Clajon Gas Co., L.P., Aquila Gas Pipeline Corp., Tax Matters Partner v. Commissioner , 119 T.C. No. 12 ( 2002 )

119 T.C. No. 12UNITED STATES TAX COURT
CLAJON GAS CO., L.P., AQUILA GAS PIPELINE CORP.,
TAX MATTERS PARTNER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15968-97. Filed October 25, 2002.
Partnership C owned and operated natural gas
gathering systems to transport gas purchased from
natural gas producers. C treated certain pipeline and
related components of the gathering systems as natural
gas production assets within asset class 13.2 of Rev.
Proc. 87-56, 1987-2 C.B. 674, with a 7-year recovery
period.
Held: Because C’s use of its gathering systems
determines the proper asset class, and because C was
not a “natural gas producer”, the components in
question are not within asset class 13.2; rather, they
are used by C to transport gas and are, therefore,
within asset class 46.0, with a 15-year recovery
period. We shall follow our decision in Duke Energy
Natural Gas Corp. v. Commissioner, 109 T.C. 416 (1997),
revd. 172 F.3d 1255 (10th Cir. 1999).
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Michael Thompson, Martin M. Loring, and Lori J. Sellers, for
petitioner.
Robert M. Morrison, Michael C. Prindible, and Todd A. Ludeke
for respondent.
HALPERN, Judge: By notices of final partnership
administrative adjustment dated April 28, 1997, respondent made
adjustments to partnership returns filed by Clajon Gas Co., L.P.
(Clajon), for taxable years ending December 31, 1990, September
25, 1991, December 31, 1991, and June 30, 1992 (the audit years).
Taking into account issues and items resolved by the parties, the
sole adjustments in dispute are respondent’s adjustments reducing
Clajon’s deduction for “pipeline depreciation”, as follows:
Tax Year Ended Adjustment
12/31/90 $7,920,799
9/25/91 19,644,092
12/31/91 4,372,916
6/30/92 12,187,347
The issue for our decision is the proper cost recovery period to
be used by Clajon in determining its depreciation deductions for
the property in question.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years at issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
Petitioner bears the burden of proof. Rule 142(a).
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FINDINGS OF FACT
Some facts are stipulated and are so found. The stipulation
of facts, with accompanying exhibits, is incorporated herein by
this reference.
Principal Place of Business
At the time the petition was filed, Clajon’s principal place
of business was in San Antonio, Texas.
Natural Gas Production Process
Natural gas is extracted from the earth through gas wells.
It leaves the earth at the wellhead and passes into flow lines.
The flow lines carry the gas to a separator located at the well
site or to a central production facility (which serves two or
more wells), where, among other things, oil, water, and sand are
removed from the gas. The gas next flows to a meter installation
for measurement and then enters a gathering system.
A gathering system is a system of interconnected
subterranean pipelines and related facilities, including
compression stations and metering installations, that aggregates
gas from multiple wells for delivery to a transmission line or a
gas processing plant. A gathering system’s smaller diameter
pipelines, sometimes called feeder lines or lateral lines,
connect individual wells or one or more central production
facilities to larger diameter lateral lines or trunk lines that
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eventually deliver the gas to a gas processing plant or to a
transmission line.
Gas containing substantial amounts of natural gas liquids
(NGLs), such as ethane, propane, butane, and natural gasoline
(termed “wet gas”), must be fractionated to remove NGLs before
the gas can be transmitted to consumers. Fractionation occurs at
gas processing plants, where the resulting components are residue
gas (primarily methane) and extracted NGLs. The NGLs are
delivered by truck, rail, or pipeline to another specialized
processing plant for further fractionation and marketing. The
residue gas is delivered to a transmission line.
The person extracting the gas from the earth may own the
gathering system, or it may be owned by an independent pipeline
company (i.e., a company not in the business of extracting gas
from the earth).
Clajon’s Gathering Systems
During the audit years, Clajon’s activities included
purchasing, transporting, processing, and selling natural gas and
NGLs. Clajon owned six natural gas gathering systems, all
located in Texas (the Texas gathering systems), and two natural
gas processing plants, one in College Station, Texas (which was
closed in early 1990), and one in La Grange, Texas. The Texas
gathering systems were known as the Southeast Texas Pipeline
System, which gathered wet gas for delivery to the processing
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plants, and the Mentone Pipeline System, Gomez Pipeline System,
Maverick County Pipeline System, Rhoda Walker Pipeline System,
and Panola County Pipeline System, which gathered gas containing
little or no NGLs (termed “lean gas”) for delivery to purchasers’
transmission pipelines. The Panola and Rhoda Walker Systems
provided compression and dehydration services. The Gomez and
Mentone Systems provided dehydration services.
The Texas gathering systems included more than 1,100 miles
of feeder, lateral, and trunk lines. Clajon, via the Texas
gathering systems, purchased and transported gas from 190 third-
party gas producers and more than 1,000 wells.
Clajon did not own any oil or natural gas reserves and did
not own an economic interest in any well connected to the Texas
gathering systems.
Clajon’s Contractual Relationships
During the audit years, gas flowed through the Texas
gathering systems under the following types of contracts:
wellhead purchase contracts, gas processing contracts, and gas
transportation contracts.
Under a wellhead purchase contract, Clajon purchases a
producer’s gas at a meter located at the producer’s well. The
price may be fixed, or it may be calculated based upon the price
received by Clajon for residue gas at the tailgate of the gas
processing plant.
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A gas processing contract is similar, except that Clajon and
the producer share revenues from Clajon’s sale of extracted NGLs
and residue gas.
Under a gas transportation contract, Clajon charges its
customers a fee to move gas through one of the Texas gathering
systems.
Depreciation Adjustments in Dispute
Respondent’s adjustments to “pipeline depreciation” consist
of separate adjustments with respect to “pipelines”, “compressor
stations” and “meter runs”. Clajon depreciated those assets
using a 7-year recovery period. Respondent determined that
Clajon should have used a 15-year recovery period. We shall
generally refer to the foregoing elements of Clajon’s gathering
system, collectively and without distinction, as “gathering
pipelines”.
OPINION
I. Introduction
This case involves a dispute as to the length (in years) of
the recovery period that Clajon must use in calculating its
annual depreciation deductions for the gathering pipelines. On
similar facts, we decided in the Commissioner’s favor in Duke
Energy Natural Gas Corp. v. Commissioner, 109 T.C. 416 (1997),
revd. 172 F.3d 1255 (10th Cir. 1999). Petitioner urges us not to
follow our decision in Duke Energy and to adopt the reasoning of
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the Court of Appeals for the Tenth Circuit in that case. Duke
Energy Natural Gas Corp. v. Commissioner, 172 F.3d 1255 (10th
Cir. 1999), revg. 109 T.C. 416 (1997). As explained below, we
follow our decision in Duke Energy, and we hold that the proper
recovery period for the gathering pipelines is 15 years.
