Florida Progress Corporation and Subsidiaries v. Commissioner , 114 T.C. No. 36 ( 2000 )

114 T.C. No. 36UNITED STATES TAX COURT
FLORIDA PROGRESS CORPORATION & SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 2961-97. Filed June 30, 2000.
U, a public utility filing consolidated Federal
income tax returns with P, engaged in the retail and
wholesale distribution of electricity and related
services. Federal income tax rates were reduced in
1986 pursuant to the Tax Reform Act of 1986, Pub. L.
99-514, sec. 821, 100 Stat. 2372, creating an excess in
deferred Federal income tax collected from customers of
U. U was required to adjust utility rates in 1987 and
1988 to compensate for this overcollection.
U was allowed to collect funds equal to its
projected fuel and energy conservation costs. Pursuant
to regulatory law, monthly collections remained fixed
over a 6-month recovery period in order to decrease the
volatility of customers’ bills.
1. Held, U’s rate reductions from 1987 through
1990 to compensate for excess deferred Federal income
tax are not deductible business expenses within the
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meaning of sec. 1341, I.R.C., and, therefore, P is not
entitled to the beneficial treatment of sec. 1341.
2. Held, further, overcollections for fuel and
energy conservation costs are not income to P under
sec. 61 because U acquired funds subject to an
unconditional obligation to repay.
David E. Jacobson and Richard P. Swanson, for petitioner.
James F. Kearney, for respondent.
OPINION
COHEN, Judge: Respondent determined deficiencies in
petitioner’s consolidated Federal income tax for 1986, 1987, and
1988 in the amounts of $1,356,802, $1,321,896, and $7,099,160,
respectively.
After concessions by the parties, the issues for decision
are: (1) Whether one of petitioner’s subsidiaries is entitled to
compute its tax liability for 1987 and 1988 pursuant to section
1341 and (2) whether funds overcollected pursuant to fuel and
energy conservation cost recovery rates constitute income under
section 61.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
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Background
The parties submitted this case fully stipulated pursuant to
Rule 122. The stipulated facts are incorporated by this
reference.
Florida Progress Corporation (petitioner) is a corporation
organized and existing under the laws of the State of Florida.
At the time of the filing of the petition, petitioner’s principal
place of business was located in St. Petersburg, Florida.
Petitioner operates Florida Power Corporation (Florida
Power), a public utility that provides electricity service to
approximately 1.3 million retail customers over 20,000 square
miles of central and northern Florida. Florida Power also
provides wholesale electricity to other electricity providers.
Petitioner and its subsidiaries, including Florida Power, filed
consolidated Federal income tax returns, reported income on a
calendar year, and used the accrual method of accounting during
all of the years in issue.
Florida Power is subject to the rules and regulations of
both the Florida Public Service Commission (FPSC) and the Federal
Energy Regulatory Commission (FERC). The FPSC regulates the
rates that Florida Power may charge its retail customers, whereas
the FERC regulates the rates that Florida Power may charge its
wholesale customers. Both the FPSC and the FERC allow Florida
Power to charge its customers a rate for electricity calculated
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from two components, the estimated costs of providing future
services and an approved rate of return on its invested capital.
The projected amount of Federal income tax that Florida Power
will pay is a component of the estimated costs of providing
future services.
Excess Deferred Federal Income Tax
The Federal income tax expense that Florida Power uses in
determining its costs of providing future services for rate-
making purposes is generally different from the Federal income
tax expense that it currently owes to the Government. This
difference is attributable to timing differences in recognition
of items of income and expense. For example, the FPSC and the
FERC allow Florida Power to use straight-line depreciation for
rate-making purposes, while accelerated depreciation is used for
determining current taxable income. In an earlier year when
accelerated depreciation is greater than straight-line
depreciation, this timing difference causes a utility to collect
a higher Federal income tax component for rate-making purposes
than the income taxes currently owed to the Government for that
year. This excess of the estimated Federal income tax expense is
referred to as “deferred Federal income tax expense”. In a
subsequent year when the timing differences reverse, the income
tax component that the utility charges yields collections that
are less than the Federal income taxes owed by the utility. The
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utility uses the amounts that it overcollects in earlier years to
pay the taxes owed in later years.
