NA Gen. P'ship & Subsidiaries v. Comm'r of Internal Revenue
| Decision Date | 19 June 2012 |
| Docket Number | Docket No. 525-10,T.C. Memo. 2012-172 |
| Parties | NA GENERAL PARTNERSHIP & SUBSIDIARIES, IBERDROLA RENEWABLES HOLDINGS, INC. & SUBSIDIARIES (SUCCESSOR IN INTEREST TO NA GENERAL PARTNERSHIP & SUBSIDIARIES), Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
Miriam Louise Fisher, Brian C. McManus, Gary B. Wilcox, and Steven P. Johnson, for petitioner.
Mary E. Wynne, James P. Thurston, Scott W. Mentink, and Shirley D. Chin, for respondent.
KROUPA, Judge: Respondent determined deficiencies exceeding $188 million in petitioner's Federal income tax for taxable years ended March 31, 2001(2001 tax year), March 31, 2002 (2002 tax year) and March 31, 2003 (2003 tax year) (collectively, years at issue).1 The deficiencies concern $932 million of payments made on loan notes that NA General Partnership & Subsidiaries (NAGP) issued to its parent ScottishPower plc (ScottishPower). The sole question2 is whether an advance made by ScottishPower to NAGP in connection with NAGP's acquisition of PacifiCorp & Subsidiaries (PacifiCorp) was a loan or a capital contribution for Federal tax purposes, and thus whether petitioner is entitled to interest expense deductions under sections 162(a)3 and 163. We hold the advance was a loan, and the payments on the loan notes are deductible as interest.
Some of the facts have been stipulated and are so found. We incorporate the Stipulation of Facts, the Supplemental Stipulation of Facts and the accompanying exhibits by this reference.
NAGP was a Nevada general partnership and elected to be treated as a corporation for Federal tax purposes. See sec. 301.7701-3(a), Proced. & Admin. Regs. NAGP maintained its principal place of business in Portland, Oregon at the time it filed the petition and filed consolidated Federal tax returns on the accrual basis for the years at issue.4
ScottishPower indirectly owned NAGP at all material times. ScottishPower was a publicly held "multi-utility business in the U.K.," with its principal office in Glasgow, Scotland. ScottishPower provided customers in Scotland, England and Wales with electric, gas, telecommunications and water services. ScottishPower organized NAGP as a special-purpose entity to acquire PacifiCorp.
PacifiCorp was a publicly held U.S. utility company and the common parent of a U.S. consolidated Federal income tax group that owned various regulated and nonregulated subsidiaries. PacifiCorp provided electricity and energy-related services to retail customers in several States, including Oregon, Utah, Washington, Idaho, Wyoming and California. PacifiCorp also indirectly owned interests in Australian companies. PacifiCorp owned 100% of Powercor Australia, Ltd.(Australia Powercor), an electric distribution company in Victoria, Australia, and 19.9% of the Hazelwood power station (Hazelwood), an adjacent brown coal mine in Victoria, Australia.
ScottishPower began exploring international acquisitions in the mid-1990s. ScottishPower's strategy group studied the U.S. utility industry and obtained advice from various advisers, including investment bankers and U.S. regulatory experts. PacifiCorp's stock in late 1998 was trading at approximately $19 per share (down sharply from over $27 per share a year earlier). PacifiCorp's stock had declined, in part, due to a failed acquisition attempt of its own and management turnover. There also was a general perception in the financial community that PacifiCorp had "taken its eye off the ball" of its core businesses in pursuing international expansion activities. ScottishPower believed that PacifiCorp had not paid sufficient attention to controlling its costs.
PacifiCorp was otherwise a highly valuable and respected company with an "A" debt rating, a good asset base with solid growth and demand for electricity, a consistent dividend-paying record and a strong presence in the western UnitedStates. In sum, ScottishPower viewed PacifiCorp as a sound company and ultimately an ideal acquisition target.
In early July 1998 ScottishPower contacted PacifiCorp to discuss possibly strategically combining. The parties discussed potential combination scenarios over the summer and early fall and eventually entered into a confidentiality and standstill agreement in October 1998. Both companies commenced detailed due diligence and engaged numerous advisers to provide advice on financial, regulatory, tax and legal matters. ScottishPower organized NAGP to serve as the acquirer of PacifiCorp, anticipating the proposed merger.