II. Applicable Statutory and Administrative Provisions
Section 167(a) allows “as a depreciation deduction a
reasonable allowance for the exhaustion, wear and tear * * * of
property used in * * * [a] trade or business”. Section 167(b)
references section 168 for determination of the depreciation
deduction in the case of property to which section 168 applies.
Section 168 is entitled “Accelerated Cost Recovery System”, and
it sets forth a cost recovery system based not on the useful life
of an item of property but, instead, on certain congressionally
determined (accelerated) recovery periods. In pertinent part,
section 168(a) provides: “the depreciation deduction provided by
section 167(a) for any tangible property shall be determined by
using * * * the applicable recovery period”. Pursuant to section
168(c) and (e), the recovery period for property is based upon
(but, generally, is shorter than) its “class life”. Section
168(i)(1) defines “class life” as “the class life * * * which
would be applicable with respect to any property as of January 1,
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1986, under subsection (m) of section 167”.1 Section 167(m)(1),
in pertinent part, provided for depreciation “based on the class
life prescribed by the Secretary which reasonably reflects the
anticipated useful life of that class of property to the industry
or other group.” Section 167(m) (which was added to the Internal
Revenue Code by section 109 of the Revenue Act of 1971, Pub. L.
92-178, 85 Stat. 508) codified, with certain modifications, the
Asset Depreciation Range (ADR) system described in section
1.167(a)-11, Income Tax Regs., and, in particular, the
regulations’ adoption of asset guideline classes and periods or
“class lives”.2 See H. Rept. 92-533, 1972-1 C.B. 498, 514-516;
S. Rept. 92-437, 1972-1 C.B. 559, 584-588.
Consistent with the directive in section 167(m)(1) to
prescribe class lives for depreciable assets, section 1.167(a)-
11(b)(4)(ii), Income Tax Regs., provides that asset guideline
classes and periods (lives) will be “established, supplemented,
and revised * * *, and will be published in the Internal Revenue
Bulletin.” The regulation references Rev. Proc. 72-10, 1972-1
1
Sec. 167(m) was deleted from the Internal Revenue Code by
the Omnibus Budget Reconciliation Act of 1990, Pub. L. 101-508,
sec. 11812(a)(1), 104 Stat. 1388-534.
2
A notice of proposed rulemaking was published in the
Federal Register on Mar. 13, 1971, 36 F.R. 4885, and a Treasury
Decision setting forth final regulations was published in the
Federal Register on June 23, 1971, 36 F.R. 11924. See T.D. 7128,
1971-2 C.B. 132. The final regulations were subsequently
modified, in 1973, to conform the ADR system to sec. 167(m). See
T.D. 7272, 1973-1 C.B. 82.
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C.B. 721, as setting forth the applicable “asset guideline
classes”. Rev. Proc. 72-10 was the first of several revenue
procedures establishing asset guideline classes, each superseding
or obsoleting its predecessor and culminating in Rev. Proc. 87-
56, 1987-2 C.B. 674.3 Rev. Proc. 87-56 is the revenue procedure
establishing asset guideline classes that is in effect for
purposes of this case.
The Rev. Proc. 87-56 asset guideline classes at issue in
this case are as follows:
[Asset Class] 13.2 Exploration for and Production of
Petroleum and Natural Gas Deposits: Includes assets
used by petroleum and natural gas producers for
drilling of wells and production of petroleum and
natural gas, including gathering pipelines and related
storage facilities. Also includes petroleum and
natural gas offshore transportation facilities used by
producers and others consisting of platforms (other
than drilling platforms classified in Class 13.0),
compression or pumping equipment, and gathering and
transmission lines to the first onshore transshipment
facility. * * *
* * * * * * *
[Asset Class] 46.0 Pipeline Transportation: Includes
assets used in the private, commercial, and contract
carrying of petroleum, gas and other products by means
of pipes and conveyors. The trunk lines and related
storage facilities of integrated petroleum and natural
gas producers are included in this class. * * *
3
Rev. Proc. 87-56, 1987-2 C.B. 674, was issued to take
into account amendments made to sec. 168 as part of the Tax
Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2121.
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Property within Asset Class 13.2 (13.2) is assigned a class
life of 14 years and has a recovery period of 7 years; property
within Asset Class 46.0 (46.0) is assigned a class life of
22 years and has a recovery period of 15 years. Rev. Proc. 87-
56, 1987-2 C.B. at 678, 684.4
III. Class Lives Are Composite Lives
Historical material pertaining to the ADR system establishes
that the class lives contemplated in section 1.167(a)-
11(b)(4)(ii), Income Tax Regs., and established by Rev. Proc. 87-
56, supra, and preceding revenue procedures, are composite lives.
In other words, each class life is based on the useful lives of
the assets constituting the class but does not necessarily equal
the useful life of any constituent asset.
In June 1971, contemporaneous with the adoption of section
1.167(a)-11, Income Tax Regs., by T.D. 7128, 1971-2 C.B. 132, the
Department of the Treasury published “Asset Depreciation Range
(ADR) System” (U.S. Government Printing Office: 1971 O-428-904)
(hereafter referred to as Treasury Publication or T.P.). The
Treasury Publication states that, in 1962, with the publication
4
The recovery periods assigned to property within 13.2 and
46.0 are in accordance with sec. 168(c)(1) and (e)(1), which,
together, provide that the recovery period for property with a
class life of 10 or more years but less than 16 years is 7 years,
and the recovery period for property with a class life of 20 or
more years but less than 25 years is 15 years.
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of Rev. Proc. 62-21, 1962-2 C.B. 418, the Treasury introduced a
fundamental change in the concept of depreciation. T.P. at 212-
213. The fundamental change was to classify assets on a basis
other than the particular life of the particular asset to the
particular user. Id. at 215. On the new basis, assets were
classified “as a stock of capital even though assets within a
class were heterogeneous with respect to ages, useful lives, and
physical characteristics.” Id. “Assets within the class would
have individual lives far longer and far shorter than the
guideline class life.” Id. at 215-216. The Treasury Publication
describes Rev. Proc. 62-21 as providing a substitute for the
thousands of asset classifications of the previous system. Id.
at 212-213. Under Rev. Proc. 62-21, “assets were grouped by
broad industrial classifications and by certain broad general
asset classifications, with a ‘guideline life’ established for
each of these classes.” Id. at 213. An examination of the asset
guideline classes in Rev. Proc. 62-21 discloses that, generally,
the classes are tied to particular business activities. The
drafters of the revenue procedure recognized that the anticipated
useful life of many assets, even the same types of assets, will
vary in accordance with the experience of persons using such
assets. The drafters assumed that persons in the same business
activity would have similar experiences and, except for assets
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used by businesses generally (e.g., trucks and railroad cars),
generally classified assets by business activity.
