UNITED STATES TAX COURT

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115 T.C. No. 38

UNITED STATES TAX COURT

FPL GROUP, INC. AND SUBSIDIARIES, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 5271-96.

Filed December 13, 2000.

F, a regulated electric utility, is a wholly owned

subsidiary of P. F is required to follow prescribed

regulatory rules for regulatory accounting and

financial reporting purposes.

In preparing its

consolidated tax returns for the years in issue, P

characterized F' s expenditures by using the same

characterization that F used for regulatory accounting

and financial reporting purposes.

In.an amended

petition, P sought to recharacterize as repalr

expenses, expenditures which it had characterized as

capital expenditures for tax purposes.

Held: P's method of accounting for tax reporting

purposes was to characterize the expenditures in issue

consistently with the method that F used for regulatory

accounting and financial reporting purposes. By

seeking to alter the method which it used to

characterize expenditures, P is attempting to change

its method of accounting. P has failed to obtain the.

consent of the Secretary to change its method of

SERVED DEC 1 3 2000

- 2 acöounting under sec. 446(e), I.R.C.; therefore, P is

noh entitled to the claimed expense deductions.

Robert Thomas Carney, for petitioner.

Gary F. Walker, Sergio Garcia-Pages, and Robert W. Dillard,

for respondent .

OPINION

RÚWE, Judge:

This matter is before the Court on

respondent's motion for partial summary judgment filed pursuant

to Rule 121.1

The sole issue presented is whether petitioner's

attempf to recharacterize as repair expenses, expenditures which

it hadl characterized on its tax returns as capital expenditures

for the taxable years 1988 to 1992, is an impermissible change in

accounhing method under section 446 (e) .

Background

FPL Group, Inc.

(petitioner) is a corporation organized and

existihg under the laws of the State of Florida with its

principal office located in Juno Beach, Florida. . Florida Power &

Light Co.

(Florida Power) is a wholly owned subsidiary of

1Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in issue, and

all RÊle references are to the Tax Court Rules of Practice and

Procedure .

- 3 petitioner.

Petitioner filed consolidated returns with Florida

Power during the years in issue .

On December 28, 1995, respondent issued a notice of

deficiency for the taxable years 1988 through 1992.

In its First

Amended Petition, filed May 13, 1996, petitioner argued for the

first time that respondent erred in failing to allow a deduction

for certain repair expenses related to Florida Power when

determining the· deficiency amounts in the notice of deficiency.

Petitioner claimed that it had improperly characterized the

following expenditures relatedsto Florida Power as capital

expenditures and that it should have deducted them as repair

expenses:

Year

1988

1989

1990

1991 .

1992

Total

Amount

$35, 324 , 412

52,115,791

54,746,820

56,823,897

11, 914 , 614

210 , 925, 534

Petitioner did not file a Form 3115, Application for Change in

Accounting Method, with respondent to request a change in

accounting method for the expenditures at issue.

Respondent did

not raise the change in accounting method issue prior to the

filing of his motion for partial summary judgment.

Florida Power owns and operates fossil and nuclear electric

generating plants in Florida and also owns interests in coalfired electric generating plants in Georgia and Florida, which

are operated by other utilities. Florida Power provides.public

electric utility services in Florida.

Florida Power is subject

to the regulatory rules of the Federal Energy Regulatory

Commiss on (FERC) and the Florida Public Service Commission

(FPSC).

The FERC regulates the rates that Florida Power may

charge

o its wholesale customers.

The FPSC regulates the rates

that Florida Power may charge to its retail customers.

For regulatory purposes, property at Florida Power's

electrfc generating plants (electric plants) is considered as

consisning of "retirement units" and. "minor items of property".

A retirement unit is the overall unit of property while the minor

items of property are the associated parts or items which compose

a retirement unit.

Examples of retirement units include air-

conditioning systems, bridges, elevators, and cars.

The

regulatory rules determine which expenditures at Florida Power's

electric plants are capitalized and which expenditures are

expensed for regulatory accounting purposes.

Expenditures for

the addition or replacement of a retirement unit are required to

be caØitalized, while the replacement of a minor item of property

is generally deducted as a repair expense.2

Florida Power, as a

2Under regulatory accounting, expenses that are capitalized

are taken into the capital base for ratemaking purposes (i.e.,

they receive an allowed "rate of return" on capital investment).

On the other hand, expenditures deducted as current expenses are

passeÈ on to customers (and, therefore, reimbursed dollar-fordollar) in the allowed rates.

regulated electric utility, is required to follow regulatory

accounting for financial reporting purposes.

The FERC publishes a Uniform System of Accounts (USOA) which

contains a standard set of accounts3 rules, and regulations.

Florida Power, as a major electric utility, is required to follow

the USOA.

USOA.

