Gas Company Denies Additional Income From Supplier Refunds

Bay State states that it was the parent corporation of an affiliated group of corporations that filed consolidated federal returns and used the accrual method of accounting. Bay State was also a natural gas utility company providing local distribution service of natural gas in Massachusetts. In the course of their respective businesses, Bay State and its affiliates purchased natural gas from unrelated upstream natural gas suppliers at rates set by the supplier subject to retrospective review and adjustment by the Federal Energy Regulatory Commission (FERC).

For 1993 and 1994 FERC determined that the gas rates charged by the upstream natural gas suppliers to Bay State and its affiliates were excessive and issued an order requiring refunds (including interest) to be made to Bay State and its affiliates. The utility asserts that after the refunds were made, Bay State and its affiliates were required to and did refund to its customers the full amount of the refunds plus interest. Therefore, the utility maintains it did not realize any additional gross income from the refunds for the years in issue.

PETITION

The petitioner hereby petitions for a redetermination of the deficiencies set forth by the Commissioner of Internal Revenue in his NOTICE OF DEFICIENCY dated June 14, 2000, and as the basis for the petitioner's case alleges as follows:

1. The petitioner is Bay State Gas Co., Incorporated and Consolidated Subsidiaries. Petitioner's principal place of business and mailing address is 801 East 86th Avenue, Merrillville, Indiana 46410. Petitioner's taxpayer identification number is [TIN omitted]. The returns for the periods here involved were filed with the Office of the Internal Revenue Service at Andover, Massachusetts.

2. The Notice of Deficiency, a copy of which is attached hereto and marked "Exhibit A" is dated June 14, 2000, and purportedly was mailed on that date by the Office of the Internal Revenue Service at Boston, Massachusetts to: Bay State Gas Co., Incorporated and Consolidated Subsidiaries, c/o Tax Department, 300 Friberg Parkway, Westborough, MA 01581-3900.

3. The deficiencies as determined by the Commissioner are in income taxes for the taxable years ended December 31, 1993 and December 31, 1994 in the amounts of $327,834 and $4,419,681, respectively, all of which deficiencies are in dispute.

4. The determination of the tax set forth in the Notice of Deficiency is based on the following errors:

a) The Commissioner erred in determining that for the year ended December 31, 1993, petitioner had additional gross income from supplier refunds and interest on those refunds in the amount of $1,069,332.

b) The Commissioner erred in determining that for the year ended December 31, 1994, petitioner had additional gross income from supplier refunds and interest on those refunds in the amount of $14,965,107.

5. The facts upon which the petitioner relies, as the basis for petitioner's case, are as follows:

a) Bay State Gas Company ("Bay State") is a Massachusetts corporation and for the calendar years 1993 and 1994 was the parent corporation of an affiliated group of corporations that filed consolidated federal income tax returns.

b) For the calendar years 1993 and 1994, each of Northern Utilities, Inc. ("Northern"), a New Hampshire corporation, and Granite State Gas Transmission, Inc. ("Granite"), a New Hampshire corporation, were members of the Bay State affiliated group.

c) For the calendar years 1993 and 1994, each of Bay State, Northern and Granite utilized the accrual method of accounting.

d) During the years 1993 and 1994, Bay State was a natural gas utility company providing local distribution service ("LDS") of natural gas in Massachusetts. Northern provided natural gas LDS in Maine and New Hampshire. Granite was in the business of transporting and selling natural gas through interstate pipelines to Bay State and Northern. Each of Bay State, Northern and Granite were subject to regulation by state public utility departments or commissions as well as by the Federal Energy Regulatory Commission ("FERC").

e) In the course of their respective businesses, Bay State, Northern and/or Granite purchased natural gas from unrelated upstream natural gas suppliers at rates set by the suppliers subject to retrospective review, adjustment and adjudication by FERC.

f) During the years 1993 and 1994, the rate structure of Bay State and its affiliates which formed the basis of charges to its customers consisted of two components: "base rates" (i.e., distribution rates) and "gas rates."

g) During the years 1993 and 1994, pursuant to state public utility regulation, a natural gas utility was permitted to derive a profit from natural gas LDS solely from base rates; a natural gas public utility was not permitted to derive a profit from the gas rate component of the rate structure.

h) Bay State and Northern charged their respective customers for the natural gas furnished based upon the gas rates charged to Bay State and Northern by their upstream gas suppliers.

i) For the calendar years 1993 and 1994, FERC determined that the gas rates charged by the upstream natural gas suppliers to Bay State and its affiliates were excessive and issued an order requiring refunds (including interest) (hereinafter the "Refunds") to be made by the upstream natural gas suppliers to Bay State and its affiliates.

j) Pursuant to state regulation, Bay State and its affiliates were required to refund to their customers any Refunds, plus interest accruing thereon, by means of a cost of gas adjustment mechanism.

k) During the calendar years 1993 and 1994, Bay State and its affiliates made refunds to its customers by means of the cost of gas adjustment with respect to the Refunds, plus interest accruing thereon. As a result, the amount charged by Bay State and its affiliates to its customers for natural gas in subsequent periods was reduced.

l) At all times following the payment by the upstream natural gas suppliers of the Refunds, Bay State and its affiliates were under state and/or federal regulatory compulsion to, and did, refund to their customers the full amount of the Refunds, plus interest accruing thereon.

m) Bay State and its affiliates did not have gross income from Refunds for the calendar year 1993 in the amount of $1,069,332 or any other amount.

n) Bay State and its affiliates did not have gross income from Refunds for the calendar year 1994 in the amount of $14,965,107 or any other amount.

o) Bay State and its affiliates correctly reported their income for the calendar years 1993 and 1994 by not including therein any portion of the Refunds attributable to those years.

WHEREFORE, petitioner prays that the Court may hear this proceeding and:

1. Determine that the Commissioner erred as alleged in the Assignment of Errors as set forth in paragraph 4 above; and

2. Give such other and further relief as the Court may deem fit and proper.

Dated: August 22, 2000

[Editor's Note: The attachment has been omitted. However, this document in its entirety can be obtained through our Tax Analysts' Access Service as Doc 2000-24106 (12 pages).]