## 1 RECOMMENDED FOR FULL-TEXT PUBLICATION Pursuant to Six

th Circuit Rul e 206

ELECTRO NIC CIT

ATION: 2003 FED App . 0259P (6th C ir.) File Name: 03a02 59p.06



# UNITED STATES COURT OF APPEALS

FOR THE SIXT H CIR CUIT

_________________
S AGINAW 

## B AY 

## P IPE LINE 

## C OMPANY 

## , CMS S AGINAW 

## B AY 

## C OMPANY 

## , S AGINAW 

## B AY 

## L ATER AL 

## C OMPANY 

## , and CMS S AGINAW 

## B AY 

## L ATERAL 

## C OMPANY 

## , Plaintiffs- Appellant s,

v.

U NITED 

## S TAT ES OF 

## A MERICA 

## , Defendant-Appellee. X

- - - -
> , - - - - - - - - N No. 01-2599

Appeal from the United States District Court for the E astern D istrict of Michiga n at Detr oit. No. 99-70454—John Corbett O’Meara, District Judge.

Argued: May

7, 2003 Decided and Filed: July 30, 2003

Befor e: KRUPAN SKY, SILER, a nd GILMAN , Circuit Judges. 2 Saginaw Bay Pipeline Co., et al. v. United States No. 01-2599

1 Pl aintiffs Sa gi na w Ba y P ip el in e Co mpa nyan d CMS S ag in aw Ba y Comp any formed a l imit ed busines s partn ershi p known as “ Saginaw Bay Area Limit ed Partners hip.” Plaintif fs Saginaw Bay Lateral Company and CMS Saginaw Bay Lat eral Company cr eated a second limited p artners hip call ed “Sagin aw Bay La teral Limited Pa rtnership.” To gether, those two limit ed partnerships developed and constructed, and at all times relevant to the cas e inst

anterowned and operated, the Sagi naw Ba y nat ural g as pipeline network at i ssue herein.
On review, the Am erican Petro leum I nstitute (“API” ), w ith le ave of



## _________________ COUNSEL

ARGUED: Todd R. Men del, BARRIS, SOTT, DENN & DRIK ER, Detroit, Michigan, for A p pellants. Teresa T. Milton, UNITED STATES DEPARTM ENT OF JUSTICE, APPELLATE

SECTION TAX DI

VISI ON, Washington, D.C., for Appellee. ON BRI EF: Todd R. Men del, BAR RIS, SOTT, DENN & D RIKER, Detroi t, Michig an, Th omas P. Marinis, Jr., VINSON & EL KIN S, Houston, Texas, for Ap pe llants. Teresa T. Milton, Richard Farber, UNI TED STATES DEPARTMENT OF JUSTICE, APPELL ATE SECTION

TAX DIVI SION, Washington, D.C., for Appellee. Al anI. Horowitz, Ta

mara W. Ashford, MI LL ER & CHEVA LI

ER CHARTERED, Washington, D.C., for Amicus Curiae.

_________________

OPINION

_________________ KRUPANSKY, Circui t Ju dge. The plaintif fs-appe llants, Saginaw Bay Pipeline Company, CMS Sagi naw Bay Company , Saginaw Bay

Lateral Company

, and CMS Saginaw Bay Lateral Company

(collectively “

the plaintiffs,” “Saginaw Ba y,” or “the pipeline companies”), 1 

## have contested th e

## No. 01-2599 Saginaw Bay Pipeline Co., et al. v. United States 3

the court, lodged an amicus c uriae brief in support of the plaintiffs. API describeditsel f as “a nat ional trade associat ion representing t he entire petroleum industry, inc luding com pan ies enga ged in exp lo ra tion and pr od uction, transportati on, r efi nin g, a nd mark eti ng. With ove r 400 member compa ni es and wi th petrol eum cou ncils in 27 state cap itals representing members in 33 stat es, API is dedicated to protecting and advancing the i nteres ts of all parts of the oil an d natura l gas indust ry. ” 

## districtcourt’s disallowance, following a bench tria l, of their claim ag ainst the defendant-appellee United States of America through the I nternal Revenue Service (herei nafter “the defendant,” “the governme nt,” or “the I .R.S. ”) for reimbursement o f $3,474, 244.00 in in come tax pa

yme nts, deposited under protest, which the I.R.S. had assesse d via tax deficiency

notices f or the five calen

dar y ears 199 1 thro ugh 1995. See Saginaw Bay Pipeline Co. v. United States , No. 99-CV-704 54, 2001 WL 1203283 (E.D. Mich. Aug. 23, 2001 ) (ordering final judgment for the defendan t United States); Saginaw Bay Pipeline Co. v. United States , 124 F. Supp. 2d 465 (E.D. Mich. 2000) (denying, on cross-motions, summary judgmen t to all litigants). The sole issu e in controversy was (and remain s) whethe

r, under prevail ing law , the plai

ntiffs’ underground

natural gas pipelines should be depreciated over a seven-ye ar period, as argued by the plaintiffs, or instead should be subject

to fifteen-ye ar depreciation, as asserted by the government and as resolved by the district court. The factual and legal epicenter of the dispute is whether

or not the subject pipeline syste m is a “gathering” pipeline (as defined
an d developed herein) used in the gas produc tion pro ces s even though the plaintif

fs are not the mselves producers of natural gas.