The FPSC also requires Florida Power to follow the

For regulatory accounting purposes, the FERC also

publishes a list of Units of Property for Use in Accounting for

Additions and Retirements of Electric Plant (FERC.list), which is

separate from the USOA.

The units of property identified in the

list are referred to as retirement units.

The FERC list of

retirement units may be expanded by any utility without other

authorization by the FERC, but no retirement unit may be larger

in size than those identified in the FERC list.

The FERC list

may not be condensed, but a subdivision or addition of other

units is.permitted.

The FPSC authorizes an expanded list of retirement units

(FPSC list) beyond those prescribed by the FERC.

The FPSC has

the discretion to authorize a list of retirement units in which

the retirement units are larger in size than dhe corresponding

FERC retirement units.

Florida Power could add retirement units

to the FPSC list or expand the size of existing retirement units,

but it had to notify the FPSC semiannually of these changes.

Increasing the size of retirement units would increase the amount

of costs charged to expense, while decreasing the size of

retiremënt units would increase the amount of capitalized costs.

During the years in issue, petitioner utilized.the FPSC

requirements for regulatory ·accounting purposes.

Florida Power

made mo e than 450 changes between 1988 and 1992 to the FPSC list

of retirement units and semiannually notified the FPSC of the

changes.

However, the retirement units used by Florida Power for

FPSC'pu poses did not exceed the limits for retirement units as

prescribed by the FERC.

Thus, Florida Power's utilization of the

FPSC requirements in defining retirement units automatically

conforded with the FERC regulatory accounting requirements.3

32ba example of the aforementioned regulatory concepts

illust$ates the accounting principles of the FERC and FPSC.

Suppose that P owns five cars. Each car is defined as a

retirement unit in the FERC list. The wheels, seats, and other

components of the car would be considered minor items of

property. Under the FERC, P could add more cars or replace

existing cars, and the corresponding costs would be capitalized.

The costs of the replacement of the wheels, seats, etc., would

generally be considered as expenditures related to minor items of

property and generally would be expensed. Theoretically, P could

subdivide the car into smaller retirement units, so that the

wheels; seats, etc., would be considered separate retirement

units. This would increase the amount of capitalized costs

because additions or replacements of the wheels, seats, etc.,

would be required to be capitalized under regulatory rules.

However, under the FERC, P is prohibited from increasing the size

of the retirement units; i.e.,. defining a retirement unit to

include all five cars. The FPSC has the discretion to allow P to

increase the size of the retirement units. This action, if

available to P, might theoretically allow all five cars to be

identified as one retirement unit; thus, the individual cars

might be defined as minor items of property. This would result

in an increase in the size of the retirement unit (from one car

to five cars), and the amount of costs charged to repair expense

(continued...)

During the years in issue,'Florida PQwer incurred

substantial costs related to its electric plants.

The

expenditures for these costs were recorded as either capital

expenditures or repair expenses for regulatory.accounting and

financial reporting purposes.

In preparing its tax returns for

the years in issue, petitioner used the same characterization of

expenditures for tax reporting purposes that Florida Power did

for regulatory accounting and financial reporting purposes,

except for specific Schedule M-1, Reconciliatioh of Income (Loss)

Per Books With Income Per Return, adjustments.'

For the years in

.issue, petitioner characterized approximately $2.1 billion in

expenditures related to Florida Power's electric plants as repair

Texpenses for tax purposes.

During the years in issue,.petitioner made Schedule M-1

adjustments on its original tax returns with respect to Florida

Power.

The Schedules M-1 adjustments for the years 1988 to 1991

3(...continued)

might be increased. However-, if P did elect to increase the size

of the retirement units under the authority of the FPSC, P would

be in violation of the FERC rules prohibiting increases in the

size of retirement units. Thus, the retirement units actually

used by Florida Power for regulatory accounting purposes

conformed with FERC rules.

'A Schedule M-1 is a schedule attached to a Form 1120, U.S.

Corporation Income Tax Return. It identifies the different

treatment of income and expense items for book and tax purposes.

See Southwestern Energy Co. v. Commissioner, 100 T.C. 500, 503

n.4 (1993); Orange & Rockland Utils. v. Commissioner, 86 T.C.

199, 205

(1986).

- 8 reflected petitioner's election to apply the.percentage repair

allowance (PRA), a specific tax provision allowing petitioner to

deduct as repair expenses.a set percentage of expenditures for

the repåir, maintenance, rehabilitation, or improvement of

certain property.

See sec. 1.167(a)-11(d) (2), Income Tax Regs.®

The Schedule M-1 adjustment for 1992 was for a storm reserve and

related to damages caused by Hurricane Andrew.'

Other than the

variatiöns for the PRA and storm reserve, petitioner used the

same characterizations of expenditures for tax purposes that

Florida Power did for regulatory accounting and financial

reportihg purposes.

For the taxable year 1992, petitioner filed two amended

returns with claims related to the characterization of

expenditures associated with Florida Power.

