IRS proposes to change treatment of long-standing utility removal costs.

• Author: Wagner, Elizabeth

The IRS Utility Industry Specialization Program (UISP) coordinator recently submitted a proposed Coordinated Issue Paper (CIP) to the IRS National Office on the tax treatment to be afforded the costs that utilities incur to remove fixed assets used in that industry. The UISP proposes that the Service adopt a policy that would require the vast preponderance of these costs to be capitalized into the bases of other utility assets (thereby being recovered through depreciation over the lives of those other assets). This stands in direct contrast to the deduction of such costs, which has been the industry's current and historical treatment.

The UISP proposal does not apply direct precedent to the utility industry (i.e., the UISP paper does not cite any case or ruling requiring removal costs to be capitalized). Instead, the paper extends one or more existing tax law principles--the "general plan" doctrine of capital improvement and the general principle of cost capitalization. Citing Werhli, 400 F2d 686 (10th Cir. 1968) and True, 10th Cir., 1990, the UISP paper contends that if there is a general capital improvements plan, all costs (not only those directly attributable to asset acquisition and installation) are subject to capitalization. This would be the case regardless of whether any expenditure, by itself, could be classified as a deductible business expense. In addition, the UISP proposal contends that Secs. 263 and 263A apply, because all direct and indirect costs of a capital project (in this case, some new asset) must be capitalized unless there is a specific exemption. The UISP and the industry disagree on whether removal costs are, in fact, a direct or indirect cost of such capital projects.

For many years, the utility industry has deducted fixed asset removal costs as incurred, because it believes that this cost is a component of the asset removal life cycle. (i.e., it relates to that asset's economic productivity, not to that of some subsequent asset). This relationship "backward" (to the removed asset) and not "forward" (to some new asset) has facilitated income and expense matching, as reflected in the accounting literature that addresses utility industry regulatory and financial accounting practices. Moreover, utility industry companies' engineering and construction management systems specifically identify removal costs as such (due to the very distinctive regulatory accounting requirements relating to these costs); the regulatory...