Citations
- 952 F. Supp. 1346
Full opinion text
ORDER ADOPTING REPORTS AND RECOMMENDATIONS OF THE MAGISTRATE JUDGE
TUNHEIM, District Judge.
This case involves two independent disputes regarding the federal taxes of plaintiff Northern States Power Company (“NSP”). The Court referred cross motions for summary judgment on both disputes to Magistrate Judge John M. Mason, who issued separate reports and recommendations on each dispute. The first Report and Recommendation, dated July 15,1996, deals with what the parties refer to as the nuclear fuel assembly issue. The second Report and Recommendation, dated November 25, 1996, addresses a disagreement which has been called the DOE contracts issue.
The matter is before the Court on objections to each Report and Recommendation. The Court has reviewed de novo all of the objections to each Report and Recommendation on these dispositive pretrial matters, pursuant to 28 U.S.C. § 636(b)(1)(C) and D.Minn. LR 72.1(e)(2). For the reasons set forth below, the Court adopts each Report and Recommendation, grants summary judgment for NSP on the nuclear fuel assembly issue, and grants summary judgment for the United States on the DOE contracts issue.
Rule 56(c) of the Federal Rules of Civil Procedure provides that summary judgment “shall be rendered forthwith if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is' no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law.” Summary judgment is mandated when, after adequate time for discovery and upon motion, the nonmoving party fails to make a showing sufficient to establish the existence of an element essential to its case on which that party would bear the burden of proof at trial. Celotex Corp. v. Catrett, 477 U.S. 317, 322, 106 S.Ct. 2548, 2552, 91 L.Ed.2d 265 (1986). The parties have stipulated as to most of the facts relevant to both issues, so the motions considered by the Court present only legal issues.
I. The Nuclear Fuel Assembly Issue
The Report and Recommendation dated July 15, 1996 recommended entering judgment in favor of NSP’ finding that NSP is entitled to the investment tax credit and depreciation deductions claimed on its federal income tax returns for 1985 and 1986, respectively, with regard to 40 nuclear fuel assemblies which Westinghouse Electric Corporation delivered to NSP’s Prairie Island nuclear steam-generated power plant in December, 1985, and with regard to the 44 nuclear fuel assemblies which Westinghouse delivered to the Prairie Island plant in December, 1986.
When NSP received these fuel assemblies, it proceeded to install them in the reactor core and test them before they could be used to generate electricity. Actual generation of electricity from the fuel assemblies did not begin until the year following the year of delivery. The United States argues that the investment tax credit and depreciation deductions related to each set of nuclear fuel assemblies should not be allowed until the years when they first used for the generation of electricity.
The Court agrees with the Magistrate Judge that the investment tax credit and depreciation deductions for each set of nuclear fuel assemblies should be allowed in the years when they were delivered to NSP, because they were ready and available for use at that time. 26 C.F.R. § 1.167(a)-ll(e)(l)(i) (depreciation deduction available when property is first placed in a condition of “readiness and availability”); 26 C.F.R. § 1.46-3(d) (investment tax credit available when property is placed in a condition of “readiness and availability”).
The United States has also objected to the Magistrate Judge’s recommendation that judgment be entered separately in this dispute, prior to the entry of judgment in the dispute involving DOE contracts issue. This objection is mooted by the fact that the Court is currently ruling on both disputes.
II. The DOE Contracts Issue
The Report and Recommendation dated November 25, 1996 recommended entering judgment in favor of the United States on the separate claim regarding the tax treatment of costs related to the acquisition of nuclear fuel in the tax returns of NSP for the years 1985 and 1986. NSP objects to this recommendation.
This dispute is related to whether the costs of contracts for enriching nuclear fuel should be treated as capital expenses or deducted in the current year as ordinary losses or business expenses. NSP normally treats these costs as capital expenses, but it seeks to treat the cost of such contracts as ordinary losses or business expenses as to those contracts which were resold or assigned to third parties at a loss. The issue is whether NSP made a mistake which it can now correct when it treated the losses on such resales and assignments as capital expenses, rather than ordinary losses or business expenses.
NSP has long purchased services for the enrichment of uranium pellets for fueling nuclear reactors from the Department of Energy (“DOE”), in units known as “separative work units” or SWUs. In the tax years of 1985 and 1986, NSP had contractual obligations to buy more SWUs from the Department of Energy than it wanted or needed. NSP bought the SWUs required by the contract and resold them at a loss to third parties.