In its first amended

return, filed in September of 1993, petitioner claimed additional

storm expenses of $412,042 and an additional repair expense

deduction of approximately $4.7 million for cable injection

Respondent has alleged -that the following amounts were

deductsd as repair expenses under the PRA for the years 1988 to

1991:

Year

Amount

1988

1989

1990

1991

$28,501,471

29,315,281

28,635,238

25,806,865

Petitioner has not disputed these amounts.

'The Schedule M-1 adjustment for the storm reserve was in

the amount of $6 million.

expenditures .

The storm expenses were accepted by respondent and

a portion of the claimed repair expense deduction was allowed by

respondent.

In its second amended return,. filed in December of

1993, petitioner claimed an additional repair expense deduction

of approximately $21 million related to the same type of

expenditures currently in issue .

Respondent allowed an

additional repair expense deduction for these expenditures .in the

amount of approximately $11 million.

During the audit of the .

years 1988 to 1992, respondent proposed to capitalize certain

expenditures related to Florida.·Power that. petitioner had

reported as deductible repair expenses on its original tax

returns.

Discussion

Summary judgment is intended to expedite litigation and

avoid unnecessary and expensive trials.

See Northern Ind. Pub.

Serv. Co. v. Commissioner, 101 T. C. 294, 295

Commissioner, 61 T.C. 861, 862

(1974) .

(1993) ; Shiosaki v.

Rule 121(a) provides that

either party may move for a summary judgment :upon all or any part

of the legal issues. in controversy.

Full or partial summary

judgment is appropriate where there is no genuine issue as to any

material fact and a decision may be rendered as a matter of law.

See Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518,

520 (1992), affd. 17 F.3d 965 .(7th Cir. 1994).

Respondent, as

the moving party, bears the burden of proving that no genuine

- 10 issue exists as to any material fact and that he is entitled to

judgment as a matter of law.

See Bond v. Commissioner, 100 T.C.

32, 36 .(1993); Naftel v. Commissioner, 85 T.C. 527, 529

(1985).

In deciding whether to'grant summary judgment, the factual

materials and the inferences drawn from them must be considered

in the light most favorable to the nonmoving party.

See Bond v.

Commissioner, supra at 36; Naftel v. Commissioner, supra at 529.

Once a motion for summary judgment is made and supported,

the nonmoving party must do more than merely allege or deny facts

in its pleadings, it must "set forth specific facts showing that

there is a genuine issue for trial.

If the adverse party does

not so respond, then a decision, if appropriate, may be entered

against such party."

Rule 121(d); Celotex Corp. v. Catrett, 477

U.S. 317, 324. (1986); Sundstrand Corp. v. Commissioner, supra at

520.

Moreover, summary judgment may be granted if the evidence

submitted by the nonmoving party is merely colorable or not

significantly probative.

477 U.S. 242, 249-250

See Anderson v. Liberty Lobby5 Inc.,

(1986).

Pëtitioner argues that some of the factual allegations made

by respondent are in dispute.

After reviewing the materials

filed by both parties, we find that there is no genuine issue as

to any of the material facts that we have set forth in the

background section of this opinion.

"Only disputes over facts

that sight affect the outcome of the suit under the governing law

- 11 -

will properly preclude entry of summary judgment.

Factual

disputes that are irrelevant or unnecessary will not be counted."

Anderson v. Liberty Lobby, Inc., supra at 248.

Respondent argues that petitioner's attempt to

recharacterize as repair expenses, expenditures which it had

characterized as capital expenditures, is prohibited under

section 446(e) as an impermissible change in accounting method

because petitìoner did not obtain respondent's consent to

recharacterize the expenditures.

Respondent claims that, for

regulatory, financial, and tax accounting purposes, petitioner

consistently followed the regulatory accounting rules and

pguidelines to determine which expenditures to capitalize and

which expenditures to expense at Florida Power's electric plants.

Respondent contends. that this consistent treatment constitutes

petitioner's method of accounting with respect to the

expenditures in issue.

Petitioner argues that its method of accounting was to

deduct expenditures to the extent allowed under section 1.162-4,

Income Tax Regs.,7 and that the regulatory accounting

7Sec. 1.162-4, Income Tax Regs., provides:

Sec. 1.162-4. Repairs.--The cost of incidental

repairs which neither materially add to the value of

the property nor appreciably prolong its life,.but keep

it in an ordinarily efficient operating condition, may

be deducted as an expense, provided the cost of

acquisition or production or the gain or loss basis of

(continued...)

- 12 requirements of the FERC and the FPSC were not its method of

accounting for purposes of determining the characterization of

expendiÜures at Florida Power's electric plants.

In classifying

expenditures as capital expenditures or repair expenses for tax

purposes, petitioner claims that it used the amount of repair

expensey determined for regulatory accounting and financial

reporting purposes as a "reasonable approximation" of the amount

of repair expenses allowable for tax purposes.