Inth e late 1980s, Shell Western Exploration and Production, Inc. (“SWEPI ”), a division of Shell Oil Company (“Shell”), commenced neg oti ations with the Michigan Co n solidated

Gas Corporation (“MichCon”) for MichCon’s constructionand oper

ation of a

steel pipe line system to transmit unpro cesse d natural gas (known in prevailing 4 Saginaw Bay Pipeline Co., et al. v. United States No. 01-2599

2 The plain tif

fs’ s tandard service contracts with gas producers require d that t

he producers separate specified amounts of water, sand, and certain other materials from the naturalgas at the well head viathe use of “field separ ator s,” prior to t he i ntr oducti on of

the extracted hydrocarbons into the Sa gin aw Bay pipeline sys tem, in order to meet specif ications enginee red to reduce the risk s of pipeline corrosion and obstructi on. Acc ord ingly, the Sagi naw Bay sys tem’s lat eral gat heri ng l ines did not connect direc tly to the field wellheads, and it s li nes transport ed par tially purif ied “raw” natural ga s. Nevertheless, t he gas moved by the pipeline companies from th e gas f ields to th e Kalkaska p rocessing plant was not
con suma ble “dry” methane gas. Rather, although that product cont ained contract -res tri cted quantities of certain natural po llutants, it nonetheless req uir ed substa ntial pro cessing at the K alkask a facility to co mple te its fin al conv ersion into “ dry pipeli ne-qual ity ” methane f uel suitable for sale to end user s. See f

urther discus sion bel ow. 

## industry parlance as “raw” o r “wet” natural gas) fr om SWEPI’s gas wellheads in eighteen distinct production fields located in the Michigan

East Centr

al Basin to its natural gas processingplant situated in Kalkaska, Michigan (“the Kalkaska facility ”). MichCon, throu

gh its sub sidiary

MCN Corporation, formed the plaintif f entitie s for

that purpose. Between 1988 and 1 990, the p laintiff s constru cte d, in accordancewith SWEPI ’s speci fication s, a 126-m ile subterranean

ste el pi peline network traversing six Michigan counties whichlinked SWEPI ’s East Ce ntral Basin

gas fields to th e K al ka sk a f

ac il it y.
That system c o nsisted of a central line leading into the Kalkaska processingplant, which was fed by lateral adjoining pipes which link

ed speci fic well

heads to “fi eld sepa

rators”2 

## and ultimately

to the main pipeline. The main pipeline had a daily maximum capacity of 13 5 m illion cubi c feet o f “wet” gas. At all time s mate rial t o thi s lit iga tion, alt hough the plaintiffs owned and operated the pipeline sy stem, the transient “raw” natural gas re

mained the propert

y of its

## No. 01-2599 Saginaw Bay Pipeline Co., et al. v. United States 5

3 During the relev ant pe riod 199 1-95 , the Sa ginaw Bay pipeline network did no t exclusiv ely t rans por t “wet” gas belongi ng to SW EPI. Rather, it al so carried “raw” naturalgas produced by, among o thers, Sun Oil, Marathon , Ory x, a nd Amoco.

4 Although both “transm ission” lin es and “distribu tion” lin e s carry pure, “dry” natura l gas for u ltimate consumer us e, t he t erm “ transmi ssi on lin e” evidently i s most fre que ntly us ed to describe an interst ate pipeline which carri es cle an processed gas fr om a cl eans ing cent er t o a dis tri buti on center, whereas th e phrase “ distribut ion line” apparent ly i s most of ten employed to descri

be a pip elin e which t

ransf ers “dr y” gas from a l ocal dist ributi on center to spec ific business or residential custom er add resses. See, e.g., Phil li

ps Petrole um Co. v. Wisc ons in , 347 U.S. 672, 691 ( 1954) (Clark, J. , dissentin g) (“T he natu ral gas ind ustry, like A ncient G aul, is divided into th ree p arts. These parts are production and gatheri ng, interstate transmi ssi on by pipel ine, and dist ribut ion to cons umers by l ocal distri bution companies.”) 

## producer through out the tra

nsportat ion proce ss. 3 

## The produce rs compensated the plaintiffs for the use of the pipeline on a contr

actual “ fee-f

or-ser vice” basis.

