El Paso Co. v. U.S.

• Decision Date: 03 December 1982
• Docket Number: No. 23-78,23-78
• Citation: 694 F.2d 703
• Parties: 82-2 USTC P 9711 The EL PASO COMPANY, and El Paso Natural Gas Company, Appellants, v. The UNITED STATES, Appellee. Appeal
• Court: U.S. Court of Appeals — Federal Circuit

Page 703

694 F.2d 703

82-2 USTC P 9711

The EL PASO COMPANY, and El Paso Natural Gas Company, Appellants, v. The UNITED STATES, Appellee.

Appeal No. 23-78.

United States Court of Appeals Federal Circuit.

Dec. 3, 1982.

David A. Vaughan, New York City, argued for appellants. With him on the brief was Donald J. Zoeller, New York City.

Bruce W. Reynolds, Washington, D.C., argued for appellee. With him on the brief were Asst. Attys. Gen. M. Carr Ferguson, Theodore D. Peyser, Jr., and Kenneth R. Boiarsky, Washington, D. C.

Before MARKEY, Chief Judge, and DAVIS, NICHOLS, KASHIWA, and NIES, Circuit Judges.

PER CURIAM.

I Issues

This is a suit brought in the former United States Court of Claims and seeking refund of corporate income taxes paid. It involves several years during which the taxpayers incurred expenditures to effect divestiture of corporate property pursuant to requirements of the United States Supreme Court. Some expenditures were fruitless as the divestiture plans they were to implement were ultimately disapproved. Some helped effectuate the final approved divestiture. The issues we are to decide are the proper treatment of these expenditures. We hold in Part III of this opinion that, in general, with certain exceptions, the expenditures are deductible as ordinary and necessary business expenses under section 162 of the Internal Revenue Code. The exceptions are set forth in the second portion of Part III, and as there explained, expenditures by a subsidiary are deductible to some extent under the same code section, and to what extent remains to be determined in a later phase of this case.

This case was tried before then Trial Judge George Willi, who, on June 25, 1981, submitted a recommended decision and conclusion of law in accordance with former Rule 134(h). Both parties filed briefs and exceptions to his findings of fact and opinion; taxpayers filed first and are therefore designated appellants even though their objections were relatively minor; we characterize the government as appellee because it filed second. The successor Court of Appeals for the Federal Circuit returned the case to Judge Willi, now of the Claims Court, by Order of October 4, 1982, so that he might enter judgment in accordance with his report. He did this on October 9, 1982, and we heard oral argument November 1, 1982. Our opinion for the most part incorporates Judge Willi's recommended opinion, generally for the plaintiffs, with modifications. His decision did not purport to determine the quantum of recovery on the issues on which he held for plaintiffs, this being left under former Rule 131(c) for future determination, nor does, of course, the judgment of October 9, 1982, do this.

II Facts

In 1964 the Supreme Court held in a civil suit that when the El Paso Natural Gas Company (EPNG) acquired the Pacific Northwest Pipeline Company (Pacific) in 1957, it substantially lessened competition in the sale of natural gas in California in violation of Sec. 7 of the Clayton Act. ¹ The Court thereupon remanded the cause to the district court with directions that the latter "order divestiture without delay." United States v. El Paso Natural Gas Co., 376 U.S. 651, 662, 84 S.Ct. 1044, 1050, 12 L.Ed.2d 12 (1964). Pursuant to that mandate, the district court, after extensive hearing in each instance, entered two consecutive divestiture decrees that the Supreme Court, in turn, found unresponsive to its mandate. Cascade Natural Gas Corp. v. El Paso Natural Gas Co., 386 U.S. 129, 87 S.Ct. 932, 17 L.Ed.2d 814 (1967); Utah Public Service Commission v. El Paso Natural Gas, 395 U.S. 464, 89 S.Ct. 1860, 23 L.Ed.2d 474 (1969). Parenthetically, it was not until 1973 that the Court affirmed the third and final divestiture decree entered by the district court. El Paso Natural Gas Co. v United States, 410 U.S. 962, 93 S.Ct. 1440, 35 L.Ed.2d 697.

The predominant question in this tax refund suit, involving the years 1964 through 1969, is the tax treatment, deductible or capital, to be accorded the expenditures made by EPNG ² in those years for the legal, consulting, accounting, and related services that it appropriated to the formulation and partial implementation of the two divestiture decrees that were ultimately set aside by the Supreme Court.

EPNG's principal business throughout has been the production, transmission and sale of natural gas. ³ In 1957 it had large reserves in the San Juan Basin, located in the so-called "four corners" area (the intersection of Utah, Colorado, Arizona, and New Mexico), from which it serviced more than one-half of the burgeoning California market as that state's sole out-of-state supplier.