From there,

petitioner claims that it made certain adjustments to increase

the ded ctible repair amount for tax purposes when it became

aware that certain expenditures were erroneously classified as

capital expenditures.

Petitioner also claims that the

recharabterization is a mere "correction" which does not

constitute a change in accounting method.

Finally, petitioner

implies that respondent's failure to raise the change in

accountiing method argument when petitioner.claimed the additional

repair expense deduction for 1992 should prevent respondent from

now challenging petitioner's attempted recharacterization.

7(...continued)

the taxpayer's plant, equipment, or other property, as

the case may be, is not increased by the amount of such

espenditures. Repairs in the nature of replacements,

to the extent that they arrest deterioration, and

appreciably prolong the life of the property, shall

either be capitalized and depreciated in accordance

with section 167 or charged against the depreciation

reserve if such an account is kept.

- 13 -

Method of Accounting

Section 446(a) provides that "Taxable income shall be

computed under the method of accounting on the basis of which the

taxpayer regularly computes his income in keeping his books."

The term "method of accounting" includes both the "over-all

method of accounting" and "the accounting treatment of any item."

Sec. 1.446-1(a) (1), Income Tax Regs.

A method of accounting

includes "the consistent treatment of.a recurring, material item,

whether that treatment be correct or incorrect."

Co. v. Commissioner, 53 T.C. 439, 447

(6th Cir. 1971).

H.F. Campbell

(1969),·affd. 443 F.2d 965

A taxpayer changes its method of accounting

when it changes either the "overall plan of accounting for gross

income or deductions" or "the treatment of any material item used

in such overall plan."

Sec. 1.446-1(e) (2) (ii) (a), Income Tax

Regs.

A "material item" is "any item which involves the proper

time for the inclusion of the item in income or the taking of a

deduction."

510

Wayne Bolt & Nut Co. v. Commissioner, 93 T.C. 500,

(1989); sec. 1.446-1(e) (2) (ii) (a), Income Tax Regs.

A change

in accounting method may be ·effected only after consent is

obtained from the Secretary.

See sec. 446(e).

"The primary effect of characterizing a payment as either a

business expense or a capital expenditure concerns the timing of

the taxpayer's cost recovery: While business expenses are

currently deductible, a capital expenditure usually is amortized

and depreciated over the life of the relevant asset".

Inc. v. Commissioner

503 U.S. 79, 83-84

(1992).

INDOPCO,

This Court has

held that the determination of whether an expenditure constitutes

a capitål expenditure or a currently deductible expense involves

the question of the proper time for taking a deduction.

See

Pelaez à Sons, Inc. v. Commïssioner, 114 T.C. 473, 489 (2000);

Southern Pac. Transp. Co. v. Commissioner, 75 T.C. 497,. 683

(1980), supplemented by 82 T.C. 122

(1984); Hooker. Indus., Inc.

v. Commissioner, T.C. Memo. 1982-357; sec. 1.446-1(e) (2) (ii) (a),

Income Tax Regs.

An accounting practice involving the timing of

when ad item is deducted is considered a method of accounting.

See GMd & Subs. v. Commissioner, 112 T.C. 270, 296

(1999);

Knight-Ridder Newspapers, Inc. v. United States, 743 F.2d 781,

797-798

(11th Cir. 1984).

In Southern Pac. Transp. Co. v. Commissioner,. supra, we

applieÊ section 1.446-1(e) (2) (ii) (b), Income Tax Regs., for

purposes of deciding whether the expenditures in issue were for a

"material item".

Section 1.446-1(e) (2) (ii) (b), Income Tax Regs.,

providès that "a correction to require depreciation in lieu of a

deduction for the cost of a class of depreciable assets which had

been cónsistently treated as an expense in the year of purchase

involvës the question of the proper timing of an item, and is to

be tre ted as a change :'u2 method of accounting."

Although the

taxpayer in Southern Pac. Transp. Co. v. Commissioner, supra, was

- 15 -

attempting to change from capitalizing the expenditures in issue

to expensing them, the reverse of the situation described in the

regulations, we were not convinced of the merit of this

distinction and we regarded both situations as examples of

changes involving the timing of a deduction.

See Southern Pac.

Transp. Co. v. Commissioner, supra at 683 n.211.

We held that

the expenditures that the taxpayer was attempting to

recharacterize from capital to expense fit the definition of

"material item".

Id. at 683.

Although section 446(a) requires a taxpayer to compute his

taxable income.in the same manner that he computes income in his

books, this requirement is not absolute.

Courts have permitted

variations between financial and tax reporting where other Code

requirements, such as sections 162 and 263, are met, and the

method of accounting clearly.reflects income.

See USFreightways

Corp. & Subs. v. Commissioner, 113 T.C. 329, 332

(1999).

