*The Hon. Howard F. Sachs, United States District Judge for

the Western District of Missouri, sitting by designation.

_____________

No. 96-1204

_____________

EPCO, Inc. and Subsidiaries, *

*

Petitioner, *

* On Petition for Review

v. * of a Decision of the 

* United States Tax Court.

*

Commissioner of Internal *

Revenue, *

*

Respondent. *

___________

 Submitted: November 21, 1996

 Filed: January 6, 1997

___________

Before RICHARD S. ARNOLD, Chief Judge, MAGILL, Circuit Judge, and SACHS,*

District Judge.

___________

RICHARD S. ARNOLD, Chief Judge.

Imperial Utility Corporation, a wholly owned subsidiary of EPCO,

Inc., together with Brooks McArthy, a developer, paid for the construction

of a sewer pipeline to service a tract of land owned by McArthy on which

he planned to develop a mobile home park. McArthy contributed $200,000 to

the construction of the sewer line, which is owned by Imperial. The

Commissioner of Internal Revenue found a deficiency in EPCO's 1989 federal

income tax based on Imperial's failure to report a portion of this

contribution as
 Another possibility - treating the waste in a three-to-five 1

acre on-site open-air lagoon using microbes to break down and

purify the waste - would have required McArthy to acquire

additional land, and McArthy abandoned this possibility without

inquiring into the possibility of purchasing land that was adjacent

to his property.

-2-

gross income. (EPCO and its subsidiaries filed a consolidated return.)

EPCO then petitioned the Tax Court for a redetermination of the tax, and

the Tax Court upheld the Commissioner's determination. Upon EPCO's motion,

the Tax Court reconsidered its decision and again held for the

Commissioner. This appeal followed. We affirm the Tax Court on the main

substantive issue, whether McArthy's contribution resulted in income to

Imperial, but remand for further proceedings on the proper amount of that

income.

I.

In the mid-1980s, Brooks McArthy began to develop a mobile home park

upon a tract of land that he owned in Jefferson County, Missouri. To

provide sewage service to the property, as Missouri law requires, McArthy

had two feasible options. First, he could have constructed, at his own

1

expense, an on-site mechanical waste treatment facility. In the

alternative, he could have had the waste treated at a plant, owned by

Imperial, 2 1/2 miles north of the park. This option required the

construction of a mainline extension from the plant to the park as well as

the expansion of the plant to handle the additional sewage from the park.

McArthy consulted with Imperial on which option to choose.

Each option had its disadvantages. The on-site facility would have

been unsightly, somewhat noisy, and potentially malodorous. In addition,

the facility would have discharged the treated waste into a so-called

"losing stream," which is defined as one which loses at least 30 per cent.

of its flow into a groundwater system. As a result, "the discharge

effluent . . . would have emptied into
 Had McArthy chosen to build the on-site treatment facility, 2

EPCO would still have been responsible for operating the facility

and would have earned its monthly fee for this service.

 Imperial's president testified that it would not have built 3

the sewer line without McArthy's agreement to pay for part of it.

 McArthy eventually received $100,000 from this corporation.

4

Thus, the entire project cost McArthy only $100,000.

-3-

a losing stream . . . at a point upstream from preschool playgrounds,

fishing lakes, homes, churches, and schools." Appellee Br. 4. Because of

this potential environmental hazard, the Missouri Department of Natural

Resources preferred the mainline sewer extension, though it would have

approved either method.

The primary disadvantage of the mainline-extension alternative was

its cost, which turned out to be more than three times the $150,000 cost

of the on-site facility. Imperial would have earned the same amount of

income ($18 per month per mobile-home pad) from the McArthy property

regardless of which method was chosen. Nevertheless, McArthy and Imperial 2

decided to build the sewer line and agreed to share the cost of

construction. McArthy placed $200,000 in an escrow account to be used to 3

finance the construction of the line, and the balance of the cost was to

come from Imperial. Withdrawals from the escrow required the signatures

of both McArthy and the president of Imperial, and owner of EPCO, Eugene

Fribis. According to the contract, the $200,000 contribution was to

replace "tap-on fees" that the Missouri Public Service Commission

authorized Imperial to charge the owners of mobile-home pads for connecting

their property to sewage service. Because the $200,000 was likely to

exceed the total of the authorized tap-on fees for the McArthy property,

McArthy and Fribis also agreed to credit any excess contribution to the

tap-on account of adjoining property owned by another corporation. 

