Illinois Power Co. v. Comm'r of Internal Revenue

Full title: ILLINOIS POWER COMPANY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE…

Court: United States Tax Court

Date published: Nov 29, 1984

83 T.C. 47 (U.S.T.C. 1984)

83 T.C. 47

Opinion

Docket No. 14701-79.

1984-11-29

ILLINOIS POWER COMPANY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

SEYMOUR I. SHERMAN, and THOMAS C. BORDERS, for the respondent. EDWARD C. RUSTIGAN and WILLIAM A. SCHMALZL, for the petitioner.

WILBUR

The construction of the Baldwin Power Station, a multi-unit electric generating station commenced in March of 1967. The construction of Unit 3 began in 1971 and it was placed in commercial service on June 20, 1975. Sargent & Lundy, an engineering partnership, designed and provided construction management for the project and Baldwin Associates, a joint venture of construction companies, performed the actual physical construction of Unit 3. Petitioner, Illinois Power, provided general criteria for Unit 3 to its agent, Sargent & Lundy, purchased all major components, approved specifications, accepted delivery of, stored, and safeguarded components and equipment delivered to the jobsite. It also held legal title to all work completed and in progress and bore the risk of damage or loss to the plant and equipment during construction. Further, petitioner retained the right to change the scope of work, to cease work at any stage and to prevent the hiring of any subcontractor without explicit approval. Thus, petitioner exercised active and significant control over the details of construction. HELD: Unit 3 of the Baldwin Power Station was CONSTRUCTED BY petitioner Illinois Power Company within the meaning of sec. 46(a)(1)(D)(i), I.R.C. of 1954. Accordingly, petitioner constructed rather than acquired Unit 3 and is entitled to a ten percent investment tax credit only for that portion of the cost basis of Unit 3 attributable to construction completed after January 21, 1975.

In 1974 and 1975, petitioner charged certain customers a substantially higher rate for gas as an incentive for such users to switch to alternative fuel sources. The Illinois Commerce Commission (ICC) required petitioner to retain a portion of these funds pending its further order. These Rider R amounts were commingled with petitioner's other funds, were available for general corporate purposes and remained in petitioner's possession at the end of each respective taxable year of receipt. In late 1979, the ICC directed petitioner to ‘refund‘ all such Rider R amounts to certain customers (not the same customers who paid such amounts) through a monthly credit against such customer's facilities charge. HELD FURTHER: Amounts designated as Rider R income are taxable to petitioner in the year of receipt. SEYMOUR I. SHERMAN, and THOMAS C. BORDERS, for the respondent. EDWARD C. RUSTIGAN and WILLIAM A. SCHMALZL, for the petitioner.

WILBUR, JUDGE:

Respondent determined the following deficiencies in petitioner's Federal income tax:

+-------------------------------+ ¦TYE Dec. 31— ¦Amount ¦ +-----------------+-------------¦ ¦ ¦ ¦ +-----------------+-------------¦ ¦1975 ¦$7,090,791.12¦ +-----------------+-------------¦ ¦1976 ¦644,094.74 ¦ +-------------------------------+

After concessions, two issues remain for our consideration:

1. Whether Unit 3 of petitioner's Baldwin Power Station was CONSTRUCTED BY the petitioner or ACQUIRED BY the petitioner for purposes of computing the investment tax credit; and

2. Whether amounts designated as ‘Rider R Income‘ collected from certain gas utility customers constitute taxable income in the year of receipt.

Some of the facts have been stipulated and are found accordingly. The several stipulations of fact and attached exhibits are incorporated herein by reference.

FINDINGS OF FACT

Illinois Power Company (hereinafter referred to as ‘petitioner‘ or ‘Illinois Power‘) is an Illinois Corporation with its principal office at Monticello, Illinois. Petitioner filed its Federal income tax returns (Form 1120) for the taxable years ended December 31, 1975 and December 31, 1976 with the District Director of Internal Revenue at Chicago, Illinois. Petitioner has been at all times here pertinent engaged in the manufacture and sale of electric power to areas in central and southern Illinois aggregating approximately 15,000 square miles. During periods relevant to this case, petitioner also distributed and sold natural gas to approximately 350,000 commercial, industrial, residential and certain seasonal consumers in the same geographical area.