Both the FPSC and the FERC require the establishment and
maintenance of deferred income tax accounts that represent the
net cumulative amount of Federal income tax expected to be paid
in future years. If the income tax rate remains constant, the
deferred income tax account will zero out once the timing
differences between rate-making income and taxable income expire.
Customers of Florida Power receive the economic benefit of
all deferred income taxes for as long as they are held by Florida
Power. The FERC treats deferred income tax as a reduction to the
capital rate base used to calculate the approved rate of return
on Florida Power’s invested capital. The FPSC treats deferred
income tax as zero cost capital, meaning that deferred income tax
is used to fund services for the benefit of the ratepayers and no
return is collected because it was the ratepayers who supplied
the capital. Customers get the resulting economic benefit in
reduced rates.
From 1975 through 1986, Florida Power collected revenues
based on a 46-percent Federal income tax rate and increased its
deferred income tax account by the amount of tax related to net
income accrued for rate-making purposes over the amount accrued
for tax purposes. However, the Tax Reform Act of 1986 (TRA),
Pub. L. 99-514, sec. 821, 100 Stat. 289, effective for 1987 and
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later years, lowered the maximum Federal corporate income tax
rates to 39.95 percent in 1987 and 34 percent in 1988. As a
result, Florida Power’s accumulated deferred income tax balance
on December 31, 1986, exceeded the amount of Federal income tax
that Florida Power would be expected to pay to the Government in
later years. As of December 31, 1986, all deferred Federal
income tax expense collected by Florida Power from its retail
customers in years prior to 1975 had been completely reversed.
Both the FPSC and the FERC reserve the power to order
refunds of excess amounts collected for deferred income taxes.
However, TRA section 203(e), 100 Stat. 2146, provides that the
normalization provisions of sections 167 and 168 of the Internal
Revenue Code would be violated if a utility were to reduce its
excess deferred income tax reserve more rapidly than as provided
under the average rate assumption method (ARAM). TRA section
203(e) applies to excess deferred income taxes attributable to
timing differences related to depreciation and described in
sections 167(l) and 168(e)(3) of the Internal Revenue Code
(protected excess deferred taxes). Under ARAM, protected excess
deferred income taxes can be reversed only as the timing
differences that created them reverse.
In addition to protected excess deferred taxes, Florida
Power had accumulated excess amounts of deferred income tax for
other timing differences not subject to TRA section 203(e)
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(unprotected excess deferred taxes). Examples of other timing
differences, which created unprotected excess deferred taxes,
include deductible State and local tax, certain pension costs,
and research and development costs. These costs were deducted
for Federal income tax purposes and capitalized for rate-making
purposes.
For 1987, the FPSC ordered Florida Power, pursuant to Fla.
Admin. Code Ann. r. 25-14.05 (1982) (Fla. Rule 14.05), to return
one-fifth of its total excess deferred income tax to its retail
customers. Fla. Rule 14.05 generally provided that excess
deferred income tax be returned to customers over a period of 5
years. The return amounted to a refund of $2,186,000 of
unprotected excess deferred tax and $874,000 of protected excess
deferred tax. The refund was made to retail customers in the
form of 12 monthly credits on customers’ electric bills under the
heading “1987 Monthly Rate Reduction”.
Florida Power also entered into a settlement agreement with
its wholesale customers for a return of excess deferred income
tax in 1987. Under the terms of settlement and pursuant to FERC
regulation, Florida Power agreed to refund $157,000 to its
wholesale customers from its unprotected excess deferred tax and
$63,000 from its protected excess deferred tax. The settlement
agreement was made effective as of January 1, 1987, but, because
the agreement was not finalized until October 9, 1987, credits
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that wholesale customers were entitled to receive from January
through October were not reflected on those months’ bills. To
compensate wholesale customers for credits they did not receive,
checks were issued to each wholesale customer. The wholesale
customers received credits on their November and December bills.
