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PPL Corp. v. Commissioner: Common Sense Prevails in Taxpayer Victory

Tax Alert

A recent Tax Court decision underscores the potential value to taxpayers in reexamining the manner in which they have identified “land improvements” and whether a shorter depreciable life is appropriate. Where assets have been misclassified as land improvements, a change in accounting method may generate substantial cash flow benefits. Of equal importance is the Tax Court’s reminder that sometimes common sense is the most important element in defending against an IRS challenge.

In PPL Corporation v. Commissioner, 135 T.C. No. 8 (July 28, 2010), the Tax Court considered the appropriate recovery period for an electric utility’s street lighting assets. The IRS argued that the street lights were properly depreciated over 20 years as Electric Utility Transmission and Distribution Plant, as described in asset class 49.14 of Revenue Procedure 87-56, 1987-2 C.B. 674. Alternatively, the IRS argued that the street lighting assets should be depreciated over 15 years as “Land Improvements” described in asset class 00.3. The taxpayer argued that the street lighting assets fell within neither of these two asset classes, nor within any other specific asset class, and as such were depreciable over 7 years (the so-called “residual class”).

Common Sense Approach to Classifying Assets

In holding in favor of the taxpayer, the Tax Court concluded first that the primary use of the street lighting assets (including the wires, poles, brackets, and the luminaires (the light fixtures)) is making light, not distributing electricity. As such, street lights are not “distribution property” depreciable over 20 years. The court supported this common sense approach to the issue by refuting each of the IRS’s several assertions. The court rejected a number of the IRS’s arguments as either factually or technically unconvincing, with one of the IRS’s positions relying “at best” upon a misquotation of the relevant language from Rev. Proc. 87-56.

As an aside, the Tax Court indicated without explicitly stating that it may still adhere to its interpretation of the “primary use test” as articulated in Clajon Gas Co., L.P. v. Commissioner, 119 T.C. 197 (2002), rev’d 354 F.3d 786 (8th Cir. 2004), and Duke Energy Natural Gas Corp. v. Commissioner, 109 T.C. 416 (1997), rev’d 172 F.3d 1255 (10th Cir. 1999). Those cases dealt with whether in determining the appropriate asset class the relevant “primary use” is that of the taxpayer (as the Tax Court found) or instead that of the taxpayer’s overall industry (as some appellate courts found). Because it found that “no one uses street light assets in the distribution of electricity for sale” (emphasis in original) the PPL court was not required to address these conflicting approaches. The court’s emphatic statement that no one uses street lights to distribute electricity provides insight into the court’s view of the merits of the IRS’s position in PPL. It also underscores the ability of anyone owning street lights to take advantage of this decision.

The court considered but ultimately rejected the IRS’s partial reliance on the company’s treatment of the street lighting assets for operational, management, or regulatory purposes. Instead, the court concluded that non-tax regulations and standards such as FERC’s Uniform System of Accounts, various safety regulations, and even the manner in which the company classifies the property for internal operational and maintenance purposes had been developed for purposes other than the tax depreciation rules with which the court was concerned. As such, the Tax Court concluded that these non-tax standards had no relevance in resolving the issue under consideration.

Because taxpayers and the government alike have been considering the role that regulatory accounting standards should play in applying the capitalization provisions of the Code, the Tax Court’s discussion of these standards in the context of the tax depreciation rules is of particular interest to those following the on-going capitalization projects.

Plain Language Trumps Treasury Intent

The Tax Court construed the language of Revenue Procedure 87-56 against the government, relying upon the plain language of the document regardless of whether it reflected Treasury’s intent. The IRS argued that the Treasury and National Office drafters of the revenue procedure must have intended that asset class 49.14 include street lighting, since the asset classification system was intended to be as comprehensive as possible. Because street lights had been in use for many decades at the time the revenue procedure was drafted, the IRS reasoned, the drafters necessarily intended that they fall within one of the specific categories rather than the residual class. While finding the IRS argument “plausible,” the court rejected it nonetheless, stating that even if Treasury intended asset class 49.14 to include street lighting, the language used by the drafters fails to do so.

