Dominion Resources v. USA.

• Decision Date: 01 May 2000
• Docket Number: No. 99-1636,No. 99-1645,CA-97-326,99-1636,99-1645
• Citation: 219 F.3d 359
• Parties: (4th Cir. 2000) DOMINION RESOURCES, INCORPORATED, Plaintiff-Appellee, v. UNITED STATES OF AMERICA, Defendant-Appellant. (). . Argued:
• Court: U.S. Court of Appeals — Fourth Circuit

Page 359

219 F.3d 359 (4th Cir. 2000)

DOMINION RESOURCES, INCORPORATED, Plaintiff-Appellee, v. UNITED STATES OF AMERICA, Defendant-Appellant.

No. 99-1636 No. 99-1645 (CA-97-326).

UNITED STATES COURT OF APPEALS, FOR THE FOURTH CIRCUIT.

Argued: May 1, 2000.

Decided: July 19, 2000.

Appeals from the United States District Court for the Eastern District of Virginia, at Richmond.

Robert E. Payne, District Judge.

[Copyrighted Material Omitted] COUNSEL ARGUED: Charles Bricken, Tax Division, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for Appellant. Virginia W. Powell, HUNTON & WILLIAMS, Richmond, Virginia, for Appellee. ON BRIEF: Loretta C. Argrett, Assistant Attorney General, Helen F. Fahey, United States Attorney, Richard Farber, Tax Division, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for Appellant.

Before MOTZ and TRAXLER, Circuit Judges, and Frank W. BULLOCK, Jr., United States District Judge for the Middle District of North Carolina, sitting by designation.

Affirmed by published opinion. Judge Motz wrote the opinion, in which Judge Traxler and Judge Bullock joined.

OPINION

DIANA GRIBBON MOTZ, Circuit Judge:

Dominion Resources, Inc. (DRI), which owns all of the stock of a regulated public utility, incurred two significant expenses in 1991 for which it claimed entitlement to a tax benefit. The first expense arose when regulatory authorities required DRI to restore to its customers approximately $10 million in previous rate overcharges upon which DRI had paid taxes during a thirteen year (1975 through 1987) period. Pursuant to 26 U.S.C. § 1341 (1994), DRI sought, but was denied, a refund of $1,204,283 in income tax payments that it had made on the $10 million in prior tax years. DRI incurred the second expense when it spent approximately $2.2 million on environmental cleanup of a property that it had formerly used as a power plant. The company sought to deduct these costs as an "ordinary and necessary business expense" under 26 U.S.C. § 162 (1994 & Supp. IV 1998) and thereby obtain a refund of $764,135. The IRS disallowed the deduction and required DRI to treat the cleanup costs as a capital expenditure.

DRI brought this suit seeking both refunds. Following a bench trial, Judge Payne issued a thorough opinion holding in favor of DRI on the first issue and granting the $1,204,283 refund, but finding in favor of the IRS on the second issue, and so denying the $764,135 refund. See Dominion Resources, Inc. v. United States, 48 F. Supp. 2d 527 (E.D. Va. 1999). Both DRI and the United States (often referred to within as the IRS) appeal. For the reasons set forth below, we affirm.

I.

DRI's entitlement to the larger claimed refund depends on the proper interpretation of § 1341 of the Internal Revenue Code. See 26 U.S.C. § 1341.

A.

The relevant facts underlying this claim are undisputed and fully detailed in the district court's opinion. We set forth only the facts necessary to understand the legal issues. DRI, a Virginia corporation, owns directly or indirectly all of the common stock of Virginia Electric and Power Company, a public utility engaged in the production and sale of electricity in North Carolina and Virginia. (For convenience, in this section we refer to DRI and Virginia Power simply as DRI.) DRI's gross income from its electric utility business is a function of the electricity rates it charges its customers.

The Federal Energy Regulatory Commission (FERC) and the North Carolina Utilities Commission (NCUC) regulate DRI's rates. FERC and NCUC permit a utility to bill its customers, as part of the overall cost of service, a charge reflecting the utility's projected liability for federal income taxes. This charge may cover not only the payment of current taxes, but future tax liability as well. DRI imposed such a charge in order to phase in the cost of anticipated liabilities in future years when favorable timing differences between its tax and book accounting would reverse. Many public utilities have established similar reserve accounts to meet deferred income tax liability.