4

The total project cost $540,000. Imperial spent about
-4-

$190,000 of its own money to expand the treatment capacity of its plant and

$150,000 of its own money to construct the sewer line. The remaining

contribution came from the escrowed funds which went to pay the general

contractor and subcontractors who built the sewer line. In 1988 Imperial

spent $164,375 of the $200,000 on the sewer line and reported the

contribution as income. EPCO also took a depreciation deduction on the

part of the sewer line that the contribution financed. In 1989, Imperial

spent the remainder of the $200,000 but did not report the $35,625 as

income and, consequently, also did not take the corresponding depreciation

deduction. 

II.

The Internal Revenue Code allows corporations to exclude both

shareholder and nonshareholder contributions to capital from their gross

income. 26 U.S.C. § 118(a). Under the 1986 Tax Reform Act, "the term

`contribution to the capital of the taxpayer' does not include any

contribution in aid of construction or any other contribution as a customer

or potential customer." 26 U.S.C. § 118(b). The Report of the House Ways

and Means Committee explained that the provision's effect "is to require

that a utility report as an item of gross income the value of any property,

including money, that it receives to provide, or encourage . . . the

provision of, services to or for the benefit of the person transferring the

property." H.R. Rep. No. 99-426, 99th Cong., 1st Sess. 644 (1985). The

Tax Court found, and the Commissioner argues, that the $200,000 that

McArthy contributed to the building of the sewer line was a contribution

in aid of construction (CIAC) and that it thus constituted taxable income

that EPCO should have reported.

Two things are clear. McArthy was a customer of EPCO (or at the very

least was acting on behalf of potential customers of EPCO), and his

contribution aided in the construction of a line
 Ibid. Neither party argues that we should disregard this

5

exception because it does not appear in the statute itself. We

would disregard it anyway were it not for the history behind the

provision, which helps illuminate its meaning. The distinction

between contributions to capital made by customers to procure

service and contributions to achieve indirect benefits to the

public at large was a familiar one in judicial decisions that

preceded passage of 26 U.S.C. § 118 in 1954, and it is universally

recognized that this statute was no more than a codification of

judicial decisions up to that point. The post-passage preservation

of the distinction is evident from such cases as Teleservice Co. of

Wyoming Valley v. Commissioner, 254 F.2d 105 (3d Cir.), cert.

denied, 357 U.S. 919 (1958), and its preservation in 26 U.S.C.

§ 118(b) is evident from the fact that 118(b) exempts only customer

contributions in aid of construction from the exclusion for

contributions to capital. 

 EPCO does not argue in this Court that the contribution in

6

question was not income within the meaning of the Sixteenth

Amendment. Its argument is based solely on the statute.

-5-

which was to provide sewer service to McArthy's development. EPCO,

however, seizes upon language in the Committee's Report that states that

transfers of property to utilities by members of a particular group will

normally be assumed "to encourage the provision of services . . . unless

it is clearly shown that the benefit of the public as a whole was the

primary motivating factor in the transfers."5

The "public benefit" exception, as well as the general exclusion for

contributions to capital, has its origin in a 1925 Supreme Court decision

which held that cash subsidies as well as land and buildings provided by

the government of Cuba to a railroad company to construct a railroad in

Cuba were not income within the meaning of the Sixteenth Amendment.6

Edwards v. Cuba R.R., 268 U.S. 628 (1925). The Court reached this

conclusion because it found that the payments "were not made for services

rendered or to be rendered" and were not "profits or gains from the use or

operation of the railroad." Id. at 633.

EPCO contends that McArthy's contributions to the sewer line
-6-

were not made to encourage service to McArthy's property, but instead to

benefit the public. McArthy would have gotten sewage treatment for his

property regardless of the method chosen. He chose what was, both for him

and EPCO, the far more expensive method of sewage treatment only because

the alternative would have led to more water pollution. While EPCO

obviously cannot deny that the sewage line provides its customer with

sewage service, EPCO contends that McArthy's choice of the more expensive

method was for the public's benefit.

