Southwestern Energy Co. v. Comm'r of Internal Revenue, 772–91.

Citation100 T.C. No. 32,100 T.C. 500
Decision Date01 June 1993
Docket NumberNo. 772–91.,772–91.
PartiesSOUTHWESTERN ENERGY COMPANY AND SUBSIDIARIES, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
CourtUnited States Tax Court

OPINION TEXT STARTS HERE

Neal R. Pendergraft, E.J. Ball, and Kenneth R. Mourton, Fayetteville, AR, for petitioner.

Jeffry J. Erney, Mark I. Siegel, Cleveland, OH, for respondent.

OPINION

RAUM, Judge:

The Commissioner determined income tax deficiencies against petitioner for 1985 and 1986 in the amounts of $306,283.10 and $205,922.68, respectively. Petitioner is a group of consolidated corporations consisting of a parent, Southwestern Energy Company (SW Energy), and subsidiaries which had filed consolidated returns on the accrual basis for those years. Petitioner's principal place of business when the petition herein was filed was in Fayetteville, Arkansas. The dispute before us relates solely to the parent corporation and to one of the subsidiaries, Arkansas Western Gas Company (AWG). For convenience, the term petitioner will be used at times to refer either to SW Energy, AWG, or the entire consolidated group, as indicated by the context. The issues presented for decision relate to: (1) The proper treatment by AWG of certain “overrecoveries” of revenues from the sale of gas in excess of actual gas costs, and (2) the deductibility of SW Energy's claimed liability for interest on convertible debentures allocable to the periods ending on December 31 of each of the taxable years (1985 and 1986) where such interest would never become payable if the debentures were to be converted in the respective following years (1986 and 1987) prior to the March 1 date of record for payment on March 15. The facts have been stipulated.

1. Gas Sales Overrecoveries. During the years at issue, AWG was a public utility engaged in the business of selling and distributing natural gas to customers in Arkansas, and was regulated by the Arkansas Public Service Commission (PSC). As a regulated utility, AWG was required to receive approval from the PSC for the tariff rates charged to its customers.

In 1981, AWG received approval from the PSC to use a “cost of gas adjustment” (CGA) clause to compute the tariff-authorized cost of gas to be charged to its customers. The purpose of the CGA was to allow AWG to recoup the entire cost of the gas purchased without having to petition the PSC each time the price of gas changed. However, since there was apparently some lapse of time between the increase or decrease of the price of gas purchased by AWG and the implementation of the new tariff rate computed in accordance with the CGA, the sales of gas by AWG during that interval at the existing tariff rate would result in underrecoveries or overrecoveries by AWG in respect of its cost. Accordingly, the CGA itself was computed by use of a formula that undertook to take into account such underrecoveries or overrecoveries.

The 1981 formula for computing the CGA was superseded by a “tariff agreement” effective January 11, 1985, which was in turn superseded by another “tariff agreement” effective August 7, 1986. A considerably simplified version of the CGA formula as applicable here, but sufficiently accurate for purposes of this case, may be stated as follows: As the cost of gas to AWG rises or falls, the tariff rate is periodically increased or decreased in an amount that reflects the underrecoveries or overrecoveries with respect to gas meanwhile sold by the AWG after the change in the cost of gas to it but prior to the implementation of the new tariff rate.

Neither Arkansas law nor the CGA clause within the tariff agreement required interest to be paid or collected on overrecoveries and underrecoveries, respectively.

AWG reflected the net underrecovery or overrecovery of gas cost on the balance sheet of its financial reports through an asset account entitled “deferred gas purchase cost” (deferred account).1 Net underrecoveries of gas cost increased the debit balance in the deferred gas purchase asset account, and represented the amount by which actual gas cost exceeded the “authorized cost of gas” under the tariff agreement. Net overrecoveries of gas cost decreased the debit balance (and/or increased the credit balance) in the deferred gas purchase asset account, and represented the amount by which the actual gas cost was less than the “authorized cost of gas” based on the tariff rates.

