Dominion Res. Inc v. United States
| Decision Date | 25 February 2011 |
| Docket Number | No. 08-195T,08-195T |
| Parties | DOMINION RESOURCES, INC., Plaintiff, v. UNITED STATES, Defendant. |
| Court | U.S. Claims Court |
Corporate tax case; capitalization of imputed interest on the basis of property temporarily removed from service that otherwise would be used for the production of income, which temporary removal occurs in connection with the installation or construction of a capitalized improvement to the income-producing property; validity of Treas. Reg. § 1.263A-11(e)(1) (ii)(B); Section 702(2)(A) of the Administrative Procedure Act; application of the "substantial variance" doctrine to preclude consideration of the retroactivity of Treas. Reg. § 1.263A-11(e)(2); alleged mistake in settlement agreement
Eric R. Fox, Ivins, Phillips, & Barker, Chartered, Washington, D.C., for plaintiff. With him on the briefs were Leslie J. Schneider and Patrick J. Smith, Ivins, Phillips & Barker, Chartered. Washington, D.C.
Carl D. Wasserman, Court of Federal Claims Section, Tax Division, United States Department of Justice, Washington, D.C., for the defendant. With him on the briefs were John A. DiCicco, Assistant Attorney General, Steven I. Frahm, Chief, and Mary M. Abate, Assistant Chief, Court of Federal Claims Section, Tax Division, United States Department of Justice, Washington, D.C.
This case presents an issue of first impression concerning the validity and application of the Treasury Department's associated-property rule for capitalizing interest on a taxpayer's installation or construction of improvements or additions to property used to generate income. The associated-property rule relates to property temporarily removed from service in connection with the installation or addition of an improvement, and, in effect, requires the capitalized cost of the improvement to include both direct expenditures for the improvement and imputed interest on the basis of the property temporarily removed from service, for the time of that removal.
The plaintiff, Dominion Resources, Inc. ("Dominion" or "Dominion Resources"), is a Virginia corporation whose primary business is providing electric power and natural gas to individual and commercial customers. Stipulation of Facts ("Stipulation" or "Stip.") ¶¶ 13, 14. In 1996, a Dominion subsidiary replaced certain burners in two of its electric generating plants, one located in Virginia and the other located in West Virginia, and had to temporarily remove the generating units from service in the process of making the replacement. Stip. ¶¶ 15-19, 4246. Under 26 U.S.C. ("I.R.C.") § 263A and its accompanying regulations, Dominion had to treat at least some of the costs of those improvements as capital expenditures rather than as amounts deductible from its 1996 income.
Subsection 263A(f) also required Dominion to capitalize interest on debt directly and indirectly related to the plants' improvements. Subparagraph 263A(f)(2)(A) establishes allocation rules for such capitalization of interest. The first such allocation rule provides that "interest on any indebtedness directly attributable to production expenditures with respect to such property shall be assigned to such property." I.R.C. § 263A(f)(2)(A)(i). Application of that direct-attribution rule is not in dispute. The second allocation rule, however, provides that "interest on any other indebtedness shall be assigned to such property to the extent that the taxpayer's interest costs could have been reduced if production expenditures (not attributable to indebtedness described in clause (i)) had not been incurred." I.R.C. § 263A(f)(2)(A)(ii). This indirect-attribution rule is the statutory crux of this case.
The "associated-property rule" set out in 26 C.F.R. ("Treas. Reg.") § 1.263A-11(e) (1)(ii)(B) requires that, when real property is temporarily withdrawn from service to install or construct an improvement, as happened with the boilers and associated generating units to accomplish installation of the new burners, 1 the adjusted basis of that property (termed "associated property") must be included in the indirect-attribution calculation. Dominion Resources has challenged the validity of Treas. Reg. § 1.263A-11(e)(1)(ii)(B) as applied to its improvements, arguing that the regulation is inconsistent with the statutory text of Section 263A and also was adopted in contravention of the requirements of the Administrative Procedure Act.
Secondary contentions are also at issue. If unsuccessful on its primary claims, Dominion alternatively seeks retroactively to invoke a so-called "de minimus" rule, Treas. Reg. § 1.263A-11(e)(2), as applied to the improvement made at one of its plants.2 The government has alsofiled a counterclaim, arguing that a settlement agreement between it and Dominion should be reopened and that Dominion should have capitalized more interest in 1996 than the amount agreed by the parties in the settlement.