Where

the taxpayer is governed by regulatory agencies, the taxpayer is

not automatically required to follow the regulatory accounting

rules when it reports its activities for tax purposes.

Commissioner v. Idaho Power Co., 418 U.S. 1,

14-15

Colony R..R. v. Commissioner, 284 U.S. 552, 562

See

(1974); Old

(1.932).

However,

while regulatory accounting rules are not binding on a taxpayer,

they are necessarily linked with tax accounting, and the

consistent practice of applying regulatory rules for tax

_ 16 -

reporti g purposes cannot be ignored.

Power Co., supra at 14-15.

See Commissioner v. Idaho

In that case, the Supreme Court

stated:

Some, although not controlling, weight must be

given to the fact :that the Federal Power Commission and

thé Idaho Public -Utilities Commission required the

taxpayer to use accounting procedures that capitalized

construction-related depreciation. Although agencyimposed compulsory accounting practices do not

necessarily dictate tax consequences, they are not

irrelevant and may be accorded some significance. * * *

where a taxpayer' s generally accepted method of

accounting is made compulsory by the regulatory agency

anÊl that method clearly reflects income, it is almost

presumptively controlling of federal income tax

consequences.

[Id. at 14-15; citations and fn. ref.

omitted.]

For regulatory accounting and financial reporting purposes,

Florida Power followed regulatory rules and guidelines to

determine the characterization of expenditures related to its

electric plants.

The fact that the regulatory accounting

requirements allowed Florida Power some flexibility in defining

retirempnt units does not change this.

The retirement units used

by Florida Power for FPSC purposes did not exceed the limits

prescribed by the FERC for the years in issue, and petitioner

. acknowledges that its characterization of expenditures for FPSC

purposes "automatically conformed with FERC regulatory .accounting

principles."

The FERC prohibited public utilities from

condensing the FERC list of retirement units or from adding any

retirement units that exceeded the size of the FERC retirement

units. 1 Once a retirement unit was established, the cost of

- 17.adding or replacing the retirement unit had to be capitalized.

Thus, while Florida Power's.limited ·flexibility in defining

retirement units could in some cases affect the amounts of

capital expenditures.or repair expenses, once the retirement unit

was identified the regulatory characterization rules requiring

capitalization were not flexible,. · The regulatory rules

ultimately determined which expenditures were capitalized and

which expenditures were expensed for regulatory accounting and

financial reporting purposes.

In Southern Pac. Transp. Co. v..Commissioner, supra, the

taxpayer was subject to Interstate Commerce Commission (ICC)

accounting rules which required the capitalization of certain

expenditures.

See id. at 676.

For the taxable years at issue,

the taxpayer followed the ICC accounting rules and capitalized

the expenditures in issue for regulatory and tax purposes.

id.

See

The Commissioner issued a notice of deficiency regarding

other issues, and the taxpayer filed a petition with this Court

for a redetermination of the deficiency.

See id. at 505.

In an

amended petition, the taxpayer raised,.for the first time, the

argument that the Commissioner erred in failing to allow the

capitalized expenditures as currently deductible expenses.

id. at 677.

See

The Commissioner argued that the taxpayer's attempt

to recharacterize the expenditures was an impermissible change in

the taxpayer's method of accounting under section 446(e) because

_ 18 -

the Comnissioner had not consented to the change.

680.

See id. at

held that, regardless of whether the expenditures were

more pr perly deductible as business expenses under section 162.,

allowin

the taxpayer to. deduct such expenditures would result in

an impe missible change in method of accounting.

We foun

alte

See id. at 687.

it readily apparent that the taxpayer was seeking to

the manner in which it had consistently accounteds for a

recurrihg, material item.

See id. - at 686.

We explained that a

change kn the treatment of the expenditures involved a. question

of prop r timing, .thus the àhange in treatment would af fect a

materia L item.

See id.' at 683.

The taxpayer consistently

followed the ICC accounting rules in capitalizing certain

expendi ures · for tax reporting purposes, and its later attempt to

recharapterize those. expenditures as repair expenses was

prohibited, absent consent by the Commissioner.

In Wayne Bol t & Nut Co . v . Commis s ioner , 93 T . C . 50 0 (1989) ,

the tax ayer, for a number of years, determined its ending

invento y by selecting a small portion of its inventory cards and

using them to approximate the ending. inventory.

See id. at 503.

Later, Èhe taxpayer completed a physical inventory in which it

identified and catalogued all inventory.

See id. at 504.

Based

on this thorough examination of inventory, the. taxpayer attempted

to adjust iÈs opening inventory to reflect the actual amount

identified.

See id. at 504-505.

This amount was considerably

- 19 larger than the amount determined under the approximation method

previously used by the taxpayer.

See id. at 512.

We held that

the taxpayer's "change from a seriously flawed and disorganized

method * * * to a method of determining both opening and ending

inventory * * * on the basis of a complete.physical inventory

[was] a change in the treatment of a material item and,

therefore,

510.