N a tural gas, in its “raw” form when extracted fr om the earth at the we llhead, i s ty pical ly c ontamina

ted with
numerous impuritie s, includi ng, among othe

r things
, butane, ethane, pentane, propane, water, nitroge n, carbon dioxide, other ine rt gas es, sulphu

r, sand, a

nd drilling

fluids. Al l adulter ants must be substantially removed at a pur i f ication site such as the Kalka ska fac ility , leaving only nearly

- pure “d ry” methane

gas, pr ior its sal e to residential or commercial
consumer s. The cleansed, customer-ready “dry ” petro chemical fuel is the

n exported

from the p

urifica ti on plant to distributors or other customers via lines whic h, for purposes of this dec ision, sha ll b e denomin ate d “transmission ” or “distribution” pipelines, which are pipeline s designed and opera

t ed so le ly f

or th e c ar ri ag e o f “ dr y” hydrocar bon ga s, sometimes referred to in the fossil fuel businessas “pipeline-quality gas.” 4 

## By contrast, becau se the Saginaw Bay pipeline was desig

ned to, an d was ope rated a s, 6 Saginaw Bay Pipeline Co., et al. v. United States No. 01-2599

5 The record herein reveal ed that various terms of

art f requently used in t he natural ga s tr ade have not always been used consistently, and may have differen t mean ings whe n used in diffe re nt cont exts. For example, main or trunk pipel ines w hich adjoi n lat eral “ gather ing” lines ru nning from fie ld wellheads, whi ch transmit t he “raw” gas gathered from the late ral lines t o a pur ifi cat ion fa cili ty, have somet imes been ca lled “transmiss ion” pipe lines. Sim ilarly, “wet” gas part ially cle ansed by field separators has oc casio nally be en de signated “pipe line-qua lity gas” in refer ence to it s confor

mity to contr act specificat ions for intro duc tion into

a “gathering” pi peline for carriage to a puri fication c omplex, as opposed to that term’s m ore c ommo n usag e in refer ence to “dry” gas wh ich is suitable for t

ransi t vi a a “t rans miss ion” or “di str ibut ion” pipel ine for ultimate delivery t o a consumer. Howe ver, as developed herein, the terminology used , whethe r by the p ipeline ’s owne r or an yone else, to descr ibe or ident ify

a parti cular pipeli ne, i s not di sposit ive of its proper tre atment u nder the federal i ncome tax laws. Rather, as evolved herein, the act ua l functi onal use to whic h a pa rticular p ipeline or pip e system is dedicateddeter mines its ass et c las sif ication for tax depre ciation purpo ses. 

## a conduit for “w et” natural gas, it constituted a species of natural gas transportation pipeline frequently described, within prevailing natural gas industry nomenclatur e, as a natural gas “gather

ing” pipeline. 5



## Becau se the respective functions of “ gather ing” pip elines, vis a vis “transmission” or “distribution” pipelines, as defined herein
, are entirely

distinct, the operating standards for the two systems are c o rre spondingly dissimilar. For e xample, whereas “transmission” or “distribution” pipeline systems ar e typ ically unable to safely a

ccommodate any

significant presence of soli d or li quid conta minan ts, “ga theri ng” pipelines including the Saginaw Bay system must be equipped to handle at least limited amounts of the no n

gaseous components of “raw” natural gas. Ad ditio na ll y, because “raw” natural gas ordina rily burns at a hig

her temperature than “dry” natural gas, “tra

nsm ission” or “distribution” line service contracts gener ally provide for

the tr ansportof fossil fuel having a relatively low “heating value,” us ua ll y n o more than 950 B ritish The

rmal Units

## No. 01-2599 Saginaw Bay Pipeline Co., et al. v. United States 7

(“BTUs”); whereas “gathering” lines (includingthe Saginaw Bay system) transport “r

aw” gas with higher “e

nergy values,” typ ically ranging between 950 and 1400 BTUs. The Saginaw Bay service contracts specified that “the Gas shall have a total heatin gvalue per standard cubic foot of not less than 950 British thermal units.” (Emphasis added). Likewise, a “gathe ring ” sy stem must be constructed to functionat relatively low pr essures over

comparatively shor

t distance s. The Saginaw Bay system could tolerate no more than1440 pounds per square inch (“psi”) of pressure , an d covered only 126 miles. By

contrast, a “t

r ansmission” or “distribution” line usually function s at compa

ratively higher pressures over longer distances, often totali ng hundreds of miles. Perhaps most significant ly, “gathering” pipelines must be flushed out reg ularly – a proce ss labele d “pigging” – to avert
or del a y excessive wea

r-and-tear pipeline corrosion and the accumulation

of foreign obstructive materi al s, given the ubiquitous presence of

contaminants disso lved withi n“wet” natural gas; w

herea s “transmission” or “distribution” lines
conveying

only clean “ dry” gas never require that ty pe of expensive and time-consumingroutine maintenance. Record proof reflected that, during the

interval pertinent to the instant action, at least s ome portions o f the Saginaw Bay system
re qu ir ed “p ig gi ng ” t wi ce or th ri ce da il y.
C onseque nt ly, because the purposes and functions of “gather ing” lin es are commercially distinct from those of “transmission” or “distr ibution” li

nes, the c oordinat

e economic costs and investment risks accompany ing each are also di ve rs e. Th e u ni qu e e xp en se s a nd pr od uc ti on de la ys affiliated with the regular “pigging” of “gathering” pipelines
are obvious examples. The singu lar ri sks o f seri ous da mage to “gathering” lines by

corrosion or obstruction, a nd t he attendant i nitial need to construct a comparatively sturdy 8 Saginaw Bay Pipeline Co., et al. v. United States No. 01-2599

