Saginaw Bay Pipeline v. United States

• Court: Court of Appeals for the Sixth Circuit
• Decided: July 30, 2003
• Docket: 01-2599
• Status: Published

Opinion

RECOMMENDED FOR FULL-TEXT PUBLICATION Pursuant to Sixth Circuit Rule 206 2 Saginaw Bay Pipeline Co., No. 01-2599 ELECTRONIC CITATION: 2003 FED App. 0259P (6th Cir.) et al. v. United States File Name: 03a0259p.06 _________________ UNITED STATES COURT OF APPEALS COUNSEL FOR THE SIXTH CIRCUIT ARGUED: Todd R. Mendel, BARRIS, SOTT, DENN & _________________ DRIKER, Detroit, Michigan, for Appellants. Teresa T. Milton, UNITED STATES DEPARTMENT OF JUSTICE, SAGINAW BAY PIPELINE X APPELLATE SECTION TAX DIVISION, Washington, COMPANY , CMS SAGINAW - D.C., for Appellee. ON BRIEF: Todd R. Mendel, BARRIS, BAY COMPANY , SAGINAW - SOTT, DENN & DRIKER, Detroit, Michigan, Thomas P. - No. 01-2599 Marinis, Jr., VINSON & ELKINS, Houston, Texas, for BAY LATERAL COMPANY , and - Appellants. Teresa T. Milton, Richard Farber, UNITED CMS SAGINAW BAY LATERAL > STATES DEPARTMENT OF JUSTICE, APPELLATE , COMPANY , - SECTION TAX DIVISION, Washington, D.C., for Appellee. Plaintiffs-Appellants, - Alan I. Horowitz, Tamara W. Ashford, MILLER & - CHEVALIER CHARTERED, Washington, D.C., for Amicus - Curiae. v. - _________________ UNITED STATES OF AMERICA , - - OPINION Defendant-Appellee. - _________________ N Appeal from the United States District Court KRUPANSKY, Circuit Judge. The plaintiffs-appellants, for the Eastern District of Michigan at Detroit. Saginaw Bay Pipeline Company, CMS Saginaw Bay No. 99-70454—John Corbett O’Meara, District Judge. Company, Saginaw Bay Lateral Company, and CMS Saginaw Bay Lateral Company (collectively “the plaintiffs,” “Saginaw Argued: May 7, 2003 Bay,” or “the pipeline companies”),1 have contested the

Decided and Filed: July 30, 2003 1 Plaintiffs Saginaw Bay Pipeline Company and CMS Saginaw Bay Before: KRUPANSKY, SILER, and GILMAN, Circuit Comp any formed a limited business partnership known as “Saginaw Bay Area Limited Partnership.” Plaintiffs Saginaw Bay Lateral Company and Judges. C M S Saginaw Bay Lateral Company created a second limited p artnership called “Saginaw Bay La teral Limited Pa rtnership.” To gether, those two limited partnerships developed and constructed, and at all times relevant to the case instanter owned and operated, the Saginaw Bay natural gas pipeline network at issue herein.

On review, the Am erican Petro leum Institute (“API”), with leave of

1 No. 01-2599 Saginaw Bay Pipeline Co., 3 4 Saginaw Bay Pipeline Co., No. 01-2599 et al. v. United States et al. v. United States

