Koramba Farmers & Graziers No. 1, Dean Phillips, Tax Matters Partner v. Commissioner , 110 T.C. 445 ( 1998 )

110 T.C. No. 33
UNITED STATES TAX COURT
KORAMBA FARMERS & GRAZIERS NO. 1, DEAN PHILLIPS, TAX MATTERS
PARTNER, ET AL.,1 Petitioners v. COMMISSIONER OF
INTERNAL REVENUE, Respondent
Docket Nos. 3679-96, 3680-96, Filed June 29, 1998.
3681-96, 3682-96.
Partnerships subject to U.S. income reporting
made soil and water conservation expenditures in
connection with their farming operations in New South Wales,
Australia, during the years in issue. Under sec. 175,
I.R.C., R allowed the deduction of such expenditures made by
one of the partnerships during calendar year 1986, but
applying sec. 175(c)(3)(A), I.R.C., denied deductions by
both partnerships of such expenditures made after Dec.
31, 1986. The Tax Reform Act of 1986, Pub. L. 99-514, sec.
401(a), 100 Stat. 2221, added sec. 175(c)(3)(A) to the
1
Cases of the following petitioners are consolidated
herewith: Koramba Farmers & Graziers No. 1, Dean Phillips, Tax
Matters Partner, docket No. 3680-96; Koramba Farmers & Graziers
No. 2, Dean Phillips, Tax Matters Partner, docket No. 3681-96;
and Koramba Farmers & Graziers No. 2, Dean Phillips, Tax Matters
Partner, docket No. 3682-96.
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Internal Revenue Code effective for amounts paid or
incurred after Dec. 31, 1986, in taxable years ending after
that date.
Held: Sec. 175(c)(3)(A)(i) and (ii), I.R.C., limits
the deduction of soil and water conservation expenditures
to those that are consistent with a soil conservation plan
approved by the Soil Conservation Service (SCS) of the
Department of Agriculture or a soil conservation plan of a
State agency, which agency is comparable to the SCS. The
area where the land to which the plan relates must be
located within the United States, and not in a foreign
country.
John R. Wilson, Robert S. Rich, and Patrick A. Jackman, for
petitioners.
Frederick J. Lockhart, Jr., for respondent.
OPINION
NIMS, Judge: Respondent issued a notice of final
partnership administrative adjustment (FPAA) to each of the two
subject partnerships, disallowing in each instance soil and water
conservation expenditure deductions under section 175, as
follows:
Partnership Taxable Year Amount of Deduction
Ending Disallowed
Koramba Farmers & June 30, 1987 $806,633
Graziers No. 1 June 30, 1988 519,004
(Koramba No. 1)
Koramba Farmers & June 30, 1988 1,011,360
Graziers No. 2 June 30, 1989 2,683,415
(Koramba No. 2)
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All section references, unless otherwise specified, are to
sections of the Internal Revenue Code in effect for the years in
issue. All Rule references are to the Tax Court Rules of
Practice and Procedure.
By order, these cases were consolidated for trial, briefing,
and opinion. They were submitted fully stipulated.
The sole issue for our consideration is whether the Koramba
partnerships' soil and water conservation expenditures
(conservation expenditures) incurred after December 31, 1986,
with respect to land located outside the United States can
qualify for deductibility under section 175.
Background
Koramba No. 1 was organized as a general partnership under
the laws of Australia. At the time each of the Koramba No. 1
petitions was filed, the partnership had its principal place of
business at Koramba, Boomi, New South Wales, Australia.
Koramba No. 2 was organized as a general partnership under
the laws of Australia. At the time each of the Koramba No. 2
petitions was filed, the partnership had its principal place of
business at Koramba, Boomi, New South Wales, Australia.
At all relevant times, Dean Phillips (Phillips) has been the
tax matters partner of Koramba No. 1 and Koramba No. 2
(partnerships). Phillips' address at the time the petitions were
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filed was No. 326, 4132 S. Rainbow Boulevard, Las Vegas, Nevada
89013.
Prior to 1985, William Michael Owen and Penelope Ann Owen
(the Owens) of New South Wales, Australia, were the owners of a
farm, named Koramba, located in New South Wales. The Koramba
farmland was used for grazing sheep and cattle and for farming
dry-land wheat and sorghum. The Owens, who were looking for a
financial partner to develop their farm, were introduced to
Phillips, who was interested in acquiring additional rural
properties in Australia. In 1985, Phillips and Heetco, Inc.
