                  T.C. Memo. 1997-47



                UNITED STATES TAX COURT



     UTILICORP UNITED, INC. & SUBSIDIARIES, F.K.A.
       MISSOURI PUBLIC SERVICE CO., Petitioner v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 8563-94.                    Filed January 27, 1997.



     S, a subsidiary of P, purchased certain of the
assets of a reconstructed hydroelectric power facility
and immediately leased those assets back to the seller.
R determined that S should have allocated a portion of
the asset purchase price to goodwill or going concern
value. P contends that a reallocation is inappropriate
because S acquired no going concern value or goodwill.
     Held: P has proven that the fair market value of
the listed assets acquired by S, which did not include
going concern value or goodwill, equaled or exceeded
the price paid for them; therefore, S need not allocate
any portion of that purchase price to goodwill or going
concern value.
                               - 2 -

     James G. Kreissman, Michael H. Simonson, and Naftali Z.

Dembitzer, for petitioner.

     Peter J. Graziano and Pamela L. Cohen, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     HALPERN, Judge:   Petitioner Utilicorp United, Inc.

(petitioner) is the common parent corporation of an affiliated

group of corporations making a consolidated return of income (the

affiliated group).   Respondent has determined deficiencies of

$2,462,443 and $229,479 in the consolidated Federal taxable

income of the affiliated group for the group’s 1984 and 1987

taxable (calendar) years, respectively.     The only issue remaining

for decision is the depreciable basis of certain assets.

Respondent has determined that one member of the affiliated

group, Utilicorp, Inc. (UtilCo), improperly included in the

depreciable basis of certain property the nondepreciable cost of

goodwill or going concern value.

     Unless otherwise noted, all section references are to the

Internal Revenue Code in effect for the years in issue, and all

Rule references are to the Tax Court Rules of Practice and

Procedure.




                         FINDINGS OF FACT
                               - 3 -

Introduction

     Some facts have been stipulated and are so found.    The

stipulations of fact filed by the parties and accompanying

exhibits are incorporated herein by this reference.

     Petitioner is a Delaware corporation with its principal

place of business in Kansas City, Missouri.

     On December 17, 1987, UtilCo entered into a sale-leaseback

transaction with a Minnesota limited partnership, Topsham Hydro

Partners Limited Partnership (THP).    THP owned a hydroelectric

facility in Topsham and Brunswick, Maine, on the Androscoggin

River, at the Pejepscot Mill Dam (the hydroelectric facility).

UtilCo purchased an undivided 50-percent interest in certain

assets (including real property) constituting the hydroelectric

facility (the undivided interest) and immediately thereafter

leased the undivided interest back to THP.    Chrysler Capital

Corp. (Chrysler Capital) simultaneously purchased (and leased

back) the remaining undivided interest.

History of the Facility

     Androscoggin Water Power Company

     The Pejepscot Mill Dam originally was owned by a Maine

corporation, the Androscoggin Water Power Co. (AWP).    In 1982,

AWP obtained a license from the Federal Energy Regulatory

Commission (FERC) to construct a hydroelectric generating

facility at the dam.   In furtherance of that project, among other

actions, AWP entered into contracts for reconstruction of the
                                - 4 -

site (the construction contracts) and negotiated a power purchase

agreement with Central Maine Power Co. (CMP).

     Construction Contracts

     The construction contracts included (1) an agreement with

Cianbro Corp. (Cianbro) for general construction and the

installation of equipment, (2) an agreement with Allis-Chalmers

Corp. (Allis-Chalmers) for a turbine/generator and related

equipment, and (3) an agreement with Acres International Corp.

(Acres) for design and engineering services.

     None of the construction contracts entitles AWP to a

complete and working hydroelectric generating facility.    In

particular, Acres was only responsible for (1) preliminary

engineering of the facility, (2) determining the total project

cost, (3) final design of the facility, including the creation of

detailed construction drawings, and (4) management of the

construction process.    Acres was not obligated to deliver to AWP

a functional facility.   Acres did not function as a general

contractor for the construction of the facility.   The only

warranties provided by Allis-Chalmers and Cianbro were that the

work that those companies performed would conform to the

requirements of their respective contracts and would be free from

defects in design, workmanship, materials, and/or performance.

Cianbro and Allis-Chalmers did not guarantee each other's work.