UNIT 3 - BALDWIN POWER STATION

Illinois Power is a public utility within the meaning of Article I, Section 10, of an act entitled ‘An Act Concerning Public Utilities,‘ approved June 29, 1921, as amended and now in effect in the state of Illinois. This Act is commonly referred to as the ‘Public Utilities Act.‘ On August 24, 1966, petitioner filed a petition with the Illinois Commerce Commission (ICC), in which it alleged as follows: ‘To provide adequate operating and reserve capacity for its present and future electric power supply requirements in Illinois, it is necessary that petitioner construct and thereafter operate and maintain additional electric supply facilities.‘ Illinois Power requested, inter alia, that the ICC issue a certificate of public convenience and necessity to construct, operate and maintain a multi-unit mine mouth steam electric generating station and substation facilities in Randolph Country, Illinois, to be known as the Baldwin Power Station. After a hearing, a certificate to the effect that public convenience and necessity required the construction, operation and maintenance of a unit steam electric generating power plant was granted to petitioner on October 19, 1966.

As of December 12, 1966, Illinois Power owned or had under option approximately 3,546 of the 3,830 acres of land needed to construct the Baldwin Power Station. By a petition dated December 12, 1966, petitioner sought an order, which was subsequently granted, empowering it to use the power of eminent domain of the state of Illinois to obtain title or a perpetual easement to the additional 284 acres required for the construction, operation and maintenance of the Baldwin Power Station.

Construction of the Baldwin Power Station commenced in March of 1967. Unit 1, with a generating capacity of 605 megawatts, went into commercial service on July 11, 1970. The construction of Unit 2 commenced in February of 1969. That unit, with a generating capacity of 605 megawatts, was placed in commercial service on May 21, 1973. The construction of Unit 3 commenced in 1971. Unit 3, with a nameplate generating capacity of 585 megawatts, was placed in commercial service on June 20, 1975.

The construction of Unit 1 included the construction or provision of many facilities which were intended to be and were in fact ultimately utilized in common by all three units, including the following: (1) 2000-acre cooling lake; (2) intake crib and pump house to pump water from Kaskaskia River to the cooling lake; (3) 600-acre ash pond; (4) centralized control room; (5) coal handling facilities, including trash hopper outlets, conveyors, bins, separators and chutes; (6) railroad spur from G.M.&0. railroad; (7) railroad tracks to transport coal to coal handling facilities; (8) computer room; (9) circulating water system; (10) sewage disposal system; (11) parking lot; (12) fencing; and (13) fire protection system. A substantial part of the total construction costs of Unit I was for the development of such common facilities and equipment for all three units.

The total cost as of December 31, 1976 of the three units at the Baldwin Power Station (as reported by Illinois Power to the ICC) was $346,903,816. These costs were broken down as follows:

+--------------------------------------+ ¦Land and land rights ¦$2,587,911 ¦ +--------------------------+-----------¦ ¦Structure and improvements¦80,128,638 ¦ +--------------------------+-----------¦ ¦Equipment costs ¦264,187,267¦ +--------------------------+-----------¦ ¦Total cost ¦346,903,816¦ +--------------------------------------+ Unit 3 of the Baldwin Power Plant is an extremely complex facility consisting of hundreds of components and was technologically difficult to design and construct. It is approximately the height of a 24-story building and the boiler alone weighs 10,000 tons. The total cost of Unit 3 as computed from reports filed by the petitioner with the ICC, was as follows:

+------------------------------------------+ ¦Structures and improvements¦$31,638,686 ¦ +---------------------------+--------------¦ ¦Equipment costs ¦95,670,814 ¦ +---------------------------+--------------¦ ¦Total cost ¦ 127,309,500¦ +------------------------------------------+ In addition, the land and land rights for all three units amounted to $2,587,911.

Illinois Power had a construction department, but did not itself perform the physical construction work required when a new generating plant was built or an addition made to an existing plant. The primary function of petitioner's construction department was to oversee and monitor such work performed by outside contractors. Petitioner's construction department included approximately 24 supervisory and professional employees who were trained engineers. This number also included inspectors responsible for the construction work performed by contractors on petitioner's transmission lines and substation facilities. Illinois Power did not have sufficient personnel to construct a power plant utilizing only its own employees.

