Madison Gas and Elec. Co. v. C. I. R.

• Decision Date: 27 October 1980
• Docket Number: No. 80-1380,80-1380
• Citation: 633 F.2d 512
• Parties: 80-2 USTC P 9754 MADISON GAS AND ELECTRIC COMPANY, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 512

633 F.2d 512

80-2 USTC P 9754

MADISON GAS AND ELECTRIC COMPANY, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

No. 80-1380.

United States Court of Appeals Seventh Circuit.

Argued Sept. 23, 1980.

Decided Oct. 27, 1980.

Steven E. Keane, Milwaukee, Wis., for appellant.

Karl Fryzel, Tax Division, Dept. of Justice, Washington, D. C., for appellee.

Before CUMMINGS and WOOD, Circuit Judges, and CAMPBELL, Senior District Judge. ^*

CUMMINGS, Circuit Judge.

This is an action under 26 U.S.C. § 7422 for the refund of federal income taxes. The question is whether certain training and related expenses incurred by a public utility in the expansion of its generating capacity through the joint construction and operation of a nuclear plant with two other utilities are deductible as ordinary and necessary expenses in the years of payment or are non-deductible pre-operating capital expenditures of a new partnership venture. The Tax Court in an opinion reported at 72 T.C. 521 held that they are non-deductible capital expenditures. We affirm.

I

All relevant facts have been stipulated by the parties (App. 8-41) and found and set forth at length by the Tax Court. We find it necessary to summarize them only briefly. Taxpayer Madison Gas and Electric Co. (MGE), a Wisconsin corporation, is an operating public utility which has been engaged since 1896 in the production, purchase, transmission and distribution of electricity and the purchase and distribution of natural gas. MGE is subject to the jurisdiction and regulation of the Public Service Commission of Wisconsin (PSC) and the Nuclear Regulatory Commission. The Federal Energy Regulatory Commission (FERC) also has or may have jurisdiction over MGE.

MGE is required to furnish reasonably adequate service and facilities within its service area at rates found reasonable and just by the PSC. During 1969 and 1970, the tax years here in issue, MGE rendered service to some 73,000 residential and commercial customers in a service area of approximately 200 square miles in Dane County, Wisconsin. MGE also sells a small percentage of its electrical power to other utilities in Wisconsin. Its primary responsibility, however, is to its customers in the service area. The number of customers within that area has grown rapidly and continuously during the past 25 years, and the customer demand for electricity has increased with the expansion of commercial and industrial accounts, the substitution of electricity for other forms of energy, and the increasing prevalence of high-energy devices such as air-conditioning units. Thus at the time of trial MGE was servicing almost 90,000 residential, commercial and industrial customers.

MGE has over the years kept pace with the increasing demand for electrical power and provided it at reasonable rates by expanding the generating capacity of its facilities, contracting for the purchase and sale of excess electrical power, interconnecting transmission facilities with those of other Wisconsin utilities, and finally by building and operating additional facilities in conjunction with other utilities. Expenses incurred in connection with one of these joint ventures is the subject of the present suit.

On February 2, 1967, MGE entered into an agreement, entitled "Joint Power Supply Agreement" (Agreement) (App. 42-59), with Wisconsin Public Service Corporation (WPS) and Wisconsin Power and Light Co. (WPL) under which the three utilities agreed, inter alia, to construct and own together a nuclear generating plant now known as the Kewaunee Nuclear Power Plant (Plant). Under the Agreement, the Plant is owned by MGE, WPS and WPL as tenants-in-common with undivided ownership interests of 17.8%, 41.2% and 41.0% respectively. Electricity produced by the Plant is distributed to each of the utilities in proportion to their ownership interests. Each utility sells or uses its share of the power as it does power produced by its own individually owned facilities, and the profits thereby earned by MGE contribute only to MGE's individual profits. No portion of the power generated at the Plant is offered for sale by the utilities collectively, and the Plant is not recognized by the relevant regulatory bodies as a separate utility licensed to sell electricity. Each utility also pays a portion of all expenditures for operation, maintenance and repair of the Plant corresponding exactly to its respective share of ownership. Under utility accounting procedures mandated by the PSC and the FERC, these expenses are combined with and treated in the same manner by MGE as expenses from its individually owned facilities. The ownership and operation of the Plant by MGE, WPS and WPL is regarded by the PSC and the FERC as a tenancy-in-common. It was the intention of the utilities to create only a co-tenancy and not a partnership and to be taxed as co-tenants and not as partners.