On March 2, 1987, Occidental Chemical Corporation, Florida
Power’s largest retail customer, filed a complaint with the FPSC
alleging that Florida Power’s rates should be reduced further in
1988. Fla. Rule 14.05 was repealed on November 10, 1987, because
the 5-year refund period violated the ARAM method prescribed by
TRA. On January 4, 1988, the FPSC approved a settlement reached
by the parties in which Florida Power agreed to refund
$18,500,000, the remainder of unprotected excess deferred tax
owed to retail customers, and $2,153,000 of protected excess
deferred tax to Florida Power’s retail customers according to
ARAM. The refund was made in the form of 12 monthly credits on
customers’ electric bills during 1988 under the heading “1988
Monthly Rate Reduction”.
In 1988, Florida Power also entered into a settlement
agreement with its wholesale customers to refund excess deferred
income tax. Under the terms of the 1988 settlement, Florida
Power agreed to refund $1,225,000, the remainder of the
unprotected excess deferred tax owed to wholesale customers, and
$155,000 from its protected excess deferred tax according to
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ARAM. The settlement agreement was made effective as of
January 1, 1988, but, because the agreement was not finalized
until August 30, 1988, credits that wholesale customers were
entitled to receive from January through August were not
reflected on those months’ bills. To compensate wholesale
customers for credits they did not receive, checks were issued to
each wholesale customer. The wholesale customers received
credits on their September, October, November, and December
bills.
No interest component was ever included with any refund.
Florida Power did not take a deduction for the credits and refund
checks. Instead, the credits and refund checks were netted
against taxable revenues for 1987 and 1988, thereby lowering
Florida Power’s gross income in both years. The amount of refund
that was returned to a particular retail customer was based on
the projected amount of electricity to be provided to that
customer during the refund period and was not determined by the
amount of excess deferred income tax paid, if any, by a
particular customer between 1975 and 1986. In addition, many
customers who paid excess deferred income tax between 1975 and
1986 did not receive any refund because they left Florida Power’s
service area, died, or otherwise terminated their accounts.
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Respondent has denied Florida Power the right to relief
under section 1341 with respect to the FPSC and FERC 1987 and
1988 returns of excess deferred Federal income tax.
Fuel and Energy Conservation Costs
Both the FPSC and FERC allow Florida Power to charge its
customers for its actual, necessary, and prudently incurred fuel
costs. Florida Power uses enriched uranium, coal, natural gas,
and oil as fuel to generate electricity. The FPSC also allows
Florida Power to charge its customers for reasonable and prudent
energy conservation costs. Florida Power is required by the FPSC
to develop plans for increasing efficiency and decreasing energy
consumption within its service area. Reducing the growth rate of
electricity demand benefits not only the individual customer, who
reduces his demand, but also all other customers on the system,
who realize the immediate benefit of reduced fuel costs and the
long-term benefit of deferring the need for additional generating
capacity.
Fuel costs are recovered from customers through fuel rates
set by the FPSC or FERC, which are stated separately on
customers’ bills. Energy conservation costs are recovered
through rates set by the FPSC only. Florida Power is not
permitted to mark up or otherwise earn a profit on amounts it
charges its customers for fuel or energy conservation costs.
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In order to calculate fuel and energy conservation rates,
Florida Power must provide the FPSC and FERC with data that
estimate fuel costs, energy conservation costs, and projected
sales over a 6-month recovery period. Recovery periods run from
April through September and October through March. The agencies
calculate a fuel and energy conservation cost per kilowatt hour
of electricity consumed that remains level over the entire
period. The FPSC and FERC have determined that level pricing
over a 6-month period is beneficial to customers because it
reduces the volatility of customers’ monthly bills caused by
fluctuating fuel prices and random energy conservation
expenditures.