For financial reporting purposes, NSP has historically treated the acquisition costs for fuel assemblies, including the enrichment services, as capital expenses. NSP followed this practice in the tax years of 1985 and 1986, despite the fact that some SWUs were resold at a loss during those tax years. The SWU liabilities to the DOE, along with the offsetting credits reflecting the amounts for which NSP sold or assigned the unwanted SWUs, were included in a capital account known as a “work order.”
When NSP’s income tax department prepared the federal income tax returns for 1984 through 1986, it did not know about the sales and assignments of SWUs, so it utilized the fuel assembly reload work order figures without subtracting the net unrecouped expenses or losses from these transactions from the work order capital account. Consequently, the tax returns included those amounts in the capital cost of NSP’s fuel assemblies on its tax returns. Had NSP’s income tax department known of the sale and assignments of SWUs at the time, it would have reported the net unreeouped DOE SWU liabilities on those returns as currently deductible ordinary and necessary business expenses and/or ordinary losses.
When NSP’s tax department became aware that NSP’s fuel purchasing department had sold or assigned DOE SWUs to third parties during 1984 through 1986, the tax department timely filed claims for refund for tax years 1985 and 1986 seeking to change the treatment of the subject DOE SWU liabilities from capital expenses to currently deductible ordinary and necessary business expenses and/or ordinary losses. By the time the tax department became aware of the sales and assignments, however, it was too late for NSP to file a claim for refund for the 1984 tax year because the statute of limitations on refunds or credits, 26 U.S.C. § 6511, had expired as to that year.
The Court agrees' with the Magistrate Judge and the United States that NSP is now seeking a change of accounting method which requires the consent of the Commissioner of Internal Revenue. 26 U.S.C. § 446(e). Regulations specify that a change involving a question of timing cannot be made without consent, and they provide the example of “a correction to require depreciation in lieu of a deduction for the cost of a class of depreciable assets which had been consistently treated as an expense in the year of purchase.” Treasury Regulation Section 1.446 — 1(e)(2)(ii)(b). The current case involves exactly this kind of change, albeit in the opposite direction. Consequently, NSP’s failure to seek the consent of the Commissioner of Internal Revenue by filing a Form 3115 in a timely way is fatal to its claim.
NSP argues that it should be allowed to correct the use of an erroneous accounting treatment because its method was in error, and NSP objects to language in the Report and Recommendation suggesting that NSP is merely trying to change from one acceptable method to another. The Court agrees with the United States that it is irrelevant whether NSP could have properly elected to treat the losses from the SWU sales and assignments as capital expenses. Assuming this was purely erroneous, this is not the kind of error which can be corrected without consent, such as “mathematical or posting errors, or errors in the computation of tax liability.” Treasury Regulation Section 1.446~l(e)(2)(ii)(b). Rather, NSP’s asserted error was one involving the proper timing for the taking of a deduction. Changing an accounting method to correct such an error requires the consent of the Commissioner of Internal Revenue.
ORDER
Based on the submissions of the parties, the arguments of counsel and the entire file and proceedings herein, IT IS HEREBY ORDERED that the Magistrate Judge’s Report and Recommendation dated July 15, 1996 is ADOPTED, and the Magistrate Judge’s Report and Recommendation dated November 25,1996 is ADOPTED.
LET JUDGMENT BE ENTERED ACCORDINGLY.
ORDER GRANTING RELIEF FROM JUDGMENT AND MODIFYING ORDER OF JANUARY 16, 1997
TUNHEIM, District Judge.
On January 16, 1997, the Court adopted two Report and Recommendations of the Magistrate Judge concerning this dispute regarding the federal taxes of plaintiff Northern States Power Company (“NSP”) and directed entry of judgment in keeping with the Magistrate Judge’s recommendations that judgment, be entered pursuant to Fed.R.Civ.P. 54(b). Subsequently, the parties informed the Court that there are outstanding issues concerning the computation of interest on tax refunds which the parties did not raise in their objections. Consequently, judgment should not yet be entered.
Pursuant to Fed.R.Civ.P. 60(a), the Court relieves the parties from the final judgment, and the clerk is directed not to enter judgment until further order from the Court. The Order of January 16,1997 is amended so as to reject the recommendations of the Magistrate Judge concerning the entry of judgment at this time. IT IS SO ORDERED.