In its 1969 and 1970 taxable years, MGE incurred certain expenses relating to the nuclear training of WPS employees, the establishment of internal procedures and guidelines for plant operation and maintenance, employee hiring activities, nuclear field management, environmental activities and the purchase of certain spare parts (App. 116-126). MGE had to incur these expenses in order to carry out its Plant activities. Pursuant to order of the PSC, MGE was required to amortize training expenses, net of income taxes, over a 60-month period from the date of commercial operation of the Plant, a date occurring after those in issue here, and the other non-construction expenses associated with the Plant, net of income taxes, over a three-year period beginning January 1, 1973. MGE did not deduct the expenses described above on its tax returns for 1969 and 1970, but in the Tax Court claimed a deduction for them by amendment to its refund petition in the total amounts of $33,418.45 and $114,434.27 for 1969 and 1970 respectively.

MGE's position was, and is, that the claimed expenses were currently deductible under Section 162(a) of the Internal Revenue Code of 1954 (Code) as ordinary and necessary business expenses. The Commissioner's position was, and is, that the claimed expenses were non-deductible capital expenditures. The Tax Court agreed with the Commissioner, holding that the operation of the Plant by MGE, WPS and WPL is a partnership within the meaning of Section 7701(a)(2) of the Code, that the expenses in question were incurred not in the carrying out of an existing business but as part of the start-up costs of the new partnership venture, and that the expenses were therefore not currently deductible but must be capitalized under Section 263(a) of the Code. MGE appeals from this judgment, arguing that its arrangement with WPS and WPL is not a partnership within the meaning of the Code and, alternatively, that even if it is a partnership the expenses are currently deductible.

II

The threshold issue is whether MGE's joint venture with WPS and WPL is a tax partnership. The Commissioner concedes that if it is not, the expenses are currently deductible under Section 162(a). ¹ A partnership for federal tax purposes is defined by the Code in Section 7701(a)(2), which provides in pertinent part:

"The term 'partnership' includes a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this title, a trust estate or a corporation."

MGE's arrangement with WPS and WPL in connection with the Plant clearly establishes an unincorporated organization carrying on a "business, financial operation, or venture" and therefore falls within the literal statutory definition of a partnership. The arrangement is, of course, not taken out of this classification simply because the three utilities intended to be taxed only as a co-tenancy and not as a partnership. While it is well-settled that mere co-ownership of property does not create a tax partnership, see, e. g., Estate of Appleby v. Commissioner, 41 B.T.A. 18 (1940), co-owners may also be partners if they or their agents carry on the requisite "degree of business activities." Powell v. Commissioner, 26 T.C.M. 161 (1967); Hahn v. Commissioner, 22 T.C. 212 (1954).

MGE's argument is that a co-tenancy does not meet the business activities test of partnership status unless the co-tenants anticipate the earning and sharing of a single joint cash profit from their joint activity. Because its common venture with WPS and WPL does not result in the division of cash profits from joint marketing, MGE contends that the venture constitutes only a co-tenancy coupled with an expense-sharing arrangement and not a tax partnership. The Tax Court held that the Code definition of partnership does not require joint venturers to share in a single joint cash profit and that to the extent that a profit motive is required by the Code it is met here by the distribution of profits in kind. We agree.

The definition of partnership in Section 7701(a)(2) was added to the Code by Section 1111(a) of the Revenue Act of 1932 and first appeared in Section 3797(a)(2) of the 1939 Code. The Congressional Reports accompanying the 1932 Act make clear, in largely identical language, that Congress intended to broaden the definition of partnership for federal tax purposes to include a number of arrangements, such as joint ventures, which were not partnerships under state law. H.P.Rep. No. 708, 72d Cong., 1st Sess., 53 (1932); S.Rep. No. 665, 72d Cong., 1st Sess., 59 (1932). In so doing, they briefly discuss the advantages of requiring a partnership return for joint venturers rather than leaving the sole responsibility for reporting annual gains and losses on the individual members. MGE invites us to infer from these discussions that Congress contemplated inclusion only of those joint ventures that are capable of producing joint cash gains and losses....