district court’s disallowance, following a bench trial, of their industry parlance as “raw” or “wet” natural gas) from claim against the defendant-appellee United States of SWEPI’s gas wellheads in eighteen distinct production fields America through the Internal Revenue Service (hereinafter located in the Michigan East Central Basin to its natural gas “the defendant,” “the government,” or “the I.R.S.”) for processing plant situated in Kalkaska, Michigan (“the reimbursement of $3,474,244.00 in income tax payments, Kalkaska facility”). MichCon, through its subsidiary MCN deposited under protest, which the I.R.S. had assessed via tax Corporation, formed the plaintiff entities for that purpose. deficiency notices for the five calendar years 1991 through Between 1988 and 1990, the plaintiffs constructed, in 1995. See Saginaw Bay Pipeline Co. v. United States, No. accordance with SWEPI’s specifications, a 126-mile 99-CV-70454, 2001 WL 1203283 (E.D. Mich. Aug. 23, 2001) subterranean steel pipeline network traversing six Michigan (ordering final judgment for the defendant United States); counties which linked SWEPI’s East Central Basin gas fields Saginaw Bay Pipeline Co. v. United States, 124 F. Supp. 2d to the Kalkaska facility. 465 (E.D. Mich. 2000) (denying, on cross-motions, summary judgment to all litigants). The sole issue in controversy was That system consisted of a central line leading into the (and remains) whether, under prevailing law, the plaintiffs’ Kalkaska processing plant, which was fed by lateral adjoining underground natural gas pipelines should be depreciated over pipes which linked specific wellheads to “field separators”2 a seven-year period, as argued by the plaintiffs, or instead and ultimately to the main pipeline. The main pipeline had a should be subject to fifteen-year depreciation, as asserted by daily maximum capacity of 135 million cubic feet of “wet” the government and as resolved by the district court. The gas. At all times material to this litigation, although the factual and legal epicenter of the dispute is whether or not the plaintiffs owned and operated the pipeline system, the subject pipeline system is a “gathering” pipeline (as defined transient “raw” natural gas remained the property of its and developed herein) used in the gas production process even though the plaintiffs are not themselves producers of natural gas. In the late 1980s, Shell Western Exploration and Production, Inc. (“SWEPI”), a division of Shell Oil Company 2 The plaintiffs’ standard service contracts with gas producers (“Shell”), commenced negotiations with the Michigan required that the producers separate specified amounts of water, sand, and Consolidated Gas Corporation (“MichCon”) for MichCon’s certain other materials from the natural gas at the wellhead via the use of construction and operation of a steel pipeline system to “field separators,” prior to the introduction of the extracted hydrocarbons transmit unprocessed natural gas (known in prevailing into the Saginaw Bay pipeline system, in order to meet specifications engineered to reduce the risks of pipeline corrosion and obstruction. Accordingly, the Saginaw Bay system’s lateral gathering lines did not connect directly to the field wellheads, and its lines transported partially the court, lodged an amicus curiae brief in support of the plaintiffs. API purified “raw” natural gas. Nevertheless, the gas moved by the pipeline described itself as “a national trade association representing the entire companies from the gas fields to the Kalkaska processing plant was not petroleum industry, inc luding companies engaged in exploration and consumable “dry” methane gas. Rather, although that product contained production, transportation, refining, and marketing. With over 400 contract-restricted quantities of certain natural pollutants, it nonetheless member companies and with petroleum councils in 27 state cap itals required substantial pro cessing at the K alkaska facility to co mplete its representing members in 33 states, API is dedicated to protecting and final conversion into “dry pipeline-quality” methane fuel suitable for sale advancing the interests of all parts of the oil and natural gas industry.” to end users. See further discussion below. No. 01-2599 Saginaw Bay Pipeline Co., 5 6 Saginaw Bay Pipeline Co., No. 01-2599 et al. v. United States et al. v. United States

producer throughout the transportation process.3 The a conduit for “wet” natural gas, it constituted a species of producers compensated the plaintiffs for the use of the natural gas transportation pipeline frequently described, pipeline on a contractual “fee-for-service” basis. within prevailing natural gas industry nomenclature, as a natural gas “gathering” pipeline.5 Natural gas, in its “raw” form when extracted from the earth at the wellhead, is typically contaminated with Because the respective functions of “gathering” pipelines, numerous impurities, including, among other things, butane, vis a vis “transmission” or “distribution” pipelines, as defined ethane, pentane, propane, water, nitrogen, carbon dioxide, herein, are entirely distinct, the operating standards for the other inert gases, sulphur, sand, and drilling fluids. All two systems are correspondingly dissimilar. For example, adulterants must be substantially removed at a purification whereas “transmission” or “distribution” pipeline systems are site such as the Kalkaska facility, leaving only nearly-pure typically unable to safely accommodate any significant “dry” methane gas, prior its sale to residential or commercial presence of solid or liquid contaminants, “gathering” consumers. The cleansed, customer-ready “dry” pipelines including the Saginaw Bay system must be petrochemical fuel is then exported from the purification plant equipped to handle at least limited amounts of the non- to distributors or other customers via lines which, for gaseous components of “raw” natural gas. Additionally, purposes of this decision, shall be denominated because “raw” natural gas ordinarily burns at a higher “transmission” or “distribution” pipelines, which are pipelines temperature than “dry” natural gas, “transmission” or designed and operated solely for the carriage of “dry” “distribution” line service contracts generally provide for the hydrocarbon gas, sometimes referred to in the fossil fuel transport of fossil fuel having a relatively low “heating business as “pipeline-quality gas.”4 By contrast, because the value,” usually no more than 950 British Thermal Units Saginaw Bay pipeline was designed to, and was operated as,

