Rev. Rul. 84-40
Caution: Amplified by 88-23 & 88-43
Internal Revenue Service
Revenue Ruling
INVESTMENT CREDIT; PRIVATELY-OWNED DAM USED IN THE PRODUCTION OF
ELECTRICITY FOR A MANUFACTURING OPERATION
Published: March 19, 1984
Section 48. - -Definitions, Special Rules [Investment Credit], 26 CFR 1.48-1: Definition of section 38 property.
Investment credit; privately-owned dam used in the production of electricity for a manufacturing operation. The reconstructed portion of a dam that provides water pressure for the generation of hydroelectric power that is used to operate machinery in taxpayer's textile manufacturing mill is "section 38 property."
ISSUE
Whether the reconstructed portion of a dam that provides water pressure for the generation of hydroelectric power that is used to operate machinery in taxpayer's textile manufacturing mill is "section 38 property" within the meaning of section 48(a)(1)(B) of the Internal Revenue Code.
FACTS
The taxpayer is in the business of manufacturing various types of cloth fabrics. The textile mill is located adjacent to a river over which a dam has been constructed to provide water pressure for the production of hydroelectric power. The hydroelectric generating equipment is owned by the taxpayer and was installed to generate electricity for the textile machinery used in the manufacturing activity. A portion of the dam was washed out by a sudden rise in the water level due to heavy spring rains and the rapid melting of snow and ice. In the same taxable year, the taxpayer rebuilt the dam. While the dam was being rebuilt, the mill was run entirely on power purchased from the local utility. The qualification of the capitalized cost of reconstructing the dam for the investment tax credit is the subject matter of this ruling.
LAW AND ANALYSIS
Section 38 of the Code allows a credit against Federal income tax for qualified investment in "section 38 property". The determination of what property qualifies as "section 38 property" is made in accordance with section 48.
Section 48(a)(1) of the Code defines the term "section 38 property" to include (A) "tangible personal property" and (B) "other tangible property" (not including a building and its structural components) used as an integral part of manufacturing, production or other specified activities. The term "section 38 property" includes recovery property (within the meaning of section 168 without regard to any useful life) and any other property with respect to which depreciation is allowable and having a useful life determined at the time such property is placed in service of 3 years or more.
Section 1.48-1(c) of the Income Tax Regulations provides that the term "tangible personal property" means any tangible property except land and improvements thereto, such as buildings or other inherently permanent structures. The term includes all property (other than structural components) which is contained in or attached to a building and all property which is in the nature of machinery (other than structural components of a building or other inherently permanent structure) even though located outside a building.
Section 1.48-1(d)(1) of the Income Tax Regulations provides that other tangible property (but not including a building and its structural components) used as an integral part of manufacturing, production, or extraction, or used as an integral part of furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services by a person engaged in a trade or business of furnishing such service may qualify as section 38 property.
Section 1.48-1(d)(2) of the regulations defines the terms "manufacturing", and "production" for purposes of the credit allowed by section 38. Section 38 property would include, for example, property used as an integral part of the fabrication or treatment of textiles.
Section 1.48-1(d)(4) of the regulations provides that property is used as an integral part of one of the specified activities if it is used directly in the activity and is essential to the completeness of the activity. Thus, for example, in determining whether property is used as an integral part of manufacturing, all properties used by the taxpayer in acquiring or transporting raw materials or supplies to the point where the actual processing commences (such as docks, railroad tracks, and bridges), or in processing raw materials into the taxpayer's final product, would be considered property used as an integral part of manufacturing.
Rev. Rul. 81-120, 1981-1 C.B. 20, concludes that a deep well constructed as part of a disposal system for liquid waste generated by an acid production process is used as an integral part of the manufacturing activity within the meaning of section 1.48-1(d)(4) of the regulations. Even though the waste products discharged into the deep well are not reused, the well is essential to the
manufacturing process and used directly in the activity.
Rev. Rul. 73-420, 1973-2 C.B. 9, concludes that tailings disposal dams, constructed by a mining company to dispose of waste materials from its concentrator, qualify as "section 38 property" because they are an integral part of taxpayer's mineral extraction activity. When filled, the dams will be abandoned.
Rev. Rul. 72-96, 1972-1 C.B. 67, concludes that a reservoir, including a dam structure, roadway, and preparation of the reservoir site, constructed by an electric utility for use with a steam turbine generating plant is depreciable and is "other tangible property" for investment credit purposes.
Rev. Rul. 71-555, 1971-2 C.B. 65, concludes that roadways within a manufacturing complex that are devoted solely to truck traffic and those used regularly by trucks in transporting raw materials, supplies, and finished and semi-finished products, are used directly in, and are essential to, the completeness of the taxpayer's manufacturing activity and therefore, qualify, as "section 38 property." However, roadways that provide solely for employee and visitor vehicle traffic are not an integral part of the manufacturing activity and do not qualify.
Taxpayer's dam qualifies as section 38 property if it is other tangible property used as an integral part of manufacturing or production under section 48(a)(1)(B)(i) of the Code and section 1.48-1(d) of the regulations. Docks, railroad tracks, bridges (section 1.48-1(d)(4) ), roadways (Rev. Rul. 71-555), tailings disposal dams (Rev. Rul. 73-420), and deep wells (Rev. Rul. 81-120) are viewed as integral parts of a qualifying activity when used in the manner described. Although other alternatives may have been available to taxpayers in the situations described above, qualification of the property as "section 38 property" is dependent solely upon whether the property is an integral part of the described activity. In each situation, the test is whether the property is used directly in the activity and essential to the manufacturing process.
Here, the hydroelectric power generated by the dam provided the electricity used to operate the textile machinery. The taxpayer's final product was dependent on a proximate, dependable and uninterrupted source of electricity, and the dam was constructed specifically to be used in the textile manufacturing process. The dam was used directly in the manufacturing activity and was essential to its completeness. Thus, taxpayer's dam is an integral part of the textile manufacturing activity.
HOLDING
The reconstructed portion of a dam that provides water pressure for the generation of hydroelectric power that is used to operate machinery in taxpayer's textile manufacturing mill is "section 38 property" within the meaning of section 48(a)(1)(B) of the Internal Revenue Code.
Rev. Rul. 84-40, 1984-1 C.B. 11, 1984-12 I.R.B. 4.