                  T.C. Memo. 1999-77



                UNITED STATES TAX COURT



  LYKES ENERGY, INC. AND SUBSIDIARIES, Petitioners v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket Nos. 7685-96; 4979-97.    Filed March 11, 1999.



     S, a gas utility company, collected funds from its
customers which were earmarked for legislatively
mandated energy conservation programs. The State
required S to account separately for the funds and
monitored program expenditures. S could not retain the
unexpended amounts and was charged interest on the
funds that exceeded expenditures. The largest
expenditure was subsidies paid to purchasers of gas
appliances from S. S' sales, customer base, and rate
base increased as a result of the programs. Held: S'
gross income includes the funds. Held, further, S must
capitalize the expenditures, less the amount paid as
subsidies, which is currently deductible.



Nathan B. Simpson and Matthew J. Foster, for petitioners.

William A. Goss and Benjamin A. DeLuna, for respondent.
                                 - 2 -




             MEMORANDUM FINDINGS OF FACT AND OPINION

     LARO, Judge:    This consolidated case was submitted to the

Court without trial.    See Rule 122(a).   Lykes Energy, Inc.

(Lykes) and Subsidiaries petitioned the Court to redetermine the

following Federal income tax deficiencies:

          Taxable Year           Deficiency

              1988               $1,075,219
              1989                1,023,665
              1990                1,306,399
              1991                1,524,819
              1992                1,704,765
              1993                1,904,928
              1994                1,953,607

     We must decide whether funds collected by Lykes' subsidiary,

People's Gas System, Inc. (People's), under the terms of certain

energy conservation programs (FEECA programs) are includable in

People's gross income.    We hold they are.   We also must decide

whether People's expenditures under the FEECA programs are

required to be capitalized under section 263(a).1     We hold they

are to the extent described herein.      Unless otherwise indicated,

section references are to the Internal Revenue Code in effect for

the subject years.     Rule references are to the Tax Court Rules of


     1
       People's participated in seven FEECA programs. Respondent
has conceded that petitioners may deduct expenditures for two of
these programs; namely, the Residential Conservation Service
Program and the Appliance Energy Savings Payback Program. The
parties agree that any amounts required to be capitalized must be
amortized over 13 years.
                               - 3 -


Practice and Procedure.   Dollar amounts are rounded to the

nearest dollar.

                          FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulation of facts and the exhibits submitted therewith are

incorporated herein by this reference.     Lykes is the parent

corporation of an affiliated group of corporations that files

consolidated Federal income tax returns based on a fiscal year

ending on September 30.   Lykes was headquartered in Tampa,

Florida, when the petitions were filed.

     People's distributes natural gas in Florida.     It is a

utility subject to regulation by the Florida Public Service

Commission (PSC).   Pursuant to the Florida Energy Efficiency and

Conservation Act (FEECA), the PSC required that People's design

and administer the FEECA programs.     People's administers these

programs subject to the PSC's supervision.     The FEECA programs

are generally designed to reduce consumption of high cost

petroleum and to lower electrical energy consumption.

     For its 1988 through 1991 taxable years, People's included

receipts from the FEECA programs (FEECA receipts) in its gross

income, and it deducted its expenditures under the programs

(FEECA expenditures).   Starting with its 1992 taxable year,

People's excluded FEECA receipts from its gross income and did

not deduct any FEECA expenditures.
                             - 4 -


    People's undertook the following programs to comply with

FEECA:

         (1) SINGLE FAMILY RESIDENTIAL HOME BUILDER
    PROGRAM.--Under this program, which was designed to
    increase the number of gas customers in the new
    residential construction market, People's paid builders
    to install gas appliances in new residential
    developments. For the respective taxable years in
    issue, expenditures for this program were $165,077,
    $155,636, $198,027, $232,213, $829,481, $1,915,006, and
    $2,824,892.

          (2) RESIDENTIAL CONSERVATION SERVICE PROGRAM.--
    Under this program, which was designed to help existing
    residential customers reduce energy consumption,
    People's paid contractors to perform energy efficiency
    audits and recommend energy saving steps. Expenditures
    for this program were $20,131 in 1988 and $4,974 in
    1989.
         (3) REPLACEMENT OF OIL HEATING PROGRAM.--Under
    this program, which was targeted at customers mainly
    interested in converting oil heat to gas heat, People's
    paid for part of the cost of installing gas appliances.
    For the respective taxable years in issue, expenditures
    for this program were $179,788, $102,230, $81,036,
    $92,772, $72,360, $64,756, and $51,810.

