Court of Federal Claims Rules Nuclear Decommissioning Obligations Assumed On Purchase Not Included In Basis
The Court of Federal Claims (CFC) has ruled that AmerGen Energy may not include nuclear decommissioning and similar future dismantlement liabilities assumed on the purchase of nuclear plants in its tax basis. AmerGen Energy Co. v. United States, ___ Fed. Cl. ___ (Oct. 8, 2013). The CFC accepted the IRS position that obligations assumed in an asset purchase are not includable in cost basis, and not subject to depreciation or amortization, until the purchaser satisfies the economic performance requirement of Section 461(h) of the Internal Revenue Code. Because economic performance of the decommissioning and similar obligations will not occur until AmerGen closes the plants, AmerGen was not permitted to currently include such obligations in basis. The decision results in asymmetrical treatment of the sellers and buyers in these transactions.
Taxpayers like AmerGen, who acquire assets that carry substantial future decommissioning, dismantlement, or similar liabilities, need to be alert for the potentially costly impact of this result. If the AmerGen reasoning stands, where a buyer acquires assets in exchange for cash and assumption of a liability that has not yet satisfied the economic performance standard, the buyer's cost basis may be limited to the cash paid until such time as economic performance occurs. Where the assumed liability is of significant magnitude, as is the case for nuclear decommissioning liabilities, application of the economic performance requirement can result in significant distortions of the buyer's cost basis and income in the years following the acquisition.
AmerGen purchased three nuclear plants in exchange for cash and the agreement to assume the nuclear decommissioning and similar liabilities associated with each plant. In addition to depreciable assets, the sellers had previously established two trusts for each plant to fund decommissioning: (i) qualified nuclear decommissioning reserve funds under Section 468A (qualified trusts), which were not at issue in the case, and (ii) grantor trusts that were not qualified under Code Section 468A (nonqualified trusts). The issue in the case was whether AmerGen could include the assumed nuclear decommissioning liabilities in its cost basis under Code Section 1012, including in the basis of the assets included in the nonqualified trusts. As explained below, the CFC determined this issue adversely for AmerGen, which created significant phantom gains for AmerGen on routine sale of the assets in the nonqualified trusts and reinvestment of the proceeds.
Economic Performance Applied to Determinations of Cost Basis
The parties agreed that, with respect to the nuclear decommissioning and similar liabilities assumed by AmerGen, the fact of liability was established and the amount of the liabilities could be determined with reasonable accuracy. The IRS argued that AmerGen, an accrual basis taxpayer, could not include the decommissioning liabilities in its cost basis until economic performance had occurred. The IRS relied upon the third prong of the "all events" test in Code Section 461(h), which Congress added in 1984. AmerGen, in opposition, argued that whether liabilities were included in basis should be determined under the contingency test that courts applied under Section 1012 prior to enactment of Section 461(h), and the decommissioning liabilities were not so contingent so as to be excluded from basis under that test. See, e.g., Albany Car Wheel. Co. v. Comm'r, 40 T.C. 841 (1963) (taxpayer's obligation under labor contract was of such contingent character that it could not be considered part of the cost of acquired assets under Section 1012).
The CFC, in a case of first impression, found that the plain meaning of Section 461(h) was that the economic performance test applied to "any item," not limited to deductions and, in the CFC's view, including basis determinations. The CFC reasoned that prior to Section 461(h), courts applied the all events test to determine basis, and the economic performance test is now a part of the all events test. However, the cases cited by the CFC do not involve determinations of cost basis under Section 1012. See, e.g., ExxonMobil Corp. v. Comm'r, 114 T.C. 293 (2000) (applying all-events test to additions to basis, not cost basis); La Rue v. Comm'r, 90 T.C. 465 (1988) (applying all events test to partnership liabilities included in basis under Section 752). In this sense, the CFC opinion breaks new ground. The CFC also relied upon Treasury Regulation § 1.446-1(c)(1)(ii), providing that a liability is taken into account for Federal income tax purposes by an accrual basis taxpayer only after economic performance has occurred. Although this regulation was controversial when promulgated, the CFC said that the regulation was a valid interpretation of the statute and entitled to deference. Moreover, the CFC held that the regulation applies in determining cost basis under Section 1012 in a taxable purchase transaction. Accordingly, the CFC found that the decommissioning and similar liabilities assumed by AmerGen could not be taken into account in computing basis because economic performance had not yet occurred.
AmerGen argued that applying the economic performance requirement to cost basis determinations based on Treasury Regulations § 1.446-1(c)(1)(ii), which is by its terms applicable only to accrual basis taxpayers, would create separate rules for determining cost basis for taxpayers on the accrual basis, compared to cash basis taxpayers. The CFC did not address this argument, holding that AmerGen was too late in raising this argument in its reply brief. It remains to be seen whether different rules apply for taxpayers on the cash basis, although the AmerGen Court did not appear likely to be swayed by this argument.
Asymmetrical Treatment and Phantom Gains
The AmerGen decision created asymmetrical results for the sellers of the nuclear plants, and AmerGen as buyer of the plants. The IRS apparently issued PLR 200243024 (Oct. 25, 2002) in the administrative consideration of the AmerGen case, or at least the ruling covers a very similar situation. In the PLR, the IRS addressed the tax consequences of nuclear decommissioning and similar liabilities assumed in a purchase for both the seller and the buyer and held that the economic performance test was satisfied for the seller, but not the buyer. For the seller the economic performance test was deemed satisfied at the time of the sale of the trade or business under Treasury Regulation § 1.461-4(d)(5) (sale of trade or business along with liability satisfies economic performance requirement). For the buyer economic performance was deemed not to be satisfied, and the buyer could not increase its cost basis, until the plants were closed and the decommissioning funds were spent. This asymmetrical treatment of the sellers and buyer is an odd result in a taxable transaction.
The consequences of this asymmetrical treatment appear to have been particularly onerous for AmerGen because of the relative size of the nuclear decommissioning liabilities that AmerGen assumed in the transaction. Under the CFC's ruling, the basis in the investment assets held in the nonqualified trusts for decommissioing costs could include only the cash paid by AmerGen, which AmerGen had to allocate in a cascading sequence among the various classes of assets that AmerGen acquired in the transaction. See Code § 1060; Treas. Reg. §§ 1.1060-1(c), 1.338-6, 1.338-7 (sequential allocation among assets in classes I (cash) through VII (goodwill)). AmerGen's cash consideration in the purchases was insufficient to bring its cost basis in the assets in the non-qualified trusts up to fair market value. As a result, AmerGen had over $80 million in gains from sales of the investment assets; gains which would not have been realized had AmerGen been permitted to include the decommissioning liabilities in basis.
In sum, the Court of Federal Claims has upheld the IRS position that liabilities assumed in an asset purchase are not includible in cost basis until the purchaser satisfies the economic performance requirement with respect to such obligations. For AmerGen, the inability to include assumed decommissioning and similar liabilities in cost basis resulted in a reduction in depreciation and amortization deductions for assets purchased. More significantly, however, it also appears to have resulted in significant phantom gains on investment assets held in trust to fund the decommissioning liabilities in question received as part of the purchase.
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