The Treasury Publication describes the ADR and class life
system then being established by Treasury decision (T.D. 7128,
1971-2 C.B. 132, adopting section 1.167(a)-11, Income Tax Regs.)
as, essentially, an extension and modification of the asset
guideline class approach taken in Rev. Proc. 62-21. T.P. 212-
219. The Treasury Publication describes adoption of the new
system as being prompted, in part, by (1) recognition that it had
been more than 7 years since there had been any significant
changes in the guidelines classes or lives, and (2) requests from
members of Congress that Treasury study the adequacy of the then
existing depreciation allowances. Id. at 215, 217-218.
Reflecting the approach that had been taken in Rev. Proc.
62-21, supra, and section 1.167-11, Income Tax Regs., Congress,
in section 167(m)(1), provided that, for each class of property,
the Secretary must prescribe a class life that reflects the
anticipated useful life of that class of property “to the
industry or other group.” Pursuant to that mandate, the
Secretary had the authority to, and did, subdivide industries,
establishing asset guideline classes inclusive of one or more
sectors of the industry and exclusive of others. Thus, the same
asset used in more than one sector of an industry might be
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included in two or more asset guideline classes, each with its
own (different) class life.5 Gathering pipelines are subject to
depreciation by both natural gas producers (under 13.2) and
pipeline companies (under 46.0).
IV. Duke Energy
In Duke Energy Natural Gas Corp. v. Commissioner, 109 T.C.
at 421, we concluded that the taxpayer’s gathering systems were
“used primarily by a pipeline company [the taxpayer] to carry gas
to a production facility, which * * * brings them within asset
class 46.0.” In reaching that conclusion, we rejected the
taxpayer’s argument “that its gathering systems are included in
asset class 13.2 because the systems are used by petroleum and
natural gas producers to produce natural gas in that the systems
are essential to the production and sale of gas in the market.”
Id. We noted: “The mere fact that the gathering systems may
5
For example, Rev. Proc. 87-56, 1987-2 C.B. 674, provides
that “assets used in the drilling of onshore oil and gas wells”
are generally includable within Asset Class 13.1, which has a
6-year class life and a 5-year recovery period. Asset Class 13.1
specifically excludes “assets used in the performance of any of
these activities * * * by integrated petroleum and natural gas
producers for their own account”. Asset Class 13.2, on the other
hand, which specifically pertains to “assets used by petroleum
and natural gas producers for drilling of wells and production of
petroleum and natural gas” has a 14-year class life and a 7-year
recovery period. An onshore oil drilling rig, therefore, has a
shorter class life and recovery period if owned and used by a
person whose sole activity is well drilling than it would have if
owned and used by an integrated oil and gas producer.
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have helped producers produce and sell their gas in the market
does not mean that the systems are exploration or production
assets within * * * asset class 13.2.” Id.In reversing our decision in Duke Energy, the Court of
Appeals for the Tenth Circuit reasoned that “the plain language
of Asset Class 13.2 leads most logically to a reading that
includes Duke’s gathering systems even though they are ‘used by’
producers through contractual arrangements with Duke.” Duke
Energy Natural Gas Corp. v. Commissioner, 172 F.3d at 1259. The
Court of Appeals stated that “Duke’s gathering systems are
literally used by producers for gas production in a number of
different ways”, id. at 1258, noting the parties’ agreement that
“producers would not be able to produce natural gas in the
absence of an adequately designed gathering system”, id. After
reviewing the overall function and usage of gathering systems,
the Court of Appeals stated that “the economic character of
Duke’s gathering activities is more akin to production than
pipeline operation.” Id. at 1259. The Court of Appeals rejected
the Government’s argument that the words “used by” in 13.2
incorporate an ownership requirement, reasoning: “‘Use’ does not
mean ‘own’ in either the legal dictionary definition of the word
use * * * nor in everyday parlance.” Id. Ultimately, the Court
concluded as follows:
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Because of the primary use of gathering systems in
the process of producing natural gas, as well as the
plain language of the asset class descriptions, Duke’s
gathering systems fit more logically within Asset Class
13.2 than Asset Class 46.0. [Fn. ref. omitted.]
Id. at 1262.6
V. Nonapplication of Golsen v. Commissioner
Under the rule of Golsen v. Commissioner, 54 T.C. 742, 757
(1970), affd. 445 F.2d 985 (10th Cir. 1971), this Court will
6
The Court of Appeals for the Tenth Circuit distinguishes
between “gathering pipelines”, which “fall within Asset Class
13.2", and “trunk lines and related storage facilities”, which
“fall within Asset Class 46.0", stating that “it is undisputed
that trunk lines and gathering systems are mutually exclusive
terms referring to different types of pipeline systems.” Duke
Energy Natural Gas Corp. v. Commissioner, 172 F.3d 1255, 1259
(10th Cir. 1999), revg. 109 T.C. 416 (1997). Petitioner argues
that Clajon’s trunk lines are part of its gathering system and,
like the rest of the system, must be included within 13.2.
Petitioner urges that we distinguish the Court of Appeals’
classification of trunk lines on the basis that that court must
have considered Duke Energy’s trunk lines to be transmission
rather than gathering pipelines. Because we conclude that all of
the pipelines in the Texas gathering systems fall within 46.0, we
need not address the Court of Appeals’ refusal to treat trunk
lines as part of the gathering system for asset classification
purposes.
In concluding that petitioner’s trunk lines are includable
within 46.0, we obviously reject petitioner’s suggestion that the
specific inclusion, within 46.0, of “trunk lines * * * of
integrated * * * natural gas producers” necessarily implies the
exclusion of its trunk lines from that asset class (since it is
not an integrated natural gas producer). We view the quoted
language as simply intended to clarify that an integrated
producer’s trunk lines are not to be considered gathering
pipelines includable within 13.2. That language has no bearing
upon the inclusion, within 46.0, of trunk lines owned and used by
a pipeline company like petitioner.
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“follow a Court of Appeals decision which is squarely in point
where appeal from our decision lies to that Court of Appeals”.