The prices charged by Allis-Chalmers and Cianbro were not fixed

and were subject to increases or decreases in the event those
                                 - 5 -

contractors were required to make changes in the amount of work

that they had to perform.

     Power Purchase Agreement

     AWP and CMP entered into the power purchase agreement on

June 25, 1984, and amended it on June 17, 1985 (as so amended,

the power purchase agreement).    Pursuant to the power purchase

agreement, CMP agreed to purchase the electrical output of the

hydroelectric facility for 15 years and obtained an option to

purchase such output for an additional 5 years.      The power

purchase agreement expressly provided that it would terminate if

CMP did not receive electricity from the hydroelectric facility

by September 1, 1988.   The rates provided by the power purchase

agreement were market rates.

THP Acquires AWP and Completes the Hydroelectric Facility

     THP was formed in 1985.    In June 1985, THP acquired all of

the shares of stock of AWP for $10.5 million.      At that time, AWP

had sold no electricity and had no paid employees.      AWP assigned

its rights and obligations under the power purchase agreement and

the construction contracts to THP.       The power purchase agreement

was not significant to THP’s decision to purchase AWP, since the

power purchase agreement was a market rate contract and there was

a risk that it might expire before construction of the

hydroelectric facility was completed.      AWP's FERC license was

transferred to THP.   On February 10, 1986, AWP was liquidated and

its assets distributed to THP.
                                - 6 -

     In June 1985, THP commenced reconstruction of the

hydroelectric facility.    Over the next 2-1/2 years, THP made

substantial alterations to the properties acquired from AWP.

During that period, THP assumed various construction risks,

including labor strikes, unforeseen delays and costs, and

physical damage.   Personnel employed by THP managed the

completion of construction.    THP paid a total of $48.2 million to

acquire the stock in AWP and to complete the reconstruction of

the hydroelectric facility.    The hydroelectric facility was

synchronized with CMP, and THP began furnishing electric power to

CMP on October 31, 1987.

UtilCo Acquisition and Lease

     Purchase of Undivided Interest

     On December 17, 1987, UtilCo purchased the undivided

interest from THP for $32,250,000.      UtilCo immediately leased the

undivided interest back to THP for a 15-year term pursuant to

Project Lease Agreement No. 2, dated December 1, 1987 (the

project lease).    Under the terms of the project lease, THP has,

at the end of that 15-year term, the option of either extending

the lease term or repurchasing the undivided interest.     UtilCo

effected its purchase and lease of the undivided interest through

the Meridian Trust Co., which, pursuant to a trust agreement,

purchased the undivided interest on behalf of UtilCo.

(Hereafter, we shall disregard Meridian’s role and consider

UtilCo   as owning directly the undivided interest.)
                                 - 7 -

     The Bill of Sale

     The document evidencing the purchase of the undivided

interest by UtilCo was Warranty Deed and Bill of Sale No. 2,

dated December 15, 1987 (the bill of sale).     The bill of sale

sets forth with particularity the assets that were acquired by

UtilCo pursuant to the bill of sale (the bill of sale assets).

The bill of sale assets consist of (1) the land upon which the

hydroelectric facility was constructed, (2) the flowage rights

appurtenant to that land, (3) certain easements appurtenant to

that land (excluding the previously referenced flowage rights),

(4) the structures located on that land, and (5) the equipment

comprising the hydroelectric facility.

     FERC License

      The FERC license was not specifically identified in the

bill of sale or the schedules attached thereto as an asset to be

transferred to UtilCo.     FERC requires that owners of

hydroelectric facilities become colicensees for such facilities,

regardless of whether those owners perform significant services

with respect to the ownership or management of the facility.       On

November 6, 1987, FERC issued an order transferring the license

for the hydroelectric facility from THP alone to THP, UtilCo, and

Chrysler Capital as colicensees.

     Operating Agreement

      As part of the sale-leaseback, UtilCo entered into an

operating agreement with THP.
                               - 8 -

     Security for Lease Payments

     The bill of sale does not provide for a sale by THP of its

interest in the power purchase agreement or the construction

contracts.   THP assigned its rights under the power purchase

agreement and the construction contracts to UtilCo to secure the

payment of rents by THP under the project lease.