ScottishPower's management presented to its board of directors the results of their financial analysis, cost-savings projections and due diligence reviews of PacifiCorp. ScottishPower's management ultimately advised its board that the merger would create significant value for ScottishPower's shareholders and recommended that ScottishPower proceed. ScottishPower's board unanimously authorized the merger with PacifiCorp in December 1998. Likewise, the PacifiCorp board of directors unanimously approved the proposed merger after PacifiCorp management and advisers made presentations.
ScottishPower, PacifiCorp and NAGP entered into a plan and agreement of merger in December 1998, which was later amended in January 1999 (merger agreement). ScottishPower would indirectly acquire 100% of PacifiCorp issued and outstanding common stock under the merger agreement. PacifiCorp common stock shareholders would receive ScottishPower American Depository Shares (ADS). Alternatively, PacifiCorp's common stock shareholders could elect to receive common shares of ScottishPower. The merger agreement further provided that NAGP would own PacifiCorp's shares and would issue loan notes to ScottishPower in consideration for the shares.
On November 19, 1999, ScottishPower and PacifiCorp completed their proposed merger under which PacifiCorp became a direct subsidiary of NAGP and an indirect subsidiary of ScottishPower (acquisition). To effect the acquisition, ScottishPower organized two wholly owned U.K. subsidiaries with an aggregate capital contribution of £100,000, NA1 Limited (NA1) and NA2 Limited (NA2). Both NA1 and NA2 were treated as disregarded entities for U.S. Federal income tax purposes. NA1 and NA2 contributed the £100,000 to NAGP in exchange for 10% and 90% of the interests in NAGP, respectively. NAGP formed a subsidiary corporation (ScottishPower Acquisition Co.) solely for the purpose of effecting theacquisition. ScottishPower Acquisition Co. was merged with and into PacifiCorp under Oregon corporate law.
At closing, each outstanding share of PacifiCorp's common stock was cancelled and converted into the right to receive either ScottishPower ADS or ScottishPower shares. PacifiCorp issued new shares of common stock to NAGP. NAGP issued loan notes to ScottishPower equal to 75% of the ScottishPower ADSs and ScottishPower common shares provided to PacifiCorp's shareholders. NAGP also pledged its PacifiCorp shares as security for repayment. And NA1 and NA2 issued shares to ScottishPower representing 25% of the value of the ScottishPower ADSs and ScottishPower common shares provided to PacifiCorp's shareholders at the closing.
A new holding company for the combined group, New ScottishPower plc, was incorporated under the laws of Scotland in February 1999 also in connection with the acquisition. Under an arrangement, ScottishPower became a subsidiary of New ScottishPower plc. New ScottishPower plc was renamed ScottishPower plc and ScottishPower was renamed ScottishPower U.K. plc.
ScottishPower and NAGP contemplated separating PacifiCorp's nonregulated subsidiaries from its regulated subsidiaries and placing them under a newly formed holding company before and after the acquisition. To that end, ScottishPower decided to insert PacifiCorp Holdings, Inc. (PHI) as a holding company for PacifiCorp, PacifiCorp Group Holdings Company (PGHC) and PacifiCorp Power Marketing (PPM) a little over a year after the acquisition (PHI restructuring).
PHI was formed, and ScottishPower and PacifiCorp sought consent from the U.K. Treasury and U.S. State regulators to insert PHI and separate the regulated businesses from the nonregulated businesses. NAGP transferred its PacifiCorp stock to PHI at the end of 2001, approximately a year after seeking regulatory approval. PacifiCorp thereafter distributed PGHC to PHI, making PGHC and PacifiCorp brother-sister subsidiaries of PHI.
ScottishPower's management anticipated selling PacifiCorp's Australian operations, Australia Powercor and Hazelwood, before the acquisition. Australia Powercor was eventually sold in September 2000, and PacifiCorp's subsidiary,PGHC, received net cash proceeds from the sale of Australia Powercor of approximately $675 million. PGHC distributed $300 million of those proceeds as a dividend to Australia Powercor in March 2002. Hazelwood was sold in November 2000 for approximately $45.77 million.
As previously mentioned, NAGP issued loan notes to ScottishPower in consideration for ScottishPower transferring on behalf of NAGP its ADS shares and common shares to PacifiCorp shareholders in connection with the acquisition (advance). The loan notes consisted of $4 billion of fixed-rate loan notes (fixed-rate notes) and $896 million of floating-rate notes (floating-rate notes) to ScottishPower (collectively, loan notes or intercompany debt). Each loan note was evidenced by a certificate issued to ScottishPower. The fixed-rate notes had an interest rate of 7.3% and matured in November 2011. The floating-rate notes had an interest rate equal to LIBOR5 plus 55 basis points and matured in ...
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