At the time the petition was filed, Clajon’s principal place of
business was San Antonio, Texas. Pursuant to section
7482(b)(1)(E), an appeal from our decision in this case would
likely lie to the Court of Appeals for the Fifth Circuit, where
there is no authority on point. We are, therefore, not required
by Golsen to follow the Court of Appeals for the Tenth Circuit’s
decision in Duke Energy Natural Gas Corp. v. Commissioner, supra.
VI. The Gathering Pipelines Fall Within 46.0 Rather Than 13.2
Because Clajon Was Not a “Producer,” and It Is Clajon’s Use
That Is Relevant
A. Analysis
1. Clajon Was Not a “Producer” of Natural Gas
In order for the gathering pipelines to be included in 13.2,
it is necessary that they be “used by” a natural gas “producer”
for “production of” natural gas. There is, thus, both an “actor”
requirement (used by) and an “activity” requirement (the
production of natural gas) necessary for 13.2 classification.
The actor requirement is satisfied if the gathering pipelines are
used by a natural gas “producer”. Duke Energy conceded that it
was “not a producer of gas as that term is used in the asset
class descriptions of MACRS.” Duke Energy Natural Gas Corp. v.
Commissioner, 172 F.3d at 1256 n.2 (apparently referring to the
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asset guideline classes set forth in Rev. Proc. 87-56, supra).
Although petitioner has not specifically conceded (nor has it
been stipulated) that Clajon is not a producer of natural gas,
counsel for petitioner tacitly admitted as much during the trial
and, again, during the posttrial oral argument. Similarly,
petitioner’s expert witness acknowledged that a gas gatherer is
not a producer of natural gas. Therefore, we find that Clajon
was not a producer as that term is commonly used in the natural
gas industry. Authorities in the oil and gas field agree. See
Williams & Meyers, Manual of Oil and Gas Terms 846 (11th ed.
2000), generally defining a producer as “[a]n operator who owns
wells that produce * * * gas.”7
2. The Relevant “Use” Under 13.2 and 46.0 Is That of
the Taxpayer, Clajon
a. Introduction
In Duke Energy Natural Gas Corp. v. Commissioner, supra, the
Court of Appeals focused upon industry (rather than taxpayer)
usage of Duke Energy’s gathering system. It concluded: “Within
the industry and in the functional and contractual relationship
between producers and nonproducer gathering system owners, Duke’s
gathering systems are literally used by producers for gas
7
The parties have stipulated that Clajon owns no oil or
natural gas reserves, nor does it own an economic interest in the
wells connected to the Texas gathering systems.
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production”. Id. at 1258. This focus fails to take into
account, and is contrary to, an important aspect of the
regulations authorizing the issuance of Rev. Proc. 87-56, 1987-2
C.B. 674, and its predecessor revenue procedures. The
regulations require not only that property be classified by the
type of activity in which the property is used but also that the
taxpayer depreciating property on the basis of a particular class
life must itself be engaged in (be the actor in) the activity
described in the asset guideline class. Moreover, the Court of
Appeals’ focus fails to take into account the segmented approach
to the natural gas industry taken in Rev. Proc. 87-56, supra.
b. The Regulations
Section 1.167(a)-11(b)(4)(iii)(b), Income Tax Regs., states
that “property shall be included in the asset guideline class for
the activity in which the property is primarily used” and that
“[p]roperty shall be classified according to primary use even
though the activity in which such property is primarily used is
insubstantial in relation to all the taxpayer’s activities.”
(Emphasis added.) Because the regulation considers the
substantiality of the primary use activity in relation to all of
the taxpayer’s activities, we interpret the regulation as
comparing a part to the whole (i.e., one of the taxpayer’s
activities is compared to all of the taxpayer’s activities) so
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that it is the taxpayer’s primary use of the property that is
relevant. It is, thus, the taxpayer’s primary use of the
property, and not some other person’s use, that determines
classification.8 The taxpayer in question, of course, is the
person electing to use asset guideline classes for purposes of
computing its depreciation deductions for property placed in
service during the year.9 That it is only the electing
taxpayer’s use that counts is verified by the special rule in the
regulations that applies to leased property. After stating the
general rule that “property shall be included in the asset
guideline class for the activity in which the property is
8
Generally, as in this case, the taxpayer is the owner of
the property. See, however, sec. 1.167(a)-4, Income Tax Regs.,
which provides for lessee depreciation of permanent leasehold
improvements to a lessor-owner’s premises; see also Depot
Investors, Ltd. v. Commissioner, T.C. Memo. 1992-145 (allowing
lessee cost recovery of a leasehold improvement over the
remaining lease term).
9
Sec. 1.167(a)-11(b)(1), Income Tax Regs., provides: “The
allowance for depreciation of eligible property * * * to which
the taxpayer elects to apply this section shall * * * constitute
the reasonable allowance for depreciation of such property under
section 167(a).” (Emphasis added.)
Although Clajon is a partnership and, thus, not itself
subject to the income tax, see sec. 701 (partners not partnership
subject to income tax), the depreciation deduction is taken in
computing Clajon’s taxable income, see sec. 703(a), and the
regulations provide that, if a partnership places eligible
property in service, the partnership is to make the election to
apply sec. 1.167(a)-11, Income Tax Regs., sec. 1.167(a)-
11(e)(3)(ii), Income Tax Regs.
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primarily used”, section 1.167(a)-11(b)(4)(iii)(b), Income Tax
Regs., cross-references paragraph (e)(3)(iii) “for [the] rule for
leased property”. The referenced paragraph provides: “In the
case of a lessor of property [claiming an allowance for
depreciation of leased property], unless there is an asset
guideline class in effect for lessors of such property, the asset
guideline class for such property shall be determined as if the
property were owned by the lessee.” (Emphasis added.) That
provision would be wholly unnecessary under the “industry usage”
rationale of the Court of Appeals in Duke Energy Natural Gas
Corp. v. Commissioner, supra.10 Moreover, the regulation
drafter’s analogy to deemed ownership by the lessee strengthens
the presumption that, in general (outside the special case for
leased property), it is the taxpayer-owner’s use of property that
determines its proper classification.
It is true that, in the case of the activity-based
classifications,11 Rev. Proc. 87-56, supra, does not specifically
10
Under that rationale, the fact that the property in
question is leased would have no bearing whatsoever on the
determination of the asset guideline class for such property, for
it is of no consequence whether the lessor or lessee of property
is considered the owner if, as stated by the Court of Appeals for
the Tenth Circuit in Duke Energy Natural Gas Corp. v.
Commissioner, supra at 1259, primary use of the property is
unrelated to ownership.
11
Some of the asset guideline classes set forth in Rev.
Proc. 87-56, 1987-2 C.B. 674, are based upon the type of property
(such as trucks or railroad cars) as distinguished from the
(continued...)