Purchase Price Allocation

     In making its purchase price allocation, UtilCo allocated

the $32,250,000 purchase price among the bill of sale assets.

After consummating its purchase of the undivided interest, UtilCo

calculated its investment tax credit, business energy tax credit,

and depreciation for the 1987 taxable year, using that purchase

price allocation.   Because UtilCo could not use all of its

general business credit in the 1987 taxable year, a portion of

that credit was carried back to the 1984 taxable year.    UtilCo

did not record any goodwill or going concern value on its books

as a result of the acquisition of the undivided interest.




Expert Testimony

     Petitioner's Expert

     Petitioner presented the expert testimony of David C. Moody,

vice president of Stone & Webster Management Consultants, Inc.

Mr. Moody is licensed in the State of Maine as a professional

engineer and as a real estate appraiser.   Mr. Moody is
                                 - 9 -

experienced in the appraisal of all kinds of utility properties,

including hydroelectric plants.    Mr. Moody has opinions as to the

market values of (1) the bill of sale assets and (2) an undivided

50-percent interest therein.   He is of the opinion that, as of

December 17, 1987, the market values of the bill of sale assets

and of an undivided 50-percent interest therein were $65,000,000

and $32,500,000, respectively.

     Mr. Moody arrived at his opinions by determining the

reproduction cost of the bill of sale assets to be $64,879,102.

He also applied an earnings analysis to the income stream that

the bill of sale assets (in conjunction with certain other assets

of THP) could have been expected to produce.   He determined that

the present value of such income stream was $73,261,609.

     Mr. Moody determined the reproduction cost of the bill of

sale assets as follows:




          Cost of AWP stock               $10,500,000
          New construction                 28,566,497
               Subtotal                    39,066,497

          Turnkey fee (15%)                 5,860,000
          Other costs1                      9,142,605
               Total construction costs    54,069,102

          Developer's profit (20%)         10,810,000
               Total cost indicator       $64,879,102
          1
           Construction interest, financing, and legal costs,
    administrative and general costs, and contingency costs.
                                - 10 -

     Mr. Moody applied his earnings analysis by considering an

estimate of annual net operating income, which was adjusted for

income tax considerations and then discounted to present value

using an after-tax discount rate of 10.55 percent.

     Mr. Moody reconciled the difference in result between his

two valuation approaches by assigning virtually all of the excess

under his earnings analysis to certain business assets, such as

the right to receive payments under the power purchase agreement,

retained by THP.

Respondent's Expert

     Respondent presented the expert testimony of Richard H.

Knoll, senior consultant, Business Valuation Services, Inc.

Mr. Knoll is experienced in the valuation of assets, operating

entities, and proprietary technologies in the fields of petroleum

refining, chemical processing, food processing, pharmaceuticals,

and related fields.    Mr. Knoll is licensed as an engineer in the

State of Illinois.     Mr. Knoll has opinions as to the market

values of UtilCo's undivided 50-percent interest in (1) all of

the assets that he believed were acquired by UtilCo and Chrysler

Capital and (2) only the tangible assets acquired by UtilCo and

Chrysler Capital.     He is of the opinion that the market values of

such interests at December 17, 1987, were $32,250,000 and

$20,650,008, respectively.

     In part, Mr. Knoll arrived at his opinions by determining

the replacement cost of the real and personal property purchased
                                 - 11 -

by THP.   He determined replacement cost by adding to the actual

cost of that property an entrepreneurial profit of 13 percent.      A

13-percent allowance for entrepreneurial profit was considered

reasonable by Mr. Knoll because it represented the weighted-

average cost of capital of UtilCo at the time of the sale-

leaseback transaction.   Mr. Knoll determined that the

“acquisition cost/rehabilitation cost of a 50% interest to THP

was approximately $24,000,000.”     Mr. Knoll also applied an income

approach, which involved determining the present value of

UtilCo's after tax cash flows (including residual value), using a

discount rate of 13 percent.     Taking into account that present

value, he determined that the value of UtilCo's undivided

50-percent interest in all of the assets that he believed were

acquired by UtilCo and Chrysler Capital was $34,538,942 as of

December 17, 1987.   In arriving at his opinion that the market

value of UtilCo's undivided interest was $32,250,000, Mr. Knoll

assumed that UtilCo enjoyed some negotiating advantage over THP.

