TAM 1113025: briquetting facility was placed in service before July 1, 1998

Plain-English summary

The IRS considered whether a taxpayer's briquetting facility was placed in service before July 1, 1998, the deadline relevant to the former IRC § 29 credit. The facility had permits, had completed critical testing, and had produced and sold substantial quantities of briquettes using one feedstock before the deadline. The IRS concluded that this production showed the facility had begun regular or daily operations, and that the facility's production using another feedstock could also be considered because no mechanical changes were needed between the two uses. The facility was therefore placed in service before July 1, 1998.

Ruling snapshot

• Question: Was the briquetting facility placed in service before July 1, 1998, for purposes of IRC § 29?
• Outcome: Advice given.
• Key authorities: IRC § 29; Treas. Reg. § 1.46-3(d)(1)(ii); Rev. Ruls. 76-526, 76-428, and 84-85.

Full text (IRS public release)

                        INTERNAL REVENUE SERVICE
              NATIONAL OFFICE TECHNICAL ADVICE MEMORANDUM

                                         December 09, 2010

                                                  Third Party Communication: None
                                                  Date of Communication: Not Applicable

Number: 201113025
Release Date: 4/1/2011
Index (UIL) No.: 29.04-00
CASE-MIS No.: TAM-142365-10

Team Manager,

     Taxpayer's Name:                            ------------------------------------------------------
     Taxpayer's Address:                         ---------------------------------------------
                                                 ----------------------------------------
     Taxpayer's Identification No                ----------------
     Year(s) Involved:                           ---------------
     Date of Conference:                         --------------------------

Legend:

State: ------
Authority: -----------------------------------------
Location: ------------------------------------------------
Company: ------------------
A: ---------------
B: -----------------
C: --------------
W: --------
X: -----
Y: -----
Z: ---------
Year 1: -------
Year 2: -------
Year 3: --------
Year 4: -------
Time 1: -------------
Time 2: ----------------------
Time 3: ------------------
Time 4: ------------------
Time 5: -----------------------
Time 6: ------------------
Time 7: ------------------
Time 8: -----------------------
Time 9: ----------------------

ISSUE

Was the facility at issue placed in service by the Taxpayer prior to July 1, 1998?

CONCLUSION

The facility at issue was placed in service by the Taxpayer prior to July 1, 1998.

FACTS

   In Year 1, Taxpayer acquired technology including binding agents for making

briquettes from combining A, B, and C with various binders. Taxpayer began
developing a briquetting business and opened a prototype briquetting facility in Year 2.
In Year 3 Taxpayer began negotiations with Company for the construction of a
briquetting facility at Location, owned by Company. In Time 1, Taxpayer and Company
entered into an agreement for the construction of a briquetting plant “to briquette [B] and
other in-plant [A] or other suitable fine materials.” That lease did provide that Taxpayer
could bring other materials onto the site and briquette those materials with the written
permission of Company.

   In Time 2, Taxpayer received a patent for its briquetting process, providing for

the briquetting of A, B, or C. In that some month, Taxpayer received a ruling letter from
the Service which concluded that the application of its binder to C in its briquetting
process resulted in a qualified fuel for purposes of § 29 of the Internal Revenue Code.

    In Time 2, as part of its test of the equipment at Location, Taxpayer processed X

tons of C through the briquetting facility to test the equipment. By letter dated Time 5,
Taxpayer informed Company that it intended to briquette W tons of C briquettes. The
letter was withdrawn after Company objected.

    In Time 3, Authority issued a certificate of intent to approve an air quality permit

for the briquetting facility at Location. The permit issued by Authority allowed Taxpayer
to process A, B, and C at the facility at Location beginning in Time 4. A building permit
and business license were also issued to Taxpayer by the relevant local authorities. On
Time 6, Taxpayer and Company entered into a revised briquetting services agreement
which restates that Taxpayer may not bring any C onto the premises without written
permission of Company. Taxpayer completed testing of the briquetting facility at
Location and began commercial operations for the purpose of producing briquettes on
Time 7.

     From Time 7 through Time 8, Taxpayer produced and sold to Company, Z tons

of briquettes using A as the feedstock material. By letter dated Time 8, Company
notified Taxpayer that it was no longer supplying any raw materials for the briquetting
operation. In addition to the X tons of briquettes produced using C in testing the
equipment in Time 2, the facility also produced small amounts (less than one ton) of
briquettes using C several times prior to beginning commercial operations on Time 7.
Finally, in Time 9, Taxpayer produced approximately Y tons of briquettes using C. Part
of this production was observed by an independent engineer who certified that the
facility did produce briquettes using C. Those briquettes were consumed by Company
in its operations.

    In Time 9, Taxpayer and Company entered into a Memorandum of Intent to

explore producing briquettes using C with the equipment. Later, Taxpayer and Company
also discussed producing briquettes using A, B, and other materials. None of these was
implemented due to Company’s financial problems which ultimately resulting in its
bankruptcy. Taxpayer removed the briquetting machinery from Location and attempted
to find a buyer for the facility over the next several years. The facility was finally
relocated in Year 4 to another state where the facility, with no mechanical changes,
produced qualified synthetic briquettes with C as the feedstock.

LAW AND ANALYSIS

Section 29 provides a credit for the sale, to unrelated parties, of qualified synthetic fuel
produced in a facility originally placed in service after December 31, 1992, and before
July 1, 1998.

Section 1.46-3(d)(1)(ii) of the Federal Income Tax regulations provides generally that
property is placed in service when it is placed in a condition or state of readiness and
availability for a specifically assigned function. This definition of placed in service has
been extensively analyzed in revenue rulings and court cases under both section 46
and section 167.