“gather ing” pipeline

rela tive t o a “transmission” or “distribu tion” line , constitu

te furthe r examples

. Ad di ti on al ly, a functional “transmission” or “distribution” line will ordinarily retain a use ful and profitable economic life for as long as gasdealers or consumers connected by that line to the proc essing p lant cont inue to pur

chase heating

gas; however, a “gathering” line more lik ely may become obsolete, redundant, or otherwise unprofitable prior to its natural “wear-and-tear” e xpiration, if, for

example, the field wellheads it services become deplet e d or other wise unproductive, or

compara tively inexpensive altern

ate sources of “raw ” natural gas accessible to the proce ssing plant become compe titi vely avai lable . Accor dingl y, “gatheri ng” lines are not only more costly and labor-int

ens ive to
cons truc t, maintain, and operate, but also generally have a
s horte r operational life span than “transmission” or “distribu tion” line s.
Becau se both “tra

nsmission”

or “dist rib ution” natural gas pipes, and “g atherin

g” natu ral ga s lines, c onstitute property used in a trade or busines s, the owner of either ty pe of pipeline is entitled to a “reasonable allowance” for annual depreciation

of that asset against the owner’s ordinary businessincome for a finite number of years. See26 U.S.C. § 167(a)(1). The depreciation allowanc e for ta

ngible propert y used ina trade or business should be ascertained by reference to three f

actors –

namely

the leg ally -presc rib e d (1) “depreciation metho d,” (2) “recovery period,” and (3) “convention” – for the business asset at issue. See26 U.S.C. §§ 167(b) , 168(a) . The adversarie s sub j udicehave agreed that the instant controversy i nvolves on

ly element two, the selection of the proper depreciation “re covery period” for the Sag inaw Ba

y pi pelines.

The pl aintiffs, as taxpayers, must car ry the burde

n o f provingtheir entitlement to a claimed deduction which has been contested by the I.R.S. H elvering v. Taylor , 293 U.S.

## No. 01-2599 Saginaw Bay Pipeline Co., et al. v. United States 9

6 The part ies here in h ave ag reed t hat, alt hou gh Congress r emoved § 167(m) from the tax c ode via a 199 0 am end men t, subs ecti on 167(m)( 1) h a s retaine d co ntinuing v itality by its inco rpo ration b y referen ce into §168(i)(1), which remained a part of the code during the 199 1-95 tax years mater ialto the subje ct actio n. Accord, Duke Energy Nat ural Gas Corp. v. Commissi oner , 172 F.3d 12 55, 1257 (10th Cir. 1999).

7 “Forpurposes of

thi s sect ion, pr operty s hall be incl uded in the asset guidel ine class for the activity in wh ich the pro perty is prim arily used

. See paragraph (e)(3)(iii) of this section for rul e for l ease d pr ope rty. Pro perty shall

be classi

fied accor

ding to pri mary use even t hough th e activity in wh ich su ch p rop erty is pr im arily u sed is in subs tantia l in rel ation to all

the t axpayer’s acti

viti es .” 26 C .F.R. § 1.167(a)- 11(b)(4)(iii)(b). (Emphases adde d). 

## 507, 514 (1 935). Ho wever, “if doubt exists as to the constructionof

a taxing statute, the doubt should be resolved inf a vor of the taxpayer.” Hassett v. Welch , 303 U.S. 303, 314 (1938).

The ap pl icable d

epreci ation “r

ecover y pe riod” is k eyed to the “c la ss li fe ” o f t he su bj ec t p ro pe rt y. 26 U.S.C. § 168(e)(1). Anasset’s “ class life” is defined by re ferencing “the class life [c at eg or y] prescr

ibed by the Secr

etary whic h reasona

bly reflects the anticipated useful life of that c lass of prope

rty to the industry or other g roup.” 26 U.S.C. § 167( m)( 1) (repealed), incorporated

by refer ence int o § 168(i)(1). 6 

## The Treasury Regula tions (“the Regul atio ns”) posit a “use-dr iv en” functional

stan dard for assig

ning ass et classi fication s. 7 

## 26 C.F.R. § 1.167(a)-11(b)(4)(iii)(b).
However, the Treasury

Se cret ary has pr

omulgated two materia l, specific, functionally-defined na tu ral gas industry asset life classifications which facially may encompass the Saginaw Bay pipe line complex -- to wit, As set Cla ss 13.2 (defined to include “gathering pipe lines” and other propert y used in the pr oducti on of natural gas), which has a listed “classlife” of fourteen y ears and an associated Genera l Depreciation

System “recove

ry period”

of seven ye ars; and 10 Saginaw Bay Pipeline Co., et al. v. United States No. 01-2599

8 [Asset Class] 13.2: Explorat ion f or and Product ion of

Petrol eum and N atural Gas D eposits :

Includes assets used by petr oleum and natural gas produ cers for drilli ng of we lls and product ion of petr oleum and natural gas , incl uding gat

heri ng pipeli nes and r elated storag e facilities. . .

.