(Heetco), a U.S. corporation in which Phillips is a shareholder,
acquired a 50-percent interest in the Koramba farm from the
Owens. Phillips, Heetco, and the Owens thereupon formed Koramba
No. 1 to develop the farmland.
The Koramba farmland is located in a floodplain along the
Macintyre and Barwon Rivers in northern New South Wales. The
Koramba partners decided to use the nearby water resources to
develop a portion of the farmland to grow cotton, which requires
ample water supplies. In 1986, Koramba No. 1 started the
construction of an irrigation system to raise cotton on the land.
With the subsequent purchase of two adjacent farms in 1987 and
1988, the scale of the cotton farming operations was expanded,
leading to the formation of Koramba No. 2, a second Australian
general partnership, between Phillips and the Owens. By 1991,
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the partnerships' irrigation system covered 11,000 acres of
farmland.
By following sound soil and water conservation
(conservation) practices in their cotton farming operations, the
partnerships minimize the consumption of irrigation water.
Pursuant to authorization from the New South Wales authorities,
the partnerships pump water from the Macintyre and Barwon Rivers
and store it in five reservoirs, together with excess water
captured during flood season. From the reservoirs, the water is
delivered to the cotton fields through a comprehensive system of
irrigation pipes and channels. The partnerships' 44 cotton
fields have been precisely leveled, using laser surveying
technology, to permit proper water application and drainage.
Run off water from the fields is recovered and returned to the
reservoirs for future use. Using computer technology, the
partnerships continuously measure soil moisture during the
growing season, allowing precise determination of when and how
much irrigation is needed.
In building their irrigation system, the partnerships
complied with the standards and procedures for floodplain
construction set forth by the New South Wales Government
Department of Water Resources (the Department of Water
Resources). The Department of Water Resources encourages and
controls the implementation of sound conservation practices in
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New South Wales, and exercises stringent controls over the
placement of levees, banks, water channels, and reservoirs to
ensure proper floodplain management. Pursuant to Part VIII of
the New South Wales Water Act (the Water Act), the partnerships'
conservation expenditures received general approval from the
Department of Water Resources as being consistent with the
conservation guidelines and plan for the area. Thus, the
conservation expenditures incurred by the partnerships were
consistent and in accordance with a conservation plan approved by
the Department of Water Resources for the floodplain in which the
land was located.
In connection with the filing of Forms 1065, U.S.
Partnership Return of Income, the partnerships elected to deduct
conservation expenditures under section 175. Respondent accepted
the deductibility of the conservation expenditures incurred
through December 31, 1986, but has disallowed the deductibility
of subsequent conservation expenditures. In so doing, respondent
has taken the position that section 175, as modified by the Tax
Reform Act of 1986, Pub. L. 99-514, sec. 401(a), 100 Stat. 2221,
which added section 175(c)(3), no longer applies to conservation
expenditures incurred with respect to land located outside the
United States. Respondent concedes that, but for the application
of section 175(c)(3)(A), all of the partnerships' conservation
expenditures would qualify for section 175 treatment.
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Discussion
The relevant provisions of section 175 are as follows:
SEC. 175. SOIL AND WATER CONSERVATION EXPENDITURES.
(a) In general.--A taxpayer engaged in the business of
farming may treat expenditures which are paid or incurred by
him during the taxable year for the purpose of soil or water
conservation in respect of land used in farming, or for the
prevention of erosion of land used in farming, as expenses
which are not chargeable to capital account. The
expenditures so treated shall be allowed as a deduction.
* * * * * * *
(c) Definitions.--For purposes of subsection(a)--
* * * * * * *
(3) Additional limitations.--
(A) Expenditures must be
consistent with soil conservation plan.
--Notwithstanding any other provision of
this section, subsection (a) shall not
apply to any expenditures unless such
expenditures are consistent with--
(i) the plan (if any)
approved by the Soil Conservation
Service of the Department of
Agriculture for the area in which
the land is located, or
(ii) if there is no plan
described in clause (i), any soil
conservation plan of a comparable
State agency.
Until 1954, the resolution of the question of the treatment
for tax purposes of the expenditures made by farmers to improve
their land required a highly fact-intensive inquiry. Compare,
e.g., Collingwood v. Commissioner, 20 T.C. 937 (1953)
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(terracing), with Beltzer v. United States, 4 AFTR 2d 5595, 59-2
USTC par. 9701 (D. Neb. 1959) (land leveling).