Sargent & Lundy is an engineering partnership specializing in the design of steam-generated electrical power plants. Its capabilities range from partial assistance in designing a project to complete construction management. The particular services it provides are determined by the requirements of the client. Sargent & Lundy itself does not engage in the physical construction of power plants. It views itself as a professional service organization, and its philosophy is that the professional services it provides should be separate from construction contracting and labor. Illinois Power has been a client of Sargent & Lundy since 1947. Since that time, Sargent & Lundy has designed every steam-generating facility owned by petitioner, including all three units of the Baldwin Power Station.

In about 1969, Illinois Power requested Sargent & Lundy to assist in the design and construction of the third unit of its Baldwin Power Station in order to meet anticipated generating needs. Thereafter, Sargent & Lundy executed a service agreement with petitioner dated September 4, 1970, which specifies the services that it in fact performed in connection with the construction of Unit 3.

The agreement provides that Sargent & Lundy shall, ‘at the request of‘ Illinois Power, perform the following specified services:

(a) Prepare and submit to Company (petitioner) as requested preliminary layout drawings showing arrangement and location of proposed said Project and assist Company in the choice and approval of the final layout and arrangement for construction purposes.

(b) Prepare and submit to Company specifications and electrical bills of material for all equipment and material required for the construction and installation of said Project, including generator and low voltage switching equipment, and as requested, assist representatives of Company in procuring prices for such material and equipment and in the choice of appropriate contractors and in the preparation of any contracts required therefor.

(c) Prepare and submit to Company designs and drawings in all necessary detail for the use of Contractors in the construction of said Project and for all purposes incident to the installation and placing in operation of said Project.

(d) Provide the desired number of field personnel to assist in construction activities to assure that the construction of said Project is in accordance with the specifications and designs therefor.

(e) Perform all other usual engineering services as may be necessary from time to time on account of the location, design, construction and placing in operation of said Project.

In performing the services required of it by its agreement with petitioner, Sargent & Lundy assigned many of its employees to work full-time and many to work part-time on the project. ‘A couple of hundred‘ different individuals were involved in the engineering and design of the plant. The equivalent number of full-time employees was about 75 during the peak of construction.

The agreement also provides that Illinois Power will carry on the following activities in connection with the design and construction of Unit 3:

(a) Approve final arrangement and layout for said Project, together with specifications, designs and construction drawings therefor.

(b) Purchase all equipment, material, and apparatus required for the complete installation and placing in operation of said Project.

(c) Engage and pay all contractors utilized in the installation and construction of said Project, and arrange for all necessary insurance required in the judgment of Company for the proper protection of Company during said construction procedure.

(d) Provide construction field manager and construction accounting forces, and arrange for the appropriate receipt of all materials and equipment and for the payment of all construction payrolls and of all personnel of Company located at the construction site.

(e) Perform or cause to be performed all other activities not hereinabove described and necessary for the complete installation and placing in operation of said Project.

As compensation for its services, petitioner agreed to pay Sargent & Lundy current expense charges as set forth in the agreement and, in addition, a flat engineering service fee of $800,000.

Sargent & Lundy prepared a ‘scope of work‘ document for Unit 3. The preliminary draft and subsequent revisions dated August 22, 1972 and August 1974, all provide as follows:

This scope of work outlines the equipment and structures involved in the design and construction of the 585,500 kW Unit 3 at the Baldwin Power Station. Sargent & Lundy will furnish all structural, mechanical and electrical design as herein outlined. All field supervision will be furnished by the Illinois Power Company. Expediting of material and equipment will be done by the Illinois Power Company and Sargent & Lundy. Sargent & Lundy will review contract change proposals. Sargent & Lundy will provide job cost estimates to cover the following work * * *.

The overall design concept for the Baldwin Power Plant was formulated by Sargent & Lundy after consultation with petitioner. Petitioner outlined the general criteria, such as electrical load requirements, plant location, and type of fuel required. The general design for Unit 3 followed that used for Units 1 and 2 and the Sargent & Lundy general outline for design.