. . . . [Asset C lass] 46 .0: Pipel ine Trans portati on :

Includes asse ts used in the pr ivate, commercial, and contract carry ingof

petrol eum, gas and other p roduc ts by means of pipes and conveyors . The trunk li nes and rel ated st orage fa cil it ies of int egrate d petro leum a nd na tural gas pro duc ers are in clude d in this class. . . .

Rev. Proc

. 87-56, 1987-2 C.B. 678, 684. ( Boldface in origi nal; ita lics added). “Trunk lines” are large-di ameter, usual ly hi gh-pres sure mai nli nes which conn ect dista nt po ints; they gen erally inclu de “tra nsmissio n lines.” However, large “gathering” ma in lines are sometimes a lso refer red to as “trunklin es.” Neverthel ess, rea ding t he two asset clas s descriptions togethe r, i t is evident that all functionally-defined “gathering pipelines” shou ld be cons igned to Asse t Class 1 3.2, lea ving all remaini ng natural ga s transport lines (s uch as “transmis sion” and “distribution” lin es, as well as non-gathering “tr

unk li nes” owned by integrated producers of nat ural g as which are usedto tr ansmit “dry”n atural

gas to distributors or co nsumers) within A sset Cla ss 46 .0. See further d evelo pme nt belo w. 

## Asset Class 46.0 (defin ed to include assets used in the carry ing of ga s b y p ipes), which triggers a listed “c lass life” of tw en ty- tw o ye ar s, an d a n a cc om pa nyi ng G eneral Deprec iatio n S yst

em “rec overy

period” of fifte en y

ears. 8 

## Rev. Pr oc. 87-56, 1987-2 C.B. 678, 684 (hereinafter “ the Revenue Procedure”).

The pipeline companies have maintained that the Saginaw Bay pipeline network fits into As set Cl ass 13. 2, and hence they should be entitled to comparatively accelerated sevenyear deprec iation. B y c ontrast, th e I. R.S. arg ued, with
success before the district court, that the plaintiffs’ pipelines

## No. 01-2599 Saginaw Bay Pipeline Co., et al. v. United States 11

9 The government

has aver red that a material f

act disti nguishes Duke Ene rgy’s pipeli ne sys tems f rom the Sagi naw Bay pipel ines, b ecause the United States in Duke Energy did not di spute t hat Duke’ s pipel in e networks were “gathering systems” fo r asset class a t tri bution pur poses ( see Duke Energy Natural Gas Corp. v. Comm iss ioner , 172 F. 3d 1255, 1256-58 (10th Cir. 19 99)); where as in the case here in controversy t he tri al court agreed with t he government ’s ar gument t hat t he Saginaw Bay network was nota “gather ing system .” See Saginaw Bay Pipeline Co. v. United States , No. 99- CV-70454, 2001 W L 12 032 83, a t *2-3 (E.D. M ich. Aug. 23, 2001) (fi nding, as a matt er of both fact and law, that

the Sagi naw Bay pipeline was not a “gat hering” pipeline bec ause it d id no t directly connectto any field wellhea d, and also b ecau se it was no t substan tially locatedon a natural gas p roduc er’s l and f rom w hich na turalgas was extracted). In supp ort of its “d iscon nectio n” theo ry, t he tri al court adopted the reasoning of a non- controlling Fi fth Circ uit decision, Ham man v. Southwestern Gas Pipel ine, I nc. , 721 F.2d 140 , 142 -43 (5 th Cir. 1983), by which that court had constr ued federal natural gas pipeline safety regul

ati ons to requi re tha t “gather ing” lines must atta ch dire ctly to wellheads. The key regulation po sited that a “‘gathering line’ means a pipeline that t

ransports gas fr om a cur re nt pr oducti on fa cil ity t o a transmi ssi on line or main.” 49 C.F.R. § 19 2.3. (A gas wel lhead quali fies

as a “currentproduction facili ty”). The Hamman court ’s const ruct ion of that regula tion to re strict th e me aning o f “gatherin g pip eline” so lely to late ral “f

eeder” pipe li nes whi ch connect direct ly t o fiel d wellh eads, as opposed to pipelines whi ch transport natur al gas from fiel d wellheads but do not physi cally joi n th ose we ll heads , i s f acia ll y open to qu est ion . At any rate, to th e extent

that Hamman might carry any persuasive weight

in the Sixth

Circui t, i t would be r estr icte d to const ructi on of th e laws governing natural gas pipe line sa fety
, such as the f

ederal rules controll ing the dep ths at w hich certain types o f gas pip elines m ust be b uried

. See Hamman , 721 F.2d at 14 2. No evident rationa le supports the appli cati on of a saf ety r egulat ion’s judici al ly-r efined defini tion of “gat hering pipeli ne” to the inc ome tax de prec iation re gulatio n s, gi ven the total di ssim ilarity of the p urpo ses of the two sets o f standa rds. Id . at 143 (“Keeping in mind that Co ngress mea nt the [N atural G as Pip eline S afety] Act to minim ize ac ciden ts caus ed by natural ga s pipel ines, we hold t hat

a pipe line mu st be d irectly attac hed to a gas well i n order to meet the 

## belongin Asset Class 46. 0, which authorizes fifteen-y ear depreciation.

To date, the only sister

circuit t o confront a

similar c ontest has been the Tenth

Circuit, w

hich, on nearly

identica l facts, 9 

## 12 Saginaw Bay Pipeline Co., et al. v. United States No. 01-2599

gathering l ine defini tion.”).

