Con Ed Seeks Refund, Claiming Entitlement to Transition Relief

Con Ed provides electricity, gas, and steam services to wholesale and retail customers under various agreements including franchises, power supply contracts, and other provisions of the regulatory compact with New York State. Con Ed maintains that in 1986, 1987, 1988 and 1990 it placed in service generation, transmission, and distribution equipment in order to meet its service and supply obligations under its franchises and power supply contracts and agreements. Con Ed states that these property additions were readily identifiable with and necessary to carry out the franchise agreements and that it is therefore entitled to additional investment tax credits and depreciation deductions under the transition rules of the Tax Reform Act of 1986.

Period and Amount at Issue: 1996 -- $21 million; 1997 -- $22.4 million; 1988 -- $857,000; 1990 -- $37.5 million

Code Sections: 167, 168, 46, 38

JURY TRIAL DEMANDED

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK

1. Plaintiff, Consolidated Edison Company of New York, Inc., and Subsidiaries by and through its undersigned attorney, for its complaint hereby alleges as follows:

PARTIES

2. Plaintiff, Consolidated Edison Company of New York, Inc. and Subsidiaries ("Plaintiff"), is a corporation duly organized and existing under the laws of the State of New York with an office and principal place of business at 4 Irving Place, New York, New York. Its taxpayer identification number is [TIN omitted].

3. The Defendant is the United States of America.

JURISDICTION AND VENUE

4. Plaintiff brings this action against the United States of America pursuant to sections 6532 and 7422 of the Internal Revenue Code ("IRC") of 1986, as amended, for the recovery of federal income taxes illegally or erroneously assessed and collected from Plaintiff by Defendant, and related statutory interest, for calendar taxable years 1986, 1987, 1988, and 1990.

5. This Court has jurisdiction over this action pursuant to 28 U.S.C. sections 1331, 1340, and 1346(a)(1).

6. Venue is proper in this District pursuant to 28 U.S.C. sections 1331, 1340, 1346(a)(1), and 1402(a)(2).

PROCEDURAL BACKGROUND

7. Plaintiff timely filed consolidated federal income tax returns for its calendar taxable years 1986, 1987, 1988, and 1990 with the Internal Revenue Service Center in Holtsville, New York, and paid all federal income taxes due and owing under the returns or otherwise assessed for 1986, 1987, 1988, and 1990.

8. Plaintiff timely filed claims for refunds in the amounts of (i) $21,025,900 for 1986, (ii) $22,397,467 for 1987, (iii) $856,800 for 1988, and (iv) $37,445,892 for 1990, together with interest as allowed by law (the "Refund Claims"). The Refund Claims set forth the grounds for recovery described in this complaint. True and correct copies of these refund claims are attached hereto as Exhibits A through D, and all the facts and arguments asserted in these refund claims are incorporated herein by reference.

9. The refund Claims were filed as follows:

(a) On or about December 12, 1994, Plaintiff timely filed form 1120X -- Amended U.S. Corporation Income Tax Return -- with the Internal Revenue Service Center in Holtsville, New York, claiming a refund of federal income tax for the taxable year 1986 in the amount of $21,025,900, plus interest as allowed by law. A true and correct copy of this refund claim is attached hereto as Exhibit A and all the facts and arguments asserted in this claim are incorporated herein by reference.

(b) 0n or about December 12, 1994, Plaintiff timely filed 1120X -- Amended U.S. Corporation Income Tax Return -- with the Internal Revenue Service Center in Holtsville, New York, claiming a refund of federal income tax for the taxable year 1987 in the amount of $22,397,467, plus interest as allowed by law. A true and correct copy of this refund claim is attached hereto as Exhibit B and all the facts and arguments asserted in this claim are incorporated herein by reference.

(c) On or about July 26, 1994, Plaintiff timely filed form 1120X -- Amended U.S. Corporation Income Tax Return -- with the Internal Revenue Service Center in Holtsville, New York, claiming a refund of federal income tax for the taxable year 1988 in the amount of $856,800, plus interest as allowed by law. A true and correct copy of this refund claim is attached hereto as Exhibit C and all the facts and arguments asserted in this claim are incorporated herein by reference.

(d) On or about December 12, 1994, Plaintiff timely filed form 1120X -- Amended U.S. Corporation Income Tax Return -- with the Internal Revenue Service Center in Holtsville, New York, claiming a refund of federal income tax for the taxable year 1990 in the amount of $37,445,892 plus interest as allowed by law. A true and correct copy of this refund claim is attached hereto as Exhibit D and all the facts and arguments asserted in this claim are incorporated herein by reference.