In 1954, Congress added section 175 to the Code, which was
intended to provide statutory rules under which taxpayers engaged
in the business of farming could "deduct certain expenditures for
the purpose of soil or water conservation in respect of land used
in farming or for the prevention of erosion of land used in
farming." S. Rept. 1622, to accompany H.R. 8300, 83d Cong., 2d
Sess., 216. Until 1986, section 175 remained substantially
unchanged from its original enactment in 1954, with the exception
of several amendments not relevant here. Before 1986, neither
section 175, itself, nor its legislative history, nor the related
regulations, specified the locale in which the improved farmland
had to be situated.
In 1991, the IRS issued Tech. Adv. Mem. 91-19-005 (Jan. 18,
1991) (TAM), in the first part of which the IRS concluded that
the partnerships' pre-1987 conservation expenditures could
qualify under section 175 even if paid or incurred with respect
to foreign land. As a consequence, respondent has not challenged
Koramba No. 1's conservation expenditures paid or incurred in
calendar 1986.
Unfortunately from the partnerships' perspective, however,
the IRS in the TAM also took the position (which is respondent's
position here) that, even if a proper section 175 election had
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been made by the partnerships, postcalendar 1986 conservation
expenditures in a foreign country, in this instance Australia, do
not qualify under section 175 by reason of section 175(c)(3)(A).
As stated previously, section 175(c)(3)(A) was added by the
Tax Reform Act of 1986, Pub. L. 99-514, sec. 401(a), 100 Stat.
2221, effective for amounts paid or incurred after December 31,
1986, in taxable years ending after that date. Consequently,
since the June 30, 1987, taxable year of Koramba No. 1 ended
after December 31, 1986, only the last 6 months of its
conservation expenses for that year are subject to section
175(c)(3)(A).
With the enactment of section 175(c)(3)(A), section 175 is
for the first time arguably site-specific (the partnerships
challenge site-specificity as to section 175(c)(3)(A)(ii)). The
Congressional objective in enacting the 1986 amendment is
cogently articulated in the Senate report:
The committee is concerned that certain
Federal income tax provisions may be
affecting prudent farming decisions adversely
under present law. In particular, the
committee is concerned that such provisions
may have contributed to an increase in
acreage under production, which in turn may
have encouraged the present-day
overproduction of agricultural commodities.
* * * [S. Rept. 99-313, 1986-3 C.B. (Vol. 3)
265.]
Thus, the focus of the amendment is to discourage
overproduction of agricultural commodities by keying the
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availability of conservation expenditure deductions to amounts
incurred that are consistent with a conservation plan approved by
the Soil Conservation Service (SCS) of the Department of
Agriculture, and if there is no SCS conservation plan for the
area in which the property is located, amounts incurred for
improvements that are consistent with a plan of a State
conservation agency. S. Rept. 99-313, supra, 1986-3 C.B. (Vol.
3) at 265.
Respondent argues that the consequence of the form in which
Congress chose to cast section 175(c)(3)(A) requires the
disallowance of deductions for conservation expenditures outside
the United States. The partnerships, of course, dispute this.
The partnerships agree with respondent that their
conservation expenditures obviously cannot qualify under section
175(c)(3)(A)(i) because in that provision it is expressly
provided that the conservation expenditures must be consistent
with an SCS-approved plan for the area in which the land is
located. The Department of Agriculture through the SCS would be
unlikely, to say the least, to deal with land located outside the
United States. The partnerships argue that their conservation
expenditures can, however, qualify under section
175(c)(3)(A)(ii).
They first maintain that the term "State", as used in clause
(ii), should be read expansively so as to embrace governmental
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entities over and beyond the 50 States constituting the United
States plus the District of Columbia. We need not tarry long
over this first argument. The partnerships argue, among other
things, that including foreign agencies is consistent with the
use of the term "State" in the international context. We quote
from the partnerships' opening brief:
Including foreign agencies in the
definition of "comparable State agency" is
also consistent with the general usage of the
term "State" in the international tax
context. Although "State" naturally is often
limited to the U.S. states when used
domestically, it more typically is used
internationally to refer to national
governments. For example, in the
U.S./Australia income tax treaty, the term is
defined as follows:
The term "State" means any National
State, whether or not one of the Contracting
States.
Convention Between the Government of the
United States of America and the Government
of Australia for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion
with Respect to Taxes on Income, Article
3(1)(h), reprinted in 1986-2 C.B. 220.
