Dominion Resources, Inc. v. U.S.

• Decision Date: 05 March 1999
• Docket Number: Civ. A. No. 3:97CV326.
• Citation: 48 F.Supp.2d 527
• Court: U.S. District Court — Eastern District of Virginia
• Parties: DOMINION RESOURCES, INC., Plaintiff, v. UNITED STATES of America, Defendant.

48 F.Supp.2d 527

DOMINION RESOURCES, INC., Plaintiff, v. UNITED STATES of America, Defendant.

Civ. A. No. 3:97CV326.

United States District Court, E.D. Virginia, Richmond Division.

March 5, 1999.

COPYRIGHT MATERIAL OMITTED

Virginia W. Powell, Hunton & Williams, Richmond, VA, Robert Joseph Muething, Hunton & Williams, Atlanta, GA, Winfield L. Ryan, Richmond, VA, for plaintiff.

James J. Wilkinson, U.S. Department of Justice, Tax Division, Washington, DC, Joan E. Evans, U.S. Attorney's Office, Richmond, VA, Alan J.J. Swirski, U.S. Department of Justice, Tax Division, Washington, DC, for defendant.

MEMORANDUM OPINION

PAYNE, District Judge.

Dominion Resources, Inc. ("DRI") instituted this action against the United States (the "IRS"), seeking a refund of federal taxes for the 1991 tax year, asserting four distinct tax claims. Having compromised Counts Three and Four of the original Complaint, DRI filed an Amended Complaint presenting only two counts.

In Count One of the Amended Complaint, DRI seeks a refund because the IRS erroneously refused to allow DRI's subsidiary, Virginia Power Company, to use 26 U.S.C. § 1341 ("Section 1341") in calculating its tax liability for 1991. The parties agree that if the IRS erroneously refused to apply Section 1341, the amount of the refund is $1,204,283.

Count Two seeks a refund on the theory that DRI is entitled to a deduction for expenses incurred by Dominion Lands, Inc. ("DLI"), another DRI subsidiary, in cleaning up environmental contamination on property formerly owned and operated by Virginia Power as an electric power generating station. That property, known as the 12th Street Station, was transferred to DLI as part of the corporate reorganization by which DRI was formed to become Virginia Power's holding company. Count Two seeks to recover $762,359 which is the agreed refund owed if DRI is entitled to a deduction for these clean-up expenses. The Court, sitting without a jury, heard evidence and argument on these issues.

FINDINGS OF FACT: COUNT ONE

The facts are largely undisputed and most have been set forth in the joint stipulation of facts. (Pl.'s Trial Ex. 68.) Those, and the findings respecting the few disputed facts, are set forth below.

DRI is a Virginia corporation, which owned, directly or indirectly, all the outstanding common stock of Virginia Power and DLI at all times relevant to this action. Virginia Power generates, transmits, and distributes electricity to customers in Virginia and North Carolina. The company is a public service corporation which is organized under the laws of the Commonwealth of Virginia and which is subject to regulation by the Virginia State Corporation Commission ("VSCC"), the North Carolina Utilities Commission ("NCUC"), and the Federal Energy Regulatory Commission ("FERC") (collectively, the "Regulatory Authorities").

Between 1975 and 1987, Virginia Power collected revenues from its customers under rates approved by the Regulatory Authorities. The basis for those rates was the estimate of Virginia Power's cost of service in generating and transmitting electricity. Cost of service includes operational and maintenance expenses, depreciation and amortization, taxes, working capital, and costs of invested capital. Virginia Power's projected federal income taxes were a component of the cost of service estimate in every relevant year.

Virginia Power's projections of federal income taxes for ratemaking purposes consisted of a "current" component and a "deferred" component. The "current" component for a particular year represented the amount of federal income tax which Virginia Power expected to pay on its projected revenue amounts for that year. In contrast, the "deferred" component for a particular year represented the amount of future federal income tax that Virginia Power estimated it would be required to pay with respect to the projected revenue amounts for that year.

The deferred component is the subject of Count One. The deferred component consists of estimated taxes paid with respect to either: (1) income received in a current year that is deferred for income tax purposes to a later year; or (2) deductions in later years that are accelerated into a current year. Both deferred income and accelerated deductions result in differences between income for financial reporting purposes and income for income tax purposes, and those differences are referred to as "book-tax timing" differences or as "temporary differences."