In adhering to the plain language of the revenue procedure regardless of whether it reflects the intent of Treasury, the Tax Court reaffirmed the long-standing canon of construction that a document is to be construed against its drafters. The court’s discussion in PPL may have implications in other areas in which the IRS takes positions on audit that the examination team asserts to be consistent with the spirit or intent -- but not the language -- of the agency’s own documents. PPL should be particularly meaningful to the Appeals division.

Land Improvements

The IRS argued in the alternative that street lighting should be treated as land improvements under asset class 00.3 of Rev. Proc. 87-56. This asset class includes “improvements directly to or added to land,” such as sidewalks, roads, canals, bridges, fences, and landscaping. The Tax Court rejected this argument as well. Placing the burden of proof with respect to this issue upon the IRS (because the government raised it for the first time following trial), the court found that the IRS failed to sustain its burden.

In particular, the court applied the so-called “Whiteco factors” for identifying land improvements, derived from Whiteco Indus. Inc. v. Commissioner, 65 T.C. 664 (1975). The court gave particular consideration to its decision in Trentadue v. Commissioner, 128 T.C. 91 (2007), in which it stated that the six Whiteco factors are only “an aid to deciding whether a particular property is or is not a permanent improvement to real property,” and that no one factor is determinative. Instead, quoting Trentadue, the Tax Court noted that the primary focus of Whiteco is the question of (i) the permanence of depreciable property and (ii) the damage caused to it or to realty upon the removal of the depreciable property.

In applying the Whiteco factors to street lighting, the court found that each supports the taxpayer’s position that even street lighting bolted to a concrete foundation is not a land improvement (and hinted that its conclusion is likely to be even more broadly applicable). Having concluded that the street lighting assets neither are used in distributing electricity nor are land improvements, the Tax Court held that the taxpayer properly classified them as 7-year property under the “residual class.”

Lessons of PPL

PPL is of considerable importance to electric utilities, many of whom have been challenging the IRS regarding the proper tax treatment of street lighting for several years. Pending a potential appeal to the United States Court of Appeals for the Third Circuit, PPL may allow every owner of street lighting assets to depreciate those items over 7 years. Those not currently doing so should consider taking steps to change their method of accounting.

Until the IRS determines its official reaction to PPL, however, there will be some uncertainty as to whether those method changes should be made under the “automatic” consent provisions of Revenue Procedure 2008-52, 2008-2 C.B. 587, as modified by Revenue Procedure 2009-39, 2009-2 C.B. 371, or instead as “manual” changes under Revenue Procedure 97-27, 1997-1 C.B. 680, as modified by Rev. Proc. 2002-19, 2002-1 C.B. 696, and others. The procedural difference will depend upon whether the IRS acquiesces in PPL and agrees that depreciating street lighting assets over more than 7 years is an “improper” method of accounting that may be changed under the “automatic” consent provisions. Otherwise, taxpayers are likely to require prior IRS consent before making the change. Of course, whether the IRS would grant such consent will depend on its reaction to PPL.

PPL may benefit taxpayers other than electric utilities as well. The case underscores the importance of periodically reexamining how depreciable property is classified under Revenue Procedure 87-56. In particular, PPL marks an opportune time to reconsider whether you have classified as a “land improvement” tangible property that instead falls within another asset class having a shorter recovery period. Internal reviews short of a full-blown “cost segregation study” can often provide significant cash flow benefits.

Of broader importance given the current audit climate is the common sense approach that the Tax Court brought to this issue. While the court analyzed each of the IRS’s specific arguments, at the end of the day it seems to have been guided by two simple propositions. First, street lights provide light, they do not distribute electricity. Second, if Treasury and the IRS had meant for “distribution assets” to include street lights, they should have written what they meant. These two simple propositions underscore that during a period in which some IRS examination teams are aggressively challenging long-standing tax accounting positions using novel approaches that sometimes fly in the face of the Code, regulations, and even the IRS’s own administrative guidance, it is important to remember that common sense and the plain language of the law remain important touchstones in defending the company’s positions.

For more information, please contact:

Steve Gertzman,, 202-626-6080

Patricia Sweeney,, 202-626-5926

James Atkinson

Dwight Mersereau

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