Rev. Rul. 85-93

1985-2 C.B. 9, 1985-27 I.R.B. 4.

INVESTMENT CREDIT; SECTION 38 PROPERTY; SNOWMAKING SYSTEM

Published: July 8, 1985

Section 48-Definitions; Special Rules, 26 CFR 1.48-1:Definition of Section 38 property

  Investment credit; section 38 property; snowmaking system. Components of a snowmaking system such as air and water distribution pipes, hydrants, electrical transmission lines, and a water intake pipe are not section 38 property and do not qualify for the investment credit.

ISSUE

  Are various components of a snowmaking system used by a taxpayer in the operation of its ski resort section 38 property within the meaning of section 1.48-1 of the Income Tax Regulations?

FACTS

  The taxpayer operates a ski resort. It also owns and operates a snowmaking system that produces snow used on the ski slopes and trails.

  The system operates through the use of water pumps, air compressors, power transformers, and other machinery, which are housed adjacent to the water source, a large pond. Water is pumped through welded steel pipe from the pond, up the nearby ski slopes, and along the ski trailers. Almost all the pipe is buried for insulation, safety, or aesthetic purposes. High voltage electrical transmission lines to the pumphouse are also buried as required by state and local law. Other welded steel pipe, buried in the same trenches with the water lines, carries compressed air from an air compressor located in the pumphouse. The water and air distribution lines are tapped at appropriate intervals along the slopes and trails by upright pipes and valves. Flexible hoses connected to these hydrants deliver the water and air to the guns through which the water is ejected and atomized by a jet of the compressed air. When the guns are operated in temperatures of less than 32 degrees Fahrenheit, the spray freezes and falls as snow along the slopes and trails, all of which are a part of the taxpayer's ski resort. (No snow is sold to other parties.)

  The taxpayer and the Service agree that the pumphouse is a building and not section 38 property. It is also agreed that the snowmaking guns and hoses, power transformers, pumps, compressors, control equipment, and plumbing and wiring interconnections in and around the pumphouse are all in the nature of machinery and are, therefore, tangible personal property qualifying as section 38 property. The only snowmaking system components at issue in this revenue ruling are the air and water distribution pipes, the hydrants, the electrical transmission lines and the water intake pipe.

LAW AND ANALYSIS

  Section 38 of the Internal Revenue Code allows a credit against federal income tax for qualified investments. Section 48 and the corresponding regulations define what property qualifies under section 38.

  Section 48(a)(1) of the Code provides that the term 'section 38 property' includes: (1) tangible property (not including a building and its structural components) if such property is used as an integral part of one of certain specific activities among which are manufacturing and production.

  Section 1.48-1(c) of the regulations provides that, for investment credit purposes, the term 'tangible personal property' means any tangible property except land and improvements thereto such as buildings or other inherently permanent structures (including items which are structural components of such buildings or structures). Tangible personal property includes all property (other than structural components) which is contained in or attached to a building. Furthermore, all property which is in the nature of machinery (other than structural components of a building or other inherently permanent structure) shall be considered tangible personal property even though located outside a building.

  Section 1.48-1(d)(2) of the regulations provides that, for investment credit purposes, the terms 'manufacturing' and 'production' include the construction, reconstruction, or making of property out of scrap, salvage, or junk material, as well as from new or raw material, by processing, manipulating, refining, or changing the form of an article, or by combining or assembling two or more articles.

  The snowmaking system components in question - the air and water distribution pipes, the hydrants, the electrical transmission lines, and the water intake pipe - may qualify as section 38 property if they are either tangible personal property or are used as an integral part of manufacturing or production.

  The committee reports prepared when the investment credit was first enacted mention oil and gas pipelines as examples of real property. H.R. Rep. No. 1447, 87th Cong., 2d Sess. 12 (1962), 1962-3 C.B. 405, 416; S. Rep. No. 1881, 87th Cong., 2d Sess. 16 (1962), 1962-3 C.B. 707, 722. Because they are analogous to oil and gas pipelines, extensive systems of underground piping are considered inherently permanent improvements to land and not tangible personal property. See, e.g., Johnston v. United States, 80-1 U.S.T.C. paragraph 9199 (D. Mont. 1979) (underground water and sewer pipes); Rev. Rul. 69-273, 1969-1 C.B. 30

(underground pipes and valves in a golf course irrigation system); Rev. Rul. 66-269, 1966-2 C.B. 13 (underground pipes in a trailer park water and sewer system), all relying on the oil and gas pipeline analogy.

  The air and water distribution pipes and hydrants of the snowmaking system are similar to the types of property involved in the above authorities in that all consist of extensive systems of underground piping connected to machinery or equipment. Accordingly, the air and water distribution pipes and hydrants are not tangible personal property, but are inherently permanent improvements to land.

  Electrical wiring and plumbing appurtenant to machinery or equipment are sometimes considered part of the machinery or equipment and, thus, tangible personal property. See, e.g., Rev. Rul. 69-558, 1969-2 C.B. 4; Rev. Rul. 66- 299, 1966-2 C.B. 14. In the cited revenue rulings, the electrical wiring and plumbing are located in the immediate vicinity of, and inside the building housing, the machinery to which they are connected.

  The water intake pipe and electrical transmission lines of the snowmaking system are located outside the pumphouse and buried underground. Therefore, these components are not tangible personal property, but are inherently permanent property not in the nature of machinery or equipment.

  Although none of the components in question are tangible personal property, they may be section 38 property if used as an integral part of manufacturing or production.

  As used in section 48(a)(1) of the Code the terms 'manufacturing' and  'production' are to be given their commonly accepted meanings. H.R. Rep. No. 1447, at A18, 1962-3 C.B. at 516; S. Rep. No. 1881, at 155, 1962-3 C.B. at 859. Interpreting the term 'manufacturing' in its usual sense, Rev. Rul. 81-66, 1981-1 C.B. 19, concludes that the operation of a cafeteria is a retail activity, not a manufacturing activity within the meaning of section 48(a)(1), and that leasehold improvements to the cafeteria facility that are not tangible personal property do not qualify as section 38 property. Rev. Rul. 81-66, 1981- 1 C.B. at 20, states:

  Activities involving the sale of merchandise, food and other items to the general public for personal or household consumption, and the rendering of services incidental to the sale of goods are considered to be retail activities rather than manufacturing within the commonly accepted meaning of the item. Processing incidental or subordinate to selling is often conducted at retail stores. For example, drug stores prepare prescriptions, restaurants prepare meals, and meat markets cut meat.

  The operation of a cafeteria, like the operation of a restaurant or cafe, is considered in the trade to be a retail activity rather than a manufacturing activity. The food and drink prepared by the cafeteria employees is for direct sale to and for the consumption by the general public. The food preparation activity is incidental or subordinate to the selling of the prepared meals and is not considered to be similar to any of the activities encompassed by the definition of manufacturing provided by section 1.48-1(d)(2) of the regulations.

  Thus, Rev. Rul. 81-66 determines that in common parlance the term  'manufacturing' does not include incidental or subordinate activities occurring in a retail context.

  Similarly, the terms 'manufacturing' and 'production' in their customary sense do not embrace activities that are incidental or subordinate to the provision of recreational services, such as snowmaking by the operator of a ski resort. Accordingly, the air and water distribution pipes, hydrants, electrical transmission lines and the water intake pipe in the present case are not used as an integral part of manufacturing or production.

HOLDING

  The snowmaking system components in question are not section 38 property and do not qualify for the investment credit.

Rev. Rul. 85-93, 1985-2 C.B. 9, 1985-27 I.R.B. 4.