Because the rates approved by the regulatory agencies are
based on estimates, the amount billed by Florida Power for fuel
or energy conservation costs in a given month may be more or less
than the costs actually incurred in that month. However, an over
or underrecovery at the close of a given month may be increased
or decreased by over or underrecoveries occurring in a subsequent
month during the same recovery period. Therefore, any
overrecovery balance as of December 31 of any taxable year could
be reduced or eliminated as a result of underrecoveries occurring
during January, February, or March of the following year but same
rate period.
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If over and underrecoveries for retail fuel and energy
conservation rates do not cancel during a recovery period, the
FPSC allows for a “true-up” adjustment during the succeeding two
recovery periods. The FERC allows for a true-up rate adjustment
for wholesale fuel costs during the single succeeding recovery
period. Both the FPSC and FERC require that overrecoveries be
returned, and underrecoveries be collected, with interest.
When a customer receives and pays a bill rendered by Florida
Power, the bill shows that the portions relating to fuel and
energy conservation costs are based on estimates, and, when the
estimate is compared to the actual cost of fuel, the customer
knows he will be required either to pay more or he will be
entitled to a setoff on a future electricity bill. However, the
customer does not know the amount of future true-up involved or
whether it will result in an additional payment by the customer
or an amount received from Florida Power. Funds collected from
customers for fuel and energy conservation costs are not
segregated in separate bank accounts nor held in trust by Florida
Power.
At the end of 1986 and 1988, Florida Power had combined
retail and wholesale fuel cost overrecoveries of $11,833,183 and
$31,915,284, respectively. At the end of 1987, Florida Power had
a combined fuel cost underrecovery of $25,236,199. In 1986,
1987, and 1988, Florida Power had energy conservation cost
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overrecoveries of $2,419,002, $509,206, and $1,141,079,
respectively. Petitioner included the overrecoveries in income
and deducted the underrecovery on its consolidated Federal income
tax returns for these years. Respondent has denied petitioner’s
request to exclude the overrecoveries from gross income.
Discussion
Application of Section 1341
Petitioner argues that it is entitled to section 1341
treatment for the amount by which Florida Power reduced utility
rates in 1987 and 1988 to compensate for excess deferred Federal
income taxes. Section 1341 provides in pertinent part:
SEC. 1341(a). In General.--If–-
(1) an item was included in gross income for
a prior taxable year (or years) because it
appeared that the taxpayer had an unrestricted
right to such item;
(2) a deduction is allowable for the taxable
year because it was established after the close of
such prior taxable year (or years) that the
taxpayer did not have an unrestricted right to
such item or to a portion of such item; and
(3) the amount of such deduction exceeds
$3,000,
then the tax imposed by this chapter for the taxable
year shall be the lesser of the following:
(4) the tax for the taxable year computed
with such deduction; or
(5) an amount equal to–-
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(A) the tax for the taxable year
computed without such deduction, minus
(B) the decrease in tax under this
chapter * * * for the prior taxable year (or
years) which would result solely from the
exclusion of such item (or portion thereof)
from gross income for such prior taxable year
(or years).
* * * * * * *
(b) Special Rules.--
* * * * * * *
(2) Subsection (a) does not apply to any
deduction allowable with respect to an item which
was included in gross income by reason of the sale
or other disposition of stock in trade of the
taxpayer (or other property of a kind which would
properly have been included in the inventory of
the taxpayer if on hand at the close of the prior
taxable year) or property held by the taxpayer
primarily for sale to customers in the ordinary
course of his trade or business. This paragraph
shall not apply if the deduction arises out of
refunds or repayments with respect to rates made
by a regulated public utility * * * if such
refunds or repayments are required to be made by
the Government, political subdivision, agency, or
instrumentality referred to in such section or by
an order of a court, or are made in settlement of
litigation or under threat of imminence of
litigation.
Petitioner’s argument is essentially the same as the
argument raised by the taxpayer in MidAmerican Energy Co. v.
Commissioner, 114 T.C. ___ (2000), filed this date, and we find
no reason to reach a different conclusion in this case. In
MidAmerican Energy Co., a taxpayer-utility held excess deferred
Federal income tax after Federal income tax rates were reduced in
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1986 pursuant to TRA. The taxpayer was forced by regulatory law
to reduce its rates in subsequent years to offset the excess
deferred Federal income tax.