10. Plaintiff had failed to use the full amount of investment tax credits and depreciation deductions to which it was entitled on its original returns for 1986, 1987, 1988, and 1990. The Refund Claims reflect the additional investment tax credits and depreciation deductions on property Plaintiff placed in service in 1986, 1987, 1988, and 1990 that qualified for transition relief from the termination of the investment tax credit and the reduction in allowable depreciation.

11. During the course of Internal Revenue Service's ("IRS") review of the Refund Claims, the amount of the Refund Claims were adjusted to the following amounts: (i) $17,645,306 for 1986, (ii) $30,319,620 for 1987, (iii) $856,808 for 1988, and (iv) $44,690,546 for 1990.

12. On March 21, 1996, the IRS issued Form 5701 - Notice of Proposed Adjustment, disallowing the full amount of the Refund Claims. A true and correct copy of Form 5701 is attached hereto as Exhibit E and made a part hereof

13. On October 17, 1996, Plaintiff was issued a 30-day letter for the taxable years ended December 31, 1990 and December 31, 1991 proposing deficiencies for the taxable years 1990 and 1991 and disallowing the Refund Claims for the taxable years 1986, 1987, 1988, and 1990 in the amount of $93,512,281. A true and correct copy of the 30-day letter is attached hereto as Exhibit F and made a part hereof

14. On October 24, 1996, Plaintiff requested and was granted a sixty (60) day extension to prepare its protest to the 30-day letter. A true and correct copy of the request and its approval are attached hereto as Exhibit G and made a part hereof.

15. On January 14, 1997, Plaintiff filed its Protest to the 30- day letter.

16. On September 15, 1998, the Manhattan Appeals Office of the Internal Revenue Service disallowed the full amount of the Refund Claims. This action is, therefore, timely commenced within the period prescribed by IRC section 6532. A true and correct copy of the notice of disallowance is attached hereto as Exhibit H and made a part hereof.

17. Plaintiff is the sole owner of the aforesaid Refund Claims against Defendant, which are set forth in Exhibits A through D, and has made no assignment or transfer of these claims.

18. On January 1, 1998, Plaintiff participated in a reorganization pursuant to IRC section 351(a) in which it became a wholly-owned subsidiary of Consolidated Edison, Inc.

STATUTORY BACKGROUND

19. The issue raised in the Refund Claims and this action is whether certain property Plaintiff placed in Service after December 31, 1985 qualifies for the transition relief provided for under sections 203(b) and 204(a) (collectively referred to as the "transition rules") of the Tax Reform Act of 1986 (the "Act"), Pub. L. No. 99-514, from the termination of the investment tax credit and the reduction in allowable depreciation.

20. Section 201 of the Act replaced the Accelerated Cost Recovery System ("ACRS") of depreciation allowed under sections 167 and 168 of the IRC of 1954, as amended, with the Modified Accelerated Cost Recovery System ("MACRS") of depreciation for property placed in service after December 31, 1986. Section 211 of the Act repealed the investment tax credit ("ITC") allowed by sections 46 and 38 of the IRC of 1954, as amended, for property placed in service after December 31, 1985. However, the amendments made by sections 201 and 211 of the Act did not apply to property described in section 203(b) or 204(a) of the Act.

21. Section 204(a)(3) of the Act of the Act provided one of these exceptions to the repeal of ITC for "any property which is readily identifiable with and necessary to carry out a written supply or service contract, or agreement to lease, which was binding on [December 31, 1985.]" This transition rule is referred to a[s] the "supply or service contract rule."

22. Section 203(b)(1)(A) of the Act provided another of these exceptions to the repeal of ITC for "any property which is constructed, reconstructed, or acquired by the taxpayer pursuant to a written contract which was binding on [December 31, 1985.]" This transition rule is referred to as the "binding contract rule."

23. Section 203(b)(1)(B) of the Act provided another of these exceptions to the repeal of ITC for "property which is constructed or reconstructed by the taxpayer if --

(i) the lesser of (1) $1,000,000, or (II) 5 percent of the cost of such property has been incurred or committed by [December 31, 1985], and

(ii) the construction or reconstruction of such property began by such date."

This transition rule is referred to as the "self-constructed property rule."

FACTUAL BACKGROUND

24. Plaintiff is a regulated public utility company engaged in the business of furnishing electricity, gas and steam utility services to the general public; which during the years at issue in this action included the generation, purchase, transmission, distribution and sale of electricity, gas and steam.