Sargent & Lundy prepared over 1,600 design drawings used in the construction of Unit 3. In addition, it reviewed several thousand drawings prepared by manufacturers who supplied equipment for Unit 3. Sargent & Lundy also prepared approximately 90 specifications with respect to materials, equipment, and supplies specifically engineered for Unit 3. Such materials, supplies and components were purchased directly by petitioner in accordance with contracts executed by petitioner and the respective suppliers or manufacturers. For example, specifications were prepared by Sargent & Lundy as part of the procurement process for a wide range of components such as the boiler, turbine, motors, pumps, heat exchange equipment, electrical switch gear, transformers, control systems, coal feed equipment, piping and tanks, valves and miscellaneous water treating facilities. These specifications incorporated provisions that were tailor-made to petitioner's unique requirements for performance, size and guarantees. The specifications were part of a bid package that was assembled by Sargent & Lundy and released to a predetermined list of bidders. The list was initially prepared by Sargent & Lundy and submitted to petitioner for its concurrence. Although petitioner accepted most of Sargent & Lundy's recommendations, occasionally it exercised its discretion to strike from the list the names of certain bidders recommended by Sargent & Lundy. Invitations to bid were then forwarded to the bidders approved by petitioner.

Sargent & Lundy's internal office procedures required that it develop a document captioned ‘Outline of Procedure for Baldwin Power Station - Unit 3, ‘ which sets forth the procedures followed by Sargent & Lundy with respect to the purchasing of equipment by petitioner from various manufacturers and suppliers. Such general procedure was as follows: Sargent & Lundy would prepare the specifications and forward them, together with drawings and instructions for preparing a proposal, to the bidders approved by petitioner. The bidders were requested to submit the proposals directly to petitioner, with copies to Sargent & Lundy. Sargent & Lundy would review the proposals, and make its recommendation to petitioner of the bidder to be selected. Petitioner would then inform Sargent & Lundy in writing of its decision to award a contract to a particular manufacturer or supplier. Sargent & Lundy would thereupon notify the successful and unsuccessful bidders, and prepare a contract for execution by petitioner and the successful bidder.

Bids for other materials and supplies were obtained using a short-form or letter specification. Letter specifications were prepared by Sargent & Lundy for the purchase of standard materials, referred to as ‘shelf components.‘ A shelf component is a standard manufactured product, generally costing less than $25,000. For example, a letter specification to a particular manufacturer might indicate the specific model number and style desired by petitioner. Sargent & Lundy would review any proposals or bids submitted, and make its recommendation to petitioner. If petitioner agreed to the vendor recommended by Sargent & Lundy (which was invariably the case), it would then issue a purchase order to that vendor.

Petitioner executed forty-five separate contracts for the manufacture, installation or construction of components with specifications tailored to its particular needs and requirements. The specifications prepared by Sargent & Lundy were incorporated into each such contract. Sargent & Lundy negotiated the contracts with each of the manufacturers or suppliers. Four of these contracts were for the purchase of both field labor and materials. These contracts and each respective initial contract price were as follows:

+------------------------------------------------------+ ¦ ¦ ¦Initial ¦ +---------------------+---------------+----------------¦ ¦Contractor ¦Specification ¦contract price ¦ +---------------------+---------------+----------------¦ ¦ ¦ ¦ ¦ +---------------------+---------------+----------------¦ ¦Baldwin Associates ¦T-2808 ¦$55,200,000 ¦ +---------------------+---------------+----------------¦ ¦Grinnel Co. ¦T-2871 ¦83,525 ¦ +---------------------+---------------+----------------¦ ¦Sprinkmann Sons Corp.¦T-2875 ¦1,544,621 ¦ +---------------------+---------------+----------------¦ ¦Superior Welding ¦T-2842 ¦47,642 ¦ +---------------------+---------------+----------------¦ ¦Total ¦ ¦56,875,788 ¦ +------------------------------------------------------+ The remaining forty-one contracts were for the purchase of equipment and components manufactured and/or supplied in accordance with contract specifications prepared by Sargeant Lundy. The initial contract prices of these contracts totalled approximately $40,000,000.