5 3 The record herein revealed that various terms of art frequently used During the relevant period 199 1-95 , the Saginaw Bay pipeline in the natural gas trade have not always been used consistently, and may network did no t exclusively transport “wet” gas belonging to SW EPI. have different meanings whe n used in different contexts. For example, Rather, it also carried “raw” natural gas produced by, among o thers, Sun main or trunk pipelines which adjoin lateral “gathering” lines running Oil, Marathon, Oryx, and Amoco. from field wellheads, which transmit the “raw” gas gathered from the 4 lateral lines to a purification facility, have sometimes been called Although both “transmission” lines and “distribution” lines carry “transmission” pipelines. Similarly, “wet” gas partially cleansed by field pure, “dry” natural gas for ultimate consumer use, the term “transmission separators has occasionally been de signated “pipeline-qua lity gas” in line” evidently is most frequently used to describe an interstate pipeline reference to its conformity to contract specifications for introduction into which carries clean processed gas from a cleansing center to a distribution a “gathering” pipeline for carriage to a purification complex, as opposed center, whereas the phrase “distribution line” apparently is most often to that term’s more common usage in reference to “dry” gas which is employed to describe a pipeline which transfers “dry” gas from a local suitable for transit via a “transmission” or “distribution” pipeline for distribution center to specific business or residential customer addresses. ultimate delivery to a consumer. Howe ver, as developed herein, the See, e.g., Phillips Petroleum Co. v. Wisconsin, 347 U.S. 672, 691 (1954) terminology used, whether by the p ipeline’s owne r or anyone else, to (Clark, J., dissenting) (“T he natural gas ind ustry, like Ancient G aul, is describe or identify a particular pipeline, is not dispositive of its proper divided into three parts. These parts are production and gathering, treatment under the federal income tax laws. Rather, as evolved herein, interstate transmission by pipeline, and distribution to consumers by local the actual functional use to which a particular pipeline or pip e system is distribution companies.”) dedicated determines its asset classification for tax depre ciation purpo ses. No. 01-2599 Saginaw Bay Pipeline Co., 7 8 Saginaw Bay Pipeline Co., No. 01-2599 et al. v. United States et al. v. United States

