US Federal Circuit decision in Dominion Resources invalidates IRS regulations

The ruling also deals a blow to the Internal Revenue Service’s (IRS) policy on drafting regulations.

In 1996, utility company Dominion Resources replaced coal burners in two of its plants, temporarily removing the units from service while the improvements were made.

During the improvement period, the company incurred interest on debt unrelated to the modifications.

The taxpayer deducted some of the interest from its taxable income but the IRS disputed the deductible amount, claiming that a larger proportion of the interest should be capitalised.

Under section 263A of the Internal Revenue Code, taxpayers must allocate interest expense to property they produce based on an avoided cost analysis.

The idea behind the principle is that if a taxpayer improves property, then the money used to make the improvement would have otherwise been available to pay down existing debt.

The statute therefore requires that a portion of a taxpayer’s interest expense...