         (4) APPLIANCE ENERGY SAVINGS PAYBACK PROGRAM.--
    Under this program, which was designed to encourage gas
    customers to replace existing gas appliances with new,
    more energy-efficient appliances, People's generally
    subsidized the purchase of new, more energy-efficient
    models. For the respective taxable years in issue,
    expenditures for this program were $171,339, $152,505,
    $219,728, $160,032, $151,424, $387,110, and $386,070.

         (5) COGENERATION PROMOTION AND FEASIBILITY AUDIT
    PROGRAM.--Under this program, which was designed to
    encourage industrial, commercial, and institutional
    users to generate electricity on-site using natural gas
    fired generators, People's provided free feasibility
    audits to customers considering installing cogeneration
    facilities. Expenditures for this program totaled $118
    in 1989 and $12,500 in 1992.
                               - 5 -


          (6) APPLIANCE DEALER/CONTRACTOR PROGRAM.--Under
     this program, which was designed to encourage replacing
     electric or older gas appliances with new gas
     appliances, People's paid dealer/contractors and
     customers to install new gas appliances. In 1990, this
     program was discontinued. The expenditures listed
     below for the 1992, 1993, and 1994 taxable years relate
     to a "Gas Space Conditioning Allowance Program", which
     was designed to convert on-main customers from electric
     space conditioning equipment to gas space conditioning
     equipment. This latter program was targeted at
     existing gas consumers, offering an allowance to help
     defray the higher "first costs" of gas space
     conditioning equipment. For the respective taxable
     years in issue, expenditures for these programs were
     $84,120, $28,436, $16,630, $8,701, $52,000, $50,250,
     and $27,000.

          (7) ELECTRIC RESISTANCE REPLACEMENT PROGRAM.--
     Under this program, which was designed to encourage
     customers to replace electric appliances with gas
     appliances by subsidizing the installation of gas
     appliances, People's paid residential customers to
     switch to gas heat from electric heat. In 1990, this
     program was bifurcated into two programs, one for
     residential customers and the other for commercial
     users. For the respective taxable years in issue,
     these programs' expenditures were $2,170,942,
     $2,510,076, $3,091,036, $3,486,573, $3,364,740,
     $2,452,452, and $2,380,931.

     The largest single category of FEECA expenditures consisted

of subsidies for people who bought gas appliances from People's

or an affiliate (collectively referred to as People's).   The

percentages of program expenditures that were subsidies were:2

               Taxable Year   Percentage

                  1988           69
                  1989           79

     2
       These percentages were stipulated by the parties as
"minimum percentages". The record, however, does not allow us to
find a greater percentage.
                                  - 6 -


                     1990           83
                     1991           85
                     1992           76
                     1993           63
                     1994           62

     Each FEECA program was initially designed by People's to

meet goals established by the PSC.        The PSC had the final say as

to whether a particular program was approved and implemented.

In deciding whether to approve a particular program, the PSC

calculated the present dollar value of cost savings to be

realized by the people of Florida.        These cost savings related to

factors such as reduced consumption of kilowatt hours of electric

energy.   Other benefits taken into account were the value of

incentive payments paid to, or on behalf of, Florida public

utility customers.    The value of these benefits was then divided

into the projected costs of the program.       Under this formula, a

proposed program had to have a cost effectiveness ratio greater

than 1 to be approved.      In deciding which of People's program

proposals to approve, the PSC did not consider the benefit to

People's.

     Funds to pay for the FEECA programs were generated by

building an extra factor into the rate People's charged most of

its customers.3   People's had to identify the portion of its


     3
       Beginning in 1990, certain commercial and industrial
customers who agreed to have their gas service interrupted when
People's experienced unusually high demand did not have FEECA
costs built into their rates.
                                - 7 -


receipts allocable to the FEECA programs on its books and

records.    People's was prohibited by the PSC from separately

stating this portion on its customers' bills.

     People's collected FEECA funds subject to a statutory

obligation not to expend them for any purpose other than FEECA

programs.    It kept separate bookkeeping accounts to record FEECA

receipts and FEECA expenditures, and, at fixed intervals of 6

months to a year, the PSC conducted in-depth audits of these

accounts.    If People's charged an expense that the PSC deemed

improper, the charge was disallowed.    These disallowances were

not charged back to People's customers.    They were borne by

People's and its shareholders in the form of reduced net income.

