Filed: Dec. 16, 1997
Latest Update: Nov. 14, 2018
Summary: 109 T.C. No.19 UNITED STATES TAX COURT DUKE ENERGY NATURAL GAS CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 12720-96. Filed December 16, 1997. P owns and operates various systems of interconnected subterranean natural gas gathering pipelines and related compression facilities (the gathering systems). P argues that the modified accelerated cost recovery system allows P to depreciate the gathering systems over 7 years because P is a producer of natural gas wit
Summary: 109 T.C. No.19 UNITED STATES TAX COURT DUKE ENERGY NATURAL GAS CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 12720-96. Filed December 16, 1997. P owns and operates various systems of interconnected subterranean natural gas gathering pipelines and related compression facilities (the gathering systems). P argues that the modified accelerated cost recovery system allows P to depreciate the gathering systems over 7 years because P is a producer of natural gas with..
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109 T.C. No.19
UNITED STATES TAX COURT
DUKE ENERGY NATURAL GAS CORPORATION, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12720-96. Filed December 16, 1997.
P owns and operates various systems of
interconnected subterranean natural gas gathering
pipelines and related compression facilities (the
gathering systems). P argues that the modified
accelerated cost recovery system allows P to depreciate
the gathering systems over 7 years because P is a
producer of natural gas within the meaning of Class
13.2 of Rev. Proc. 87-56, 1987-2 C.B. 674. R argues
that P must depreciate the gathering systems over 15
years because P transports gas, which brings P within
Class 46.0 of Rev. Proc. 87-56, supra.
Held: P transports, and does not produce, gas;
thus, P must depreciate the gathering systems over 15
years.
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Thomas P. Marinis, Jr., Sarah A. Duckers, and Charles T.
Fenn, for petitioner.
Emron M. Pratt, Jr. and Todd A. Ludeke, for respondent.
OPINION
LARO, Judge: The parties submitted this case to the Court
without trial. See Rule 122. Petitioner petitioned the Court to
redetermine respondent's determination of income tax deficiencies
of $399,369 and $753,089 for its taxable years ended
September 30, 1991, and September 30, 1992, respectively.
We must decide the cost recovery period of certain natural
gas recovery systems under the modified accelerated cost recovery
system (MACRS). Petitioner argues for a 7-year recovery period.
Respondent argues for a 15-year recovery period. We hold for
respondent. Unless otherwise noted, section references are to
the Internal Revenue Code in effect for the years in issue. Rule
references are to the Tax Court Rules of Practice and Procedure.
References to "asset class" are to the asset classes set forth in
Rev. Proc. 87-56, 1987-2 C.B. 674.
Background
All facts are stipulated. The stipulated facts and exhibits
submitted therewith are incorporated herein by this reference.
Petitioner is the common parent of an affiliated group of
corporations which file consolidated Federal income tax returns.
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Petitioner's principal place of business was in Denver, Colorado,
when it petitioned the Court.
Petitioner's wholly owned subsidiary owns and operates the
subject assets. These assets, which are depreciated under MACRS,
consist of various systems of interconnected subterranean natural
gas gathering pipelines and related compression facilities (the
gathering systems). The main gathering systems are known as:
(1) The Weld County system, which is located north of Denver,
Colorado, (2) the Milfay/Keystone system, which is located in
eastern Oklahoma, and (3) the Minden system, which is located in
northern Louisiana and southern Arkansas.
The gathering systems' pipelines are laid out like a "spider
web", with small diameter pipelines connecting a well to larger
diameter pipelines that mainly deliver "raw" gas to a processing
plant in or near the oil and gas fields served by the pipelines.
Petitioner does not own an interest in the oil and gas wells that
produce the gas collected by the gathering systems.
A gathering system may be owned or operated by a producer or
by an independent gatherer like petitioner. In either case, the
system serves the same function. Some of petitioner's systems
were once owned by producers, and those systems continue to serve
the same wells that they served before petitioner acquired them.
Those systems continue to perform the same functions as they did
before acquisition.
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Generally, natural gas emerges from a well as a mixture of
gas and liquids, and the gas is separated from the liquids by
passing through a separator near the well or at a central
gathering point. After separation, the gas continues to contain
entrained natural gas liquids (NGL's) which interfere with
domestic or commercial use of the gas as an energy source. A
processing plant is needed to remove the NGL's from the gas and
to condition the gas in order to produce processed (dry) gas.
