When Congress provides a tax benefit contingent on some activity, there is often a question as to whether the activity can be read broadly to encompass many sub-activities or has to be read narrowly.
This impacts the amount of the tax benefit and how difficult it is to comply. Generally, if construed broadly, the tax benefit is greater. Compliance is also easier as taxpayers do not have to keep detailed time or activity records.
If construed narrowly, the tax benefit is less. And the compliance requirements are greater. If the activity has to be tracked using a very granular measure, even detailed timesheet or activity records may not suffice.
The NextEra Energy, Inc. v. United States, No. 17-12304 (11th Cir. 2018) case provides a good example of the subjective distinctions taxpayers have make when our tax laws specify that an expense is only qualified if tied to a vaguely-defined activity.
The Facts & Procedural History
NextEra Energy operates several nuclear power plants. It made substantial payments to the Nuclear Waste Fund for the disposal of radioactive waste. Spent nuclear fuel and worn components eventually have to be transferred to permanent storage.
The payments were sufficiently large to generate net operating loss (“NOL”) carrybacks. The taxpayer carried these NOLs back as specified liability losses.
Specified liability losses involving “amounts incurred in the decommissioning of a nuclear power plant” can be carried back to the tax year that the plant was placed in service. This can be much longer carryback than the standard one year for non-specified liability losses and ten year period for regular specified liability losses.
The IRS and lower court concluded that the payments to dispose of radioactive waste were not decommissioning costs, which resulted in the current court case.
The Definition of “Decommissioning”
The taxpayer read the definition of “decommissioning” broadly, arguing that the radioactive waste had to be disposed of before and as part of the decommissioning of the plant.
The court read the term “decommissioning” narrowly saying that “disposing of spent nuclear fuel is best thought of as a periodic operational expense and does not qualify as ‘decommissioning’ all or part of a nuclear power plant.” The court went on to explain that:
Spent nuclear fuel must be periodically disposed of, just as trash must be removed from a home. But the regular removal of household trash does not mean the occupants of the home are closing it down. In the same way, the ordinary disposal of spent nuclear fuel is an operational necessity for running a nuclear power plant. It is not an indication that the facility is being “remove[d] . . . safely from service.” See 10 C.F.R. § 50.2. Although the removal of radioactive material is a necessary step for decommissioning, every removal of spent nuclear fuel during the life of the facility is not itself an act of decommissioning. After all, if a nuclear plant operated in perpetuity—and never decommissioned—spent nuclear fuel would still need to be removed because the fuel “will remain dangerous for time spans seemingly beyond human comprehension.” New York, 681 F.3d at 474 (quotation omitted).
While this provides some clarification as to fuel given the specific facts in the case, it does not provide guidance for other expenses. This is the problem with trying to tie a tax benefit to an activity. It is impossible to pin down what qualifies and what does not.
Decommissioning Worn Parts?
For example, what about the portion of the payments that were for the removal of contaminated worn parts? Those parts are waste just like spent fuel. Is the removal of plant parts decommissioning a part of the plant?
The IRS agreed that the cost of removing nuclear fuel assemblies are decommissioning costs in PLR 200711015. Nuclear fuel assemblies are five year property for tax depreciation purposes; they are not treated as part of the plant. If nuclear fuel assemblies qualify, why not spent nuclear fuel? Presumably nuclear fuel could have a longer class life than five years and it is also a separate unit of property from the plant.
Costs Incurred As Part of a Decommissioning Plan?
Or what if the taxpayer incurred the cost as part of a plan to decommission the plant? In the PLR cited above, the IRS considered whether the property is “irrevocably committed to the process of decommissioning.” The court case did not include facts suggesting that there was such a plan. But if there had been, perhaps the court would have reached a different conclusion.
Analogous to the Holding in Union Carbide
The NextEra case did not cite it, but its holding is consistent with the holding in Union Carbide v. Commissioner, T.C. Memo 2009-50. The Union Carbide case is a research tax credit case; it did not involve a specified liability loss (research tax credits have their own carryfowrard and carryback rules).
The Union Carbide case involved a chemical plant. The taxpayer took a research tax credit for its efforts to design a new process for its chemical plant. To test the new process, the taxpayer had to perform test runs. These test runs produced chemicals, the chemicals that the taxpayer normally sold to its customers. Given that the tests were successful, the taxpayer was able to sell the chemicals that were produced during the test runs.
The court (trial and appeals) concluded that the expenses associated with the chemicals were not qualified research expenses, given that they were essentially operational costs.
Immediately Deductible vs. Capitalized
The courts concluded that “decommissioning” in the NextEra case and “research activity” in Union Carbide did not include items that were deemed to be immediately deductible.
When it comes to tax benefits or incentives tied to activities, is the real focus on whether the expense is immediately deductible (as in the case of an ordinary and necessary business expense under Sec. 162, investment expense under Sec. 212, reclamation or closing cost under Sec. 468, etc.) or an expense that has to be capitalized under Sec. 167-168 (research expense under Sec. 174 or a similar rule)?
Maybe the idea is that when there is a question as to how to define an activity and what qualifies as part of that activity, that the taxpayer has been afforded a tax benefit by being able to immediately expense and this benefit is enough to deny other tax benefits for the expense? Put another way, the benefit of immediate expensing justifies a narrow reading of what is included in the activity?
A New Tax-Specific Judicial Statutory Rule of Construction?
Can the immediately expense vs. capitalized distinction provide a demarcation line as to what expenses qualify and what expenses do not in other fact patterns and for other tax benefits and incentives provided for in the Code? And if so, is the converse true too–incentives or tax benefits associated relating to capitalized costs are to be read broadly?
The quiltwork that is our Code does not have this type of uniformity, given that it was enacted and changed on an ad hoc basis over the years.
But perhaps a judicial rule of statutory construction–a tax specific judicial rule–could provide for this. Are these two cases sufficient to conclude that such a judicial statutory construction rule already exists, even though not yet articulated as such by the courts?
How would it fit in with the related but less refined, “tax deductions and credits are a matter of legislative grace and are to be construed narrowly” rule?
If such a rule been recognized, could NextEra’s tax department have used it to conclude that spent nuclear fuel was excluded? Would other taxpayers be able to use it in other fact patterns and for other Code sections and thereby avoid some of these types of disputes altogether?
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