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state that only the taxpayer’s activities are relevant. We
conclude, however, that, because such limitation is contained in
the regulations pursuant to which Rev. Proc. 87-56, supra, was
issued, it is implicit in all activity-based classifications,
including 13.2 and 46.0. We must, therefore, look to such
classifications to see which describes petitioner’s activities.12
11
(...continued)
activity in which property is used.
12
The dissenters assume that, as described by Judge Foley,
the “central issue” in this case is whether Clajon’s gathering
pipelines were “used by * * * producers for * * * production of *
* * natural gas”. Judge Foley, finding no ambiguity in the verb
“to use”, criticizes us for failing to be governed by the “plain
language” of 13.2. The dissenters ignore the fact that a similar
criticism could be leveled against them, since the plain language
of 46.0, which includes “assets used in * * * carrying * * * gas”
(emphasis added), unambiguously includes Clajon’s pipelines.
Assuming, arguendo, that the producers use Clajon’s pipelines
(rather than simply benefit from Clajon’s own use of its
pipelines), the “central issue” is which use –- the producers’ or
Clajon’s –- controls the determination of the proper recovery
period. The proper inquiry is not whether 13.2 is or is not
ambiguous but, rather, whether 13.2 is applicable at all.
The dissenters’ reliance on the plain language of 13.2 to
support their analysis is also undercut by their ultimate
reliance not on the plain language of 13.2 but on the
regulations, which clarify that the primary use of property
controls its classification under Rev. Proc. 87-56. Moreover,
the dissenters fail to reconcile their plain language analysis
with the special rule for leased property found in section
1.167(a)-11(e)(3)(iii), Income Tax Regs. That rule, which, in
effect, looks to the lessee’s primary use of property in
determining its proper asset guideline class, necessarily implies
that, under the general rule applicable to nonleased property
(i.e., under the first sentence of section 1.167(a)-
11(b)(4)(iii)(b), Income Tax Regs.), it is the owner-taxpayer’s
primary use of property that determines its proper asset
(continued...)
- 22 -
c. Rev. Proc. 87-56
(1) Intra-Industry Asset Classes
The focus of the Court of Appeals on industry usage of
gathering pipelines also ignores the fact that Rev. Proc. 87-56,
1987-2 C.B. 674, does not provide one asset guideline class for
the whole “gas industry”. Rather, several classifications apply
to the industry, each designed to encompass a segment of the
industry, including “Offshore Drilling” (13.0), “Drilling of Oil
and Gas Wells” (13.1), “Exploration for and Production of
Petroleum and Natural Gas Deposits” (13.2), “Pipeline
Transportation” (46.0), “Natural Gas Production Plant” (49.23),
“Gas Utility Trunk Pipelines and Related Storage Facilities”
(49.24), and “Liquefied Natural Gas Plant” (49.25).
That segmented approach to the oil and gas industry is
entirely consistent with the statutory scheme. Under former
section 167(m)(1), the depreciation allowance for property
12
(...continued)
guideline class. Thus, Judge Foley’s interpretation of the third
sentence of section 1.167(a)-11(b)(4)(iii)(b), Income Tax Regs.,
as referencing the insubstantiality of anyone’s primary use of
property in relation to all of the taxpayer’s activities is not
sustainable. Moreover, we note that, had Clajon leased rather
than owned its gathering systems, the lessor would have been
required by the regulations to treat Clajon’s (not the
producers’) primary use of such systems as controlling the
determination of the proper asset guideline class. There is no
conceivable basis for interpreting section 1.167(a)-
11(b)(4)(iii)(b), Income Tax Regs., as treating the producer’s
primary use as controlling where the pipeline company owns rather
than leases its gathering systems.
- 23 -
included in any asset guideline class must be based upon the
“class life prescribed by the Secretary which reasonably reflects
the anticipated useful life of that class of property to the
industry or other group.” (Emphasis added.) Such an approach is
also consistent with Treasury’s description of section 1.167(a)-
11, Income Tax Regs., as, essentially, an extension of the
composite class life system adopted in Rev. Proc. 62-21, 1962-2
C.B. 418. See supra sec. III.
(2) Asset Class 13.2
Asset guideline class 13.2 describes property, including
gathering pipelines, used by natural gas producers. Since,
however, we have found that petitioner is not a natural gas
producer, its gathering pipelines are not 13.2 property. Given
the composite nature of class lives, that is an appropriate
result. If a taxpayer is not engaged in the activity described
in an asset guideline class, then the associated class life is
not representative of the life of any class of business assets
owned by him. Only by coincidence would the class life be the
useful life of any asset owned by the taxpayer. To permit such a
taxpayer to depreciate a particular asset or type of asset on the
basis of a composite class life designed for a completely
different group of taxpayers utilizing a completely different mix
of assets would be to frustrate the overall intent and design of
the class life system adopted by Congress and implemented by the
- 24 -
regulations and by Rev. Proc. 87-56, supra. Petitioner is not a
gas producer and, therefore, has no claim on 13.2.
The point is aptly illustrated by the treatment of drilling
equipment under Rev. Proc. 87-56, supra. Asset class 13.1
(13.1), entitled “Drilling of Oil and Gas Wells”, provides a
6-year class life and 5-year recovery period for “assets used in
the drilling of onshore oil and gas wells”, e.g., an oil or gas
drilling rig. The same assets “used by petroleum and natural gas
producers” fall within 13.2, which, as noted above, provides a
14-year class life and 7-year recovery period. Just as a
drilling rig may have two different class lives and recovery
periods, depending upon the asset class within which it is
includable, so too may gathering pipelines be subject to
different class lives and recovery periods depending upon the
user and the asset class appropriate to that user.
(3) Asset Class 46.0
Petitioner argues that 46.0 is intended to encompass only
transmission pipelines. In support of its argument, petitioner
states that, within the natural gas industry, “the term
‘transportation pipeline’ is synonymous with ‘transmission
pipeline’”, and that the Federal Energy Regulatory Commission
(FERC) distinguishes between gathering, over which it lacks
jurisdiction, and the interstate transportation of natural gas,
over which it has jurisdiction, a distinction upon which the
- 25 -
Court of Appeals for the Tenth Circuit also relies. See Duke
Energy Natural Gas Corp. v. Commissioner, 172 F.3d at 1261-1262.
We reject petitioner’s argument for several reasons.
