct the expenses, and what portion of the expenses might be reimbursed by the other parties involved in the oil spill (Transocean and others). If either or both of these contingencies materialize, BP would be required to "reverse" the tax credit it previously accrued.

Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.




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