     Mr. Knoll assumed that the difference between the

$32,250,000 value of UtilCo's undivided interest and his

determination of the tangible asset value using the cost approach

($24,000,000) was due to UtilCo's acquisition of intangible

assets.   Mr. Knoll concluded:

     The fair market value of the Project largely relates to
     its proposed power sale under the prenegotiated PPA,
     [power purchase agreement] the leasing of the Facility
     under the Participation Agreement, the guarantee of tax
     savings under the Tax Indemnity Agreement, guaranteed
                                - 12 -

     use of the FERC license, guaranteed use of the required
     easements near the Facility and going concern value, in
     addition to the tangible value associated with the
     Facility's personal property and operating assets.

     In pertinent part, Mr. Knoll’s “Total Project Cost

Allocation” was as follows:

     Personal property                    $12,856,365
     Real estate improvements              28,425,492
     Real estate-unimproved                    18,159
           Total tangibles                 41,300,016

      Intangibles
        Flowage rights
        Easement
        Permits/licenses
        Collateralization of
         power purchase agreement
        Participation agreement
        Tax indemnity agreement
        Project lease
        Security deposit agreement
        Other intangibles
                 Total intangibles         23,199,984

      Fair Market Value of Total Assets   64,500,000

      Mr. Knoll was unable to ascribe any particular value to any

intangible asset.   In his opinion, “it is nearly impossible to

quantify a single element of intangible value.”

                                OPINION

I.   Introduction

      Petitioner has assigned error to respondent’s determination

that the purchase price paid by UtilCo for its undivided

50-percent interest (the undivided interest) in certain of the

assets constituting the hydroelectric facility located at the

Pejepscot Mill Dam, on the Androscoggin River, in the State of
                              - 13 -

Maine (the hydroelectric facility), should in part be reallocated

to either goodwill or going concern value.   At trial, respondent

conceded that, if there was any goodwill, it was “very small or

nothing”.   We accept that statement as a concession by respondent

that UtilCo did not acquire goodwill.   Thus, we shall limit our

inquiry to the question of whether UtilCo acquired going concern

value.   Also at trial, the parties agreed that the Court, as an

initial matter, should determine the fair market value of the

assets listed in Warranty Deed and Bill of Sale No. 2 (the bill

of sale assets).   We have found that UtilCo acquired an undivided

50-percent interest in the bill of sale assets.   Going concern

value is not one of the bill of sale assets.   Respondent concedes

that, if the fair market value of the bill of sale assets was at

least $65,000,000, then UtilCo acquired no going concern value.1

As set forth below, we find that the value of the bill of sale

assets was $65,000,000.   Accordingly, we find that UtilCo



1
     Where assets are purchased and the fair market value of
assets other than goodwill or going concern value equals or
exceeds the purchase price, goodwill or going concern value is
not generally attributable to the purchase price. See, e.g.,
UFE, Inc. v. Commissioner, 92 T.C. 1314, 1328 (1989); Citizens &
Southern Corp. v. Commissioner, 91 T.C. 463, 511-512 (1988),
affd. 919 F.2d 1492 (11th Cir. 1990). Sec. 1060 provides special
allocation rules for certain asset acquisitions. Under the
residual method described in sec. 1.1060-1T(d), Temporary Income
Tax Regs., 53 Fed. Reg. 27040 (July 18, 1988), consideration is
first allocated among cash and other items, including both
tangible and intangible property (but not intangibles in the
nature of goodwill and going concern value), before being
allocated to goodwill and going concern value.
                                - 14 -

acquired no going concern value, and we sustain petitioner’s

assignment of error.

II.   Testimony

      A.   Reliance on Expert Testimony

      Both petitioner and respondent rely heavily, if not

exclusively, on expert testimony to establish fair market value.

As its expert witness as to valuation, petitioner called David C.

Moody.     As her expert witness as to valuation, respondent called

Richard H. Knoll.    Messrs. Moody and Knoll each provided a

written report, which were both admitted into evidence.     Like the

parties, we rely heavily on expert testimony in making our

finding as to the value of the bill of sale assets.    We found

Mr. Moody to be convincing, and we agree with his conclusion as

to the value of the bill of sale assets.    We had difficulty with

the testimony of Mr. Knoll, who, in any event, did not have an

opinion as to the amount of going concern value allegedly

acquired by UtilCo.    We were not persuaded by his testimony and

do not accept his conclusions as to value.    We shall set forth

some of our reasons for agreeing with Mr. Moody and disagreeing

with Mr. Knoll.