A deductible expense is required by section 1341(a)(2) to
qualify for relief under the statute. This Court held that the
taxpayer’s method of decreasing its deferred Federal income tax
account resembled a reduction in rates rather than a deductible
expense. Factors that led to this Court’s conclusion were:
First, the taxpayer had returned excess deferred income tax to
customer classes based upon current energy consumption, not upon
amounts each individual customer actually overpaid during the
years of overcollection; second, no interest component was
included with the refunds; and, third, the taxpayer set off the
amount to be refunded against future amounts owed for goods and
services on customers’ bills, rather than actually returning
money to customers. This Court decided that the taxpayer “was
not repaying its customers the excess deferred Federal income tax
that it collected in prior years. Rather, the rate reductions
served only to reduce income in future years and did not directly
compensate * * * [the taxpayer’s] customers for prior
overcollection.” Id. at ___ (slip op. at 26). Because these
same factors are present in the case at hand, we conclude that
Florida Power’s return of excess deferred Federal income tax
resembles a reduction in rates rather than a deductible expense.
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Although petitioner argues that Florida Power paid a form of
constructive interest on deferred income tax because both the
FPSC and the FERC calculated allowable rates using formulas that
penalized Florida Power for deferred income tax, these rate
formulas were used even before TRA triggered the liability to
return excess deferred income tax. Therefore, no interest became
payable upon the formation of the obligation to return excess
deferred income tax, which would have suggested that a liability
had arisen at that point in time.
Our holding also applies to the portion of returns made to
wholesale customers by check. These returns were carried out by
check only because they represented funds that should have been
refunded to customers under FERC regulations in previous months.
The refund should have been returned to wholesale customers
starting 10 months earlier in 1987 and 8 months earlier in 1988.
Had Florida Power made these returns in the time required by FERC
regulations, they would have been carried out by setoff on
customers’ bills. Combined with the other characteristics of the
refunds, this characteristic makes the returns by check resemble
a reduction in rates rather than a deductible expense.
Petitioner also claims that section 1341(b)(2) and section
1.1341-1(f)(2)(i), Income Tax Regs., provide that utility refunds
shall be eligible for section 1341 treatment. However, the
language of section 1341(b)(2) that refers to utility refunds and
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section 1.1341-1(f)(2)(i), Income Tax Regs., does nothing more
than create an exception to the exclusion for the sale of
inventory items, also found in section 1341(b)(2). Therefore,
although a public utility will not be excluded from the benefits
of section 1341 because its refund stemmed from a sale of
property characterized as inventory, it still must satisfy all
the requirements of section 1341(a) before it is eligible for
relief under the statute. Because the refunds by Florida Power
do not meet the deduction requirement, petitioner is not eligible
for section 1341 relief.
Inclusion of Overrecovered Costs in Income
The second issue addresses the proper tax treatment of a
portion of Florida Power’s receipts constituting an overrecovery
of fuel and energy conservation costs.
Respondent argues that the claim of right doctrine applies
to require inclusion of overrecoveries in income under section
61(a). According to respondent’s view, petitioner would be
entitled to a deduction in a subsequent year if and when the
overrecoveries are actually refunded to customers. Respondent
contends that overrecoveries are income because the obligation to
refund was contingent on no underrecoveries arising in the later
months of the recovery period that would reduce or eliminate the
amount to be refunded. Respondent claims that one should look to
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the end of a recovery period to determine whether a refund is
required.
Petitioner argues that such overrecoveries are not
includable in income under section 61(a) because the obligation
to repay, imposed by regulatory law, was unconditional.
According to petitioner’s view, Florida Power is required to
refund an overrecovery from any given month in a subsequent month
of the same recovery period by setoff or according to the true-up
adjustment imposed by regulatory law over subsequent recovery
periods. Petitioner claims one should look at a monthly
collection to determine whether a refund is required.
