AMERICAN GAS ASSOCIATION

1
AMERICAN GAS ASSOCIATION INTERSTATE NATURAL GAS
ASSOCIATION

• Update on Selected Cases, Rulings and Proposed
  Regulations
• Craig King Woody Sharpe
• June 28, 2004

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Update on Selected Court Cases, Rulings and
RegulationsRepairs versus Capitalization

• FedEx Corporation v. United States (6th Cir.
  February 16, 2005)
• Held Lower court holding that costs of heavy
  maintenance visits for aircraft were deductible
  repairs is affirmed.
• Rationale Appeals court cannot improve upon
  District Courts opinion, which had found that
  the aircraft and its engines and auxiliary power
  units were a single unit of property and had
  rejected governments argument that each
  component (engine, airframe, etc) were separate
  units of property.

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Update on Selected Court Cases, Rulings and
RegulationsClaim of Right

• Cooper v. United States, (W.D. NC, January 24,
  2005)
• Held Bankruptcy estate entitled to a refund
  under section 1341 for the restoration of funds
  fraudulently obtained by debtor.
• Rationale Imputing bad acts of debtor to the
  bankruptcy trustee, thereby precluding section
  1341 relief, was inequitable. Debtors payment to
  bankruptcy trustee qualified as payment pursuant
  to settlement of business dispute, and thus was
  deductible under section 162 as required by
  section 1341.
• Together with Pennzoil-Quaker State decision in
  2004 may show trend of broader application of
  section 1341 relief.

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Update on Selected Court Cases, Rulings and
RegulationsFERC Response to BP West Coast
Products Case

• FERC Policy Statement on Income Tax Allowances
  (May 4, 2005)
• Income tax allowance for partnerships and similar
  pass-through entities are permitted if the owner
  has an actual or potential income tax liability
  on the public utility income earned through its
  interest in the entity.
• Will be applied in pending and future rate
  proceedings.
• Taxpayer favorable response to BP West Coast
  Products, LLC v. FERC, 374 F 3d 1263 (D.C. Cir.
  2004).

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Update on Selected Court Cases, Rulings and
RegulationsLoss Disallowance Final Regulations

• Regulations section 1.337(d)-2T was adopted as
  final Regulations section 1.337(d)-2 without
  substantive change.
• IRS will continue to accept basis disconformity
  method for determining whether subsidiary stock
  loss is disallowed and whether subsidiary stock
  basis is reduced.
• Effective for dispositions and deconsolidations
  on or after March 3, 2005.
• But, IRS and Treasury intend to publish proposed
  regulations with an alternative approach in the
  near term.

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Update on Selected Court Cases, Rulings and
RegulationsLike-Kind Exchange Final Regulations

• Final Regulations section 1.1031(a)-2(b)
  substitutes NAICS 6-digit product classes for SIC
  codes for safe harbor for determining whether
  property is like-kind.
• Uses product classes within sectors 31, 32, and
  33 (manufacturing industries) of the NAICS.
• Like-kind only for 1031 purposes.
• Effective for transfers on or after August 12,
  2004.

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Update on Selected Court Cases, Rulings and
RegulationsInterest Apportionment

• Revenue Procedure 2005-28
• Provides temporary rules for obtaining automatic
  consent to change from the fair market value
  method to the alternative tax book value method
  of valuing assets for purposes of allocating and
  apportioning interest expense under section
  864(e)(2).
• Applies to changes requested for taxable years
  beginning on or after March 26, 2004 but before
  March 26, 2006 and for which a return has not
  previously been filed.

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Update on Selected Court Cases, Rulings and
RegulationsDomestic Manufacturing Deduction

• Notice 2005-14
• High level guidance leaving many issues
  unanswered.
• Interplay with NOL carryforwards likely to have
  technical correction.
• Potential flow-through issues actual and
  imputed.
• Contract manufacturing issues.

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Update on Selected Court Cases, Rulings and
RegulationsDomestic Manufacturing Deduction

• FERC Guidance Order on Ratemaking
• Utilities with cost-based stated rates or
  cost-based formula rates must reflect the
  reduction in income tax due to the domestic
  manufacturing deduction in future rate filings to
  change rates.
• Domestic manufacturing deduction will have no
  ratemaking implications for
• Utilities making electric sales at market-based
  rates
• Jurisdictional pipelines.

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Update on Selected Court Cases, Rulings and
RegulationsUse of Business Aircraft for
Entertainment

• Notice 2005-45
• Provides rules under section 274(e) amended by
  AJCA on the deductible amount of business expense
  for use of business aircraft for entertainment.
• AJCA limited employers deduction to amount
  included in income of specified individuals
  (officers, directors, greater than 10 percent
  owners).
• Effective for costs incurred after June 30, 2005.

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Update on Selected Court Cases, Rulings and
RegulationsSchedule M-3

• IR-2005-52
• Final Schedule M-3 released in January 2005.
• Web-based list of FAQs set up by IRS in
  partnership with stakeholder group.
• Taxpayers can submit questions.
• FAQs are updated weekly to add answers to
  taxpayer questions.
• FAQs are arranged on web site keyed to line items
  and sections of Schedule M-3 instructions.