[constituted] a change in accounting method."

Id. at

We found that the approximation method of determining

inventory, while disorganized and inaccurate, was consistently

used by the taxpayer despite his actual knowledge that the

.inventory amounts were not completely accurate.

See id. at 512.

This consistent practice constituted a method of accounting for

determining inventory.

See id.

Petitioner argues that Wayne Bolt & Nut Co. v..Commissioner,

supra, does not apply because it involved inventories and they

are governed by separate ·and distinct rules.for purposes of

determining a method of accounting.

We disagree.

While there

are specific regulations which address the accounting treatment

of inventories, the basic principles apply for purposes of

determining a method of accounting; namely, that a consistent

method used to determine the tax treatment of a material item is

a method of accounting.

Our holding and reasoning in Wayne Bolt

& Nut Co. v. Commissioner, supra, is applicable to the instant

case.

- 20 -

The regulatory rules provided the guidelines for determining

Florida, Power's characterization of expenditures for regulatory

accounting and financial reporting purposes.

Petitioner

conscioûsly chose to use consistently the same characterization

for tax purposes that Florida Power did for regulatory and

f inancial purposes .

Petitioner argues that it used the amounts Florida Power

reported for regulatory purposes as a "reasonable approximation"

for tax purposes rather than reviewing its work orders to

determine which expenditures to capitalize and which to expense.

Petitioner has made no allegations that it alerted respondent to

the.fact that it was reporting only approximations and expected

to recharacterize expenditures years later.

Section 1.446-

1 (a) (4) , Income Tax Regs . , provides that the taxpayer' s

accounting records must be maintained in such a manner as to

enable him to file a correct return of his taxable income for

each taxable year.

One of the essential features that the

taxpayek must consider in maintaining such records is:

Exþenditures made during the year shall be properly

classified as between capital and expense. For

example, expenditures for such items as plant and

eqùipment, which have a useful life extending

substantially beyond the taxable year, shall be charged

to a capital account. and not to an expense account .

[Electric & Neon, Inc. v. Commissioner, 56 T.C. 1324,

1332 (1971), affd. 496 F.2d 876 (5th Cir. 1974)

(quoting sec . 1. 446-1 (a) (4) (ii) , Income Tax Regs . ) . ]

- 21 The FERC and FPSC rules:provided a-regulatory accounting

system which afforded petitioner with a characterization method

based on basic accòunting principles thategenerally require the

capitalization of expenditures for larger items of property

having long-term lives and the expensing of .relatively smaller

expenditures for minor items needed for repairs.. . We,note "that

the 'decisive distinctions'.'between current expenses and capital

expenditures .'are those of degree .and not of kind, ' ,and * * *

each case 'turns on_its special facts'",

INDOPCO, Inc. v.

Commissioner,= 503 U.S. .at 86 (citation ómitted) .

Petitioner's

attempt to change retroactively from a consistent and logical

method of capitalizing the expenditures ;in issue to expensing

ethem involves the question'of proper timing and thus is a. .

material item.

See Southern Pac. Transp. Co. v. Commissioner, .75

T . C . at 683 ; sec . 1. 446-1 (e):(2 ) (ii) (a) and (b) ,

Income Tax Regs .

This attempt to recharacterize the expenditures in issue is to be

treated as 'a change,:in method of accounting.

See Southern Pac.

Transp. Co . ·v. Commissioner, supra; sec . - 1. 446-1 (e) (2) (ii) (a) and

(b) , Income Tax. Regs .:

Petitioner argues thats it made certain adjustments related

to Florida Power on its Schedules M-1 for the years in issue and

that such adjustments éstablish that petitione'r's method of*

accounting was not' simply to follow regulatory and f inancial

accounting for tax reporting purposes.

A' Schedule M-1 is a

- 22 -

schedule attached to a Form 1120, U.S. Corporation Income Tax

Return.

It identifies the different treatment of income and

expense items for book and tax purposes.

See Southwestern Energy

Co. & Subs. v. Commissioner, 100 T.C. 500, 503 n.4

(1993); Orange

& Rockland Utils. v. Commissioner, 86 T.C. 199, 205 (1986).

Respondent acknowledges that petitioner made Schedules M-1

adjustments on its tax returns for the years in issue.

However,

respondent argues that the adjustments do not change the fact

that petitioner's method of accounting with respect to the

expenditures in issue was to use the regulatory rules and

guidelines to determine the proper characterization of

expenditures for regulatory, financial, .and tax reporting

purposes.

Respondent claims that the Schedules M-1 adjustments

were only for the PRA and the storm reserve.

Petitioner does not

contend that there were any other Schedules M-1 adjustments.

Percentage Repair Allowance (PRA)

PRA concept originated in 1971 as part of- the Asset.