Approximately 81 percent of the gathering systems deliver raw gas
directly to petitioner's processing plants or to processing
plants owned by unrelated third parties. The other gathering
systems dehydrate raw gas and deliver it directly to intrastate
and interstate transmission pipelines without processing.
Regardless of whether or not the gas is processed before
delivery, title to the gas usually transfers to petitioner at the
point where petitioner's gathering system connects with a
producer's separation facilities. Title to the gas also passes
to petitioner in some cases at a common field point where raw gas
from two or more wells has been gathered.
The majority of the natural gas that flows through
petitioner's systems is purchased by petitioner under long-term
contracts with producers. Most of these contracts are
"percentage of proceeds" contracts under which the parties
thereto share revenues from sales of dry gas and NGL's that occur
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after the gas and NGL's leave the processing plants. A second
type of contract is a "keep whole" contract that provides for the
redelivery to the producer of a volume of dry gas; in this case,
the producer receives 100 percent of the dry gas and petitioner
receives 100 percent of the proceeds from the sale of the NGL's
(and sometimes a processing fee). A third type of contract is a
"wellhead purchase" contract under which the producer receives a
stated price for the gas that is delivered, and petitioner
receives payment when the gas or NGL's are sold.
Discussion
In a case of first impression in this Court, we must
determine the appropriate class life over which petitioner may
depreciate its gathering systems. The issue is purely one of
timing in that the parties agree that petitioner may depreciate
the assets, but disagree over the period of time that the
depreciation must be taken into account for Federal income tax
purposes. Respondent determined that petitioner must depreciate
the assets over 15 years because the assets are within asset
class 46.0, and respondent's primary position in this proceeding
is the same. Petitioner argues primarily for a 7-year recovery
period, asserting that the assets are within asset class 13.2.
Petitioner argues alternatively that the assets are either within
asset class 49.23, or not within any class; either classification
would let petitioner depreciate the assets over 7 years.
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Respondent argues, alternatively, that, if the assets are not
within asset class 46.0, they are within asset class 00.3. Asset
class 00.3 provides for a 15-year recovery period.
We agree with respondent's primary position. The Code lets
taxpayers deduct depreciation for the exhaustion, wear and tear,
or obsolescence of property used in a trade or business. Sec.
167(a); see also Simon v. Commissioner,
103 T.C. 247 (1994),
affd.
68 F.3d 41 (2d Cir. 1995). For tangible property, such a
deduction is computed by reference to the applicable depreciation
method, recovery period, and convention. Sec. 168(a). Under
MACRS, which generally applies to tangible property placed in
service after December 31, 1986, the recovery period depends on
the asset's class life, sec. 168(e), which, for purposes of this
case, is found by reference to Rev. Proc. 87-56, 1987-2 C.B. 674.
See sec. 168(i); see also sec. 167(m)(before repeal). The
classes at issue are as follows:
Asset Class 00.3--Land Improvements: Includes
improvements directly to or added to land, whether such
improvements are section 1245 property or section 1250
property, provided such improvements are depreciable.
Examples of such assets might include sidewalks, roads,
canals, waterways, drainage facilities, sewers * * *.
Does not include land improvements that are explicitly
included in any other class * * *. * * *
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
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producers and others consisting of platforms * * *,
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. * * *
Asset Class 49.23--Natural Gas Production Plant:
[No description given].
Rev. Proc. 87-56, supra, 1987-2 C.B. at 677, 678, 684, 686. A
15-year recovery period is assigned to property within either
asset class 46.0 or asset class 00.3. A 7-year recovery period
is assigned to property within either asset class 13.2 or asset
class 49.23. Sec. 168(c), (e)(1); see also Rev. Proc. 87-56,
supra, 1987-2 C.B. at 677, 678, 684, 686. Property without a
class life generally has a 7-year recovery period. Sec.
168(e)(3)(C).
Asset class 13.2 and asset class 46.0, when read together,
refer to assets used in the process that starts with the drilling
and removal from the ground of petroleum and natural gas
(production) and ends with the transportation of the gas to its
end use. The question, therefore, is whether petitioner's
gathering systems produce or transport gas. We conclude that
they transport gas. The gathering systems are primarily
pipelines that are used by a nonproducer privately, commercially,
and/or contractually to carry gas; they are not used by a
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producer to drill wells or produce gas. See Williams & Meyers,
Manual of Oil & Gas Terms, 866 (9th ed. 1994)("production of gas"
means "bringing forth gas from the earth"); see also sec.
