Bp's Deepwater Horizon Oil

Relevant Facts:

About five years ago, BP’s Deepwater Horizon rig blew up in the Gulf of Mexico. In the event, not only 11 people lost their lives but also more than 200 million gallons of oil fouled the Gulf coastlines and ocean. This was probably the worst environment disaster in the U.S. history. On October 5, 2015, U.S. government and five Gulf States reached settlement with BP to solve the civil lawsuit over Deepwater Horizon oil spill, and this resolution might be worth $20.8 billion.

Specific Issues:

(1) What is the deductibility of the payments to be made other than the $5.5 billion civil penalty?

(2) Are they deductible currently or deductible only on a cost-recovery basis after being capitalized initially?

Support and Analysis:

If the payments could produce significant future benefits for the company and make permanent improvements for that property, then Kerr-McGee Corporation need to capitalize these payments. However, from experience we know that the difference between a deductible expense and a capital expenditure is one “of degree and not of kind.” Welch v. Helvering, 290 U.S. 111, 113-14 [12 AFTR 1456] (1933). The key point here is that we need to compare the status of the Gulf of Mexico after the expenditures with its status before the condition arose. For the oil spill in the Gulf of Mexico, the biggest victim is the marine ecosystem, which is not the asset of BP. As we know, the ocean and Gulf coastlines in that region were not contaminated until the oil spill disaster happened, or we can just ignore the contamination status before. Also, the consent decree states that $8.1 billion funds will be used for the restoration of injured natural resources in the Gulf of Mexico region. As it is extremely difficult for people to restore the fragile marine ecosystem once the balance in nature is disturbed, we might not be able to rehabilitate the environment of the ocean and coastlines in the near future, so the expenditures BP need to pay are not for permanent improvements. On the other hand, BP dose not have the ownership of the ocean and coastlines, and it cannot make significant economic benefits after the payments. Hence, we can come to a conclusion that BP should not capitalize the expenditures for the nature resource damages, and these costs are ordinary and necessary expense in