Si milarly, the distric t judge ’s invoc ation o f Public Servi c e Commissi on of

Kentuck y v. Federal

Energy Commiss ion , 610 F. 2d 439, 444 (6th Cir. 1979) (ruling t ha t exclus ive feder al r egul ator y juris dict ion under the Natur al Gas Act encompasse d natura l gas from th e moment that it enter ed the st

ream of i nters tate commerce by exi tin g the wel lhead and entering a “gat

hering ” pipeli ne, despi te a statut ory exemption permitting state regul atory jurisdiction ove r “produ ction and ga thering” activities, which the court

const rued t o be limi ted to production act ivi ties undertaken by natura l gas pro ducers upon the re al e state wh ere t he gas wellheads

were locate d) wa s misco nceive d. T he trial jur ist erron eou sly i nt ima ted that Public Servi ce Commiss ion supported t h e con clusion that only gas product ion activities which occurred on the realt y which pro duced the natura l gas shoul d be categori zed as “gathering” activities, and therefore pipe lin es large ly lying on property from whi ch no gas was extra cted shou ld not be deemed “ gath eri ng” pi pel ines for any purposes including in come tax as set cl assi fication. Howev er, alth ough the t ransport ed

con tents of “gath eri ng pi peli nes” migh t be di stingui shabl e fr om “gathering” activities which t ranspire on the p roducer ’s propert y or leaseh old for federal regul atory juri sdict ional purposes, that distinctio n is entirely imma terial to the feder al inco me tax dep reciati on tr eatme nt of pipeli nes which t

ransport “wet” as opposed to “dr y” natura l gas, irrespective of the labe l attributed to such pipe lines.

Acc ord ingly, the tri al c ourt erre d, as bot

h a mat ter of f act and l aw, by characterizing the Saginaw Bay pipelines as s omething other than a “gathering” syst em as defi ned for pur poses of t

he instant l itigation. See Razavi v. Commissioner , 74 F. 3d 125, 127 (6th Ci r. 1996) (expl aini ng that

a distri ct court’s findings of histori cal fact are examined for clear error, but its app lications of law to the facts a nd its ultim ate l egal conclusions including re solutions of mixed ques tions of lawand fact are scr uti nized de novo ). As il luminated herein, the undi sput ed pract ical uses to whic h the Sagin aw B ay pip eline s were put du ring the five tax year s in controve rsy mili tat e d to ch aract eri ze them as “gat heri ng pi peli nes” for in come tax purpos es wit hin t he a mbit of Asse t Cl ass 13.2 as a mat ter of law, irr espective of t

heir lac k of direct connec ti ons t o fi eld we ll heads by

reas on of i nter

veni ng “f

iel d separ ator s,” and re gardl ess of th e subject pipel ine’ s si tus on land fr om whic h nat uralgas w as not

extract ed. 

## reversed the United

States Tax Court’s application of fifteenyear depreciation, in favor of the seven -ye ar writeoff. Duke Energy Natural Gas Corp. v. Commissioner , 172 F.3d 1255

## No. 01-2599 Saginaw Bay Pipeline Co., et al. v. United States 13

10 The ini tial

adjudicat or in t

he case i n controve rsy opi ned that “ Duke

was wron gly decid ed in its inte rpre tation o f the term ‘used b y’ in the first sent ence of Asset

Class 13. 2.” Saginaw Bay Pi peli ne Co. v. Uni te d States , No. 99-CV- 70454, 2001 WL 1203283, at *2 (E. D. Mich. Aug. 23, 2001). In reality, the d istric t c ourt ha d misc onstru ed the “used by” phraseology to mean “owne d by” a nat ural g as pro duc er. As p ersua sively exp licated by the T enth C ircuit:

We are n ot pe rs ua de d b y th e g ov er nm en t's int erpre tat ion of the asset clas s descriptions. "Use" do es not mean "ow n" in eith er the legal dictionary definition of the wo rd use
, see Bla ck's Law Dictiona ry 1541 (6th ed. 1990) ("T o ma ke use of; to convert to on e's servi ce; to employ; to avai l onesel f of; to ut ili ze; to carryout a purpose or a cti on by means of ; t o put into a cti on
or servi ce, espec ially to at tain an end."), nor in e veryday parla nce. . . .

The Revenue Procedure bef ore us cr eates and descri bes asset cla sses for

the purpos e of e sta bli shi ng depr eciati on schedules, and contai ns cri tica l in formati on aff ecti ng taxpay er decisions abo ut cap ital investm ent. W e can not a ccept the go ve rn me nt 's attemp t to in ter pola te the wo rds " own ed b y" into the descr ipt ion of

Asset Clas s 13 .2. We instead i nterpre t th at descr ipt ion to include any gathering system, so long as it is us ed by a gas producer --wh ether under it s own ow ners hip or

through contract ual arran gem ents--in the expl orat ion for and produ cti on of pe troleum and n atural ga s. 