In order to determine when a facility has reached a condition or state of readiness and
availability for a specifically assigned function, all facts and circumstances must be
considered. The Service has generally looked to a number of factors to determine
when a facility is in a condition or state of readiness and availability for a specifically
assigned function. They are:

   (1) approval of required licenses and permits;

   (2) passage of control of the facility to taxpayer;

   (3) completion of critical tests; and

   (4) commencement of daily or regular operation.

See generally, Rev. Rul. 76-526, 1976-2 C.B. 46; Rev. Rul. 76-428, 1976-2 C.B. 47;
Rev. Rul. 84-85, 1984-1 C.B. 103.1 These factors are not exclusive – they are used as
guideposts to determine whether, looking at the totality of the facts and circumstances,
a facility has been placed in service.

It is important to note that a facility need not have reached design capacity to be
considered placed in service. Rev. Rul. 84-85. However, a facility must be ready and
available to produce on a sustained and reliable basis in commercial quantities. To the
factors used by the Service, courts have generally also required that the taxpayer be
engaged in a trade or business. See, e.g., Piggy Wiggly Southern, Inc. v.
Commissioner, 84 T.C. 739, 748 (1985), nonacq. on another issue, 1988-2 C.B. 1, aff’d
on another issue, 803 F2d 1572 (11th Cir. 1986). While neither the Code nor the
regulations defines when a taxpayer is carrying on trade or business, the Supreme
Court has stated that the taxpayer must be involved in the activity with continuity and
regularity and the taxpayer’s primary purpose for engaging in the activity must be for
income or profit. Commissioner v. Groetzinger, 480 U.S. 345, 352 (1971). Each of
these requires that all of the relevant facts and circumstances be taken into account in
determining whether the taxpayer has placed the facility in service as well as whether
the taxpayer is in a trade or business.

As an initial matter, the briquetting facility was removed from Location and stored
elsewhere for several years while Taxpayer attempted to locate a buyer for the facility.
Once an asset is placed in service it remains in service unless the taxpayer abandons the
property. See, e.g., Yellow Cab Company of Pittsburgh v. Driscoll, 24 F. Supp. 993
(D. Penn. 1938) (Taxicabs stored in garage by owner without gasoline, water, or
batteries considered available for use even though they were warehoused due to
economic conditions). Taxpayer took allowable depreciation deductions for the facility
throughout this period and thus did not abandon the property.

Because section 29 requires that the Facilities be placed in service prior to July 1, 1998,
we must examine the facts as they existed at that time. However, one cannot simply
take a “snapshot” at a moment in time, as events before and after the key date must be
considered to determine whether the facilities at issue were placed in service prior to
July 1, 1998. We shall first consider the four factors.

1
The revenue rulings using these factors involve power plants but the four factors listed above are also
useful in analyzing other types of facilities. A fifth factor, synchronization to the power grid, is useful only
in the context of power plants.

The first factor is whether the Taxpayer had secured approval of all required licenses
and permits. All licenses and permits necessary for operation of the facilities were
secured by the Taxpayer prior to July 1, 1998.

The second factor, whether control of the facility had passed to Taxpayer prior to July 1,
1998, is also satisfied by the Taxpayer, inasmuch as the facility was constructed by the
Taxpayer.

The third factor, completion of critical tests, is also in the Taxpayer’s favor. By Time 7,
the Taxpayer had completed all critical tests.

The fourth factor, commencement of daily or regular operation, is at the heart of this
matter. “Daily or regular operation” is considered to have begun when a facility begins
continuous operations at progressively increasing output consistent with minor testing to
eliminate defects.

It is clear that, in general, a facility must be able to produce what a taxpayer intends to
produce in order to be considered to be placed in service. For example, in Valley
Natural Fuels v. Commissioner, T.C. Memo 1991-341, the Tax Court, relying on the
taxpayer’s offering circular, determined that the specifically assigned function of the
facility was to produce 198.2 proof ethanol and concluded that the facility was not
placed in service when it could not produce ethanol of that purity level because it lacked
a certain molecular sieve. Production of other, less pure alcohol, was not considered.
Similarly, in 85 Gorgonio Wind Generating Co. v. Commissioner, T.C. Memo 1994-544,
the Tax Court found that the specifically assigned function of the taxpayer’s wind
turbines was to produce electricity on a regular, ongoing basis. The turbines lacked an
automatic controller so they could not produce electricity on a regular basis so the court
determined that they were not placed in service even though the turbines were capable
of producing electricity for short periods of time.

The Taxpayer asserts that the facility at Location was placed in service to produce
briquettes, including qualified synthetic fuel, and that all briquettes produced should be
considered in determining whether the facility satisfies the placed in service tests.
Contemporaneous documents, such as the lease and other agreements with Company,
indicate that Taxpayer contemplated using the facility to produce several types of
briquettes, including qualified synthetic fuel. From Time 7 through Time 8, Taxpayer
produced and sold to Company Z tons of briquettes using A as a feedstock. These
times are prior to July 1, 1998. Thus, the facility produced significant quantities of
briquettes using A by July 1, 1998. Production of those briquettes demonstrated that
the facility at Location met the regular or daily operation requirement for briquettes.
While the actual production of briquettes using C as a feedstock was limited and
intermittent, there was no mechanical change to the facility between the use of A or C
as a feedstock and therefore the production of briquettes using A as a feedstock may be
considered in determining whether the facility has met the daily or regular operation
requirement. Thus, the facility at Location met the regular or daily operation
requirement for purposes of § 29.

Thus, after a review of all the relevant facts and circumstances, we have determined
that the Taxpayer’s facility at Location was placed in service prior to July 1, 1998.

CAVEAT(S):

A copy of this technical advice memorandum is to be given to the taxpayer(s). Section
6110(k)(3) of the Code provides that it may not be used or cited as precedent.