(“BTUs”); whereas “gathering” lines (including the Saginaw “gathering” pipeline relative to a “transmission” or Bay system) transport “raw” gas with higher “energy values,” “distribution” line, constitute further examples. typically ranging between 950 and 1400 BTUs. The Saginaw Bay service contracts specified that “the Gas shall have a total Additionally, a functional “transmission” or “distribution” heating value per standard cubic foot of not less than 950 line will ordinarily retain a useful and profitable economic life British thermal units.” (Emphasis added). for as long as gas dealers or consumers connected by that line to the processing plant continue to purchase heating gas; Likewise, a “gathering” system must be constructed to however, a “gathering” line more likely may become function at relatively low pressures over comparatively short obsolete, redundant, or otherwise unprofitable prior to its distances. The Saginaw Bay system could tolerate no more natural “wear-and-tear” expiration, if, for example, the field than 1440 pounds per square inch (“psi”) of pressure, and wellheads it services become depleted or otherwise covered only 126 miles. By contrast, a “transmission” or unproductive, or comparatively inexpensive alternate sources “distribution” line usually functions at comparatively higher of “raw” natural gas accessible to the processing plant pressures over longer distances, often totaling hundreds of become competitively available. Accordingly, “gathering” miles. lines are not only more costly and labor-intensive to construct, maintain, and operate, but also generally have a Perhaps most significantly, “gathering” pipelines must be shorter operational life span than “transmission” or flushed out regularly – a process labeled “pigging” – to avert “distribution” lines. or delay excessive wear-and-tear pipeline corrosion and the accumulation of foreign obstructive materials, given the Because both “transmission” or “distribution” natural gas ubiquitous presence of contaminants dissolved within “wet” pipes, and “gathering” natural gas lines, constitute property natural gas; whereas “transmission” or “distribution” lines used in a trade or business, the owner of either type of conveying only clean “dry” gas never require that type of pipeline is entitled to a “reasonable allowance” for annual expensive and time-consuming routine maintenance. Record depreciation of that asset against the owner’s ordinary proof reflected that, during the interval pertinent to the instant business income for a finite number of years. See 26 U.S.C. action, at least some portions of the Saginaw Bay system § 167(a)(1). The depreciation allowance for tangible property required “pigging” twice or thrice daily. used in a trade or business should be ascertained by reference to three factors – namely the legally-prescribed Consequently, because the purposes and functions of (1) “depreciation method,” (2) “recovery period,” and “gathering” lines are commercially distinct from those of (3) “convention” – for the business asset at issue. See 26 “transmission” or “distribution” lines, the coordinate U.S.C. §§ 167(b), 168(a). The adversaries sub judice have economic costs and investment risks accompanying each are agreed that the instant controversy involves only element two, also diverse. The unique expenses and production delays the selection of the proper depreciation “recovery period” for affiliated with the regular “pigging” of “gathering” pipelines the Saginaw Bay pipelines. are obvious examples. The singular risks of serious damage to “gathering” lines by corrosion or obstruction, and the The plaintiffs, as taxpayers, must carry the burden of attendant initial need to construct a comparatively sturdy proving their entitlement to a claimed deduction which has been contested by the I.R.S. Helvering v. Taylor, 293 U.S. No. 01-2599 Saginaw Bay Pipeline Co., 9 10 Saginaw Bay Pipeline Co., No. 01-2599 et al. v. United States et al. v. United States

