Virginia Electric and Power Company v. The United States , 411 F.2d 1314 ( 1969 )

OPINION

PER CURIAM: ^*

The issues in this Federal income tax case (involving the calendar years 1959, 1960, and 1961) are: (1) whether the plaintiff-taxpayer, Virginia Electric and Power Company (Vepeo), is entitled to depreciation deductions on its costs in-eurred for initial clearing of easements acquired and used for construction, maintenance, and operation of its transmission and distribution lines, and if so entitled, whether such costs qualify for the double declining balance method of depreciation; (2) whether Vepco is entitled to depreciation deductions on its costs of acquisition of such easements; and (3) if Vepco is entitled to depreciation deductions with respect to the assets described, what are their estimated useful lives ?¹

With one exception, identical issues are presented to the court in Pennsylvania Power & Light Company and Subsidiary Companies v. United States, Ct. CL, 411 F.2d 1300. In that case, decided today, we held that Pennsylvania Power & Light Company’s transmission and distribution easements, and its initial clearing costs thereof, were depreciable items, the useful lives of which could be estimated with reasonable accuracy.

Upon a careful study of that exhaustive opinion and the numerous authorities cited and analyzed therein, it is our judgment that the conclusion on this point in favor of the taxpayer is entirely correct for the reasons stated in that opinion. Merely to reiterate here that careful analysis of the basic issue would seem redundant and pretentious.² Therefore, since the main issue of whether the assets involved are depreciable items is identical in both cases, judgment is entered in favor of the taxpayer-utility.

The foregoing disposes of issues (1) and (2) above, except for the question of the applicable depreciation method which is discussed below. Consideration must now be given to issue (3), namely, a determination of the useful lives of the assets in question.

At the outset, we note the very important fact that the proof as to useful lives in the present case differs from that adduced in Pennsylvania Power & Light Company. In the latter case, as fully described in the opinion, the experts in property life analyses based their estimates of useful life on historical statistical studies using the “annual rate” and “geometric mean” methods in conjunction with the so-called “Iowa type survivor curves.” ³

Vepco’s expert witnesses took a different approach. The statistical method above described was not ignored by Vep-co, however. Indeed, in this respect the same expert, John J. Reilly, testified in behalf of both Vepco and Pennsylvania Power and Light Co. His studies of Vepco’s plant and accounts resulted in an opinion that Vepco’s transmission easement and initial clearing costs had useful lives of 100 years and that its distribution easements and initial clearing costs had useful lives of 50 years. However, Mr. Reilly qualified his opinion as to the above estimated service lives by stating that they were primarily ceiling figures to indicate an upper level of estimated lives. He testified that his “estimates would be too long” if, as he thought probable, Vepco’s future retirement experience turned out to be more rapid than in the past, due both to technological improvements in underground cable construction and to the trend towards replacement of steam power plants by nuclear energy plants.

With this qualification in mind, Yepco produced expert testimony with respect to what may reasonably be expected in the area of future technological improvements and changes in operational techniques employed by electric utilities, in general, and by Vepco, in particular.

Vepco’s assistant vice president, a well-qualified electrical engineer who has spent his entire career working on the problems of Vepco’s transmission and distribution system, testified that there is substantial public concern over the appearance of overhead power lines, and this aesthetics problem is under active consideration. In his opinion, this public concern will force Vepco to replace its overhead facilities with underground cable in the foreseeable future.⁴ Apart from the cost of such conversion to underground cable, the major problem confronting the industry today is the lack of suitable insulation for such cable. However, extensive research and experimentation in this area is underway both here and abroad, and in his opinion the problem of insulation will be solved with the result that transmission and distribution facilities will be placed underground in the predictable future. Such a development means that Vepco’s easements for overhead facilities have a limited useful life because the easement agreements make no provision for any underground installations, and thus the conversion to underground cable would necessitate the acquisition of new easements and abandonment of the old. In his opinion, all Vepco’s distribution lines will be underground somewhere between the years 1990-2000, and all its transmission lines will be underground somewhere between the years 2020-2030.

Another expert witness for Vepco was Dr. Alexander Kusko, an.eminent consulting engineer with very extensive academic, research, and industrial experience in the study of electric power system problems. He testified that, at the time of the years here involved, it was possible to make rational predictions with respect to the future development of the electric power systems in the heavily populated region of the Atlantic Seaboard, including that of Vepco. He made his predictions by decades for the period 1960 to 2000 and for the period 2000 to 2030.

The decade 1960. to 1970 he described as a decade of mine-mouth coal, burning plants built close to coal mines in order to reduce the cost of fuel transportation. Their power output is transported by long extra high voltage overhead transmission lines. By the end of this decade, nuclear power generation will probably have become less expensive than fossil-fuel power generation, and, with the exception of some new hydroelectric generating stations constructed primarily in Canada, substantially all new generating plants should be operating on nuclear fuel after 1970.⁵ Because of radiological dangers, these plants will be located away from cities, but near cooling water for volume cooling of their condensers. This will require massive overhead transmission lines to carry increased voltages of up to 1,000,000 volts.