Depreciation Range system.e

The PRA was intended to end

controv rsies concerning whether certain expenditures for repair,

mainten nce, or improvement of property must be capitalized or

eI 1981, Congress repealed the entire PRA system effective

for property placed in service after Dec. 31, 1980, in taxable

years ebding after such date. See Economic Recovery Tax Act of

1981, Pub. L. 97-34, sec. 203, 95 Stat. 221.

The PRA continues

to be in effect for expenditures which, although incurred after

Dec. 31:, 1980, are for the repair, maintenance, rehabilitation,

or imprþvement of property placed in service before Jan. 1, 1981.

- 23 currently deducted.~ -See-Armco, Inc.· v. Commissioner, 88 T.

946,

949

(1987) J . sec . 1. 167 (a) -11'(a) (1) , Income $Tax ,Regs .

electing the PRA, the -taxpayer may:automatically deduct up to a

set percentage of all expenditures for repair, maintenance

rehabilitation, or .improvement- of "repair allowance property" for

the t'axablè year, as long asv such expenditures are not.;considered

"exclud'ed additions" .

Sec .ml . 042167

(a) ,11 (d) (2) , Income Tax Regs .

E penditures' in excess of the set percentage must be capitalized.

See id.

"Under * * * [the PRA],. system, certain, expenditures,

ch typicalsly would be capitalized can be treated as repair

allowances and, thus

deducted .as expenses."

United States v.

nW1sconsin Power & Light Co. , 38 F.3d 329, 331

(7th Cir. 1994) .

For the years 1988 to 1991

respondent -claims that

petitioner's repair deductions for tax_purposes consisted of the .

amounts deducted fór book purposes,. plus Schedules M-1

adjustments for the PRA as follows:

Y ar

1988

1989

1990

1991

Book Account

M-1 Adiustment

$372, 757, 769

385, 472, 395

408, 077, 080

' - 405, 017;292

$2 8, 501, 471

29, 315, 281

28, 635, 238

25, 806, 865

Tax Return

$401, 259, 240

414, 839, 472

. 436, 688, 025

430, 814, 717

P titiòñer does nott dispute respondent's figures, or allege that

there were Sdhedules M-1 adjustments for-any other. items for 1988

The PRA-is a specific taxsonly, provlslon.

Florida

not have the option 'of- using the PRA , to determine the

ower did

- 24 characterization of expenditures for regulatory accounting and

financial reporting purposes.

The PRA simply allowed petitioner

to characterize a set percentage of expenditures as repair

expenses for tax purposes.

Petitioner is now trying to recharacterize as repairs, items

that iti characterized as capital expenditures for tax purposes.

Petitidner cannot recharacterize amounts capitalized under the

PRA be ause to do so would violate. the percentage limitation.

Petitioner does not identify any adjustments in the PRA or claim

that i

made any error in the original computation under the PRA.

The ex enditures that petitioner is trying to recharacterize are

those

hat petitioner consistently capitalized for regulatory,

financial, and tax reporting purposes.

This attempted

recharacterization conflicts with petitioner's practice of having

tax accounting follow regulatory and financial accounting. .

Storm Reserve

OS its original 1992 tax return, petitioner made a Schedule

M-1 adjustment of $6 million for a storm reserve related to

Florida Power.

The storm reserve related to an extraordinary

item; Namely, to offset damages caused by Hurricane Andrew.

This

was not a recurring item which petitioner accounted for every

year, as evidenced by the absence of any Schedule M-1 adjustment

for a Átorm reserve for any of the other years in issue.

Additionally, petitioner has not ~claimed that it is seeking to

- 25 -

recharacterize this item.

The Schedule M-1 adjustment for the

storm reserve does not affect petitioner's consistent treatment

of characterizing the expenditures in issue based on regulatory

rules and guidelines.

Petitioner has not alleged that there were

Schedule M-1 adjustments for anynother items for 1992.

Audit Adiustments

Petitioner argues that respondent's allowance of additional

repair expense deductions on;audit supports its position that

later recharacterizations were part of its method- of. accounting.

Petitioner contends that the facts that it amended its 1992

return and that respondent:allowed additional repair expenses on

audit establish that petitioner's method of.accounting was not to

follow regulatory rules and guidelines when characterizing the

expenditures in issue for tax purposes.

Petitioner argues that

these adjustments support its position that its.accounting

practice was to use regulatory characterizations as a "reasonable

approximation" and then make adjustments when errors were

discovered.

Respondent disputes that the.failure to raise the change in

method of accounting issue in any way.prevents the current

disallowance- of petitioner's attempted recharacterization.

Respondent argues that the audit adjustments were simply part of

an overall settlement of the claim and that those actions do not

.establish the method'of accounting that petitioner is claiming.

- 26 -

Pe itioner consistently, applied the characterizations used

by Flor da 'Power for regulatory purposes when reporting for tax

purpose .