1.167(a)-11(b)(4)(iii)(b), Income Tax Regs. Given this
conclusion, the gathering systems fall squarely within the
language of asset class 46.0. Although asset class 13.2 includes
"gathering pipelines and related storage facilities", those
pipelines and facilities must be used by a producer to fall
within that class.
Petitioner argues that its gathering systems are outside
asset class 46.0 because they do not carry gas within the meaning
of that class. According to petitioner, asset class 46.0
includes only pipelines that move natural gas from a production
plant to an end user such as a distribution facility. Petitioner
asserts that its gathering systems do not transport gas, but
gather and/or process it. We disagree. We decline to conclude
that a pipeline company is carrying gas within the meaning of
asset class 46.0 when it pipes the gas from a production plant to
an end user, but not when it pipes the gas from the well to the
production plant. Although petitioner invites us to draw a
distinction in this case, arguing that its pipelines are
fundamentally different from the transmission systems of other
nonproducers, we decline to do so. Any difference between
petitioner's pipelines and the transmission pipelines of other
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nonproducers is a mere distinction without a difference and does
not merit a different result herein. Nor do we find dispositive
petitioner's reliance on the practice of the Federal Energy
Regulatory Commission (FERC), with respect to gas transmission
systems, on the one hand, and gas production and/or gathering
facilities on the other. We find no evidence that FERC's
practice on this subject has been adopted by either the Congress
or the Commissioner of Internal Revenue (the Commissioner) in
their promulgation of the laws, rules, and regulations which make
up our Federal income tax regime.
Petitioner argues 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.
We disagree with petitioner's conclusion. The mere fact that the
gathering systems may have helped producers produce and sell
their gas in the market does not mean that the systems are
exploration or production assets within the realm of asset class
13.2. Nor is it dispositive here that some producers own their
own gathering systems, which, in those cases, place the systems
within asset class 13.2. The critical fact is that petitioner's
gathering systems are not used by producers to produce gas. They
are used primarily by a pipeline company to carry gas to a
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production facility, which, as such, brings them within asset
class 46.0. See sec. 1.167(a)-11(b)(4)(iii)(b), Income Tax Regs.
Our conclusions herein are supported by our understanding of
the evolution of asset class 13.2. In Rev. Proc. 62-21, 1962-2
C.B. 418, the Commissioner began grouping assets into broad
industry classes for depreciation purposes. Group Three,
Guideline Class 17(b), entitled "Exploration, Drilling and
Production" states: "Includes the exploration, drilling,
maintenance and production activities of petroleum and natural
gas producers. Includes gathering pipelines and related storage
facilities of such producers. Excludes gathering pipelines and
related storage facilities of pipeline companies." Id. at 424.
Under this description, petitioner's gathering systems clearly
would not have been included in this class because the pipelines
are owned by a pipeline company and not a producer.
Later, when the Commissioner prescribed the asset classes
and guideline lives for purposes of the asset depreciation range
system, the Commissioner carried forward a similar limitation.
Rev. Proc. 71-25, 1971-2 C.B. 553, 556, provides that asset class
13.2 "Includes assets used for drilling of wells and production
of petroleum and natural gas, including gathering pipelines and
related storage facilities, when these are related activities
undertaken by petroleum and natural gas producers." After
restating this description without change, see Rev. Proc. 72-10,
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1972-1 C.B. 721, the Commissioner changed this language to read
exactly as the first sentence of asset class 13.2 reads today.
See Rev. Proc. 77-10, 1977-1 C.B. 548. In making the latest
change, the Commissioner noted explicitly that the change was
"not intended to modify the composition of the existing classes
of Rev. Proc. 72-10." Sec. 1.04 of Rev. Proc. 77-10, supra at
548.
We conclude that the gathering systems are included in asset
class 46.0, and we so hold. In so holding, we have considered
the recent opinion of the U.S. District Court for the District of
Wyoming, which reaches a contrary holding in a setting that is
similar to the one at hand. See True v. United States, No.
96-CV-1050-J (D. Wyo. Nov. 3, 1997)(order granting motion for
partial summary judgment). Although we agree with the District
Court that the classification of assets for depreciation purposes
rests on each asset's primary use, we do not agree that pipeline
companies such as petitioner use gathering lines primarily to
produce petroleum. The District Court did not consider the
evolution of the language in asset class 13.2, which we find to
be most helpful to our inquiry. The court also did not consider
the industry definition of the word "production".
We have carefully considered all arguments made by
petitioner for a contrary holding and, to the extent not
discussed above, find them to be irrelevant or without merit.
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To reflect the foregoing,
Decision will be entered
for respondent.