25. Plaintiff supplies electricity, gas and steam services to wholesale and retail customers pursuant to various written agreements, including franchises, power supply contracts, tariffs approved pursuant to state regulatory authority, state and local enactments, and other provisions of the regulatory compact with New York State and regulatory authorities, all of which were in full force and effect on December 31, 1985.

26. The franchises and other written materials referred to in paragraph 25 above (the "Franchise Agreements") require Plaintiff to provide gas, electricity and steam services and to provide facilities for the provision of these services.

27. The Franchise Agreements were written supply or service contracts binding on December 31, 1985.

28. In 1986, 1987, 1988, and 1990, Plaintiff placed in service generation, transmission, and distribution equipment (the "Property Additions") in order to meet its service and supply obligations under the Franchise Agreements, power supply contracts, and tariffs approved pursuant to state regulatory authority, state and local enactments.

29. These Property Additions were readily identifiable with and necessary to carry out the Franchise Agreements referred to in paragraph 25.

30. Plaintiff has also identified property placed in service in 1986, 1987, 1988 and 1990 which was not claimed as transition property on its return as originally filed but which was constructed, reconstructed, or acquired by the taxpayer pursuant to a written contract which was binding on December 31, 1985.

31. Plaintiff has also identified property placed in service in 1986, 1987, 1988, and 1990 which was not claimed as transition property on its return as originally filed but which was constructed or reconstructed by the Plaintiff. Further, the lesser of $1,000,000 or 5 percent of the cost of such property had been incurred or committed by December 31, 1985, and the construction or reconstruction of such property began by such date.

COUNT ONE -- 1986

32. Plaintiff restates and realleges each and every averment contained in paragraphs 1 through 31 of this complaint as if fully stated in this paragraph.

33. By reason of the foregoing, Plaintiff is entitled to additional investment tax credits and depreciation deductions in 1986 as a result of the application of the supply or service contract rule, binding contract rule, self-constructed property rule or other transition rules.

34. Plaintiff has over paid its federal income tax and is entitled to a refund for its 1986 tax year in the amount of $17,645,306, or such other or greater amount as may be legally refunded, with interest as allowed by law.

COUNT TWO -- 1987

35. Plaintiff restates and realleges each and every averment contained in paragraphs 1 through 31 of this complaint as if fully stated in this paragraph.

36. By reason of the foregoing, Plaintiff is entitled to additional investment tax credits and depreciation deductions in 1987 as a result of the application of the supply or service contract rule, binding contract rule, self-constructed property rule or other transition rules.

37. Plaintiff has over paid its federal income tax and is entitled to a refund for its 1987 tax year in the amount of $30,319,620, or such other or greater amount as may be legally refunded, with interest as allowed by law.

COUNT THREE -- 1988

38. Plaintiff restates and realleges each and every averment contained in paragraphs 1 through 31 of this complaint as if fully stated in this paragraph.

39. By reason of the foregoing, Plaintiff is entitled to additional investment tax credits and depreciation deductions in 1988 as a result of the application of the supply or service contract rule, binding contract rule, self-constructed property rule or other transition rules.

40. Plaintiff has over paid its federal income tax and is entitled to a refund for its 1988 tax year in the amount of $856,808, or such other or greater amount as may be legally refunded, with interest as allowed by law.

COUNT FOUR -- 1990

41. Plaintiff restates and realleges each and every averment contained in paragraphs 1 through 31 of this complaint as if fully stated in this paragraph.

42. By reason of the foregoing, Plaintiff is entitled to additional investment tax credits and depreciation deductions in 1990 as a result of the application of the supply or service contract rule, binding contract rule, self-constructed property rule or other transition rules.

43. Plaintiff has over paid its federal income tax and is entitled to a refund for its 1990 tax year in the amount of $44,690,546, or such other or greater amount as may be legally refunded, with interest as allowed by law.

WHEREFORE, Plaintiff demands a trial by jury and judgment against the Defendant for a refund to Plaintiff of federal income taxes paid in the amounts of (i) $17,645,306 for the taxable year 1986, (ii) $30,319,620 for the taxable year 1987, (iii) $856,808 for the taxable year 1988, and (iv) $44,690,546 for the taxable year 1990, for a total amount due of $93,512,281, or such other or greater amounts as are legally refundable, together with interest as allowed by law and such other and further relief as this Court deems just and proper.

New York, New York