In 1986, Congress reduced the maximum corporate tax rate from 46% to 34%, with an intermediate rate of 39.95% applicable to the 1987 taxable year. As a result, DRI's reserve account for deferred tax liability contained an excess of approximately $10 million, an amount obtained from customers during the taxable years between 1975 and 1987 in anticipation of the tax rate remaining at 46%. In 1991, FERC and NCUC ordered DRI to remit the $10 million in the form of a onetime payment to DRI customers, either through an immediate credit to each customer's bill, or by check or wire transfer. DRI did not restore the $10 million to exactly the same individuals who had paid the deferred tax charges between 1975 and 1987. Instead, the $10 million went to DRI's customers in 1991. Individuals and corporations who moved out of DRI's service area between 1975 and 1991 thus did not receive compensation for any overpayments they had made to DRI between 1975 and 1987 (although, as DRI points out, they may have received similar compensation from the utility serving their new residence or business). Furthermore, the remittance was allocated on the basis of the 1991 customers' electricity use during the preceding 12 months, not on the basis of electricity use between 1975 and 1987.

The $10 million repayment reduced DRI's net income in 1991, and this, in turn, reduced DRI's overall tax liability by approximately $3.4 million (34% x $10 million) for that tax year. The issue here is whether DRI is entitled to invoke § 1341 to obtain from the government an additional $1.2 million deduction, an amount that would restore in full the approximately $4.6 million DRI paid in taxes on the $10 million under the pre-1987 tax rate (46% x $10 million).

Congress enacted § 1341 in response to the Supreme Court's decision in United States v. Lewis, 340 U.S. 590 (1951), which held that a taxpayer had to report income he received under an unrestricted claim of right in the year he received it, and if, in a subsequent year, it was determined that the taxpayer was not entitled to the income, his only option was to deduct the amount of that income in the year of repayment--he could not recalculate his income for the year of receipt. See H.R. Rep. No. 83-1337, at A294 (1954), reprinted in 1954 U.S.C.C.A.N. 4017, 4436; S. Rep. No. 83-1622 at 451 (1954), reprinted in 1954 U.S.C.C.A.N. 4621, 5095. "In many instances . . ., the deduction allowable in the later year d[id] not compensate the taxpayer adequately for the tax paid in the earlier year." Id. at 118, reprinted in 1954 U.S.C.C.A.N. at 4751; see also H.R. Rep. No. 831337, at 86, reprinted in 1954 U.S.C.C.A.N. at 4113. To relieve this "inequit[y]," Congress enacted § 1341, which permits taxpayers in this situation who meet certain requirements "to recompute their taxes for the year of receipt" if they choose to do so. United States v. Skelly Oil Co., 394 U.S. 678, 682 (1969). In sum, § 1341 is designed to put the taxpayer in essentially the same position he would have been in had he never received the returned income.

Section 1341 provides in pertinent part:

(a) General Rule.--If--

(1) an item was included in gross income for a prior taxable year (or years) because it appeared that the taxpayer had an unrestricted right to such item;

(2) a deduction is allowable for the taxable year because it was established after the close of such prior taxable year (or years) that the taxpayer did not have an unrestricted right to such item or to a portion of such item; and

(3) the amount of such deduction exceeds $3,000, then the tax imposed by this chapter for the taxable year shall be the lesser of the following:

(4) the tax for the taxable year computed with such deduction; or

(5) an amount equal to--

(A) the tax for the taxable year computed without such deduction, minus

(B) the decrease in tax under this chapter (or the corresponding provisions of prior revenue laws) for the prior taxable year (or years) which would result solely from the exclusion of such item (or portion thereof) from gross income for such prior taxable year (or years).

26 U.S.C. § 1341(a).

In other words, as the parties agree, to obtain the benefit of § 1341, the following requirements must be met: 1) the taxpayer must appear to have had an unrestricted right to an item included in gross income for a prior taxable year; 2) it must have been established after the close of that prior year that the taxpayer did not have an unrestricted right to the item; 3) the taxpayer must be entitled to deduct the amount of the item; and 4) the amount of the deduction must exceed $3000.

The statute further provides that although its relief does not apply to deductions resulting from inventory sales or sales of stock in trade, it does apply if the deduction "arises out of[government required] refunds or repayments with respect to rates made by a regulated public utility." 26 U.S.C. § 1341(b)(2). Congress thus ensured that a regulated public utility, like DRI, would be able to benefit from § 1341 when forced by a regulatory authority to refund rate payments to its customers, if the utility otherwise complied with the requirements of § 1341.

In this case, the IRS concedes that § 1341's fourth requirement has been met--the amount of the asserted deduction exceeds $3000. The IRS argues, however, that it did not "appear" that DRI had an unrestricted right to the $10 million item of gross income in a prior tax year, nor was it "established" after the close of that year that DRI "did not have an unrestricted right to such item" (the first and second requirements). Brief of Appellant/Cross Appellee at 10-12. Furthermore, the IRS argues, DRI was not entitled to take a deduction for the $10 million (the third requirement). Id. at 13.

B.

The IRS first contends that DRI did not "appear" to have an unrestricted right, as required by § 1341...