Section 61(a) defines gross income as “all income from
whatever source derived.” Congress enacted this text intending
to use the full measure of its taxing power. See Helvering v.
Clifford, 309 U.S. 331, 334 (1940). The definition of gross
income is construed broadly to reach any accession to wealth
realized by a taxpayer over which the taxpayer has “complete
dominion”. Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431
(1955). “In determining whether a taxpayer enjoys ‘complete
dominion’, * * * The key is whether the taxpayer has some
guarantee that he will be allowed to keep the money.”
Indianapolis Power & Light Co. v. Commissioner, 493 U.S. 203, 210
(1990).
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A claim of right exists when property or funds are received
and treated by a taxpayer as belonging to him. See Healy v.
Commissioner, 345 U.S. 278, 282 (1953). Income received under a
claim of right is taxable in the year of receipt even though the
taxpayer may be required to return it at a later time. See North
Am. Oil Consol. v. Burnet, 286 U.S. 417, 424 (1932). If, in a
subsequent year, the claim to the funds or property is determined
to be invalid, the taxpayer would be entitled to a deduction in
the year of repayment. However, the amount of tax due and
reported in the year of receipt is unaffected by the return of
property or funds. See United States v. Skelly Oil Co., 394 U.S.
678, 680-681 (1969). Property or funds are not received under a
claim of right when there is a substantial restriction on its
disposition or use, or when there is a fixed obligation to return
the property or funds received. See Indianapolis Power & Light
Co., supra at 209; Hope v. Commissioner, 55 T.C. 1020, 1030
(1971), affd. 471 F.2d 738 (3d Cir. 1973).
In Indianapolis Power & Light Co., the Supreme Court dealt
with the issue of whether deposits, paid by customers to assure
the taxpayer of payment for future electricity, were required to
be included in income. The deposits were received by the
taxpayer subject to an express obligation to repay either at the
time service was terminated or at the time a customer established
good credit. So long as a customer fulfilled his legal
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obligation to make timely payments, the deposit ultimately was
refunded, and both the timing and method of refund were within
the control of the customer. The customer could demand that the
taxpayer return the deposit payment by check or by setoff on the
customer’s next utility bill.
The Court held that the test for whether deposit payments
paid by customers constitute income when received by the taxpayer
depends upon the rights and obligations of the parties at the
time the payments are made. See id. at 211. The Court decided
that, because it was within the customer’s domain to prevent a
forfeiture of a deposit payment and because the customer rather
than the taxpayer determined how and when a deposit payment was
returned, the payments in question did not constitute income to
the taxpayer. Where the time and manner of repayment is within
the control of the taxpayer, the payments would constitute
income. See Milenbach v. Commissioner, 106 T.C. 184, 197 (1996).
The return of overrecoveries of fuel and energy conservation
costs are not within the control of Florida Power. The 6-month
recovery period, price setting, and true-up adjustment are all
set by the FPSC and FERC, which implemented the pricing schemes
to reduce the volatility of customers’ bills. Florida Power is
required by regulatory law to overcollect for fuel and energy
conservation costs in certain months and to return those funds by
setoff on customers’ bills in the later months of the recovery
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period in order to create level pricing. Any remaining
overrecoveries existing at the end of the recovery period,
because of inaccuracies in estimating its projected costs, are
returned to customers pursuant to the true-up adjustment required
by the FPSC and FERC. Florida Power cannot change or alter the
time or method of refunding the overrecoveries. Because the time
and method of refunding overrecoveries is controlled by the FPSC
and FERC rather than by Florida Power, Florida Power does not
have complete dominion over the overrecoveries and is not
required to recognize them as income when received.
Respondent argues that Indianapolis Power & Light Co. does
not apply to this case because the Supreme Court was addressing
only the question of whether certain payments by customers were
advanced payments for services or were deposits. Respondent
maintains that, in this case, the overrecoveries were paid to
Florida Power as part of the compensation it receives for
providing electricity service rather than in the form of a
deposit, and, therefore, the test for income announced in
Indianapolis Power & Light Co. was not intended by the Supreme
Court to apply to overrecoveries.