The FERC accounting rules, NCUC's accounting rules, and Generally Accepted Accounting Principles (GAAP) require the establishment and maintenance of deferred tax accounts. Pursuant to those rules and principles, DRI maintained, at all relevant times, a Deferred Tax Account which was adjusted on an annual basis, and which represented the net cumulative amount of federal income tax expected to be paid in future years.

During the years 1975 through 1987, Virginia Power increased the Deferred Tax Account by the amount of the taxes related to net income accrued for ratemaking purposes as opposed to net income accrued for tax purposes. In each of those years, Virginia Power decreased the Deferred Tax Account by the amount of the taxes that were paid with respect to net income that had been accrued for ratemaking purposes in earlier years but not accrued for tax purposes in those earlier years. Virginia Power expected to pay the deferred taxes in future years when the book-tax timing differences associated with the deferred taxes were reversed. When deferred taxes are actually paid, the Deferred Tax Account is reduced by a corresponding amount. In general, if tax rates remain constant, a book-tax timing difference that results in an addition to the Deferred Tax Account in an earlier year will be offset completely by a corresponding decrease in the Deferred Tax Account in a later year, when the book-tax timing difference is reversed.

When the Regulatory Authorities approved rates based on the projected cost of service, (which included deferred taxes), there existed the possibility that the federal corporate income tax rates governing those deferred taxes would change before Virginia Power was required to pay those federal income taxes. There also existed a possibility that the Regulatory Authorities would later revise the approved rates. Thus, when the Regulatory Authorities approved the rates which could be charged by Virginia Power, it was uncertain whether Virginia Power ultimately would owe an amount of federal income taxes equal to the amounts collected on the basis of those rates.

At all times relevant, the Regulatory Authorities had the authority to require Virginia Power to return to its customers any amounts collected based on a cost of service which included deferred taxes if the Deferred Tax Account became overstated by reason of a reduction in the federal corporate income tax rates. Also, if the Deferred Tax Account became excess, Virginia Power was required under 18 C.F.R. Section 35.24(c) (formerly Section 35.25(c)), a FERC regulation, to adjust the income tax component of its cost of service to reflect any excess deferred taxes such as the excess caused by the reduction in federal corporate income tax rates under the Tax Reform Act of 1986. The FERC regulation provided, in pertinent part:

If, as a result of changes in tax rates, the accumulated provision for deferred taxes becomes deficient in or in excess of amounts necessary to meet future tax liabilities as determined by application of the current tax rate to all timing difference transactions originating in the test period and prior to the test period ... The public utility must compute the income tax component in its cost of service by making provision for any excess or deficiency in deferred taxes ...

Furthermore, under a FERC rule reported at 52 Fed.Reg. 24987 (1987), Virginia Power was required to establish a plan to return any excess balance in the Deferred Tax Account to its customers. That plan could take the form of a refund, a reduction of rates, or an offset against an increase in a different item in Virginia Power's cost of service.

With respect to excess deferred income taxes, the Regulatory Authorities had authority which included the following: (a) they could order Virginia Power to issue an immediate refund to its customers; (b) they could order Virginia Power to reduce future rates charged to its customers; and (c) they could offset the tax savings arising from the excess deferred taxes against increases in other "costs of service" at its next ratemaking proceeding.

In general, the federal corporate tax rate used to compute the amount of Virginia Power's deferred taxes during the years 1975 through 1987 was the statutory tax rate in effect at that time, which was at least 46% in every year except 1987 when the rate was 39.95%. Under the Tax Reform Act of 1986, the maximum corporate tax rate was reduced from 46% to 34%, effective on July 1, 1987. Therefore, the company's expected future tax liability was revised downwardly to conform with the Tax Reform Act of 1986 and, as a result, on July 1, 1987, there arose an excess balance in the Deferred Tax Account.

The excess occurred because Virginia Power was no longer expected to pay the full amount of the deferred taxes that had previously been added to the Deferred Tax Account. The excess amount in the Deferred Tax Account was generally equal to the difference between the expected future tax liability relating to book-tax timing differences, computed at the 46% corporate tax rate, and the revised expected future tax liability on those items computed at the 34% corporate tax rate. The excess amount originally had been included in the Deferred Tax Account during the years 1975 through 1987.

The Tax Reform Act of 1986 penalized a utility if it immediately refunded "protected" excess deferred taxes, which generally related to book-tax timing differences arising from accelerated...