The parties have presented these competing contentions to the court by way of cross-motions for summary judgment.
Dominion Resources generates and sells electrical power to individual and commercial customers. Stip. ¶¶ 13, 14. In 1996, its subsidiary, the Virginia Electric & Power Company, owned and operated electric generating units in Virginia and West Virginia that included two coal-fired electric generating complexes, the Possum Point Power Station ("Possum Point") and the Mount Storm Power Station ("Mount Storm"). Stip. ¶¶ 15, 42. Possum Point, in Virginia, encompassed six independent generating units, two of which were retired in the early 1990s, and Mount Storm, in West Virginia, contained three independent generating units. Stip. ¶¶ 16, 43.
In 1996, Dominion performed renovations at Possum Point and Mount Storm, replacing certain existing coal burners in the plants' boilers with low-nitrous-oxide burners to comply with requirements of the Clean Air Act, 42 U.S.C. §§ 7401-7671q. Stip. ¶¶ 15, 18, 42, 45. Replacing the burners required that Dominion temporarily take out of service the Unit 4 generating plant at Possum Point and the Unit 3 generating plant at Mount Storm. Stip. ¶¶ 19, 46. The unit at Possum Point was out of service from March 9, 1996 to May 13, 1996, and the unit at Mount Storm was out of service from September 6, 1996 to December 2, 1996. Stip. ¶¶ 19, 46.
Stated most simply, the central question at issue in this case is how much accrued interest Dominion Resources had to capitalize, rather than deduct as an expense, in 1996, as a result of its renovation of the Possum Point and Mount Storm plants. Several sections of the Internal Revenue Code and of Treasury Regulations bear on that question. Notably, neither the main issue in this case nor any of the secondary issues would arise if Dominion had a capital structure that was predicated only on equity, without any debt. Equity assuredly has an economic cost, but the several economic policy arguments made by the parties, particularly those relating to "avoided cost," are constrained to debt on which interest is being paid.
The law provides that a taxpayer can generally deduct from its taxable income "all interest paid or accrued within the taxable year on indebtedness." I.R.C. § 163(a). However, the cost of creating or increasing the value of property must be capitalized rather than deducted. Section 263 sets forth the general rules for capitalizing expenditures rather than deducting them. See I.R.C. § 263(a)(1) ( ). Interest can be such a capitalized cost. See Commissioner v. Breyer, 151 F.2d 267, 272 (3d Cir. 1945); Eskimo Pie Corp. v. Commissioner, 4 T.C. 669, aff'd, 153 F.3d 301 (3d Cir. 1946). Dominion Resources' generating units are treated as capital investments under this statute. Stip. ¶¶ 17, 44 ().
Previously, the general framework provided by Section 263 was supplemented by I.R.C. § 189, adopted in 1976. Section 189 required a taxpayer to capitalize interest on debt accrued for real property construction. See I.R.C. § 189(a) (1982) (); I.R.C. § 189(e) (1982) (). The Secretary of the Treasury was directed to prescribe regulations "provid[ing] for the allocation of interest to real property under construction," I.R.C. § 189(e) (1982), but regulations were never promulgated, and Section 189 was repealed and replaced in 1986. See Pub. L. No. 99-514, § 803(b)(1), 100 Stat. 2085 (Oct. 22, 1986).
In 1986, Section 189 was supplanted by Section 263A, which laid out a so-called uniform-capitalization ("UNICAP") structure for the capitalization of property "produced by the taxpayer" or "acquired for resale." I.R.C. § 263A(b). The Section is lengthy and complex, cluttered with a myriad of special provisions concerning, among other topics, "[r]esearch and experimental expenditures," I.R.C. § 263A(c)(2), production of "[t]imber and certain ornamental trees," I.R.C. § 263A(c)(5), activities of "citrus and almond growers," I.R.C. § 263A(d)(3)(C), and activities of "free[]lance authors, photographers, and artists." I.R.C. § 263A(h). Nonetheless, none of the special provisions and exceptions apply to Dominion. Rather, Dominion's...
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