We reject respondent’s argument that the holding in
Indianapolis Power & Light Co. should be construed so narrowly.
Respondent is essentially making the same arguments in this case
regarding overrecoveries that were rejected by the Supreme Court
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in Indianapolis Power & Light Co. with regard to deposits.
Respondent argues that the overrecoveries should be included in
income under section 61 because the overrecoveries are property
of Florida Power under a claim of right and subject to a
conditional obligation to repay. The conditional obligation to
repay vests only if an offsetting underrecovery does not occur
before the end of the 6-month recovery period. However, the true
economic substance of Florida Power’s obligation is that, at the
end of the month, Florida Power is not entitled to keep the
amount held as an overrecovery, and it must return that amount
according to regulatory law either by setoff during the remainder
of the recovery period or by the true-up adjustment.
Our decision is consistent with Houston Indus. v. United
States, 125 F.3d 1442, 1444 (Fed. Cir. 1997). In Houston Indus.,
the Court of Appeals held that overrecoveries of fuel costs are
not required to be included in income when the overrecoveries are
part of a plan to create level pricing over a 12-month recovery
period. A taxpayer-utility collected funds from its customers
equal to the fuel costs it expected to incur. The collections
were based on estimates and were followed by a reconciliation
procedure to account for any over or underrecoveries. The
governing regulatory agencies required the taxpayer to pay
interest on any overrecoveries. The taxpayer argued that it was
not required to report in gross income overrecoveries for fuel
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costs that were in the taxpayer’s possession at the close of the
year. Interpreting Indianapolis Power & Light Co., the Court of
Appeals agreed with the taxpayer.
Respondent claims that the outcome of this case should,
instead, be controlled by Brown v. Helvering, 291 U.S. 193(1934). The taxpayer in Brown was an insurance agent who
received a commission from premiums paid on insurance policies.
The insurance policies included a right of cancellation, which,
when exercised, required the insurance company to refund the
premiums paid. In the event of cancellation, the taxpayer was
required to refund to the insurance company a portion of the
commission he had received with respect to a canceled policy. On
his books, the taxpayer recorded an estimate of his future
liability to refund commissions and sought to exclude the
estimate from gross income. The Court rejected the argument of
the taxpayer stating that “the mere fact that some portion of
* * * [the commissions] might have to be refunded in some future
year in the event of cancellation or reinsurance did not affect
its quality as income.” Id. at 199.
The situation of Florida Power is distinguishable from that
of the insurance agent in Brown. Brown dealt with contingent
liabilities that may or may not have vested in future years. In
making his estimates, the taxpayer had no idea which policies, if
any, might cancel creating a liability on his part, nor did he
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know the amount of his liability at the end of the year. Florida
Power, however, is subject to a fixed and certain liability to
refund overrecoveries, and those overrecoveries are determinable
immediately after receipt of payment by subtracting its
collections for a given month by its costs actually incurred.
Our holding is also distinguishable from our opinions in
Southwestern Energy Co. v. Commissioner, 100 T.C. 500 (1993), and
Continental Ill. Corp. v. Commissioner, T.C. Memo. 1989-636,
affd. 998 F.2d 513 (7th Cir. 1993). In Southwestern Energy Co.,
the taxpayer collected monthly utility fees that were based on
the costs that it expected to incur for purchasing gas in the
subsequent month. Because the pricing was based on estimates,
over or undercollections occurred at the end of every month. At
the end of the year, the taxpayer was bound by regulatory law to
calculate the net overcollection for the year and return that
amount during the following year. Using this collection method,
the fuel cost charged to customers by the taxpayer fluctuated
each month. The purpose of the monthly gas collections was to
allow the taxpayer to recoup its cost of gas purchased and not to
create level pricing. This Court held that the obligation to
return a net overcollection during the next year was not an
immediately deductible expense.
In Continental Ill. Corp., the taxpayer made fixed-term
loans with floating interest rates to corporate borrowers.