Since the underrecoveries and overrecoveries were handled for financial accounting purposes through the deferred account (an asset account), they did not affect the income statement of AWG's financial reports for the year involved (1986).2 The cost of gas sold to customers, as reflected in AWG's financial report income statement, was based on the existing tariff rate applicable at the time of sale, without adjustment for differences between the actual cost of gas and the cost of gas based on the tariff rate.3

For Federal income tax purposes, however, AWG accounted for underrecoveries differently than it did for overrecoveries. Underrecoveries during a given year served to increase AWG's cost of gas sold, as reflected on petitioner's consolidated tax return. This was accomplished by a Schedule M–1 adjustment reversing the financial accounting entry for the deferred account. 4 Thus, in years when AWG experienced net underrecoveries, the cost of gas sold reported on petitioner's tax return in effect reflected its actual cost—a cost in excess of the cost based on the tariff rate. The result was that, during such underrecovery years, petitioner's taxable income, as shown on its consolidated Federal return, was less than the net income shown on AWG's books by the amount of the Schedule M–1 adjustments.

Conversely, no Schedule M–1 adjustment was made on petitioner's tax return for net overrecoveries. Thus, net overrecoveries did not increase or decrease the cost of gas sold above or below that reported on the financial income statements. In other words, during net overrecovery years, the cost of gas sold by AWG as shown on the petitioner's tax return was the same in amount as that shown on the income statement of its financial reports, i.e., in both cases, the cost of gas sold reflected the cost authorized under the tariff rate rather than the actual cost to AWG, which during such overrecovery years was less than the cost based on the tariff rate.

The balance in AWG's deferred gas purchase account for the tax years ending December 31, 1982, through December 31, 1988, was as follows: 5

+--------------------------------------------+
                ¦Year End¦Debit     ¦Credit    ¦CGA Status   ¦
                +--------+----------+----------+-------------¦
                ¦12–31–82¦$3,176,816¦          ¦Underrecovery¦
                +--------+----------+----------+-------------¦
                ¦12–31–83¦$1,491,346¦          ¦Underrecovery¦
                +--------+----------+----------+-------------¦
                ¦12–31–84¦$3,426,296¦          ¦Underrecovery¦
                +--------+----------+----------+-------------¦
                ¦12–31–85¦$2,814,565¦          ¦Underrecovery¦
                +--------+----------+----------+-------------¦
                ¦12–31–86¦          ¦$(369,599)¦Overrecovery ¦
                +--------+----------+----------+-------------¦
                ¦12–31–87¦          ¦(563,043) ¦Overrecovery ¦
                +--------+----------+----------+-------------¦
                ¦12–31–88¦$ 829,278 ¦          ¦Underrecovery¦
                +--------------------------------------------+
                

For the tax year ended December 31, 1986, AWG had—apparently for the first time 6—a credit balance in the deferred gas purchase asset account. That credit balance was $369,599, and represented a net overrecovery of gas purchase costs for that year.7 However, in keeping with its practice, as previously described, petitioner did not make a Schedule M–1 adjustment on its 1986 tax return to reflect the additional amount of reportable gain on the sale of gas attributable to the $369,599 net overrecovery. The upshot of this accounting legerdemain is that $369,599 of gain on the sale of gas was eliminated from petitioner's taxable income and thus escaped tax. The Commissioner's determination restored that amount to petitioner's 1986 taxable income. We uphold the Commissioner.

Petitioner's basic contention is that it was obligated under Arkansas law to return the overcharges to its customers, that all events fixing that obligation occurred prior to the close of the taxable year, and that as an accrual basis taxpayer, it was entitled to deduct such overcharges as “ordinary and necessary business expense under Section 162 of the Internal Revenue Code. We find it unnecessary to consider all of petitioner's points, since in our judgment what we are confronted with is not an expenditure (or obligation to make an expenditure) at all.8 What is before us today is instead merely a requirement under Arkansas law, as reflected in the applicable tariff agreement, that petitioner compute its tariff rate for the following year in such manner as to offset the net overrecoveries for the year in question.

In no way does this case bring into play those provisions of Arkansas law giving customers a right to a refund of overcharges, as argued by petitioner. It is quite true that sec. 23–4–205(b)(2) of the Arkansas Code Annotated (1987) (A.C.A.) provides for refunds “When a utility has charged its ratepayers an amount in excess of the utility's approved tariffs”. Here, however, by reason of the CGA, the overrecoveries were factored into the adjusted rate for the succeeding period and thus became an authorized part of the tariff rate scheme. They did not represent amounts “in excess of the utility's approved tariffs”, and did not furnish the basis for a refund to customers. Nor, as previously noted, was any interest required to be paid upon them.

Plainly, what is involved here is merely a reduction in rates for gas sold by petitioner in 1987 to take into account the 1986 overrecoveries as required by the CGA clause in the tariff agreement. The overrecovery here at issue was not a cost or expense incurred in producing income for 1986. It involved no current...

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