507, 514 (1935). However, “if doubt exists as to the Asset Class 46.0 (defined to include assets used in the construction of a taxing statute, the doubt should be resolved carrying of gas by pipes), which triggers a listed “class life” in favor of the taxpayer.” Hassett v. Welch, 303 U.S. 303, of twenty-two years, and an accompanying General 314 (1938). Depreciation System “recovery period” of fifteen years.8 Rev. Proc. 87-56, 1987-2 C.B. 678, 684 (hereinafter “the The applicable depreciation “recovery period” is keyed to Revenue Procedure”). the “class life” of the subject property. 26 U.S.C. § 168(e)(1). An asset’s “class life” is defined by referencing “the class life The pipeline companies have maintained that the Saginaw [category] prescribed by the Secretary which reasonably Bay pipeline network fits into Asset Class 13.2, and hence reflects the anticipated useful life of that class of property to they should be entitled to comparatively accelerated seven- the industry or other group.” 26 U.S.C. § 167(m)(1) year depreciation. By contrast, the I.R.S. argued, with (repealed), incorporated by reference into § 168(i)(1).6 The success before the district court, that the plaintiffs’ pipelines Treasury Regulations (“the Regulations”) posit a “use-driven” functional standard for assigning asset classifications.7 26 C.F.R. § 1.167(a)-11(b)(4)(iii)(b). 8 [Asset Class] 13.2: Exploration for and Production of Petroleum and N atural Gas D eposits: However, the Treasury Secretary has promulgated two material, specific, functionally-defined natural gas industry Includes assets used by petroleum and natural gas produ cers for asset life classifications which facially may encompass the drilling of wells and production of petroleum and natural gas, Saginaw Bay pipeline complex -- to wit, Asset Class 13.2 including gathering pipelines and related storage facilities. . . . (defined to include “gathering pipelines” and other property .... used in the production of natural gas), which has a listed “class life” of fourteen years and an associated General [Asset Class] 46 .0: Pipeline Transportation: Depreciation System “recovery period” of seven years; and Includes assets used in the private, commercial, and contract carrying of petroleum, gas and other p roducts by means of pipes 6 and conveyors. The trunk lines and related storage facilities of The parties herein have agreed that, although Congress removed integrated petro leum and natural gas producers are included in § 167(m) from the tax code via a 199 0 am endment, subsection 167(m)(1) this class. . . . has retained continuing vitality by its incorporation b y reference into §168(i)(1), which remained a part of the code during the 1991-95 tax Rev. Proc. 87-56, 1987-2 C.B. 678, 684. (Boldface in original; italics years material to the subje ct action. Accord, Duke Energy Natural Gas added). “Trunk lines” are large-diameter, usually high-pressure mainlines Corp. v. Commissioner, 172 F.3d 12 55, 1257 (10th Cir. 1999). which connect distant points; they generally include “transmissio n lines.” 7 However, large “gathering” ma in lines are sometimes also referred to as “For purposes of this section, property shall be included in the asset “trunk lines.” Nevertheless, reading the two asset class descriptions guideline class for the activity in wh ich the pro perty is prim arily used. together, it is evident that all functionally-defined “gathering pipelines” See paragraph (e)(3)(iii) of this section for rule for leased prope rty. should be consigned to Asse t Class 1 3.2, lea ving all remaining natural gas Pro perty shall be classified according to primary use even though the transport lines (such as “transmission” and “distribution” lines, as well as activity in which such property is primarily used is insubstantial in non-gathering “trunk lines” owned by integrated producers of natural gas relation to all the taxpayer’s activities.” 26 C.F.R. § 1.167(a)- which are used to transmit “dry”natural gas to distributors or co nsumers) 11(b)(4)(iii)(b). (Emphases adde d). within Asset Class 46.0. See further develo pme nt belo w. No. 01-2599 Saginaw Bay Pipeline Co., 11 12 Saginaw Bay Pipeline Co., No. 01-2599 et al. v. United States et al. v. United States