People's did not segregate the FEECA funds in separate bank

accounts.

     For each period, the FEECA rate factor was calculated as

closely as possible to generate just enough receipts to cover the

period's anticipated FEECA expenditures.    If People's FEECA

receipts exceeded a period's FEECA expenditures, the excess, plus

interest on the excess, was subtracted from the amount the

following period's rate factor was designed to yield.

     If and when the FEECA programs terminate, or if and when

People's goes out of business, any residual funds in the FEECA

accounts must be refunded to the ratepayers.    If People's is

acquired by another company, the FEECA account balances pass to
                                 - 8 -


the acquirer which must assume People's obligation to make FEECA

expenditures.

     The amounts billed to People's customers for the FEECA

programs are not payments for the goods and services a customer

consumes.   In designing the rates that People's may charge its

customers, the PSC does not consider FEECA receipts as part of

People's revenue from goods and services.    It does not consider

FEECA expenses as part of People's "prudently incurred" expenses

of providing goods and services.    It does not include excess

FEECA receipts as part of People's capital investment on which it

is entitled to earn a return.

     The State of Florida and its citizens are the intended

beneficiaries of the FEECA statute and the FEECA programs.    No

direct benefit to People's is intended.    People's customer base,

rate base, and natural gas sales have increased as a result of

FEECA expenditures.

                                OPINION

     Petitioners, relying on Seven-Up Co. v. Commissioner, 14

T.C. 965 (1950), and its progeny, contend that the FEECA receipts

are excludable from People's gross income.    Petitioners argue

that People's was a conduit for the receipts in that it received

them subject to an obligation to account for them separately and

to expend them for a set purpose under the control and

supervision of the PSC.   Petitioners contend that People's
                               - 9 -


realized no gain or profit when it collected the funds.

Respondent argues that the FEECA receipts are includable in

People's gross income.   Respondent contends that People's

collected the receipts without a trust relationship.    Respondent

contends that the FEECA expenditures benefited People's

significantly.

     We agree with respondent that the FEECA receipts are

includable in People's gross income.    We begin our analysis with

the statutory text, which provides that "gross income means all

income from whatever source derived".   Sec. 61(a).   Congress

prescribed this text intending to "use the full measure of its

taxing power".   Helvering v. Clifford, 309 U.S. 331, 334 (1940).

This text is construed broadly to reach any accession to wealth

realized by a taxpayer, and over which the taxpayer has complete

control.   See United States v. Burke, 504 U.S. 229 (1992);

Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).

     Funds received by a taxpayer are excludable from gross

income when:   (1) The funds are received in trust subject to a

restriction that they be expended for a specific purpose and

(2) the taxpayer does not profit, gain, or benefit in spending

the funds for the stated purpose.   See Ford Dealers Adver. Fund,

Inc. v. Commissioner, 55 T.C. 761, 771-772 (1971) (discussing

Seven-Up Co. v. Commissioner, supra, and its progeny), affd. per

curiam 456 F.2d 255 (5th Cir. 1972).    People's does not meet this
                                - 10 -


test.     It did not receive the FEECA receipts in trust.    A trust

requires that (1) a person (2) take title to property

(3) pursuant to an explicit directive (4) to preserve or protect

the property. See Johnson v. Commissioner, 108 T.C. 448, 476

(1997); sec. 301.7701-4(a), Proced. & Admin. Regs.       Here, the

purported settlors, namely People's customers, never intended to

create a trust or even knew they were funding the FEECA programs.

People's received the FEECA receipts from its customers as

payments for gas, and the customers, at the time of payment, did

not know that any part of the payments was for other than their

gas use.     In fact, PSC rules explicitly barred People's from

telling its customers that a portion of each payment was funding

the FEECA programs.

        Nor did People's satisfy the second prong of the Seven-Up

test, which requires that it expend the funds without profit,

gain, or benefit.     The subsidies paid by People's benefited it

significantly in that they encouraged utility users to purchase

gas appliances from People's.     The effect of the FEECA programs

was that they served to shift the cost of these subsidies from

People's to its rateholders.     The FEECA programs also increased

People's rate base, number of customers, and sales.

        We turn to the second issue; namely, whether People's must

capitalize the FEECA expenditures.       Respondent answers this

question in the affirmative as to all the disputed expenditures.
                              - 11 -


Respondent contends that the disputed expenditures are

capitalizable because they produced new customers for People's.

Petitioners argue that the expenditures are deductible.