In Dr. Kusko’s opinion, Vepco’s power system will probably change also by reason of other technological developments. With the expected increase in population will also come an increase in energy requirements. Voltages in the range of 1,000,000 to 2,000,000 volts, which is probably what will be necessary within the next 30 to 40 years, are difficult to handle by the present air insulation’ overhead lines. The development of a better insulation for both overhead and underground transmission will be necessary by the turn of the century. Such a development is under 'active research and experimentation.

Dr. Kusko further believes that, as atomic generation of electricity is proved to be safe, generating plants will no longer be constructed in isolated areas, but will be built in the heart of cities and near other load centers. This power system change will begin to take place in the decade of 1990 to 2000. No new overhead transmission lines will be constructed after 1990 because they would no longer have any function. The tremendous loads will require that generating plants be located in populated areas. It will probably be impractical to bring that type of power into such areas by overhead transmission lines. Plants will have to be brought to the load centers. In this same time period, heavy water and breeder type reactors, which reproduce their own fuel, will begin to replace the light water reactor plants constructed previously in order to conserve nuclear fuel.

On the basis of the above analysis, Dr. Kusko concluded that after 1970 it is reasonable to believe that electric distribution systems in cities and in surrounding populated areas will be constructed in underground cable. Furthermore, by the year 1990, all distribution -circuits in densely populated areas will have been converted to underground cable, and by the year 2000, substantially all the distribution facilities of Vepco, wherever located, will be in underground cable.

As for the transmission system, Dr. Kusko concluded that all new transmission will be constructed in underground cable by the year 2000. Overhead lines built after 1970 carrying 500,000 to 1,000,000 volts will remain in operation, although portions of them will be replaced by cable as population grows into, areas in which those lines are located. As stated previously, any new construction during this period will be close to load areas, not requiring extensive overhead transmission lines of the type earlier built. He. concluded that by the year 2030 the last of the overhead lines built in the 1970 to 2000 period will have been retired.

In the Government’s view, the foregoing constitutes merely some interesting crystal-ball gazing and does not rise to the stature of a “reasonable approximation” as required by the United States Supreme Court. Burnet v. Niagara Falls Brewing Co., 282 U.S. 648, 655, 51 S.Ct. 262, 75 L.Ed. 594 (1931). It will simply not do, however, to place Vepco’s expert witnesses in the category of soothsayers. All were electrical engineers possessed of impressive qualifications and long experience in the electric power industry. Admittedly, the rather startling predictions by Dr. Kusko and Vepco’s assistant vice president may not be fulfilled in precisely the manner, and sequence to which they testified.⁶ But precision in estimating useful life for purposes of the depreciation allowance is not required. The statements of Vepco’s experts are sufficiently convincing that they may be classified as reasonable predictions of “probable future developments,” which is all the regulations require in the context of this case. Treas. Reg. § 1.167(a)-l(b), 1956-1 C.B. 100. Indeed, the Supreme Court has held that the deduction may be based upon a “rough estimate.” United States v. Ludey, 274 U.S. 295, 302, 47 S.Ct. 608, 71 L.Ed. 1054 (1927). Clearly, Vepco’s expert testimony meets all of the applicable standards, and it is significant that the defendant made no effort to rebut the experts’ predictions. We repeat again that the proof in this case is very different from the proof before the court in the Pennsylvania Power & Light Co. case, and we find different objective facts to be present in the two cases. Accordingly, it is our conclusion that Vepco has proved as of 1959 a useful life for its transmission easements and initial clearing costs of 71 years and a useful life for its distribution easements and initial clearing costs of 41 years.

Finally, there remains for consideration Vepco’s contention that, being entitled to the depreciation allowance on its initial easement clearing costs, it may compute its deduction under the double declining balance method provided for in section 167(b) (2) of the 1954 Code which reads, in pertinent part:

(b) Use of Certain Methods and Rates. — For taxable years ending after December 31, 1953, the term “reasonable allowance” as used in subsection (a) [providing for the depreciation deduction] shall include (but shall not be limited to) an allowance computed in accordance with regulations prescribed by the Secretary or his delegate, under any of the following methods:

(1) the straight line method,

(2) the declining balance method, using a rate not exceeding twice the rate which would have been used had the annual allowance been computed under the method described in paragraph (1).

Subsection (c) of section 167 goes on to provide, in effect, and among other things, that the declining balance method of computing the allowance may not be used in the case of “intangible property.” Defendant argues that Vepco’s initial easement clearing costs are “intangible properties. Therefore, says tangibles” and hence do not qualify for the declining balance method. Vepco responds that the initial clearing costs are part of the costs of constructing the transmission and distribution lines themselves, the latter being obviously Vepco, since it elected for the years 1960 and 1961 to use the double declining balance method of depreciation for its ■transmission and distribution line construction, the initial clearing costs as a part of that construction also qualify for the double declining balance method.⁷

Both parties agree that the clearing costs are not an independent asset; rather they are a cost item which is included in the depreciable cost base either of the transmission and distribution lines or the cost b,ase of the easements. Both parties also agree that the trial commissioner was inconsistent in permitting rapid depreciation but finding also that the useful lives of the clearing costs are those of the easements. We agree that this is an inconsistent result and, therefore, these costs should be included in the easement costs subject to depreciation over the useful lives of the easements, and not subject to rapid depreciation.

