United States: Appeals Court Denies Cost Basis For Failure To Meet All-Events Test

In AmerGen Energy Co. LLC v. U.S., No. 14-5067 (Fed. Cir. 2015), the U.S. Court of Appeals for the Federal Circuit affirmed the Court of Federal Claims decision that the taxpayer, an energy company, could not include future nuclear decommissioning liabilities it assumed when it purchased three nuclear power plants, in the basis of those acquired assets in its 2001 through 2003 tax returns. The court reasoned that this was because the economic performance requirement of Section 461(h) hadn't been met.

Between 1999 and 2000, AmerGen purchased three nuclear plants: Three Mile Island, Clinton Power Station and Oyster Creek Nuclear Generating System. AmerGen paid approximately $93 million in cash for the three plants and assumed approximately $1.6 billion in nuclear decommissioning liabilities. As part of the purchase, AmerGen received decommissioning trust funds totaling approximately $974 million, including $393 million in qualified funds and $581 million in nonqualified funds. The trust funds were required to satisfy certain regulatory requirements for decommissioning. None of the three nuclear power plants purchased by AmerGen had been decommissioned as of the relevant 2001 through 2003 tax years.

On its amended 2001 and 2002 tax returns, and on its tax return for 2003, AmerGen asserted that its cost basis in the purchased assets equaled the sum of the cash payments made, plus the decommissioning liabilities assumed. AmerGen claimed depreciation and amortization deductions related to certain of the purchased assets based on a cost basis that reflected the inclusion of the decommissioning liabilities. The IRS disagreed with AmerGen's position and did not allow AmerGen to increase its basis in the acquired assets to the extent of the decommissioning liabilities. AmerGen paid the tax due, then sued the government for a refund in the Court of Federal Claims.

The claims court considered whether AmerGen incurred the decommissioning liabilities at the time of purchase and, specifically, whether at that time those liabilities satisfied the economic performance requirement of Section 461(h). The claims court concluded that the timing rule of Section 461(h)(2)(B) applied. It reasoned that under the rule, economic performance would occur when AmerGen provided the required services, or the decommissioning. Because AmerGen would not decommission its nuclear power plants until years later, the claims court concluded that AmerGen didn't incur the decommissioning liabilities and thus couldn't include them in the basis of the acquired assets at the time of purchase.

On appeal, AmerGen argued that the economic performance requirement codified in Section 461(h) doesn't apply to calculating the basis of purchased assets. AmerGen asserted that the "all events test" is a term of art, and, according to case law before 1984, the test applied only to expense deductions by an accrual method taxpayer, not to basis calculations. AmerGen also argued that because the all-events test isn't directed at a taxpayer using the cash method of accounting, the test doesn't apply to purchase-price basis calculation, which concerns both cash method and accrual method taxpayers.

The appeals court agreed with the IRS's view that Section 461(h) applies in determining when and whether an accrual method taxpayer incurs nuclear decommissioning liabilities for purposes of calculating the basis of an acquired nuclear power plant and associated assets. The court reasoned that Section 461(h)(1) plainly states that it applies for all "purposes of this title," i.e., the Internal Revenue Code, not just to a subset of tax provisions, such as specific deduction provisions.

Additionally, the text of Sections 461(h)(1) and (4) specifies that the sections apply "with respect to any item," and thus the statutory all-events test is not limited to expense deductions. Before 1984, there was no statutory all-events test, and regulations provided a two-prong all-events test for determining when an expense was deductible for an accrual method taxpayer. When Congress enacted Section 461(h), however, it used broader language, namely, "with respect to any item" of a liability. Thus, Congress not only added the economic performance requirement in Section 461(h)(1), but also enacted a new and more inclusive all-events test in Section 461(h)(4) that is not limited to expense deductions by an accrual method taxpayer.

AmerGen also argued that even if Section 461(h) applied, economic performance of its decommissioning liabilities had already occurred under 461(h)(2)(A)(ii), which notes that if a taxpayer liability arises from another person's providing property to the taxpayer, economic performance occurs as the person provides such property, and not under 461(h)(2)(B), which notes that if a taxpayer liability requires the taxpayer to provide property or services, economic performance occurs as the taxpayer provides such property or services. AmerGen argued that it became obligated to incur decommission costs when the sellers conveyed the nuclear power plant.

The appeals court disagreed with AmerGen and concluded that Section 461(h)(2)(B) governs, because the liabilities at issue are services to be provided by the taxpayer, not property provided or a service to be provided to the taxpayer. The appeals court also found AmerGen's other arguments unpersuasive, concluding that AmerGen didn't incur the decommissioning liabilities and couldn't include those liabilities in the basis of the asset acquired.

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