      B.   David C. Moody

      Mr. Moody is licensed in the State of Maine as an engineer

and as a real estate appraiser.    He is experienced in the

appraisal of electric and water utility properties, including

hydroelectric plants.    Like Mr. Knoll, Mr. Moody rejected a
                               - 15 -

comparable sales approach as inappropriate to the circumstances

in this case and relied on both a cost and earnings approach to

determine value.   He identified the properties that he was

appraising as the bill of sale assets.    He determined the

reproduction cost of the bill of sale assets to be $64,879,102,

but, taking into account the results of his income analysis,

concluded that the fair market value of the hydroelectric

facility was $65,000,000.    We are not troubled by that

discrepancy.   Mr. Moody did not assign any value to going concern

value.

     Respondent’s criticism of Mr. Moody’s opinions focuses on

his determination that the reproduction cost of the bill of sale

assets was $64,879,102.   Respondent quarrels with inclusion of a

15 percent turnkey fee of $5,860,000 and a 20 percent developer’s

profit of $10,810,000.    Apparently, respondent does not disagree

that the remaining acquisition and construction costs of the bill

of sale assets were $48,209,102.    Indeed, respondent’s expert,

Mr. Knoll, was of the opinion that the “overall construction

price” paid by THP was $48,200,000.

     In his report, Mr. Moody states that, although THP had

contracted for construction of the facility, it was not

guaranteed a complete working hydroelectric facility at the

completion of construction.    He states that the owners bore the

risk of nonperformance of the various contractors, as well as the

cost of unforeseen difficulties such as bad weather, floods,
                              - 16 -

subsurface geotechnical problems, or start-up problems.

Mr. Moody states that those risks could have been alleviated by

hiring an overseer of the entire process who would be in charge

of delivering a completed, operating facility.    He refers to that

risk of delivering a completed, operating facility as the

“turnkey risk”, and he states that contractors who take on a

turnkey risk charge a premium, which is typically 15 percent.

     If THP bore a turnkey risk in connection with construction

of the facility, then the addition of a turnkey premium in

determining the value of the bill of sale assets is appropriate.

See Miami Valley Broadcasting Corp. v. Commissioner, 204 Ct. Cl.

582, 499 F.2d 677, 680 (1974) (turnkey premium appropriate in

valuing a fully operational plant received on dissolution of a

corporation).   We have found that none of the construction

contracts entitled AWP (or its successor by assignment, THP) to a

complete and working hydroelectric generating facility.    AWP and

then its assignee, THP, bore the ultimate risk that the facility

would not function when completed.     Notwithstanding respondent’s

argument to the contrary, we are persuaded that THP bore a

turnkey risk in connection with the construction of the facility,

and we so find.   We must determine whether the inclusion of the

15-percent turnkey premium in Mr. Moody’s valuation of the bill

of sale assets was appropriate.

     In determining an appropriate turnkey fee, Mr. Moody

consulted employees of Stone & Webster Engineering Corp.
                             - 17 -

That corporation enters into turnkey contracts to build

hydroelectric power facilities.   Based on those conversations,

Mr. Moody concluded that contractors that enter into agreements

to deliver fully functional hydroelectric power facilities

typically charge a turnkey premium equal to 15-percent of the

funds expended in constructing the facility in question.

Respondent asserts that a 15-percent turnkey fee is excessive.

Respondent supports that assertion with Mr. Knoll's testimony.

Mr. Knoll's experience with turnkey contracts, however, is

limited to three turnkey contracts involving the construction of

assets to be used in the petrochemical industry.   Mr. Knoll

apparently has no experience in determining appropriate turnkey

fees applicable to contracts calling for the construction of

assets to be used in the hydroelectric power industry.     We find

that Mr. Moody was a more credible witness than Mr. Knoll.     We

have no reason to believe that Mr. Moody overstated the turnkey

fee, and we accept his determination and calculation of that fee.

     Respondent questions the amount of, rather than the

necessity of, a developer’s profit allowance.   Indeed, Mr. Knoll

factors into his own analysis a developer’s profit of 13 percent.