belong in Asset Class 46.0, which authorizes fifteen-year reversed the United States Tax Court’s application of fifteen- depreciation. year depreciation, in favor of the seven-year writeoff. Duke Energy Natural Gas Corp. v. Commissioner, 172 F.3d 1255 To date, the only sister circuit to confront a similar contest has been the Tenth Circuit, which, on nearly identical facts,9 gathering line definition.”). 9 The government has averred that a material fact distinguishes Duke Similarly, the district judge ’s invocation o f Public Service Energy’s pipeline systems from the Saginaw Bay pipelines, because the Commission of Kentucky v. Federal Energy Commission, 610 F.2d 439, United States in Duke Energy did not dispute that Duke’s pipeline 444 (6th Cir. 1979) (ruling that exclusive federal regulatory jurisdiction networks were “gathering systems” for asset class attribution purposes under the Natural Gas Act encompassed natural gas from the moment that (see Duke Energy Natural Gas Corp. v. Comm issioner, 172 F.3d 1255, it entered the stream of interstate commerce by exiting the wellhead and 1256-58 (10th Cir. 19 99)); where as in the case here in controversy the entering a “gathering” pipeline, despite a statutory exemption permitting trial court agreed with the government’s argument that the Saginaw Bay state regulatory jurisdiction over “produ ction and gathering” activities, network was not a “gathering system .” See Saginaw Bay Pipeline Co. v. which the court construed to be limited to production activities undertaken United States, No. 99-CV-70454, 2001 W L 12 032 83, at *2-3 (E.D. Mich. by natural gas producers upon the real estate where the gas wellheads Aug. 23, 2001) (finding, as a matter of both fact and law, that the Saginaw were located) was misco nceive d. The trial jurist erroneously intimated Bay pipeline was not a “gathering” pipeline because it did not directly that Public Service Commission supported the con clusion that only gas connect to any field wellhea d, and also because it was no t substantially production activities which occurred on the realty which produced the located on a natural gas p roducer’s land from which natural gas was natural gas should be categorized as “gathering” activities, and therefore extracted). In supp ort of its “disconnection” theo ry, the trial court pipelines largely lying on property from which no gas was extracted adopted the reasoning of a non-controlling Fifth Circuit decision, should not be deemed “gathering” pipelines for any purposes including Ham man v. Southwestern Gas Pipeline, Inc., 721 F.2d 140 , 142 -43 (5 th income tax asset classification. However, although the transported Cir. 1983), by which that court had construed federal natural gas pipeline contents of “gathering pipelines” might be distinguishable from safety regulations to require that “gathering” lines must attach dire ctly to “gathering” activities which transpire on the producer’s property or wellheads. The key regulation posited that a “‘gathering line’ means a leasehold for federal regulatory jurisdictional purposes, that distinction is pipeline that transports gas from a current production facility to a entirely immaterial to the federal income tax depreciation treatment of transmission line or main.” 49 C.F.R. § 19 2.3. (A gas wellhead qualifies pipelines which transport “wet” as opposed to “dry” natural gas, as a “current production facility”). The Hamman court’s construction of irrespective of the label attributed to such pipe lines. that regulation to re strict the meaning o f “gathering pipeline” so lely to lateral “feeder” pipelines which connect directly to field wellheads, as Accordingly, the trial court erred, as both a matter of fact and law, by opposed to pipelines which transport natural gas from field wellheads but characterizing the Saginaw Bay pipelines as something other than a do not physically join those wellheads, is facially open to question. At “gathering” system as defined for purposes of the instant litigation. See any rate, to the extent that Hamman might carry any persuasive weight in Razavi v. Commissioner, 74 F.3d 125, 127 (6th Cir. 1996) (explaining that the Sixth Circuit, it would be restricted to construction of the laws a district court’s findings of historical fact are examined for clear error, governing natural gas pipeline safety, such as the federal rules controlling but its applications of law to the facts and its ultimate legal conclusions the depths at which certain types of gas pip elines must be b uried. See including resolutions of mixed questions of law and fact are scrutinized Hamman , 721 F.2d at 14 2. No evident rationale supports the application de novo). As illuminated herein, the undisputed practical uses to which of a safety regulation’s judicially-refined definition of “gathering the Saginaw B ay pipelines were put du ring the five tax years in pipeline” to the income tax depreciation regulations, given the total controve rsy militated to characterize them as “gathering pipelines” for dissimilarity of the purpo ses of the two sets o f standards. Id. at 143 income tax purposes within the ambit of Asse t Class 13.2 as a matter of (“Keeping in mind that Co ngress meant the [N atural G as Pip eline Safety] law, irrespective of their lack of direct connections to field wellheads by Act to minim ize acciden ts caused by natural gas pipelines, we hold that reason of intervening “field separators,” and regardless of the subject a pipeline must be directly attached to a gas well in order to meet the pipeline’s situs on land from which natural gas was not extracted. No. 01-2599 Saginaw Bay Pipeline Co., 13 14 Saginaw Bay Pipeline Co., No. 01-2599 et al. v. United States et al. v. United States

