Tenn. Natural Gas Lines, Inc. v. Comm'r of Internal Revenue

• Decision Date: 30 October 1978
• Docket Number: Docket No. 8100-76.
• Citation: 71 T.C. 74
• Parties: TENNESSEE NATURAL GAS LINES, INC., and SUBSIDIARY, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

71 T.C. 74

TENNESSEE NATURAL GAS LINES, INC., and SUBSIDIARY, PETITIONERS

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 8100-76.

United States Tax Court

Filed October 30, 1978.

Tennessee Natural Gas Lines, Inc.‘s subsidiary, Nashville Gas Co., built a new liquefied natural gas facility, but transferred it to Tennessee Natural for operation in order to avoid subjecting Nashville Gas to Federal Power Commission regulation. Held, on the facts, the transfer (which triggered Nashville Gas' restoration of deferred gain) under sec. 1.1502-13(d), Income Tax Regs., occurred for tax purposes in 1973, when the burdens and benefits of ownership passed to Tennessee Natural, and not in 1974, when legal title was conveyed. Held, further, Tennessee Natural and not Nashville Gas first placed the LNG facility in service. Held, further, the LNG facility was not “public utility property” within the meaning of sec. 46 and therefore Tennessee Natural was entitled to an unreduced investment tax credit. Held, further, the LNG facility belongs entirely in asset guideline class 49.24 (gas storage facility) and not partially in class 49.23 (gas production facility) for ADR depreciation purposes. W. W. Berry and James C. Gooch, for the petitioners.

John B. Harper, for the respondent.

HALL, Judge:

Respondent determined the following deficiencies in petitioners' income tax:

+--------------------+
                ¦Year  ¦Deficiency   ¦
                +------+-------------¦
                ¦1970  ¦$8,048       ¦
                +------+-------------¦
                ¦1971  ¦77,620       ¦
                +------+-------------¦
                ¦1972  ¦54,580       ¦
                +------+-------------¦
                ¦1973  ¦382,845      ¦
                +--------------------+
                

Petitioner Tennessee Natural Gas Lines, Inc. (Tennessee Natural), files its corporate income tax returns on a consolidated basis with its wholly owned subsidiary, petitioner Nashville Gas Co. (Nashville Gas). Due to concessions by both parties, the issues remaining for decision are:

(1) Whether Nashville Gas must restore deferred gain on its sale to Tennessee Natural of a liquefied natural gas (LNG) facility in 1973 or 1974; specifically, whether this sale was consummated for tax purposes in 1973 or 1974;

(2) The amount of the investment tax credit, if any, allowable to Tennessee Natural in 1973 with respect to its purchase of the LNG facility. Specifically:

(a) Whether Tennessee Natural or Nashville Gas first placed the LNG facility into service; and

(b) Whether the LNG facility is “public utility property” within the meaning of section 46.¹

(3) The amount of (ADR) depreciation which petitioners are entitled to deduct in 1973, specifically, whether the LNG facility is depreciable in its entirety under asset guideline class 49.24 (trunk pipelines and related storage facilities) or partially under asset guideline class 49.23 (natural gas production plant).

FINDINGS OF FACT

Most of the facts have been stipulated by the parties and are found accordingly.

Tennesse Natural Gas Lines, Inc. (Tennessee Natural), is a Tennessee corporation organized in 1945. It files its corporate income tax returns on a consolidated basis with its wholly owned subsidiary, Nashville Gas Co. (Nashville Gas), which is also a Tennessee Corporation. At the time the petition herein was filed, the principal offices and places of business of both corporations were in Nashville, Tenn.

Tennessee Natural is a publicity held corporation classified as a “natural gas company” within the meaning of the Federal Natural Gas Act of 1938.² Tennessee Natural is principally engaged in the business of purchasing, transporting, and selling gas in Tennessee. Tennessee Natural sells natural gas for resale to its subsidiary, Nashville Gas; the remainder of Tennessee Natural's sales are primarily to three large industrial consumers in Davidson County, Tenn. Tennessee Natural is not regulated by the Tennessee Public Service Commission, but since it is a natural gas company within the meaning of the Federal statute, its operations are regulated by the Federal Power Commission (FPC). The FPC regulates the prices which Tennessee Natural charges Nashville Gas. The FPC regulates the volumes and priorities of natural gas sold by Tennessee Natural to its three large industrial customers, but not the prices.