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However, the loan agreements provided that, if the total amount
of interest paid by a borrower over the life of the loan exceeded
a preset fixed-rate cap, the taxpayer would refund the excess.
The taxpayer included in income the amount of interest collected
with each monthly payment only to the extent it did not exceed
the fixed-rate cap. Respondent argued, and this Court agreed,
that the excess collections should be included in gross income
because a contingent obligation to repay does not constitute a
restriction on use sufficient to prevent their being classified
as income.
The excess collections in Southwestern Energy Co. and
Continental Ill. Corp. differ from the excess fuel and energy
conservation costs collected by Florida Power in three
significant respects. First, Florida Power is required to pay
interest on its overrecoveries, whereas, in Southwestern Energy
Co. and Continental Ill. Corp., the taxpayer did not include an
interest component in its refunds of excess collections. Second,
Florida Power, burdened by additional accounting and
administrative responsibilities, derives no benefit from the
regulatory imposed recovery system. Florida Power is forced by
the FPSC and FERC to overrecover its costs and then give refunds
in later months in order to reduce the volatility of customers’
monthly bills caused by fluctuating fuel prices and random energy
conservation expenditures. The regulatory recovery method is
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designed to spread the costs of the expenditures over the 6-month
recovery period for the sole benefit of customers. By contrast,
the recovery methods in Southwestern Energy Co. and Continental
Ill. Corp. benefited only the taxpayer and not the customer.
Third, in a subsequent month, if an undercollection occurred in
Southwestern Energy Co., or if interest dipped below the
fixed-rate cap in Continental Ill. Corp., the taxpayer did not
immediately return overcollections from a prior month by setoff.
Thus, no refund occurred until the following year in Southwestern
Energy Co. or after the end of the loan period in Continental
Ill. Corp. In any event, no question was raised or considered
whether overrecoveries constituted gross income in the year of
receipt.
The final argument of respondent is that, by not including
overrecoveries in income, petitioner has improperly changed its
method of accounting with respect to a material item without the
consent of the Secretary. Consent is required by section 446(e),
which reads:
SEC. 446(e). Requirement Respecting Change of
Accounting Method.--Except as otherwise expressly
provided in this chapter, a taxpayer who changes the
method of accounting on the basis of which he regularly
computes his income in keeping his books shall, before
computing his taxable income under the new method,
secure the consent of the Secretary.
“[C]hange in method of accounting” includes a “change in the
overall plan of accounting for gross income or deductions or a
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change in the treatment of any material item used in such overall
plan.” Sec. 1.446-1(e)(2)(ii)(a), Income Tax Regs. A material
item is defined as “any item which involves the proper time for
the inclusion of the item in income or the taking of a
deduction.” Sec. 1.446-1(e)(2)(ii)(a), Income Tax Regs. When an
accounting practice does nothing more than postpone the reporting
of income, rather than permanently avoiding the reporting of
income over the taxpayer’s lifetime, it involves the proper time
for reporting income. See Wayne Bolt & Nut Co. v. Commissioner,
93 T.C. 500, 510 (1989). “[C]hange in method of accounting does
not include adjustment of any item of income or deduction which
does not involve the proper time for the inclusion of the item of
income or the taking of a deduction.” Sec. 1.446-1(e)(2)(ii)(b),
Income Tax Regs.
In Saline Sewer Co. v. Commissioner, T.C. Memo. 1992-236,
this Court held that, for purposes of section 446, a question of
whether collections should be reported in income is different
from a question as to the proper time when collections should be
reported in income. If a taxpayer seeks to change his prior
reporting position regarding whether a particular item is income
or not, a taxpayer is not required to seek the Secretary’s
permission before filing. Thus, section 446(e) is inapplicable
to the reporting of overrecoveries by Florida Power during the
years in issue.
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We have considered all remaining arguments made by both
parties for a result contrary to those expressed herein, and, to
the extent not discussed above, they are irrelevant or without
merit.
To reflect the foregoing and the concessions of the parties,
Decision will be entered
under Rule 155.