Opinion ID: 756738
Heading Depth: 2
Heading Rank: 2

Heading: The Method of Accounting for Contract Losses

Text: 10 Nuclear power plants produce electricity by using nuclear fuel assemblies to generate a fission reaction. Nuclear fuel assemblies are composed of fuel rods containing individual uranium pellets. Uranium pellets are the end result of a complex process in which natural uranium is mined, converted into a gas, and enriched to increase the U235 isotope. The enriched gas is then piped into containers and shipped to the fuel assembly fabricator. The fuel assembly fabricator converts the enriched gas into uranium pellets, which are then used to make the fuel rods. The enrichment process is critical because natural uranium does not contain enough of the U235 isotope to create and sustain a fission reaction. 11 Uranium is enriched at plants in the United States and Europe. These plants sell enriching services at a specified dollar amount for each separative work unit of service (SWU). A SWU reflects the processing work needed to enrich a unit of gas to a specified concentration of the U235 isotope. Beginning in the mid-1970s, NSP contracted with the Department of Energy's (DOE) plant in Oak Ridge, Tennessee for its enrichment needs. These contracts were designed to secure NSP's projected enrichment needs well into the future at a fixed price per SWU. They were structured as take or pay contracts. That is, NSP was bound to pay for the SWUs whether it used them or not. In the mid-1980s, it became apparent that NSP had overestimated its enriched uranium needs, primarily because it abandoned plans to complete another nuclear power plant. At the same time, the worldwide price for enriched uranium fell below the contract price. Thus, in 1984, NSP found itself bound to take or pay for SWUs that it no longer needed at a price that greatly exceeded the prevailing market price. Consequently, NSP began to sell or assign various amounts of the DOE SWUs to third parties in order to mitigate its losses. Nevertheless, NSP still lost $1,286,634 on these contracts in 1985 and $811,647 in 1986. This case involves, how, for tax purposes, NSP treated these losses. 2 12 When the tax department at NSP prepared and filed NSP's tax returns for 1984, 1985, and 1986, it was apparently unaware that NSP had sold or assigned the DOE SWUs to third parties. Therefore, it included the amount of the contract losses in the cost basis of the SWUs that Westinghouse used to fabricate the fuel assemblies acquired by NSP in those years. As a result, NSP depreciated the amount of the DOE contract losses over the life of the fuel assemblies that NSP used to generate nuclear power instead of currently deducting them as an ordinary and necessary business expense, an ordinary loss, or a capital loss. When, in 1994, the NSP's tax department learned that the DOE SWUs had been sold or assigned to third parties at a loss in 1984, 1985, and 1986, it timely filed refund claims for the tax years 1985 and 1986. In these refund claims, NSP sought to recover the difference between the taxes that it paid while depreciating the DOE contract losses and the lower taxes it would have paid had it currently deducted them. That difference, with interest, is approximately $1,800,000. 13 The IRS denied the refund claims. It construed the refund claims as a veiled attempt by NSP to change its method of accounting for the contract losses without first obtaining the consent of the Commissioner of the IRS as required by law. See 26 U.S.C. § 446(e). Since NSP had not obtained the Commissioner's consent, and the time for doing so had lapsed, the IRS concluded that NSP could not now change how it treated the contract losses. NSP challenged this ruling by filing this action, arguing that it was merely attempting to correct a mistake on its earlier returns and that it had never adopted a method of accounting for these losses. 14 The parties cross-moved for summary judgment. As with the previous issue, the district court referred the matter to a magistrate judge. The magistrate judge recommended finding in favor of the United States. The district court reviewed the magistrate judge's report and agreed with its recommendations. Specifically, the district court concluded that because NSP's mistake implicated the proper timing of taking a deduction, NSP sought to change its method of accounting, and was therefore required to obtain the Commissioner's consent before doing so. Consequently, the district court granted summary judgment in favor of the United States. See Northern States Power, 952 F.Supp. at 1348-49. NSP appeals.