Pacific also had substantial gas reserves in the San Juan Basin. In 1954 it obtained Federal Power Commission (FPC) approval to construct and operate a pipeline to the State of Washington to supply gas from the basin to the then unserved Pacific Northwest area. It was thereafter authorized to receive large quantities of Canadian gas that it planned to sell both in that area and in the rapidly expanding California market. To the latter end, in 1956, Pacific began extensive negotiations for the sale of Canadian gas to Southern California Edison Company, Southern California's largest industrial user of natural gas and one whose requirements were then supplied by EPNG only on a service interruptible basis. Faced with the possible loss of such a large customer, EPNG successfully opposed the necessary regulatory approvals and retained the account by granting Edison a guaranteed continuity of supply as well as substantial price concessions.

EPNG had entertained designs on acquiring Pacific as early as 1954, but its formal offer to do so in 1955 was rebuffed. It renewed its acquisition overtures in 1956 while Pacific was negotiating to obtain Edison's business, as previously mentioned. This time the effort was successful, with Pacific's directors approving an exchange of its shares for EPNG shares in November 1956. By May 1957 EPNG had acquired 99.8 percent of Pacific's stock. ⁴ In the face of that development, the United States Department of Justice, in July 1957, filed a civil complaint in the district court of Utah charging that the acquisition violated the Clayton Act, n. 1, supra. In November 1962, ⁵ after a trial, the court dismissed the complaint. On a direct appeal, the Supreme Court reversed, ordering " * * * divestiture without delay * * *." 376 U.S. at 662, 84 S.Ct. at 1050.

The purpose of the Court's divestiture order was restoration of competitive balance in the interstate supply of natural gas to California, this to be accomplished by placing Pacific in the same position relative to EPNG that it occupied when it was acquired in 1957.

Following issuance of the Supreme Court's mandate, EPNG initiated efforts to formulate a proposal for compliance. The effort entailed extensive studies of such matters as (1) gas reserves and other physical properties for purposes of allocation, (2) present and prospective customer demand in the area to be served by the divested assets, (3) financing requirements including distribution of debt, (4) state and federal regulatory requirements, and (5) tax consequences to EPNG and its 117,000 shareholders. EPNG incurred substantial expense in conducting these activities.

In October 1964 EPNG submitted its proposal for divestiture to the district court and extensive hearings were then held on it. These hearings continued well into 1965 and were accompanied by intensive negotiations between EPNG and the Department of Justice, negotiations that culminated in an agreed decree that was presented to the court and adopted by it on June 24, 1965.

To effectuate the decree, EPNG formed the Northwest Pipeline Company (Northwest) as a wholly owned subsidiary ⁶ to receive the divested properties subject to the debt obligations that had been incurred by EPNG to finance the considerable upgrading and expansion of the Pacific properties that it had carried out during the 8 years that had elapsed since acquiring Pacific. Because of Northwest's thin capitalization, n. 6, supra, it lacked the funds to obtain the management personnel and staff necessary to conduct the business operations planned for it. Accordingly, in 1965 and 1966, EPNG advanced Northwest $75,014.29 and $232,632.13, respectively, both for these purposes and to finance legal and related activities necessarily undertaken by Northwest to perfect its role in implementation of the decree. None of these advances have ever been repaid.

In the proceedings that led to entry of the first decree, several interested parties were denied intervention by the district court. They appealed the adverse ruling and the Supreme Court noted probable jurisdiction. 382 U.S. 970, 86 S.Ct. 528, 15 L.Ed.2d 463 (1966). The Court reversed, ordering the district court to permit each of the parties to intervene as a matter of right. More importantly, and despite the Justice Department's avowed agreement with the terms of the first decree, the Court vacated that decree as failing to meet the requirements of its divestiture mandate with respect to (1) allocation of gas reserves, (2) financial benefits and burdens assigned Northwest, and (3) the potential for continuing control of Northwest by EPNG. It therefore remanded the cause, ordering a de novo hearing addressed to the formulation of an appropriate plan of divestiture, the hearing to be before a different district judge. Cascade Natural Gas Corp. v. El Paso Natural Gas Co., 386 U.S. at 129, 87 S.Ct. at 932, 17 L.Ed.2d 814.

In light of the Supreme Court's holding and remand directive, EPNG shortly thereafter set about deactivating Northwest. This was accomplished during 1967 with the subsidiary becoming a mere corporate shell that remained in existence as such thereafter ⁷ until 1974 when it was reactivated as hereafter explained. In 1967, EPNG advanced Northwest $420,596.39 for operating purposes and to...