Respondent also argues that Mr. Moody erred by including both a

turnkey fee and a developer’s profit in computing the

reproduction cost of the facility.    Respondent cites no authority

prohibiting both a turnkey fee and a developer’s profit, and

petitioner has convinced us that the two address different
                                - 18 -

economic risks.    The turnkey risk is the risk inherent in

promising a working facility.    The developer’s profit represents

the risk inherent in constructing a facility that cannot be sold

for the price asked by the developer.      Insofar as the turnkey fee

and the developer's profit address different components of

reproduction cost, we see no logical reason why they cannot

coexist.    We are persuaded that, in the instant case, the turnkey

fee and the developer's profit figure represent different

components of the reproduction cost of the bill of sale assets

and that it was appropriate for Mr. Moody to include both of

those figures in the reproduction cost of those assets.      We now

turn to Mr. Moody's computation of the developer’s profit.

     In calculating a developer's profit, Mr. Moody looked to

conditions encountered by persons selling hydroelectric

generating assets in the northeastern United States in

December 1987.    Mr. Moody determined that an appropriate range

for a developer's profit was 20 to 25 percent; Mr. Moody applied

a developer's profit of 20 percent.      We do not believe that

Mr. Moody overstated the developer's profit, and we accept his

calculation of that profit figure.

     C.    Richard K. Knoll

     Mr. Knoll’s written report is coauthored by Martin D. Hanan;

neither Mr. Knoll nor Mr. Hanan is licensed as an appraiser.

Mr. Knoll testified that his recent professional focus has been

in the valuation of intangible assets and intellectual property.
                              - 19 -

We conclude that Mr. Knoll has limited experience in valuing

hydroelectric generating facilities.

     Mr. Knoll’s valuation is not limited to the bill of sale

assets, and his written report is inconsistent in describing

exactly what his valuation assignment was:   e.g., “50% undivided

interest * * * in the Topsham Hydroelectric Project”, “50%

undivided interest in [the sale leaseback transaction]”, “50%

undivided interest in the assets purchased by UtilCo”.     Moreover,

Mr. Knoll has no opinion as to the value of the bill of sale

assets per se.   He is of the opinion that the market value of

UtilCo’s undivided 50 percent interest in the tangible assets

acquired by UtilCo and Chrysler Capital was $20,650,008.       He has

not explained how he squares that figure with the statement in

his report that the “acquisition cost/rehabilitation cost of a

50% interest to THP was approximately $24,000,000.”

     We are troubled that Mr. Knoll’s calculation of

entrepreneurial profit is idiosyncratic.   Mr. Knoll considered a

13-percent allowance for entrepreneurial profit reasonable

because it represented the weighted-average cost of capital of

UtilCo at the time of the sale-leaseback transaction.     He

testified that, if UtilCo's weighted-average cost of capital

changed, that would change his estimate of the appropriate

percentage of entrepreneurial profit.   He testified that if there

were a different buyer, with a different cost of capital, that

might change his entrepreneurial profit allowance.     In neither
                                  - 20 -

his written report nor his oral testimony did Mr. Knoll state

that he performed any market analysis or interviewed any

developers to determine the expectations of profit required to

undertake a project such as the hydroelectric facility.

       Although Mr. Knoll is of the opinion that at least a portion

of the difference between UtilCo’s purchase price of $32,500,000

and the $24,000,000 “acquisition cost/rehabilitation cost” is

attributable to going concern value, he has no opinion as to what

that portion is, except as an inseparable portion of the value of

a package of at least nine intangibles, including flowage rights

and easements.       His opinion that UtilCo acquired going concern

value is of no help to us because he is unable to distinguish the

going concern value from the value of other intangible assets,

such as flowage rights and easements that are specifically set

forth as bill of sale assets.

       Mr. Knoll testified in rebuttal to Mr. Moody.     His rebuttal

testimony failed to persuade us that Mr. Moody made any error in

arriving at his opinion as to the fair market value of the bill

of sale assets.

III.    Conclusion

       We find that the fair market value of the bill of sale

assets was $65,000,000.       As a result, we conclude that UtilCo

acquired no going concern value.       We sustain petitioner’s

assignment of error.
- 21 -

          Decision will be entered

     under Rule 155.