(10th Cir. 1999). That court ruled that, although Duke Indeed, the United States’ posture that the depreciation Energy was not itself a “producer” of natural gas, its status of pipelines which in fact are used as “gathering” lines “gathering” systems were primarily used by gas producers to should depend not upon their function and the costs and risks transmit partially-cleansed-but-essentially-still-“wet” natural associated with their operation, but instead upon the business gas to purification plants. Id. at 1258. Moreover, after identity of their owners, would, if adopted, lead to the absurd weighing factors such as the comparatively low operational result that pipelines used for identical “gathering” purposes pressures, generally confined geographical areas serviced, would be depreciated over seven years if owned by a producer and relatively short potential economic life spans attributable of natural gas, but would instead be subject to fifteen-year to Duke’s “gathering” pipe systems, the Tenth Circuit depreciation if owned by a pipeline company engaged in the concluded that, as a functional issue, “[t]he net effect is that trade of transporting “wet” natural gas for hire. As the economic character of Duke's gathering activities is more compellingly expressed by the Duke Energy court: akin to production than pipeline operation.”10 Id. at 1258-59. Furthermore, were we to read a distinction into the asset classes requiring taxpayers to place the gathering 10 systems of nonproducers in Asset Class 46.0 and the The initial adjudicator in the case in controversy opined that “Duke was wrongly decid ed in its interpretation of the term ‘used b y’ in the first gathering systems of producers in Asset Class 13.2, we sentence of Asset Class 13.2.” Saginaw Bay Pipeline Co. v. United would thereby create an inconsistent regime for the States, No. 99-CV-70454, 2001 WL 1203283, at *2 (E.D. Mich. Aug. 23, depreciation of assets. If placed in different classes, 2001). In reality, the d istrict court ha d misc onstrued the “used by” gathering systems used for the same purpose and serving phraseology to mean “owned by” a natural gas producer. As persuasively identical wells would fall under different depreciation explicated by the T enth C ircuit: schedules depending upon the producer or nonproducer W e are not persuade d b y the gov ernm ent's interpretation of status of the asset's owner. Moreover, if a producer sells the asset class descriptions. "Use" do es not mean "own" in a gathering system to a nonproducer such as Duke, the either the legal dictionary definition of the wo rd use, see Bla ck's system would shift from one asset class to another Law Dictiona ry 1541 (6th ed. 1990) ("T o ma ke use of; to without any change in its function or characteristics, and convert to one's service; to employ; to avail oneself of; to utilize; to carry out a purpose or action by means of; to put into action the system's new owner would be forced to depreciate the or service, especially to attain an end."), nor in everyday asset over a far longer period. Absent an explicit parlance. . . .

