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Re-proposed Repair Regulations: Implications for Gas Utilities TAX Carol Conjura, KPMG LLP, Washington National Tax Susan Grais, Ernst & Young LLP, Washington.

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Presentation on theme: "Re-proposed Repair Regulations: Implications for Gas Utilities TAX Carol Conjura, KPMG LLP, Washington National Tax Susan Grais, Ernst & Young LLP, Washington."— Presentation transcript:

1 Re-proposed Repair Regulations: Implications for Gas Utilities TAX Carol Conjura, KPMG LLP, Washington National Tax Susan Grais, Ernst & Young LLP, Washington National Tax June 29, 2010 Carol Conjura, KPMG LLP, Washington National Tax Susan Grais, Ernst & Young LLP, Washington National Tax June 29, 2010

2 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. 2 ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. The information contained herein is general in nature and based on authorities that are subject to change. Applicability to specific situations is to be determined through consultation with your tax adviser. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials.

3 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. Presenters Carol Conjura, KPMG LLP: Susan Grais, Ernst & Young LLP:

4 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. Agenda Repairs Overview of re-proposed regulations Technical Update Tier 1 Status and Implications Retirements Unit of Property

5 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. Overview of Re-proposed Rules

6 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. 6 Is the expenditure for new construction, acquisition, expansion, or replacement of entire unit of property? Capitalize Restoration? Routine Maintenance Expense New or Different Use? Betterment? Capital vs. Repair Analysis Is the expenditure for new construction, acquisition, expansion, or replacement of entire unit of property? Capitalize Restoration? Routine Maintenance? Expense New or Different Use? Betterment? NO YES NO YES NO

7 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. What is the Unit of Property? Buildings and Structural Components Generally one unit of property, except leasehold improvements Retail outlets and C stores General rule for all other property Functional Interdependence Exceptions Plant property Group of components that performs a discrete and major function Compare 2006 proposal, which used the Uniform System of Accounts Network assets [reserved] (pipelines, storage facilities) Additional rule Separate financial statement lives Different and proper MACRS class or method

8 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. What is a Betterment? Amounts paid result in a betterment to the unit of property only if they: 1.Correct a material condition or defect that existed prior to taxpayers acquisition or arose during production 2.Result in material addition to the unit of property 3.Result in material increase in capacity, productivity, efficiency, strength, or quality to the unit of property or its output Focus is on qualitative, not quantitative change in fair market value Materiality not defined Unavailability of replacement parts Compare with status of property prior to last normal repair, or prior to a particular event

9 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. What is a Restoration? 1.Replace a component deducted as loss 2.Replace a component and basis adjusted for sale or exchange 3.Repair after a casualty if basis adjusted 4.Return the property to operating condition if in a state of disrepair and no longer functional for its intended use 5.Rebuild the property to like-new condition after the end of economic life 6.Replace a major component or substantial structural part after the end of the propertys MACRS recovery period Replace a combination of parts that comprise 50% or more of propertys replacement cost Replace a combination of parts that comprise 50% or more of propertys physical structure

10 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. Repairs after a Casualty Chief Counsel Memo AM Taxpayer cannot take both a casualty loss and repair deduction as a result of a single casualty Applies proposed regulations, even though prospective Inconsistent with CCM , permitting deduction for both casualty loss and restoration expenses Designated as Tier II LMSB exam issue Impact of TAM Unit of property for casualty loss purposes (SIP) Electric transmission unit of property is each transmission line, substation. Electric distribution unit of property is each circuit and substation

11 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. 11 Casualty Loss Example 123 SIP Adjusted Basis$10,000$ -0-$5,000 FMV Decline5,000 10,000 Repair Cost5,000 10,000 Deduction5,000

12 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. 12 Relocation Costs Costs of relocating pipelines and other facilities Do not result in a betterment or restoration Consistent with Badger Pipeline v. Commissioner, T.C. Memo

13 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. 13 Removal Costs Rev. Rul If retirement and removal of an asset occurs in connection with the installation or production of a replacement asset, removal costs are deductible Applies to single asset or mass asset accounts Not applicable to removal of a component of a depreciable asset If replacement is a repair--removal costs are deductible If replacement is an improvementremoval costs are capital Compare re-proposed regulations which treat replacement of component as capital if gain or loss recognized on removal

14 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. Environmental Remediation Re-proposed regulations are consistent with Rev. Rul Soil and groundwater cleanup associated with existing business operations are not required to be capitalized Costs of water treatment facility are capital But see Rev. Rul : Otherwise deductible environmental remediation costs must be capitalized under section 263A if incident to production of property 14

15 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. Environmental Remediation (contd) Pre-existing material condition or defect Remediation of pre-acquisition contamination treated as a betterment Latent hazardous conditions not treated as a pre- existing material condition or defect Compare Kerr-McGee v. US, 77 Fed. Cl. (2007) Application to otherwise periodic maintenance following an acquisition is uncertain Extension of section 198 Election to expense otherwise capital remediation 15

16 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. Spare Parts Under current law, may be classified as supplies or fixed assets, depending on facts Expendable parts are generally treated as supplies Deferred expense, deductible when consumed Emergency standby parts and repairable parts are generally treated as fixed assets Depreciation begins when acquired and ready for use Rotable spare parts Current law: deductible when placed in service Re-proposed regulations: deductible when disposed of 16

17 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. Supplies Definition of supply Not a unit of property Unit of property with economic useful life of 12 months or less Unit of property with acquisition or production cost of $100 or less Identified in published guidance Election to capitalize and depreciate if supply is a unit of property or a component of a unit of property that is not a supply 17

18 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. 18 Simplified method for regulated taxpayers FERCFCCSTB Must follow regulatory method of accounting for tax purposes Must use for all tangible property subject to regulatory accounting rules Optional Regulatory Accounting Method

19 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. Routine Maintenance Safe Harbor Includes recurring activities to keep a unit of property in ordinarily efficient operating condition Activities are routine if: Reasonably expected to occur more than once in an assets MACRS class life Gas productionEvery 7 years or more frequently Gas transportationEvery 11 years or more frequently Not applicable if property restored under tests 1-4 i.e., if replacements are componentized or after a casualty, or dysfunctional state 19

20 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. 20 Minimum Capitalization Rule Taxpayer may use financial statement minimum capitalization policy Requirements/restrictions Not applicable to repair and improvement costs Applicable Financial Statement; written accounting procedures; no income distortion Safe harbor for no distortion--total aggregate amount of expenses does not exceed the lesser of 0.1% of gross receipts 2.0% of total depreciation and amortization expense Annual, unit-by-unit, election to capitalize and depreciate

21 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. 21 Section 263A Impact Re-proposed regulations obsolete the general plan of rehabilitation doctrine See situation 3 of Rev. Rul , requiring otherwise deductible repairs to be capitalized if incurred at same time as capital improvements Pursuant to section 263A, only repairs that directly benefit or are incurred by reason of an improvement are required to be capitalized For example, if a utility incurred costs to expand the capacity of a processing plant, contemporaneous repairs to the existing structure would remain deductible

22 ©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. Section 263A Impact (contd) Repairs in connection with inventory production must be capitalized to current production Section 481 adjustment for repairs change relates to prior production activities Impact depends on inventory cost flow assumption May relate to prior LIFO layer 22


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