To begin with, 46.0, although entitled “Pipeline
Transportation”, encompasses “assets used in the private,
commercial, and contract carrying of * * * gas * * * by means of
pipes”. (Emphasis added.) The alleged term of art,
“transportation”, nowhere appears in the descriptive language of
46.0, and it is clear that Clajon’s primary use of its gathering
pipelines is “in * * * carrying * * * gas”.13 Thus, the plain
13
In our discussion to this point, we have not
distinguished between the pipelines, compression stations, and
metering installations constituting what we have termed “the
gathering pipelines”. Although respondent made separate
adjustments with respect to such components, the adjustments were
similar, and the bulk of the adjustments (in excess of 90
percent) were with respect to the pipelines. (Less than 0.5
percent were with respect to the meter runs.) We have had no
need to distinguish among the components since the issue is
whether petitioner is a natural gas producer, not whether the
components of its gathering system are within the meaning of the
term “gathering pipelines” as it is used in 13.2. With respect
to the placement of such components within 46.0, certainly
Clajon’s primary use of its pipelines was in carrying or
transporting gas. Moreover, because the sole function of field
compression is, in the words of petitioner’s expert, “to push the
gas from one location to another through the gathering system”,
the same is true of Clajon’s compressor stations. The so-called
“meter runs” are not separately discussed in either the trial
record or the briefs. However, if they are simply meters used to
ascertain the quantity of gas flowing through the pipelines (the
definition of a “meter” set forth in Williams & Meyers, Manual of
Oil and Gas Terms 626 (11th ed. 2000)), we see no reason to
differentiate them from the pipelines in terms of primary use.
- 26 -
language of 46.0 supports the inclusion of Clajon’s gathering
pipelines within that asset class.
Secondly, we do not agree with the conclusion of the Tenth
Circuit Court of Appeals that FERC’s distinction between
gathering and transmission lines necessarily establishes that
FERC considers gathering systems as related to production.14 See
Duke Energy Natural Gas Corp. v. Commissioner, supra at 1262. In
section 1(b) of the Natural Gas Act of 1938, Pub. L. 688, 52
Stat. 821, currently codified at 15 U.S.C. sec. 717(b) (2000)
(NGA), it is provided that the NGA “shall apply to the
transportation of natural gas in interstate commerce * * * but
shall not apply to * * * the production or gathering of natural
gas.” The quoted language indicates that Congress considered
“gathering” to be separate and distinct from “production”.
Indeed, had it considered “gathering” to be included within the
term “production”, Congress would not have found it necessary to
separately exclude both from Federal regulation. Moreover, that
FERC does not consider gathering and transportation (of gas) to
be mutually exclusive terms is illustrated by another decision of
14
Although we have found that petitioner’s gathering
pipelines are ineligible for inclusion within 13.2, a finding
that such pipelines are primarily production related might
justify their classification (in the hands of a nonproducer) as
“Personal Property With No Class Life” entitled to the same
7-year recovery period. See Rev. Proc. 87-56, 1987-2 C.B. 674,
687. Petitioner has not on brief argued for such classification.
- 27 -
the Court of Appeals for the Tenth Circuit, which involved the
question of FERC jurisdiction over an interstate gathering
system. See Northwest Pipeline Corp. v. FERC, 905 F.2d 1403(10th Cir. 1990). In that case, FERC had asserted jurisdiction
over the system on the basis that the primary function of the
system was “the transportation of natural gas in interstate
commerce.” Id. at 1405, 1410. The Court of Appeals disagreed
that transportation was the primary function of the system if
transportation was only incidental to an exempt function of the
system (i.e., gathering natural gas): “Some transportation must
occur to move the gas from the wellhead in some manner. What the
Commission must decide in applying the primary function test is
whether that transportation is incidental to traditional
gathering functions and, thus, exempt from its jurisdiction.”
Id. at 1410-1411 (fn. ref. omitted). It is clear, however, that
both FERC and the Court agreed that gathering pipelines are used
to transport natural gas.
Thirdly, although petitioner’s expert was of the opinion
(and respondent’s principal expert did not disagree) that
gathering pipelines have a shorter useful life than do
transmission or distribution pipelines,15 that does not persuade
15
Distribution pipelines, like transmission pipelines,
carry lean gas. They are fed by transmission pipelines and
connect to the premises of the ultimate consumers of the gas.
(continued...)
- 28 -
us that the class life of 22 years assigned to 46.0 is
inappropriate for gathering pipelines. The class life of 22
years assigned to 46.0 is a composite life, and petitioner has
made no showing that, on a composite basis, that life does not
fairly balance the relatively short life of gathering pipelines
against the relatively long lives of transmission or distribution
pipelines.16
B. Conclusion
Because Clajon is not a “producer” of natural gas, and
because it is Clajon’s use of its gathering pipelines that is
15
(...continued)
See Williams & Meyers, Manual of Oil and Gas Terms 290-291 (11th
ed. 2000).
16
There is nothing in the record to indicate that the
useful life of gathering pipelines is so short that placing them
in the same asset class as transmission and distribution
pipelines would be somehow inappropriate. Respondent’s principal
expert did not disagree with the statement by petitioner’s expert
that the life of a natural gas gathering system cannot exceed the
life of the gas field or fields that it serves. Respondent’s
expert stated, however, that gas gathering areas are extended and
gathering pipelines are added to the system as new wells are
developed within the field, a process that “may continue for
* * * 50 years or more.” He also noted that “new technology or
enhanced recovery can extend the life of an oil or gas field,
which will extend the life of a gathering system.” Such
longevity is exemplified by Clajon’s Southeast Texas Pipeline
System, which has been in operation since the late 1970s. It is
also a fact that gathering pipelines transporting lean gas
directly to customer transmission lines (such as those
constituting Clajon’s five smaller gathering systems) are not
subject to the corrosive elements that tend to shorten pipeline
useful life. Moreover, the experts appeared to agree that even
pipelines carrying raw gas remain in service throughout the life
of the gas field or fields that they serve.
- 29 -
relevant under 13.2, such gathering pipelines were not “used by”
a natural gas “producer” as required for inclusion within such
asset guideline class. Rather, Clajon’s gathering pipelines are
includable within 46.0 since they are “assets used [by Clajon] in
the * * * carrying of * * * gas * * * by means of pipes and
conveyors.”17
VII. Conclusion
Clajon is required to depreciate the gathering pipelines
utilizing a 15-year recovery period.
Decision will be entered
under Rule 155.
Reviewed by the Court.
COHEN, GERBER, RUWE, WHALEN, COLVIN, CHIECHI, LARO, GALE,
and THORNTON, JJ., agree with the majority opinion.
17
In its petition, petitioner argues, in the alternative,
that most of Clajon’s “gas gathering assets may also be properly
classified in Asset Guideline Class 49.23" (49.23), which
provides a 14-year class life and a 7-year recovery period for
“Natural Gas Production Plant”. Rev. Proc. 87-56, 1987-2 C.B.