Petitioners contend that most of the expenditures relate to sales

of appliances.   Petitioners contend that the other expenditures

yielded no significant future benefit.

     Agreeing with respondent in part and with petitioners in

part, we hold that some of the FEECA expenditures are deductible

while others must be capitalized.   Section 162(a) provides a

deduction for an accrual method taxpayer like People's only when

an expenditure is:   (1) An expense, (2) an ordinary expense,

(3) a necessary expense, (4) incurred during the taxable year,

and (5) made to carry on a trade or business.   See Commissioner

v. Lincoln Sav. & Loan Association, 403 U.S. 345 (1971).      An

expense that creates a separate and distinct asset is not

"ordinary".   Id. at 354; see also Norwest Corp. & Subs. v.

Commissioner, 112 T.C.      (1999), and the cases cited therein.

Nor is an expense "ordinary" when it generates a significant

long-term benefit that extends beyond the end of the taxable

year.   See INDOPCO v. Commissioner, 503 U.S. 79, 87-88 (1992);

Norwest Corp. & Subs. v. Commissioner, supra.   Recognizing income

concomitantly with the recognition of the related expenses is a

goal of our income tax system, and a proper matching is achieved

when an expense is deducted in the taxable year or years in which
                              - 12 -


the related income is recognized.    See Newark Morning Ledger Co.

v. United States, 507 U.S. 546, 565 (1993); INDOPCO, Inc. v.

Commissioner, supra at 84; Hertz Corp. v. United States, 364 U.S.

122, 126 (1960); Liddle v. Commissioner, 103 T.C. 285, 289

(1994), affd. 65 F.3d 329 (3d Cir. 1995); Simon v. Commissioner,

103 T.C. 247, 253 (1994), affd. 68 F.3d 41 (2d Cir. 1995).

     Our resolution of this issue turns on whether the FEECA

expenses were "ordinary".   The subsidies were.   People's

benefited from them currently in that they induced customers to

purchase products from People's.    Of course, People's sales may

yield future benefits, such as repeat business and sales of

related products or commodities.    Those future benefits, however,

are incidental to the sales at hand.

     We considered a similar issue in Fall River Gas Appliance

Co. v. Commissioner, 42 T.C. 850 (1964), affd. 349 F.2d 515 (1st

Cir. 1965).   There, the taxpayers were a gas company and its

subsidiary; the subsidiary sold and leased gas appliances.    We

held that the selling expenses related to the leased appliances

must be capitalized.   We held that the selling expenses related

to the appliance sales were deductible.    As to the latter class,

we noted that the expenses "were related to closed transactions

and were a proper charge at once against the income realized from

such transactions." Id. at 856.     The same rationale applies here

to the subsidies.   People's paid the subsidies to purchasers of
                              - 13 -


its products, and, in this setting, the subsidies relate

primarily to the income from that sale as opposed to income that

is intended to be generated in the future.   People's may deduct

the subsidies as an ordinary expense of its business.

     As to the remaining expenditures, those amounts are

promotional or selling expenses unrelated to a specific sale.

Given our finding that these expenditures primarily helped

People's increase its customer base, we now decide whether

gaining new customers yielded a future benefit to People's that

was more than incidental.   We conclude it did.   While People's

made substantial investments to induce its customers to use

natural gas, its customers also made substantial investments to

become gas customers.   That is the point of many of the FEECA

programs.   New gas customers must generally buy new appliances.

Often they have to install gas piping within the walls of their

homes or commercial structures.   As a result, both People's and

its new customers have a strong incentive to continue their

business relationships beyond the initial years.    These upfront

costs tend to discourage People's new customers from switching to

other energy sources and essentially assure People's that it will

receive revenue from these customers in the future.    This

projected revenue stream, which is the direct object of People's

promotional expenditures, is a significant future benefit.    The

expenditures connected thereto must be capitalized.    See Houston
                              - 14 -


Natural Gas Corp. v. Commissioner, 90 F.2d 814, 817 (4th Cir.

1937), affg. 34 B.T.A. 228 (1936), wherein the appellate court

stated that "an intensive campaign to get new customers at any

time gives rise to capital expenditures, and the time when such

expenditures might be incurred is not confined to the early or

formative stages of a company".

     We have considered all arguments by the parties, and, to the

extent not discussed above, find them to be irrelevant or without

merit.   To reflect the foregoing,

                                          Decisions will be entered

                                     under Rule 155.