## (10th Cir. 1999) . T hat court ruled that, although Duke Energywas not itself a “producer” of natural gas, its “gather ing” systems were pr im ar il y used bygas pro ducers t o tran smit partially-cle ansed-but-essentially-still-“wet” natural gas t o purification plants. Id . at 1258. Moreover, after weighing fa ct or s s uc h a s t he co mp ar at iv el y l ow operational pressur es, generally

confine d ge ographical areas servic ed, and relatively short potential ec onomic life spans attributa ble to Duke’s “ gather

ing” pip e sy stems, the

Tenth Circ

uit concluded

that, as a functional issue, “[t]he net effect is that the economic character

of Duke' s gathe

ring ac tivities ismore akin to production than pipeline operation.” 10 

## Id . at 1258-59. 14 Saginaw Bay Pipeline Co., et al. v. United States No. 01-2599

Duke Energy Natural Gas Corp. v. Comm iss ioner , 172 F. 3d 1255, 1259- 60 (10 th Cir. 1 999 ). Alterna tively, the Duke Energy cour t conv incingly illustr ated that, even if the Asse t Class 1 3.2 d escrip tion co uld be ra tionally constr ued to exp ressly list

“gathering” lin es whi ch were owned bynatur al gas prod ucers, the use of the word “includ es,” rather than “includes only ” (see note 8 above), signals an intent of it s draf

ter not to res tri ct the asset clas sif ication solely t o the lis ted propert y, but inst ead also t o embrace “pr ecisely analogous asset s used by non-producers to provi de servi ces direc tly to producers .” Id . at 1260 ( cit ing, inter al ia , 26 U.S. C. § 7701 (c)). 

## Indeed, the United States’ posture that the depr eciation status of pipelines which in fact are used as “gath ering” lines should depend not upon their function and the costs and risks associated

with their operation, but instea d upon the

business identity of their owners, would, if adopted, lead to the absurd result that pipel ine s used for identical “gathering” purposes would be depreciated

over seven y

ears if owned by

a producer of natural gas, but would instead be subject to fifteen-y ear deprec iation if owned by

a pipeline compan

y e ngag ed in the trade of transporting “wet” natur al gas for hire. As compellingly e

xpressed by the Duke Energy court: Furthermore, were we to read a distinction into the asset classes requirin g taxpay ers to p lace the gathering systems o f nonproducers in Asset Class 46.0 and the gathering systems of

produ cers in Asset Class 13.2, we would th ereby c

reate an inconsistent regime for the depreciation

of asset s. If

placed i n differ ent cla sses, gathering systems used for the same purpose and serving identical wells would fall under d iff erent depreciation schedules dependingupon the producer or nonproducer status of the asset's owner. Moreover, if a produce r sells
a gathering sy

stem to a nonproducer such as Duke , the system would shift from one asset clas s to a nother withoutany

chang e in

its functi on or cha

racter istics, and the system's new

owner would be forced to depreciate the
asse tover a f

ar long er peri od. Absen t an expli ci t

## No. 01-2599 Saginaw Bay Pipeline Co., et al. v. United States 15

distinction based on ownership i n the Revenue Procedure, we decline to create such an inconsistency.

Id . at 1261. (Notes omitted).

The g overnme

nt’s retort was an

chored i n an elab orate historical construct which tediou sl y t raced the pedigree of businessproperty de

preciat io n federal tax laws since the inceptionof modern national income ta xation in 191 3 in a bid to illustrate

that, ove r the y ears, the United S tates had o fttimes commanded

vary ing tax tre atments of

similar bu siness assetsused for similar purposes on the sole basis that the respective owners o f those a ssets wer e enga ged in diff erent
commerce. That effort was unavailing, beca use, since at least the early 1970s, the United States has explicitly renounced an “industry-base d” approac h t o asset classification in favor of
a “ use-bas ed” system. See26 C.F.R. § 1.167(a)- 11(b)(4)(iii)(b) (applic ableto property plac ed in service after D ec ember

31, 1970), which posits, among other things, that “[p]roper ty shall be classifie

d accord ing to prima ry

use even though the activity in which such property is primarily used is insubstantial in relation to al l the t axpayer’s activities .” (Emphasi s added). The Duke Energy court ha d corre ctly rejected the same argument by the I.R.S.:

The government argues that in pre vio us iterations of the asset classes in disp ute, the I

RS dist inguis hed between assetsowned by

gas pro ducers a

nd those owned by non-producers. See, e.g. , Rev. P roc . 72-10, 1972-1 C.B. 72 1, 73 1 (superseding Rev. Proc. 71-25, 62-21); Rev. Proc. 71-25, 1971-2 C.B. 553, 556 (establishing Asset Class 13.2 ); R ev. Proc. 62-21, 1962-2 C.B. 418, 424 (establi shing Gu

idelin e Cl ass 17(b), which "[e]xclude[d] gatheri ng pip eline s and r elate d sto rage facilities of pipeline companies"). We fi rst note tha t all of the relevant provisions of the earliest Revenue Procedures the go vernme nt cites to

support its interpretat ion of the current asset class descriptions ha v e 16 Saginaw Bay Pipeline Co., et al. v. United States No. 01-2599

been explicitly superseded

. SeeRev. Proc. 72-10, 1972-1 C.B. 721, 731 (superseding Rev. Proc. 71-25 , 62- 21); Rev. Proc. 71-25, 1971-2 C.B. 55 3, 566 (superseding Rev. Proc. 62-21).