674, 686. Petitioner has failed to pursue its alternative
argument on brief. We conclude, therefore, that petitioner has
abandoned its alternative argument. See Nicklaus v.
Commissioner, 117 T.C. 117, 120 n.4 (2001).
- 30 -
WELLS, C.J., dissenting. I respectfully dissent. In the
instant case, the majority opinion states that it will follow our
opinion in Duke Energy Natural Gas Corp. v. Commissioner, 109
T.C. 416 (1997), which was reversed by the United States Court of
Appeals for the Tenth Circuit, 172 F.3d 1255 (10th Cir. 1999).
In rejecting the plain language analysis of Rev. Proc. 87-56,
1987-2 C.B. 674 by the Court of Appeals, however, the majority
opinion in the instant case does not rely on this Court’s
rationale in Duke Energy Natural Gas Corp. Rather, the majority
injects yet another rationale, based upon its reading of the
regulations, to decide that petitioner must depreciate its
gathering system using a 15-year recovery period instead of a 7-
year recovery period. While I agree with Judge Foley’s dissent,
I have an additional point I would like to raise. Revenue
procedures are published to guide taxpayers, who are permitted to
rely on them. We should not read an ownership requirement into
Rev. Proc. 87-56, 1987 C.B. 674, where its plain language does
not require it.
In section 167(m), Congress delegated respondent broad
powers to promulgate regulations to determine the class lives of
property used in the natural gas industry. Respondent
promulgated regulations pursuant to that authority and indicated
that the class guidelines would be published pursuant to that
- 31 -
authority. Rev. Proc. 87-56 reflects respondent’s class-life
determinations.
Rather than providing guidance to taxpayers, Rev. Proc. 87-
56 has produced considerable confusion and uncertainty. In Duke
Energy Natural Gas Corp. v. Commissioner, supra, this Court and
the Court of Appeals for the Tenth Circuit, considered the
question before the Court today, and arrived at contrary results.
The majority opinion now offers another rationale for its result.
Rev. Proc. 87-56 only requires that assets be “used” by
natural gas producers to qualify under section 13.2. In the
instant litigation, respondent asserts that assets must be both
“used” and “owned” by natural gas producers. Revenue procedures
are promulgated to provide clear and precise guidance
to taxpayers, and I would hold respondent to the plain language
of that published guidance.1 To require taxpayers to consult a
team of tax attorneys to decipher that guidance frustrates the
very purpose for which it was issued.
SWIFT, BEGHE, FOLEY, VASQUEZ, and MARVEL, JJ., agree with
this dissenting opinion.
1
I note that we have held that the Commissioner may not
choose to litigate against an official position the Commissioner
has published without first revising or revoking that position.
Rauenhorst v. Commissioner, 119 T.C. ___ (Oct. 7, 2002); Coastal
Petroleum Refiners, Inc. v. Commissioner, 94 T.C. 685 (1990); see
Phillips v. Commissioner, 88 T.C. 529 (1987), affd. in part and
revd. in part 851 F.2d 1492 (D.C. Cir. 1988); see also Slechter
v. Commissioner, T.C. Memo. 1987-528.
- 32 -
BEGHE, J., dissenting: Elementary economic analysis
supports the conclusion of Judge Foley, who tried this case, that
the gathering system assets in issue are class 13.2 assets “used
by * * * producers for * * * production of * * * natural gas”
under Rev. Proc. 87-56, 1987-2 C.B. 674, 678. Petitioner’s
gathering systems are used for production of natural gas by all
the well owners/operators/producers from whose wells originated
the gas processed through the systems. This is true,
notwithstanding such producers do not own and operate any
gathering system, with most such producers selling to petitioner
at the wellhead the bulk of the gas processed through a system1
and a few other such producers paying petitioner fees for
processing their gas through the system.
Back in 1937, R.H. Coase, in the first of the papers for
which he was awarded the Nobel Prize in Economics in 1991, “The
Nature of the Firm”,2 raised and answered a basic question about
the concept of the firm and its boundaries. Coase explained why
businesses exist and operate as they do, why, for instance,
1
Albeit pursuant to contracts under which most such
producers and petitioner share the ultimate proceeds of sale to a
pipeline company that transports the processed product to public
utilities for distribution to consumers.
2
Economica 4 (Nov. 1937), reprinted in Coase, “The Firm, the
Market and the Law” 33 (1988), and Williamson & Winter, Eds.,
“The Nature of the Firm Origins, Evolution, and Development” 18
(1991).
- 33 -
companies choose to produce some goods or provide some services
for themselves and contract with outsiders to provide other goods
and services. Coase explained that relative market prices are
not the sole factor; transaction costs also affect the decision.
The nature and amount of those costs, Coase theorized, frequently
determine whether a company will seek an outside supplier or
service provider or itself supply the item or perform the
service.3 Whatever decision a gas well owner/operator/producer
firm makes in any particular case,4 there is a significant (for
3
See Easterbrook, “Derivative Securities and Corporate
Governance,” 69 U. Chi. L. Rev. 729, 729-730 (2002); Tedeschi,
“E-Commerce Report,” N.Y. Times C12 (Oct. 2, 2000).
4
A generic description of a range of possibilities similar
to those in the case at hand is found in Joskow, “Asset
Specificity and the Structure of Vertical Relationships:
Empirical Evidence”, in Williamson & Winter, Eds., supra note 2
117, 119:
there is a wide range of institutional arrangements
that can be used to govern transactions between
economic agents. Specific institutional arrangements
emerge in response to various transactional
considerations in order to minimize the total cost of
making transactions. The boundary between a firm and a
market provides a very rough distinction between the
two primary institutional mechanisms for allocating
resources, but this is the beginning, not the end, of
the inquiry. Firms can take on many different
organization structures. Market transactions can take
many different forms ranging from simple spot
transactions [sale at the wellhead for a fixed price]
to complex long-term contracts [various sharing
arrangements present in this case and described in
Tenth Circuit opinion in Duke Energy II]. The specific
set of institutional arrangements chosen would
represent the governance structure that minimized the
total cost of consummating the transactions of
interest.
- 34 -
me, dispositive) economic sense in which any such producer firm
uses a gathering system; this is irrespective of whether the
producer owns and operates the system itself, or instead, as in
the case at hand, sells its gas to petitioner at a fixed price at
the wellhead, enters into any one of the various ultimate sale
proceeds sharing arrangements with petitioner (also described in
Duke Energy Natural Gas Corp. v. Commissioner, 172 F.3d 1255(10th Cir. 1999), revg. 109 T.C. 416 (1997)), or has its gas
processed through petitioner’s system for a fee and then sold for
the producer’s account from the processing plant after the last
stage of the productive process has been completed.