We believe that the relevant inquiry is into McArthy's motivation for

choosing one sewage treatment method over another. The record does not

convince us that McArthy's primary motivation was an altruistic concern for

the environment beyond his own development. The Tax Court found that the

on-site treatment facility "would have been noisy and unsightly and would

have emitted unpleasant odors, which would have detrimentally affected

property values. . . . [and therefore] that McArthy chose the main- line

extension because it best suited his purposes in providing sewer service

to [his development]." EPCO, Inc., T.C. Memo. 1995-249, slip op. at 22-23.

Thus, the Tax Court found that McArthy chose the sewer line method because

of its direct benefit to McArthy's property and, consequently, the future

occupants of his development. 

We review this finding of fact only to determine whether it was

clearly erroneous. We hold that it is not unreasonable to think that a

developer seeking sewage service for his property would pay an extra

$50,000 to avoid having a smelly sewage facility on the property itself,

and that there was evidence to support the Tax Court's conclusion that this

was, in fact, Mr. McArthy's primary motivation. This conclusion is

reinforced by the provision in the contract that states that the $200,000

contribution was to be in lieu of fees that EPCO could have charged mobile

home owners to connect their property to sewage service. Add to this

evidence
-7-

the natural assumption that a developer acts to maximize his profit and not

the general welfare, and it becomes clear that McArthy was acting as a

customer of EPCO and not a public citizen when he made his contribution.

Accordingly, we hold that McArthy's contribution to the construction of the

sewer line was a taxable contribution in aid of construction under 26

U.S.C. § 118. 

III.

The question of how to value what EPCO got, and thus how much to

include in its income, remains. The Tax Court held that $35,625 was

includible in income for the year 1989 - the full amount of money paid from

the escrow account that year to contractors and subcontractors working on

the sewer line. These payments went to defray debts for which EPCO was

liable. (McArthy was liable for them, too, but that does not change the

essential point.) In general, a payment made to pay someone's debt is

income to that person. E.g., Old Colony Trust Co. v. Commissioner, 279

U.S. 716 (1929).

EPCO replies that this general rule does not apply where, as here,

the debt paid was itself created as part of the same transaction that

included the payment. Imperial would not have built the sewer line, and

thus would not have contracted the $200,000 in obligations that were paid

out of the escrow account, if McArthy had not agreed to contribute the

$200,000 in the first place. EPCO says that what it actually received was

not money or the liquidation of debts, but the sewer line, which Imperial

ended up owning. The value of the line, EPCO adds, was not the $540,000

cost incurred ($340,000 from Imperial and $200,000 from McArthy), but the

present value of the stream of future income expected to be realized from

customers tapping on to the sewer line - an amount EPCO fixes at about

$360,000. This would reduce the total amount of McArthy's contribution to

EPCO's (or Imperial's) capital from $200,000 to about $20,000 (the $360,000

value of the line less the
-8-

$340,000 paid by Imperial).

We agree with EPCO that the debt payments themselves were not ipso

facto income to it. See Fox v. Harrison, 145 F.2d 521 (7th Cir. 1944)

(payment of debt not income when debt incurred as part of same transaction

that envisioned the payment). We further agree that what EPCO got out of

this transaction was the sewer line. But the question of the value of the

sewer line is one of fact, and the Tax Court, the finder of fact, never

reached that question, having stopped its analysis with the conclusion that

what EPCO got was payment of its debts. The income expected to be produced

by the line from McArthy's mobile-home park is certainly one possible

criterion of that value. But it is not the only possible criterion. Also

relevant is the fact that $540,000 was paid for the line. We have

difficulty believing that businesspeople would pay $540,000 for an asset

that, immediately upon purchase, became worth only $360,000. The

difference may be due, at least in part, to the possibility that other

users might tap on to the line in the future - for example, users on the

adjoining property, whose owners contributed half of the $200,000.

This issue of fact needs to be explored further in the court of first

instance, the Tax Court.

We agree with the Tax Court that McArthy made a contribution in aid

of construction to Imperial that should have been included in Imperial's

gross income. We do not agree with that Court's holding as to the value

of that contribution. The judgment of the Tax Court is vacated, and the

cause remanded for further proceedings as to valuation not inconsistent

with this opinion. The Tax Court may in its discretion allow either party

to introduce additional evidence.

It is so ordered.
-9-

A true copy.

Attest:

CLERK, U.S. COURT OF APPEALS, EIGHTH CIRCUIT.