More i mport antly, the

language

of the most

r ecen t--and

relevant--of these prior iterations does not establishthat g

a thering systems of nonproducers have been distinguished from those of producers for depreciation purposes since 1972. See Rev. Proc. 77-10, 1977-1 C.B. 5 48 , 548 (superseding Rev. Proc. 72-10, whilenoting that the change "was not intended to modify the composition of the existing classes of Rev. Proc. 72- 1 0"). Rev. Proc. 72-10, 1972-1 C.B. 721, 723, w hic h establishes the immedi ately pri or (and still relevant) iterationof

the applicable sentence of the description of Asset Cla ss 13.2, stat

es that the

class " [i]ncludes assets used f or d rilling of wells and production of petroleum and natural gas, including gathering pipelines and r elated stora ge facilities, when these are related ac tivities undertaken

by petroleum and na

tural gas producers." This description relie s u pon essentia

lly t he same langua ge as the cu

rrent a sset clas s in stating th at when gathering systems are "used for" the drilling and production processes of

produce rs, they b elong in Asset Class 13.2. We are no m ore pe rsuaded by the g overn ment's argume

nt that the

words " underta

ke n by"--whichrefer

to "activities"--necessarily implies that the assets must be "owned by " producers than w e ar e persuaded

that the words "used by" ne cessarily r equire ownership. The relevant

earlier asset class descriptions provide us with no clear mandate to distinguish between

## No. 01-2599 Saginaw Bay Pipeline Co., et al. v. United States 17

11 Acc ord ingly, because Sagin aw B ay’s primary business i s irrel evant to the depreci at ion c lass ifi cati on of th eir pi peline s used f or natur al gas “gathering” act ivi ti es, the fac t t hat the plai nti ff

s i denti fi ed th emsel ves on their tax re turns as engag ed inthe tra de of “nat ural g as tr ansportation” (as opp osed to pro duc tion or “gather ing”) is im mate rial. 

## g atheringsystems based upon ownership, and we therefore will not do so. 11



## Id . at 1260-61. (Emphases added).

This r eviewing court has caref ully considered the tria

l court’s written opinions and final judgmen t, the brie fs and al l argume nts of counsel, the material contained within the Joint Appe ndix, and the controlling legal authorities. I t finds that the district court committed reversible legal and factual error by ruling that the Saginaw Bay pipelines at

issue herein were not“gathe

ring” p ipelines subj ect to seven-y ear depreciation under the Reve nue Proc edure’ s Ass etClass 13.2 definition. This court finds the Tenth Circuit’s reasoning and conclusions articulated

in Duke Energy Natural Gas Corp. v. Commissioner , 172 F.3d 12 5 5 (10th Cir. 1999), to be logica lly persuas ive and f

actually on point, and

thus adopts its analy sis and ruling. T his cou rt further concludes that the
s ubsequ ent

conflicting analysis and decision of the United States Tax Court in Clajon Gas Co . v. Commi s sion er , 119 T.C. 197, 2002 WL 31399696 (Oc t. 25 , 2002), was lega lly ill-formulated and unpersuasive.

Inconclusion, this reviewing court rules that every natural ga s carria ge pipe line w hich f uncti ons as a “gathe ring” pipelin e in the methane gas production process by transportingimpure “raw”or “wet” natural gasfrom the f ield wellh ea ds to a cleansing and processing f acility qualifies as
a “gathering pipeline” subjec t to seven-yea r General Depreciation

System deprecia

tion un der the strictures of Asset Class 13.2 of Rev. Proc. 87-56, irr e spective of the primary business of the owner of

that pipeline, the other uses 18 Saginaw Bay Pipeline Co., et al. v. United States No. 01-2599

of the land under which that pipeline runs, and/or whether that pipel ine was connected by lateral “feede r” lines d irectly o r indirectly to the f ield w ellheads. Concordantly, a ll natural gas transportation pip elines used for any purpose other than the production-related “g ather ing” of “wet” gas, inc luding dry-g as “tran smission” and “distribution” pipelines as de fine d herein, should be depr e ciated over fifteen y ears under the GeneralDeprec iation Sy

stem as As set Class46. 0 p ro pe rt y, even if t hey are owned or use d by

a produc er of na

tural g as.
The judgmen

t of the distr ict c ourt for the defe ndant is reversed , and the c ase is remanded for entry of judgmen t in favor of th e plaintiffs and for such necessary further proceedings as are consistent with this disposition.