As shown by the opinion of the Court of Appeals for the
Tenth Circuit in Duke Energy Natural Gas Corp., with which Judge
Foley and I agree, the question under Rev. Proc. 87-56, supra, of
who a gathering system is “used by” turns neither on who owns the
producers or the system, nor on who owns the gas processed
through the system. The gathering system is “used by * * *
producers for * * * production of * * * natural gas”, id.,
irrespective of the effects on legal ownership and refinements of
title of the terms of the contracts they use to have the gas from
their wells processed through the system.
FOLEY and VASQUEZ, JJ., agree with this dissenting opinion.
- 35 -
FOLEY, J., dissenting: I disagree with the majority’s
analysis and holding.
I. The Texas Gathering Systems (TGS) Were Production Assets
Revenue Procedure 87-56 states that asset class 13.2
includes “assets used by * * * natural gas producers for * * *
production of * * * natural gas, including gathering pipelines”.
As the trial judge I concluded, after analyzing all of the
relevant evidence and testimony, that Clajon’s pipelines were
gathering systems “used by” producers in the production of
natural gas. Gathering systems are essential to the production
process because they treat unprocessed natural gas by removing
water, hydrogen sulfide, and carbon dioxide.1 Without
dehydration and treatment, the gas cannot be used, and
transmission companies would not accept it for transportation to
ultimate consumers. Indeed, without a properly designed
gathering system the gas would never be produced at all but would
simply remain in the ground. Thus, the services provided by
Clajon were an integral part of the production process.
1
Pipes in a gathering system, generally, deteriorate
faster and have to be replaced more frequently than long-distance
transmission pipelines. Because gathering system pipes have
shorter physical lives than transmission pipelines, it is
reasonable to conclude that Clajon’s gathering systems are within
the asset class with the shorter recovery period.
- 36 -
II. The Plain Meaning of Asset Class 13.2 Controls
I agree with the analysis and conclusion of the Court of
Appeals for the Tenth Circuit in reversing Duke Energy Natural
Gas Corp. v. Commissioner, 109 T.C. 416 (1997) (Duke Energy I),
revd. 172 F.3d 1255 (10th Cir. 1999) (Duke Energy II). The Court
of Appeals correctly refused to incorporate an ownership
requirement into the phrase “used by” in asset class 13.2. Id.The court stated: “The literal terms of [asset class 13.2]
include any gathering system, so long as it is used by a gas
producer.” Id. at 1259. Contrary to our opinion in Duke Energy
I, the Court of Appeals concluded that gathering systems owned by
a nonproducer were “‘used by’ producers through contractual
arrangements”. Id. Our holding in Duke Energy I should be
overruled.
The central issue is whether the gathering systems were
“used by” producers. Absent some ambiguity, the plain meaning of
a statute or regulation controls its interpretation. “Use” is
not a difficult word to interpret or understand. See Black’s Law
Dictionary 1541 (6th ed. 1990) (defining “use” as follows: “to
convert to one’s service; to employ; to avail oneself of; to
utilize; to carry out a purpose or action by means of; to put
into action or service, especially to attain an end”). The
majority’s holding that the gathering system must be owned by
- 37 -
natural gas producers is contrary to the common understanding of
the phrase “used by”.
The majority acknowledge that the decision of the Court of
Appeals was based on the plain language of asset class 13.2
(i.e., the phrase “used by * * * natural gas producers”). See
majority op. p. 13. The majority, however, fail to analyze this
language or present any cogent reasons why we should not strictly
adhere to it. Without first finding that the language of asset
class 13.2 is ambiguous, the majority begin their analysis of
respondent’s revenue procedures using “historical material” to
conclude that Asset Depreciation Range classes were designed to
encompass industries and entities rather than assets. See
majority op. p. 11. Historical development, like legislative
history, is a far less accurate embodiment of intent than plain
language and is susceptible to a wide array of interpretations.
Only after this historical analysis do the majority turn to the
plain meaning. Even then, a plain meaning analysis is applied
only to asset class 46.2.
III. The Majority Misinterpret the Primary Use Doctrine
Before Clajon purchased the Southeast Texas Pipeline System
(SETPS) (i.e., the largest of the six systems), it is
indisputable that this system was used primarily by natural gas
producers in the production process. Clajon continued to operate
the SETPS without changing the system’s primary use. The
- 38 -
producers connected to the TGS needed a gathering system to
further the production process by removing impurities and
delivering their gas to processing facilities. Indeed, all of
the producers connected to the TGS had contractual agreements to,
and did in fact, “use” Clajon’s gathering systems. Even in
contracts where title passed to Clajon, the gathering system
remained the means by which the producers’ gas ultimately
traveled to the gas processing plant and transmission lines.
Contrary to the majority’s holding, the primary use of the TGS
was the same regardless of who owned the systems or the gas
flowing through the systems.
The majority base their holding on the theory that the
availability of all asset classes depends on the primary use of
the taxpayer rather than the primary use of the asset. This is,
essentially, an ownership requirement. Such a theory is
inconsistent with the law. Section 1.167(a)-11(b)(4)(iii)(b),
Income Tax Regs., states that “Property shall be classified
according to primary use even though the activity in which such
property is primarily used is insubstantial in relation to all
the taxpayer’s activities.” This regulation unequivocally states
that, regardless of the taxpayer’s activities, the primary use of
the asset determines the appropriate asset class for purposes of
depreciation.
- 39 -
The majority interpret section 1.167(a)-11(b)(4)(iii)(b),
Income Tax Regs., as if it read that the property shall be
classified according to the “taxpayer’s primary use”. See
majority op. p. 19 (emphasis added). We, however, must take the
law as we find it. The regulation specifically states that our
focus is the property’s primary use. Moreover, the language of
asset class 13.2 requires only that the asset be “used by” a
natural gas producer in the production of natural gas. Clajon’s
gathering systems meet the requirement even though Clajon was not
a producer.
IV. Conclusion
The plain language of asset class 13.2 does not require that
a gathering system be “owned by” a natural gas producer to be
included in that asset class. While respondent is free to issue
revised guidance, Rev. Proc. 87-56 simply requires that a
gathering system be “used by * * * a natural gas producer” in
order to fall within asset class 13.2. The TGS is so used.
Accordingly, the majority’s conclusion is incorrect, and
petitioner is entitled to recover the cost of the gathering
systems over a 7-year period.
WELLS, SWIFT, BEGHE, VASQUEZ, and MARVEL, JJ., agree with
this dissenting opinion.