Research and experimental ex­penses; environmental impact studies. A public utility company conducted, and paid another orga­nization to conduct, environmental impact studies to support its appli­cation 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 stud­ies needed to support its application to be filed with state regulatory agen­cies for a construction permit to ex­pand its facilities.

Because the taxpayer’s expansion involved both the construction of a nuclear power plant and the installa­tion 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 opera­tion of the expanded facilities. Part of the studies were conducted directly by the taxpayer. The taxpayer used a re­search 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, ascer­tained the socio-economic impact of the plant on the surrounding commu­nity, ascertained the impact of the facility on the terrestrial ecology of the proposed site, considered the com­mercial disposition of fly ash waste generated by an alternative coal pow­ered plant in order to meet state en­vironmental standards, predicted noise levels at the construction site, consid­ered the impact of construction and operation of the facilities on the aquat­ic environment of tile inland streams located on two of the sites, and pro­jected 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 experi­mental 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 In­come Tax Regulations provides that the term “research and experimental expenditures” as used in section 174 of the Code means expenditures in­curred in connection with the tax­payer’s trade or business that repre­sent 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 effi­ciency surveys, management studies, consumer surveys, advertising or pro­motions.

Section 1.174-2(a)(2) of the regu­lations provides that research and ex­perimental expenditures include not only costs paid or incurred by the tax­payer for research and experimenta­tion undertaken directly by the tax­payer, but also to expenditures paid or incurred for research or experimen­tation carried on in behalf of the tax­payer by another person or organiza­tion.

Rev. Rul. 67-401, 1967-2 C.B. 123, holds that expenses for legal and ac­counting work incurred by the tax­payer 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 sec­tion 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 tax­payer’s risk are deductible as research and experimental expenditure’s within the meaning of section 174 of the Code even though each product de­sign 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 vari­ous regulatory agencies to expand its facilities.

HOLDING

The taxpayer’s expenditures for en­vironmental impact studies prepared in connection with the expansion of its facilities are not research and ex­perimental 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 ex­penses, if not chargeable to a capital account, are ordinary and necessary business expenses deductible under section 162 (a).