Commissioner of Revenue v. New England Power Co.

• Decision Date: 16 December 1991
• Parties: COMMISSIONER OF REVENUE v. NEW ENGLAND POWER COMPANY.
• Court: United States State Supreme Judicial Court of Massachusetts Supreme Court

Page 543

582 N.E.2d 543

411 Mass. 418

COMMISSIONER OF REVENUE v. NEW ENGLAND POWER COMPANY.

Supreme Judicial Court of Massachusetts,

Suffolk.

Argued Nov. 5, 1991.

Decided Dec. 16, 1991.

Eric A. Smith, Asst. Atty. Gen., for Com'r of Revenue.

John S. Brown, Boston, for taxpayer.

Before LIACOS, C.J., and WILKINS, ABRAMS, NOLAN and LYNCH, JJ.

NOLAN, Justice.

The Commissioner of Revenue (commissioner) appeals from a decision of the Appellate Tax Board (board) granting an abatement of public utility franchise taxes assessed against the taxpayer, New England Power Company NEP), for the years 1983 and 1984. The commissioner contends that the board erred in holding that the average costs of NEP's construction work in progress (CWIP) should be considered in determining the property factor fraction used to apportion NEP's taxable income for purposes of the Massachusetts public utility franchise tax. The commissioner argues that the CWIP property was not "used" by NEP during taxable years 1983 and 1984, and therefore it is categorically excluded from the property factor equation set forth in G.L. c. 63, § 38(d) (1990 ed.). The commissioner argues alternatively that, at least, the property factor should be calculated without regard to the allowance for funds used during construction (AFUDC) component of the CWIP costs. We affirm the board's decisions.

NEP is a Massachusetts corporation engaged in the business of generating, purchasing, transmitting, and selling electrical energy in wholesale quantities. As a public utility, NEP is subject to the public utility corporation franchise tax imposed by G.L. c. 63, § 52A (1990 ed.). ¹ NEP conducts business both within and without Massachusetts; ² accordingly, its total taxable income is apportioned to Massachusetts for corporate tax purposes pursuant to a formula set forth in G.L. c. 63, § 38. NEP timely paid the franchise taxes assessed against it in 1983 and 1984.

NEP is subject to rate regulation by the Federal Energy Regulatory Commission (FERC). FERC also imposes a tariff on public utilities and requires those companies to fulfil the power requirements of their customers and to give not less than seven years' notice of intention to cease furnishing power, subject to a hearing and approval by FERC of arrangements for an alternative supply. To ensure compliance with this regulation and anticipate the projected market demand for its services, NEP regularly engages in forecasting and planning the types of plants to build, from which to purchase power, or in which to invest. During 1983 and 1984, NEP was involved in the construction of two nuclear energy plants located outside Massachusetts and the conversion of Salem Harbor Station in Massachusetts from oil to coal-based energy production. See note 2, supra. NEP included the CWIP costs associated with these projects in its tax returns for 1983 and 1984. ³

On August 25, 1987, the commissioner notified NEP of the intention of the Department of Revenue (department) to assess additional taxes against NEP for taxable years 1982, 1983, and 1984. The commissioner subsequently adjusted NEP's 1983 and 1984 tax assessments, deducting the value of NEP's CWIP account from the property factor of the fraction used to determine the portion of NEP's total income which was derived from business carried on within the Commonwealth. In revising NEP's taxable income in this regard, the commissioner purported to act pursuant to an "audit guideline," which expressly excluded property under construction from the property factor. Exclusion of the CWIP value from the property factor substantially increased NEP's Massachusetts taxable income.

NEP paid the adjusted tax assessments and timely filed applications for abatement. The commissioner denied NEP's applications stating that "[i]t has been the consistent position of the Commissioner ... that property in the construction in progress account is not used to produce income nor to create jobs prior to its being placed in use[,] ... [therefore] [it] is not includible in the property factor of the income apportionment formula." NEP thereafter petitioned the board for review of the commissioner's decision. The board overturned the commissioner's ruling, concluding that NEP "used" its CWIP property within the meaning of G.L. c. 63, § 38(d), in the sense that it engaged in the construction activities "to meet its [FERC] responsibilities as a public utility." The commissioner appealed pursuant to G.L. c. 58A, § 13 (1990 ed.). We agree with the board that NEP was entitled to an abatement of the additional taxes assessed for 1983 and 1984.

1. The property factor. As indicated above, NEP is obligated to pay a Massachusetts corporate franchise tax, which is based on a percentage of the portion of NEP's taxable income attributable to business conducted in Massachusetts. G.L. c. 63, § 52A (1990 ed.). In order to determine the percentage of the business apportionable to Massachusetts, the corporation's total income is multiplied by a fraction, "the numerator of which is the property factor plus the payroll factor plus the sales factor, and the denominator is three." G.L. c. 63, § 52A(3). The "property factor" is defined in G.L. c. 63, § 38(d), as follows: "[A] fraction, the numerator of which is the average value of the corporation's real and tangible personal property owned or rented and used in this commonwealth during the taxable year and the denominator of which is the average value of all the corporation's real and tangible personal property owned or rented and used during the taxable year" (emphasis added). The statute does not define the term "used."

The commissioner contends that NEP did not "use" its CWIP property during the subject tax years, so it properly was excluded from the apportionment equation. The commissioner argues that the "use" requirement means that the property must actually be placed in service and, since the CWIP property did not contribute to the generation of electricity during the subject tax years, it was not "used" as required by the statute and must be excluded from the property factor. NEP responds that the board properly found that NEP engaged in the construction work in order to meet the FERC requirement that it maintain a level of operating capacity beyond its current demand and thereby ensure its preparedness to meet future needs. In addition, NEP states that the board correctly observed that electric power cannot be stored and therefore "the only way [NEP] can maintain standby facilities or reserve sources of what it is required to furnish to its customers is to build and maintain facilities which generate it." On the basis of these findings, NEP asserts, the board logically determined that NEP "used" its CWIP property during 1983 and 1984 as required by § 38(d), because it "held, occupied, and had some benefit of its construction work, in the sense that it was building general capacity that would enable it to supply future demand for power and thereby to remain in business." For these reasons, NEP argues that its investment in the construction projects properly was included in the property factor. The board's decision "will only be disturbed if it was not supported by 'substantial evidence,' or was tainted by an error of law." Tenneco Inc. v. Commissioner of Revenue, 401 Mass. 380, 383, 516 N.E.2d 1164 (1987), and cases cited.

In Commissioner of Revenue v. Exxon Corp., 407 Mass. 17, 22, 551 N.E.2d 36 (1990), we upheld the board's judgment that "unoperated acreage" was property "used" by the taxpayer within the meaning of § 38(d) (and therefore includible in the property factor), despite the fact that the property did not directly generate income during the taxable year. We agreed with the board's conclusion that, since the taxpayer had to maintain the acreage for research and development purposes in order to remain a competitive force in its business, the value of the property should be included in the property factor which measures the value of the taxpayer's activities in this jurisdiction. We can discern no meaningful distinction between the Exxon case and the present case.

As the board found, NEP's maintenance and construction of energy plants is a necessary function of its business. Like the unoperated acreage in Exxon, the CWIP properties developed by NEP did not produce income as a result of producing energy in 1983 and 1984, but their existence nevertheless contributed to NEP's over-all revenue production. Exxon, supra. Pursuant to a rate-setting order issued...