Exelon Corp. v. Commissioner of Internal Revenue, 091916 FEDTAX, 29183-13

Docket Nº:29183-13, 29184-13
Opinion Judge:LARO, JUDGE
Party Name:EXELON CORPORATION, AS SUCCESSOR BY MERGER TO UNICOM CORPORATION AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent EXELON CORPORATION AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Attorney:David F. Abbott, Joel V. Williamson, Erin G. Gladney, Kristin M. Mikolaitis, Andrew W. Steigleder, Michelle A. Spiegel, and Michael D. Educate, for petitioner. Matthew I. Root, Elizabeth P. Flores, Steven N. Balahtsis, Abigail F. Dunnigan, Lisa M. Goldberg, Casey R. Kroma, and Michael T. Shelton,...
Case Date:September 19, 2016
Court:United States Tax Court
 
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147 T.C. No. 9

EXELON CORPORATION, AS SUCCESSOR BY MERGER TO UNICOM CORPORATION AND SUBSIDIARIES, Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

EXELON CORPORATION AND SUBSIDIARIES, Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Nos. 29183-13, 29184-13

United States Tax Court

September 19, 2016

P, a corporation engaged in the production, transmission, and distribution of electricity to residential, commercial, and industrial customers in Northern Illinois, sold its fossil fuel power plants in 1999 for $4.813 billion. Seeking to manage the taxable gain of $1.6 billion resulting from the sale, P pursued a series of like-kind exchanges employing sale-leaseback strategies between P and unrelated third parties C and M, each of the latter a tax-exempt public utility. P fully funded the transactions using the proceeds from the sale of its own power plants. In the transactions, C or M would lease a power plant to P for a term exceeding the plant's useful life, receiving in turn a lump-sum payment of cash, and P would sublease the power plant back to C or M. Part of the amount paid to C or M would be returned to P as a prepayment of the sublease, another part would be set aside for investment and to secure a cancellation option allowing C and M to purchase back their power plants at the end of the sublease periods, and the remainder would be retained by C and M and used for their own needs. Since exercising the cancellation options was expected to be the only economically viable option, the parties to the transactions anticipated that at the end of the sublease periods C and M would exercise their cancellation options and regain ownership of the power stations leased to P. The primary tax benefits that P expected to derive were from the deferral of income tax under I.R.C. sec. 1031 and various deductions related to the replacement properties. P identified appropriate replacement properties, conducted due diligence, and closed the transactions within the timeframes provided for in I.R.C. sec. 1031.

Held: The agreements between P and C and M are not true leases but rather properly characterized as loans since the transactions did not transfer the benefits and burdens of ownership to P. The substance of the transactions is not consistent with their form.

Held,

further, P did not satisfy the requirements of I.R.C. sec. 1031 for the 1999 tax year since P exchanged power plants for an interest in financial instruments.

Held,

further, P is not entitled to depreciation deductions claimed for 2001 with respect to its transactions with C and M.

Held,

further, P may not deduct interest or include rental income with respect to the transactions with C and M for the 2001 tax year since the transactions are not lease agreements for Federal tax purposes under I.R.C. sec. 467.

Held,

further, P must include in income for the 2001 tax year original issue discount income arising out of P's equity contribution, which is to be repaid with interest through the cancellation options in P's agreements with C and M.

Held,

further, P is not entitled to deduct transaction costs related to its transactions with C and M for its 2001 tax year and must instead include them as an additional amount lent to C and M.

Held,

further, P is liable for accuracy-related penalties under I.R.C. sec. 6662 for the 1999 and 2001 tax years on the grounds of negligence or disregard of rules or regulations. P did not show reasonable cause and good faith under I.R.C. sec. 6664(c) to meet the exception for those penalties.

David F. Abbott, Joel V. Williamson, Erin G. Gladney, Kristin M. Mikolaitis, Andrew W. Steigleder, Michelle A. Spiegel, and Michael D. Educate, for petitioner. [1]

Matthew I. Root, Elizabeth P. Flores, Steven N. Balahtsis, Abigail F. Dunnigan, Lisa M. Goldberg, Casey R. Kroma, and Michael T. Shelton, for respondent.

LARO, JUDGE

These cases are consolidated for purposes of trial, briefing, and opinion. Respondent determined the following deficiencies and penalties in petitioner's2 Federal income tax in timely issued notices of deficiency:

Year Deficiency Penalty sec. 6662(a)
1999 $431, 174, 592 $86, 234, 918
2001 5, 534, 611 1, 106, 922
Petitioner timely filed petitions with the Court seeking redetermination of these deficiencies and penalties. The deficiencies at issue arise out of petitioner's participation in six transactions that respondent labeled sale-in/lease-out (SILO) transactions in an alleged like-kind exchange under section 1031.3 The transactions are as follows:

Counterparty Transaction name
City Public Service Spruce
Municipal Electric Authority of Ga. Scherer 1, Scherer 2, Scherer 3
Municipal Electric Authority of Ga. Wansley 1, Wansley 2
The parties have agreed, with the Court's approval, to reduce the number of transactions to be tried to three "test transactions": Spruce, Scherer 1 (Scherer), and Wansley 1 (Wansley), and to apply the Court's methodology in this Opinion to the remaining transactions.[4] The parties have resolved two issues by filing stipulations of settled issues with the Court. The parties have agreed that petitioner is entitled to the benefits of interest netting as provided in section 6621(d) for 1999, the amount of which will be determined after the parties submit Rule 155 computations. The parties have also agreed that petitioner is not subject to the penalty under section 6662 for the 2001 tax year for an underpayment due to a substantial understatement of income tax, although petitioner still may be subject to the section 6662 penalty for 2001 on account of negligence or disregard of rules or regulations. We decide the following issues: 1. whether the substance of the test transactions is consistent with their form. We hold that it is not; 2. whether petitioner has satisfied the requirements of section 1031. We hold that it has not; 3. whether petitioner is entitled to depreciation deductions claimed for 2001 with respect to the test transactions. We hold that it is not; 4. whether petitioner must include in income in 2001 original issue discount income related to the test transactions. We hold that it must; 5. whether petitioner is entitled to deduct amortized transaction costs related to test transactions for its 2001 tax year. We hold that it is not; and 6. whether petitioner is liable for penalties under section 6662 for the 1999 and 2001 tax years. We hold that it is. FINDINGS OF FACT Some of the facts have been stipulated. The stipulations of fact and the facts drawn from stipulated exhibits are incorporated herein, and we find those facts accordingly. At the time of filing the petitions, Exelon, the primary petitioner, had its principal place of business in Chicago, Illinois. The parties agree that these cases are appealable to the Court of Appeals for the Seventh Circuit. Background I. Exelon and Its Subsidiaries Commonwealth Edison Co. (ComEd) was organized in Illinois on October 17, 1913, as a result of the merger of Cosmopolitan Electric Co. into ComEd. Unicom Corp. (Unicom) was...

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