Petitioner made no references in its tax returns that

would nbtify respondent. that - the amount .of claimed repair

expenses was a "reasonable approximation" and represented the

method pf accounting that petitioner is claiming.

1992,

For the year

etitioner filed two amended returns. . - In its first amended

returnd filed in September of 1993,"petitioner claimed an

adjustment for storm expenses and an additional repair expense

for cade· injection costs.

In its second amended return, filed

in December of 1993, petitioner claimed additional repair

expens s for the same type sof expenditures as those currently in

issue and an adjustment for storm expenses.

After reviewing the

origin 1 and amended returns= and meeting with petitioner,- +

respondent allowed some of the. claimed expenditures to be

deducted as repair expenses "and accepted the adjustment for storm

expens s.

Petitioner has not alleged, nor is there any

indica ion, that respondent acquiesced in a method of accounting

which

ould 'allow petitioner to "approximate" the amount of

repair expenses and then file amended returns when, and if, it

realiz d it -might have deducted a larger amount.

The fact that

pétitii ner amended its 1992 tax return for additional expense

claims does not change the fact that, in preparing its original

tax re urn, petitiorier consistently used the same

- 27 -

characterizations that Florida Power used for regulatory and

financial reporting purposes.

Accordingly, we hold that the

audit adjustments by respondent do not establish,the method of

accounting that petitioner'is claiming.

Petitioner's treatment of= the.expenditures in issue for tax

purposes was consistent with the treatment.of those expenditures

by Florida Power for regulatory accounting and financial

reporting purposes.

The Schedules M-1 adjustments are, at best,

relatively minor deviations from petitioner'.s method of

accounting.

The Schedules M-1 adjustments.for the PRA and the

storm reserve, and the audit adjustments by respondent, do not

change the fact that petitionersissretroactively attempting to

erecharacterize expenditures that it regularly and consistently

capitalized for regulatory, financial, and tax reporting

purposes.

See Potter v. Commissioner, 44 T.C. 159, 167 (1965)

(methods of accounting must be regular and consistent).

II.

Correction

A change in method of accounting does not occur when a

taxpayer seeks to correct mathematical or posting errors, errors

in the computation of tax liability, a change in treatment

arising from a change in underlying facts, cn: any other

"adjustment of any item of income or deduction which does not

involve the proper time for the inclusion of the item of income

or the takïng of a deduction."

Northern States Power Co. v.

- 28 United States,

151 F.3d 876, 883

(8th Cir. 1998); sec. 1.446-

1(e) (2) (ii) (b), Income Tax Regs..

PÉtitiòner does not contend that it made errors in

mathematical computations or in the computation of its tax

liability.

Petitioner has failed to make specific allegations

establfshing there was a change in underlying facts.

Under section 1.446-1(e) (2) (ii) (b), Income Tax Regs., a

change 'from capitalizing and depreciating the costs of a class of

depreciable assets to expensing them involves a question of

proper$timing.

Petitioner's attempt to recharacterize

expenditures at Florida Power's electric plants, which were

consisÊently capitalized on its tax' returns, fits within the

princióles of this regulatory provision.

Although the.instant

case is the reverse of the situation set forth in the regulatory

provision, we regard both situations as examples of changes

involving the timing of a deduction.

See Southern Pac..Transp.

Co. v. Commissioner, 75 T.C. at 683 n.211.

Additionally, this

Court Ëas found- that the characterization of expenditures as

capital or expense involves-the proper time for taking a

deduction.

See Pelaez & Sons, Inc. v. Commissioner, 114 T.C. at

489; S uthern Pac. Transp. Co. v. Commissioner, supra at 683;

Hooker Indus., Inc. v.- Commissioner, T.C. Memo. 1982-357.

A posting error occurs when there is an error in "the act of

transfÅrring an original entry'to a ledger."

Wayne Bolt & Nut

- 29 -

Co. v. Commissioner, 93 T.C. at 510-511 (quoting Black's Law

Dictionary 1050 (5th ed. 1979)).

Petitioner does not contend

that it erred in transferring the amount or characterization of

expenditures reported by Florida Power for regulatory purposes to

petitioner's tax return.

Rather, petitioner relies on Northern

States Power Co. v. United States, supra, in arguing that it

erroneously capitalized the expenditures at issue and that the

attempted recharacterization should be treated as a posting

error:

Petitioner's reliance on Northern States Power Co. v.

United States, supra is misplaced.

In Northern States Power.Co.

v. United States, supra, the taxpayer's tax department was

unaware that certain amounts were improperly recorded in its

accounts.

Because the taxpayer lacked knowledge of the error, it

mistakenly capitalized the amounts instead of currently deducting

them.

See id; at 884.

When it discovered the mistake, the

taxpayer promptly filed refund claims in an effort to treat the

amounts in the same manner that it had consistently treated