Following this quotation, the partnerships simply state that,
based on the treaty definition, a broader reading of the term
"State" is more appropriate "in this context".
We think it indisputable that the term "State", as it
appears in section 175(c)(3)(A)(ii), denotes one of the States
and the District of Columbia which, taken as a whole, constitute
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the United States, as defined in sections 7701(a)(9) and (10).
Those sections provide:
(9) United States.--The term "United States" when used
in a geographical sense includes only the States and the
District of Columbia.
(10) State.--The term "State" shall be construed to
include the District of Columbia, where such construction is
necessary to carry out provisions of this title.
The language of the Senate report states that "amounts incurred
for improvements that are consistent with a plan of a State
conservation agency are deemed to satisfy the Federal standards."
S. Rept. 99-313, supra, 1986-3 C.B. (Vol. 3) at 265 (emphasis
added). There isn't the slightest hint in the legislative
history or the statute itself that Congress had anything else in
mind when section 175(c)(3)(A) was enacted.
Somewhat more plausibly, but nevertheless unconvincingly,
the partnerships urge that, even if a "comparable State agency"
excludes foreign agencies, section 175(c)(3)(A)(ii) still may be
construed so as to permit the partnerships to deduct their
conservation expenditures for the years in issue. In this
connection, the partnerships contend that their conservation
expenditures need only be consistent with the plan of some State
agency to be deductible. Insofar as the New South Wales plan
applicable to the area where the Koramba farmland is located may
be equivalent to the plan of an agency of any one of the States
of the United States or the District of Columbia, the
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partnerships argue that they have satisfied the requirements of
section 175(c)(3)(A)(ii).
We disagree. For section 175(a) to apply, we believe the
statute requires that the improved land must lie within the State
whose agency is comparable to the SCS, and, as discussed above,
that the "State" referred to by the statute means one of the
States and the District of Columbia which together compose the
United States. The structure of section 175(c)(3)(A), which
expressly refers in clause (i) to "the area in which the land is
located", by obvious implication engrafts the quoted words from
clause (i) onto the end of clause (ii). Statutes "are to be
considered, each in its entirety and not as if each of its
provisions was independent and unaffected by the others."
Alexander v. Cosden Pipe Line Co., 290 U.S. 484, 496 (1934);
accord Union Carbide Corp. & Subs. v. Commissioner, 110 T.C. ___,
___ (1998). It defies logic to suggest that Congress intended to
approve the deduction of conservation expenditures in Nevada, for
example, which are consistent with a conservation plan of an
agency of some other State. The partnerships acknowledge as much
on brief in the domestic context, and we see no reason why the
site-specific requirement should be waived so as to permit
deductions for improved land located in a foreign country, in
this case Australia.
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The conference committee report dispels any doubt which may
remain as to the correctness of our analysis. There it is stated
that
the conferees wish to clarify that while
prior approval of the taxpayer's particular
project by the Soil Conservation Service or
comparable State agency is not necessary to
qualify the expenditure under this provision,
there must be an overall plan for the
taxpayer's area that has been approved by
such an agency in effect at any time during
the taxable year. [H. Conf. Rept. 99-841,
1986-3 C.B. (Vol. 4) 110; emphasis added.]
The phrase "such an agency" unmistakably refers to the SCS or a
State agency comparable to the SCS, whose plan is in effect for
the taxpayer's area.
To the extent the partnerships make other arguments
regarding the meaning of "State" and "comparable State agency" as
used in the instant statute, we find the arguments wholly
unconvincing and unnecessary to discuss.
The partnerships are understandably aggrieved that, while
subject to U.S. income tax reporting, they are nevertheless
denied conservation deductions to which a similarly situated
owner of farmland located in the United States would be entitled.
We are convinced, nevertheless, that in order to discourage
overproduction of agricultural commodities as a result of
previously existing Federal income tax provisions, Congress found
it necessary to limit allowable conservation deductions to those
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incurred with respect to land located within an area in the
United States that are consistent with statutorily specified
conservation plans for that area. The unfortunate consequence of
this restricting enactment, from the partnerships' point of view,
is that as of 1987 conservation expenditure deductions related to
foreign farmland are no longer allowed by reason of section
175(c)(3)(A). The partnerships' conservation expenditure
deductions must therefore be disallowed.
To reflect the foregoing,
Decisions will be
entered for respondent.