Research and experimental exÂpenses; environmental impact studies. A public utility company conducted, and paid another orgaÂnization to conduct, environmental impact studies to support its appliÂcation to state regulatory agencies to expand its generating facilities. The expenses are not research and experimental expenditures within the meaning of section 174 of the Code. However, if not chargeable to a capital account, the expenses are deductible business expenses.
Rev. Rul. 80-245
ISSUE
Are the taxpayer’s expenditures for environmental impact studies prepared in connection with the expansion of its facilities research and experimental expenditures within the meaning of section 174 of the Internal Revenue Code?
FACTS
In 1978, the taxpayer, a public utility company, planned expansion of its facilities for generating electricity. The taxpayer conducted various studÂies needed to support its application to be filed with state regulatory agenÂcies for a construction permit to exÂpand its facilities.
Because the taxpayer’s expansion involved both the construction of a nuclear power plant and the installaÂtion of an ultra high voltage electric transmission line, the state regulatory agencies required that the taxpayer conduct several types of environmental impact studies for site selection. The studies measured specific site conditions and the resulting environmental impact of the construction and operaÂtion of the expanded facilities. Part of the studies were conducted directly by the taxpayer. The taxpayer used a reÂsearch organization to conduct the remainder of the studies on its behalf.
During 1978, several studies were conducted either by the taxpayer or on its behalf. The studies identified suitable locations for the plant, ascerÂtained the socio-economic impact of the plant on the surrounding commuÂnity, ascertained the impact of the facility on the terrestrial ecology of the proposed site, considered the comÂmercial disposition of fly ash waste generated by an alternative coal powÂered plant in order to meet state enÂvironmental standards, predicted noise levels at the construction site, considÂered the impact of construction and operation of the facilities on the aquatÂic environment of tile inland streams located on two of the sites, and proÂjected the air pollution and radiation emissions of the coal powered and nuclear powered facilities.
LAW AND ANALYSIS
Section 174 of the Code allows a taxpayer to treat research or experiÂmental expenditures paid or incurred by the taxpayer during the taxable year in connection with the taxpayer’s trade or business as expenditures that are deductible.
Section 1.174-2 (a) (1) of the InÂcome Tax Regulations provides that the term “research and experimental expenditures” as used in section 174 of the Code means expenditures inÂcurred in connection with the taxÂpayer’s trade or business that repreÂsent research and development costs in the experimental or laboratory sense. The term includes generally all such costs incident to the development of an experimental or pilot model, a plant process, a product, a formula, an invention, or similar property, and the improvement of already existing property of the type mentioned. The term does not include expenditures such as those for the ordinary testing or inspection of materials or products for quality control or those for effiÂciency surveys, management studies, consumer surveys, advertising or proÂmotions.
Section 1.174-2(a)(2) of the reguÂlations provides that research and exÂperimental expenditures include not only costs paid or incurred by the taxÂpayer for research and experimentaÂtion undertaken directly by the taxÂpayer, but also to expenditures paid or incurred for research or experimenÂtation carried on in behalf of the taxÂpayer by another person or organizaÂtion.
Rev. Rul. 67-401, 1967-2 C.B. 123, holds that expenses for legal and acÂcounting work incurred by the taxÂpayer in obtaining a federal income tax ruling and a determination from a regulatory commission regarding the effect of a research and development project on the taxpayer’s rate structure are not deductible as research and experimental expenditures under secÂtion 174 (a) of the Code.
Rev. Rul. 73-275, 1973-1 C.B. 134, holds that the cost of the taxpayer’s product engineering department to develop and design a specially-built automated manufacturing system for a customer’s specific order at the taxÂpayer’s risk are deductible as research and experimental expenditure’s within the meaning of section 174 of the Code even though each product deÂsign results in the production of only one machine system.
In the present situation, the tax-. payer conducted extensive studies in support of its application to expand its facilities for generating electricity. The studies were not incidental to the development of an experimental or pilot model, a plant process, a product, a formula, an invention or similar property. The facilities to be expanded by the taxpayer did not involve an experimental or pilot project. Rather, the studies represented a search for the effect of the construction on the surrounding environment to support the taxpayer’s application with variÂous regulatory agencies to expand its facilities.
HOLDING
The taxpayer’s expenditures for enÂvironmental impact studies prepared in connection with the expansion of its facilities are not research and exÂperimental expenditures within the meaning of section 174 of the Code. Whether such expenses are capital expenditures will depend upon the facts of the particular case. The exÂpenses, if not chargeable to a capital account, are ordinary and necessary business expenses deductible under section 162 (a).