Nashville Gas is a local gas distribution company. It purchases gas from Tennessee Natural and sells it at retail to approximately 62,000 residential, commercial, and industrial customers in the Nashville area. The operations of Nashville Gas and the prices it charges for its gas are regulated by the Tennessee Public Service Commission; Nashville Gas is not subject to the jurisdiction of the FPC. Tennessee Natural purchases its gas from Tennessee Gas Pipeline Co. (Tenneco). In 1970, Tenneco informed Tennessee Natural that it could no longer increase the quantity of gas sold to Tennessee Natural in order to meet Tennessee Natural's peak requirements. In other words, during the winter, when consumption is highest, Tenneco could not supply gas to Tennessee Natural in excess of the amount previously contracted for. In 1970 and 1971, Tennessee Natural experienced considerable overruns on its contract with Tenneco, and as a result, Tennessee Natural had to pay $409,985 in penalties to Tenneco during those years. The overruns were caused by the winter.

In response to these large penalties, Tennessee Natural's president assigned the chief engineer of Nashville Gas to make a study of means to increase Tennessee Natural's winter gas supply. A private consultant was hired; he reported that a liquefied natural gas (LNG) storage facility could solve the need for additional gas in the winter since gas can be stored in the summer (when demand is low) and used in the winter (when demand exceeds supply).

An LNG facility operates in three basic steps—liquefaction, storage, and vaporization. High pressure pipeline gas (at approximately room temperature) is cooled in the liquefaction process to minus 260 degrees Fahrenheit, converting the gas into a liquid for storage. Prior to cooling, however, impurities which might interfere with the liquefaction process must be removed. These impurities include the odorant place into natural gas so that it can be smelled. Carbon dioxide and moisture are also removed from the natural gas, leaving pure natural gas (known as methane). The cooling of and pressure reduction. The liquefied natural gas is pumped into a storage tank, where it can be retained with the loss of only a small amount of “boil-off” each day. When additional gas is needed, the liquefied gas is pumped out of storage to vaporizers, which turn the liquefied gas back into natural gas at normal temperature. The gas then is reintroduced into the high pressure pipeline.³ The LNG facility proposed to Tennessee Natural could liquefy gas at approximately 5 million cubic feet per day at 60 Fahrenheit and could store a total of 1 billion cubic feet of natural gas. Liquefied gas could be regasified at the rate of 100 million cubic feet per day.

In December 1971, the directors of Tennessee Natural approved the idea of constructing an LNG facility. Nashville Gas' chief engineer then obtained bids from several companies for construction of the LNG facility, and selected the bid made by Chicago Bridge & Iron Co. On February 22, 1972, the directors of Tennessee Natural passed a resolution approving in principle the construction of the LNG facility by Nashville Gas. On March 22, 1972, the Tennessee Public Service Commission granted approval for acquisition of the land and construction of the LNG facility by Nashville Gas, and construction began in May 1972.

At the time construction of the LNG facility began, no thought was given to possible regulatory problems if Nashville Gas operated the facility. The construction site was adjacent to Tennessee Natural's pipeline (and not near Nashville Gas' lines). This site was selected since it was the only place offering a large source of high pressure gas, electric power, water, and proper zoning.

Construction of the LNG facility proceeded on schedule. In June 1973, as the facility neared completion, Nashville Gas an application for regulatory approval of increased rates to finance the cost of the LNG facility. At this time, Nashville Gas' counsel recognized for the first time that because the LNG facility was physically attached to Tennessee Natural's interstate gas transmission line and the liquefied gas upon release from storage was released into that line, the LNG facility would be operating in interstate commerce. Accordingly, if Nashville Gas operated the facility, Nashville Gas would become for the first time subject to regulation by the FPC. The attorney's concerns were verified by members of the legal staff of the FPC.

To avoid the expense and trouble of double regulation (by both the Tennessee Public Service Commission and the FPC Nashville Gas agreed, on advice of counsel, to transfer ownership and operation of the LNG facility to Tennessee Natural (which was already under FPC regulation). On July 16, 1973, Tennessee Natural and Nashville Gas entered into an acquisition contract, a precedent agreement, and a management contract. The acquisition contract obligated Tennessee Natural to purchase, from the date the facility was ready to be placed into service or on November 1, 1973, whichever occurred later. This transfer, however, was made contingent “Upon the issuance, by all duly constituted regulatory authorities having jurisdiction, of all authorizations acceptable to Purchaser * * * upon completion of construction and the requisite testing of the LNG facilities * * * and upon notice given by the Vendor.” The acquisition contract further provided that at closing, Tennessee Natural would pay Nashville Gas' book cost at the time of completion for the LNG facility. A portion of the consideration for the contract was that Tennessee Natural agreed to enter into a precedent agreement with Nashville Gas to sell supplemental gas...