REPORT AND RECOMMENDATION
MASON, United States Magistrate Judge.
INTRODUCTION
' This matter came before the Court on April 11, 1996, on the parties cross-motions for summary judgment. The case has been referred to the undersigned United States Magistrate Judge for Report and Recommendation pursuant to 28 U.S.C. § 636(b)(1)(B). Steven Z. Kaplan, Esq., appeared on behalf of the Plaintiff. Seth G. Heald, Esq., appeared on behalf of the Defendant.
The parties have presented two independent disputes to the court. The first relates the Nuclear Fuel Assemblies at the Prairie Island power plant and second relates to a contract between Northern States Power Company and the Department of Energy. The Court now issues this Report and Recommendation on the Nuclear Fuel Assembly issue. It will address the Department of Energy contract dispute in a subsequent Report and Recommendation.
The parties stipulated to undisputed facts for the purposes of the summary judgment motions [Docket No. 35], which are summarized as follows.
Northern States Power Company (“NSP”) has owned and operated a nuclear electric power plant in Prairie Island, Minnesota since 1974. The Internal Revenue Service (“IRS”) issued notices of deficiency to NSP disallowing depreciation deductions and investment tax credits claimed by NSP on its 1985 and 1986 income tax returns. These disallowed amounts related to nuclear fuel assemblies manufactured for NSP’s Prairie Island Plant in 1985 and 1986. On March 24, 1994, after receipt of the notices of deficiency, NSP paid with interest the additional tax requested. NSP timely filed claims for refund to recover the additional tax and interest paid to the IRS. The IRS denied NSP’s claims and NSP filed this action for a tax refund under 28 U.S.C. § 1346(a)(1) and 26 U.S.C. § 7422. The amount involved in the dispute is approximately $8,500,000.
FINDINGS OF FACT/REPORT
A. Stipulated Facts
NSP’s Prairie Island plant has two nuclear reactors housed in separate “containment” buildings. Each reactor has 121 individual fuel assemblies which comprise the “reactor core.” The reactor is shut down every ten to sixteen months for refueling, at which time about one third of the total number of fuel assemblies are replaced. Shut downs of the reactor are scheduled well in advance and usually last about five to seven weeks. Each fuel assembly typically remains in the core for a total of three to five years.
The refueling process includes a number of steps including cooling the reactor, removing the old fuel assemblies, placing the new assemblies in the core, and properly configuring the new assemblies with the used assemblies. In addition, the core must undergo “start up physics testing” before power operations can be resumed. This testing verifies that the 121 assemblies have been properly positioned in the reactor core, and that the fission reaction generated by these assemblies is within the technical specifications of the plant. The testing is a necessary safety measure before the reactor can be restarted and produce sufficient heat to generate electricity.
The fuel assemblies used at NSP’s Prairie Island plant during the years in question were manufactured by Westinghouse pursuant to a contract with NSP. The fuel assemblies consist of enriched uranium pellets which are inserted and sealed into metal rods. The metal rods are then fastened together in groups to form the assembly.
In December of 1985, NSP received a group of 40 fuel assemblies from Westinghouse for its next reload (Cycle 11) at Prairie Island. Each fuel assembly was fabricated by Westinghouse according to detailed specifications, and in accordance with the quality assurance plans of Westinghouse and NSP. After the manufacturing process was completed, in accordance with plans approved by the Nuclear Regulatory Commission, the assemblies were delivered to NSP. After receipt, NSP stored the assemblies in its “new fuel pit” before being transferred to the “spent fuel pool.” The fuel assemblies were inserted into the reactor in March of 1986. The start-up of the fission reaction using these assemblies, and the 81 used assemblies, began on April 10, 1986 and the reactor reached full power on April 14,1986.
In December of 1986, NSP received a group of 44 fuel assemblies from Westinghouse for its next reload (Cycle 12) at Prairie Island. These assemblies were stored in the new fuel pit and transferred to the spent fuel pool before being inserted into the reactor in April of 1987. Start-up of the fission reaction using these 44 fuel assemblies, and the 77 used fuel assemblies, began on May 28, 1987 and the reactor reached full power on June 1,1987.