The Revenue Procedure before us creates and describes asset classes for the purpose of establishing depreciation Duke Energy Natural Gas Corp. v. Comm issioner, 172 F.3d 1255, 1259- schedules, and contains critical information affecting taxpayer 60 (10th Cir. 1999 ). Alterna tively, the Duke Energy court convincingly decisions about capital investment. W e cannot accept the illustrated that, even if the Asset Class 1 3.2 d escription co uld be rationally go vernme nt's attemp t to interpolate the wo rds "owned by" into construed to expressly list “gathering” lines which were owned by natural the description of Asset Class 13.2. We instead interpret that gas producers, the use of the word “includ es,” rather than “includes only” description to include any gathering system, so long as it is used (see note 8 above), signals an intent of its drafter not to restrict the asset by a gas producer--whether under its own ownership or through classification solely to the listed property, but instead also to embrace contractual arrangements--in the exploration for and production “precisely analogous assets used by non-producers to provide services of petroleum and natural ga s. directly to producers.” Id. at 1260 (citing, inter alia, 26 U.S.C. § 7701 (c)). No. 01-2599 Saginaw Bay Pipeline Co., 15 16 Saginaw Bay Pipeline Co., No. 01-2599 et al. v. United States et al. v. United States

distinction based on ownership in the Revenue been explicitly superseded. See Rev. Proc. 72-10, 1972-1 Procedure, we decline to create such an inconsistency. C.B. 721, 731 (superseding Rev. Proc. 71-25, 62-21); Rev. Proc. 71-25, 1971-2 C.B. 553, 566 (superseding Id. at 1261. (Notes omitted). Rev. Proc. 62-21). The government’s retort was anchored in an elaborate More importantly, the language of the most historical construct which tediously traced the pedigree of recent--and relevant--of these prior iterations does not business property depreciation federal tax laws since the establish that gathering systems of nonproducers have inception of modern national income taxation in 1913 in a bid been distinguished from those of producers for to illustrate that, over the years, the United States had oft- depreciation purposes since 1972. See Rev. Proc. 77-10, times commanded varying tax treatments of similar business 1977-1 C.B. 548, 548 (superseding Rev. Proc. 72-10, assets used for similar purposes on the sole basis that the while noting that the change "was not intended to modify respective owners of those assets were engaged in different the composition of the existing classes of Rev. Proc. 72- commerce. That effort was unavailing, because, since at least 10"). Rev. Proc. 72-10, 1972-1 C.B. 721, 723, which the early 1970s, the United States has explicitly renounced an establishes the immediately prior (and still relevant) “industry-based” approach to asset classification in favor of iteration of the applicable sentence of the description of a “use-based” system. See 26 C.F.R. § 1.167(a)- Asset Class 13.2, states that the class "[i]ncludes assets 11(b)(4)(iii)(b) (applicable to property placed in service after used for drilling of wells and production of petroleum December 31, 1970), which posits, among other things, that and natural gas, including gathering pipelines and related “[p]roperty shall be classified according to primary use even storage facilities, when these are related activities though the activity in which such property is primarily used undertaken by petroleum and natural gas producers." is insubstantial in relation to all the taxpayer’s activities.” This description relies upon essentially the same (Emphasis added). The Duke Energy court had correctly language as the current asset class in stating that when rejected the same argument by the I.R.S.: gathering systems are "used for" the drilling and production processes of producers, they belong in Asset The government argues that in previous iterations of Class 13.2. We are no more persuaded by the the asset classes in dispute, the IRS distinguished government's argument that the words "undertaken between assets owned by gas producers and those owned by"--which refer to "activities"--necessarily implies that by non-producers. See, e.g., Rev. Proc. 72-10, 1972-1 the assets must be "owned by" producers than we are C.B. 721, 731 (superseding Rev. Proc. 71-25, 62-21); persuaded that the words "used by" necessarily require Rev. Proc. 71-25, 1971-2 C.B. 553, 556 (establishing ownership. The relevant earlier asset class descriptions Asset Class 13.2); Rev. Proc. 62-21, 1962-2 C.B. 418, provide us with no clear mandate to distinguish between 424 (establishing Guideline Class 17(b), which "[e]xclude[d] gathering pipelines and related storage facilities of pipeline companies"). We first note that all of the relevant provisions of the earliest Revenue Procedures the government cites to support its interpretation of the current asset class descriptions have No. 01-2599 Saginaw Bay Pipeline Co., 17 18 Saginaw Bay Pipeline Co., No. 01-2599 et al. v. United States et al. v. United States

gathering systems based upon ownership, and we of the land under which that pipeline runs, and/or whether that therefore will not do so.11 pipeline was connected by lateral “feeder” lines directly or indirectly to the field wellheads. Concordantly, all natural Id. at 1260-61. (Emphases added). gas transportation pipelines used for any purpose other than the production-related “gathering” of “wet” gas, including This reviewing court has carefully considered the trial dry-gas “transmission” and “distribution” pipelines as defined court’s written opinions and final judgment, the briefs and all herein, should be depreciated over fifteen years under the arguments of counsel, the material contained within the Joint General Depreciation System as Asset Class 46.0 property, Appendix, and the controlling legal authorities. It finds that even if they are owned or used by a producer of natural gas. the district court committed reversible legal and factual error by ruling that the Saginaw Bay pipelines at issue herein were The judgment of the district court for the defendant is not “gathering” pipelines subject to seven-year depreciation reversed, and the case is remanded for entry of judgment in under the Revenue Procedure’s Asset Class 13.2 definition. favor of the plaintiffs and for such necessary further This court finds the Tenth Circuit’s reasoning and conclusions proceedings as are consistent with this disposition. articulated in Duke Energy Natural Gas Corp. v. Commissioner, 172 F.3d 1255 (10th Cir. 1999), to be logically persuasive and factually on point, and thus adopts its analysis and ruling. This court further concludes that the subsequent conflicting analysis and decision of the United States Tax Court in Clajon Gas Co. v. Commissioner, 119 T.C. 197, 2002 WL 31399696 (Oct. 25, 2002), was legally ill-formulated and unpersuasive. In conclusion, this reviewing court rules that every natural gas carriage pipeline which functions as a “gathering” pipeline in the methane gas production process by transporting impure “raw” or “wet” natural gas from the field wellheads to a cleansing and processing facility qualifies as a “gathering pipeline” subject to seven-year General Depreciation System depreciation under the strictures of Asset Class 13.2 of Rev. Proc. 87-56, irrespective of the primary business of the owner of that pipeline, the other uses

11 Accordingly, because Saginaw B ay’s primary business is irrelevant to the depreciation classification of their pipelines used for natural gas “gathering” activities, the fact that the plaintiffs identified themselves on their tax returns as engaged in the trade of “natural gas transportation” (as opp osed to pro duction or “gathering”) is immaterial.