The useful life of an easement is not coterminous with the useful life of the first line to be placed on the easement because substitute lines may replace the initial line during the life of the easement. Initial clearing costs are incurred only once; yearly maintenance costs to keep the easement clear are deductible annually as operating expenses. That initial clearing cost, however, may not be exhausted over the life of the first line and, therefore, as the trial commissioner correctly held, the initial clearing costs are depreciable over the useful life of the easement, not the useful life of the line. When new lines are substituted, these initial clearing costs are not normally again incurred, and plaintiff has not proved that any part of these costs is exhausted over the life of the first line.⁸

Accordingly, we conclude that under the circumstances of this case and the proof before us, the only reasonable and consistent approach is to permit depreciation of the initial clearing costs as part of the easement costs, depreciable over the life of the easement together with other easement costs. As part of the easement cost, the initial clearing costs are considered intangibles and are not subject to rapid depreciation.

Therefore, in accordance with the above opinion, Vepco should have judgment entered in its favor, with the amount of recovery to be determined in accordance with Rule 47 (c).

* We are indebted to Trial Commissioner Lloyd Fletcher for bis opinion and recommended conclusion of law which we adopt with minor modifications, except for our denial of rapid depreciation deductions for initial clearing costs.

1 . A subsidiary issue relates to the amortization of emergency facilities by Vepco under certificates of necessity which provided that costs of easements and clearing with respect to such facilities were amortizable only if such assets qualify for the depreciation allowance under section 167 of the Internal Revenue Code. Since it is held that these assets do qualify for the depreciation allowance, it follows that amortization is allowable, and this issue is, therefore, moot,

2 . To rewrite that opinion would be to invoke recollection of Judge Frank’s jocular dictum : “Papa bring the hammer, there’s a fly on baby’s head.” Wabash Corp. v. Ross Electric Corp., 187 F.2d 577, 595 (2d Cir., 1951).

3 . This is not to say that, in reaching conclusions in this area, an engineer-analyst will rely merely on statistical computations and projections. He must also have extensive knowledge of the utility’s overall electric jilant and related facilities and information with respect to both the causes of property retirements in the past, and the likelihood that such retirements will continue or become more frequent in the future. See, Pennsylvania Power & Light Company, supra, 411 F.2d p. 1300

4 . One entire chapter of the 1905 Proceedings of the White House Conference on National Beauty is devoted to a consideration of the underground installation of utility systems; an extensive report on the subject was submitted to the Federal Power Commission i n 1966; and bills have been introduced in Congress to provide funds for research programs in the field.

5 . At the time of trial Vepco had plans to build three nuclear energy plants to become operational in 1971, 1972, and 1974.

6 . “No one — not even the most brilliant scientist alive today — really knows where science is taking us. We are aboard a train which is gathering speed, racing down a track on which there are an unknown number of switches leading to unknown destinations. No single scientist is in the engine cab and there may be demons at the switches. Most of society is in the caboose looking backward.” Lapp, The New Priesthood: The Scientific Elite and the Use of Power, Harper & Row, (1965) at p. 29.

7 . A comparable problem was before the court in Panhandle Eastern Pipeline Co. v. United States, Ct.Cl., 408 P.2d 690 (decided March 14, 1969). Therein, the rapid depreciation issue involved certain rod-dage fees paid to acquire the easements. We held that these were costs of the easement and intangibles, not subject to rapid depreciation.

8 . Plaintiff relies on Portland General Electric Co. v. United States, 189 F.Supp. 290 (D.Or.1960), aff’d on other issues, 310 F.2d 877 (9th Cir. 1962), and Commonwealth Natural Gas Corp. v. United States, 266 F.Supp. 298 (E.D.Va.1966), aff’d, 395 F.2d 493 (4th Cir. 1968).

In the Portland General Electric Co. case the parties stipulated to the cost basis of depreciable property except for two items, one of which was “Costs of Rights of Way”. In deciding that the costs of clearing rights of way were de-preciable, the court held “these properties were depreciated over the useful lives of the properties with which the rights of way are associated. These costs are proper items to be made a part of the cost basis of PGE’s depreciable properties.” [189 F.Supp. at 306.]

In our case, the initial clearing costs are depreciable over the useful life of the easements; in the PGE Co. case, they were depreciable over the useful life of the properties placed on the easement. In PGE the court made these costs part of the base of the properties and depreciable together with them. In our case, these costs are part of the depreciable base of the easements. It is incongruous to consider these costs depreciable over the life of the easements, not an independent asset yet subject to rapid depreciation.

In the Commonwealth Natural Gas Corp. case, the useful lives of the pipeline and easement were coterminous, and the court found that the useful life of the clearing costs would be exhausted together with that of the pipeline. Here, the useful life of the clearing costs extends beyond the life of the initial line and, accordingly, we have not made these costs part of the depreciable base of the line.