During the period in question, NSP reported its income under an accounting system required by the Federal Energy Regulatory Commission (“FERC”). Under the FERC, the date on which construction and manufacturing of the assemblies are deemed to have been completed is the date on which the last assembly in any group of replacement assemblies has been received at a utility company’s plant. As of that date, all costs are considered complete for the purposes of determining the cost which may be depreciated. NSP took a depreciation deduction in 1985 for the 40 fuel assemblies received in December of 1985, and a depreciation deduction in 1986 for the 44 fuel assemblies received in December of 1986. NSP also took an investment tax credit for the fuel assemblies acquired in 1985 and 1986.
B. Discussion
The issue presented to the Court on the parties’ cross motions for summary judgment is in what year the depreciation deductions and investment tax credit apply to the nuclear fuel assemblies purchased by NSP and delivered by Westinghouse to NSP in 1985 and 1986. There is no dispute that 40 fuel assemblies were received by NSP in December of 1985, and that they were placed into the reactor and used in 1986, and that 44 fuel assemblies were received in December of 1986, and that those were placed into the reactor and used in 1987.
Under 26 U.S.C. § 167, the cost of nuclear fuel assemblies is a capital expenditure for which a depreciation allowance is available. During the years in question, Section 38 and Section 46(a) of the Internal Revenue Code provided for an investment tax credit (“ITC”) equal to ten percent of the acquisition cost of qualifying depreciable property. The purpose of the ITC was “to increase economic productivity, output, and growth by creating a tax incentive for the purchase of machinery, equipment and property used to produce goods and run a business.” Illinois Cereal Mills, Inc. v. Comm’r, 789 F.2d 1234, 1236 (7th Cir.), cert. denied, 479 U.S. 995, 107 S.Ct. 600, 93 L.Ed.2d 600 (1986). In light of its purposes, Courts have construed the ITC liberally. Id. at 1239; Sealy Power, Ltd. v. Comm’r, 46 F.3d 382, 394 (5th Cir.1995).
In its simplest terms, by adopting the ITC, Congress hoped to induce companies to accelerate their capital purchases to boost the economy. As an inducement, the ITC provided that they could deduct the costs before this property was actually used, and they could do this even if they had a different accounting system. Depreciation deductions are governed by 26 C.F.R. § 1.167(a)-10(b) which states: “The period for depreciation of an asset shall begin when the asset is placed in service and shall end when the asset is retired from service.” Section 1.167(a)-11(e)(1)(i) of the Code of Federal Regulations defines when property is “placed in service”:
Property is first placed in service when first placed in a condition of readiness and availability for a specifically assigned function, whether in a trade or business, in the production of income, in a tax-exempt activity or in a personal activity.
This regulation states that the provisions of § 1.46-3(d) regarding the ITC also apply to depreciation for the purposes of determining the date on which property is placed in service. § 1.167(a)-ll(e)(l)(i).
The tax regulation applicable to investment tax credits is 26 C.F.R. § 1.46-3(d) which states:
(1) For purposes of the credit allowed by Section 38, property shall be considered placed in service in the earlier of the following taxable years:
(i) The taxable year in which, under the taxpayer’s depreciation practice, the period for depreciation with respect to such property begins; or
(ii) The taxable year in which the property is placed in a condition or state of readiness and availability for specifically assigned function, whether in a trade or business, in the production of income in a tax-exempt activity, or in a personal activity.
The regulation states that if property meets the conditions of subdivision (ii), it shall be considered “placed in service” in that year even if the period for depreciation of the property begins in a succeeding year, or is computed under the “completed contract method, the unit of production method, or the retirement method.” § 1.46-3(d)(1).
Section (2) of § 1.46-3(d) gives examples of property that shall be considered ready and available under the statute:
(2) In the case of property acquired by a taxpayer for use in his trade or business (or in the production of income), the following are examples of cases where property shall be considered in a condition or state of readiness and availability for a specifically assigned function:
(i) Parts are acquired and set aside during the taxable year for use as replacements for a particular machine (or machines) in order to avoid operational time loss.
(ii) Operational farm equipment is acquired during the taxable year and it is not practicable to use such equipment for it specifically assigned function in the taxpayer’s business of farming until the following year.
(iii) Equipment is acquired for a specifically assigned function and is operational but is undergoing testing to eliminate any defects.
(iv) Reforestation expenditures (as defined in § 1.194-3(c)) are incurred during the taxable year in connection with qualified timber property (as defined in § 1.19