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Update on Selected Court Cases, Rulings and
RegulationsContributions in Aid of Construction

• PLR 200448008
• Ruled Contributions by natural gas consumers,
  real estate developers and universal service fund
  are CIACs.
• Rationale Payments funded extension of gas
  distribution lines to new locations enabled
  taxpayer to extend distribution system to area in
  need of service and were a prerequisite to
  receipt of gas service by consumers at new
  locations.

13
Update on Selected Court Cases, Rulings and
RegulationsContributions in Aid of Construction

• PLR 200450035
• Ruled Payment to utility for relocation and
  removal of electric transmission lines on public
  university campus is taxable CIAC.
• Rationale Relocation payments resulted in direct
  benefit to transferor university. Existing
  transmission lines bifurcated the property and
  disfigured prime area for development. Relocation
  of the lines made possible the optimal
  development of the university campus.

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Update on Selected Court Cases, Rulings and
RegulationsContributions in Aid of Construction

• PLR 200518015
• Ruled Surcharges from customers for
  undergrounding lines not includable in income,
  and relocation payments from city for
  undergrounding lines are non-shareholder
  contributions to capital under section 118(a).
• Rationale Utility was mere custodian of
  surcharges it collected for the city.
  Undergrounding was mandated by city law. Caselaw
  requirements for non-shareholder contribution to
  capital were met.

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Update on Selected Court Cases, Rulings and
RegulationsBonus Depreciation

• PLR 200502004
• Ruled Manufacturers use of aircraft for
  demonstration purposes does not constitute
  original use of aircraft under section 168(k).
• Rationale Only entity that took delivery of
  aircraft prior to the one claiming bonus
  depreciation used it as demonstrator and for a
  variety of sales promotion purposes, all during
  period it was held for sale.

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Update on Selected Court Cases, Rulings and
RegulationsTax Accounting

• PLR 200510008
• Ruled Adjustments to cost of wholesale power
  calculated only after year end under complicated
  reconciliation performed by supplier were deemed
  determinable with reasonable accuracy by taxpayer
  at year end.
• Rationale Actual amount was determinable from
  data available at year end, even though taxpayer
  did not have it.

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Update on Selected Court Cases, Rulings and
RegulationsSection 29 Credit

• PLRs 200517016-018, PLRs 200518053-056, and PLR
  200518069
• Ruled Prior rulings that section 29 credit was
  available were not affected by sales of interests
  in partnership and change in chemical reagent
  used to produce synthetic fuel.
• Rationale
• Relied on expert test results regarding chemical
  reagent
• Construction contract was a pre-1997 binding
  written contract.
• Technical termination of partnership did not
  preclude meeting placed in service date
  requirement.
• Relocation of one or more production lines was
  sanctioned, provided major or essential
  components of lines are retained and production
  output is not significantly increased.

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Update on Selected Court Cases, Rulings and
RegulationsSection 45 Credit

• PLR 200518060
• Ruled Wind farm electric output, commingled with
  other electricity on power grid before it is sold
  under utility tariff, is sold to unrelated
  persons as required by section 45.
• Rationale Taxpayers electricity, including wind
  farm electricity, would be sold to taxpayers
  customers in the ordinary course of business
  under its tariff. Ruling did not apply to
  self-use electricity.

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Update on Selected Court Cases, Rulings and
RegulationsCapital Expenditures

• TAM 200521032
• Ruled Termination expenses under merger
  agreement with one entity in order to merge with
  another were non-deductible capital expenditures
  under section 263.
• Rationale Termination expenses were paid to get
  out of merger agreement so that taxpayer could
  merge with another entity that expected to
  generate synergies, broaden its customer base and
  triple its revenue by the merger. Therefore, the
  termination expenses were directly related to the
  consummated merger, rather than the unfavorable
  merger, and conferred significant future benefit.

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Update on Selected Court Cases, Rulings and
RegulationsCapital Expenditures

• TAM 200512021
• Ruled Termination fee under merger agreement
  with one entity in order to merge with another
  was non-deductible capital expenditure under
  section 263.
• Rationale Termination expenses were paid to get
  out of merger agreement so that taxpayer could
  merge with another entity that expected to
  generate synergies. Terminated merger agreement
  provided that the taxpayer could terminate the
  agreement and pay the termination fee in order to
  enter a binding written agreement concerning a
  superior proposal.

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Update on Selected Court Cases, Rulings and
RegulationsDepreciation Reclassification

• LMSB Field Directive in Response to Utility Asset
  Reclassifications
• Reclassification is generally inappropriate if
  property is used in a business activity for which
  an Asset Class exists (such as Asset Classes
  49.11-49.15), unless property is in an assigned
  Asset Class for specific assets used in all
  business activities (i.e., Asset Classes 00.11-
  00.4).
• Change in asset classification for property
  placed in service in a taxable year ending on or
  after December 30, 2003 is a change in method of
  accounting (unless due to change in use during
  that year).
• If prior to that, IRS will no longer assert the
  issue.

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Update on Selected Court Cases, Rulings and
RegulationsMiscellaneous

• Miscellaneous Observations Comments
• SOX 404 Year End Experience
• Disclosure/Footnotes in 10-Q and 10-K
• Update on 263 A Mixed Service Cost - 3115
  filings .

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Update on Selected Court Cases, Rulings and
Regulations

• QA