Each manufacturer or supplier was required, if and when requested, to permit petitioner to inspect both the materials used in any fabrication of equipment and the actual fabrication process itself. Petitioner also had the right to observe production tests, and to direct the manufacturer or supplier to make such changes as it might deem necessary. Suppliers of equipment were in some instances required to conduct certain tests in connection with the manufacturing process. These tests were required to assure that the equipment would meet the specifications prepared by Sargent & Lundy. After its review of the test results, Sargent & Lundy would forward them to petitioner. Purchase orders were issued by petitioner to the respective manufacturers or suppliers, and each such manufacturer or supplier was paid by petitioner. Legal title to the specified equipment and supplies was transferred to petitioner prior to delivery to the job site. Invoicing, shipping and routing instructions were issued by petitioner directly to the suppliers and manufacturers, and delivery was made directly to the job site. A warehouse for the storage and safeguarding of equipment and materials was located at the construction site, and an employee of petitioner maintained an inventory of all items in the warehouse.

Four contractors, (Power Systems, Fruin-Colnon, Kelso-Burnett and McCartin-McAuliffe) at the suggestion of Power Systems, formed Baldwin Associates, a joint venture, pursuant to an agreement dated February 28, 1967. Baldwin Associates was organized for the specific purpose of constructing the initial unit (Unit 1) at petitioner's Baldwin Power Station. Each venturer provided a different expertise needed in the construction of power plants. Power Systems provided expertise in mechanical contracting, Fruin-Colnon in civil engineering, Kelso-Burnett in electrical contracting, and McCartin-McAuliffe in the installation of piping.

The first recital in the joint venture agreement provides that the joint venture will construct Unit 1 ‘under the general supervision and to the satisfaction of Owner (petitioner) and Owner's Consulting Engineers (Sargent & Lundy).‘ Baldwin Associates commenced work on Baldwin Unit 1 in 1967. By amendment dated September 1, 1969, the joint venturers agreed to expand the scope of the joint venture to include the execution of a contract with petitioner for the construction of Unit 2 at petitioner's Baldwin Power Station. The construction of Unit 2 commenced in February, 1969, while Unit 1 was under construction. By amendment dated August 6, 1971, the joint venturers agreed to expand the scope of the joint venture to include the execution of a contract with petitioner for the construction of Unit 3 of petitioner's Baldwin Power Station. Construction of Unit 3 commenced in 1971.

The actual physical construction of all three units of petitioner's Baldwin Power Station was performed by Baldwin Associates. This construction included the erection of the superstructures and shell, and the installation of the equipment and components. The procedures followed in the construction of all three units were substantially identical, with the exception that on Unit 3 Baldwin Associates assumed the additional duties of erecting the turbine and steam generator.

On or about June 2, 1971, Baldwin Associates was requested to prepare a proposal for the construction of Unit 3. A contract dated July 30, 1971 and executed on February 23, 1972, between Baldwin Associates and petitioner for the construction of Unit 3 sets forth the duties and obligations undertaken by Baldwin Associates in connection with the project. This contract provided for a fixed fee to Baldwin Associates in the amount of $3,500,000. On the same date the parties executed an amendatory contract for the construction of Unit 3 on a cost plus fixed fee basis because Illinois Power believed that the construction could be done at a lower cost if Baldwin Associates' employees believed that Unit 3 was a lump sum project.

Sargent & Lundy drafted the contract between Baldwin Associates and petitioner. It included certain clauses specifically requested by petitioner, and was approved by petitioner and its counsel before submission to Baldwin Associates.

The work to be performed by Baldwin Associates as set forth in an exhibit to the contract consisted of the following general phases: (1) contractor's tooling and mobilization; (2) initial Unit 3 construction area preparation work; (3) substructure work; (4) superstructure work; (5) coal handling extension work; (6) piping work; (7) erection of mechanical equipment and materials including the steam generator and turbine generator and associated appurtenances; and (8) electrical work.

Baldwin Associates was required to complete the work in a manner satisfactory to Sargent & Lundy and to petitioner, and was also required to furnish ‘(a) complete project organization, both on and off the site, as required to administer, manage and supervise the WORK to complete satisfaction of Purchaser (petitioner) and to complete the specified WORK ready for successful commercial operation by the scheduled date.‘

Section 9 of the contract gives petitioner the right to order Baldwin Associates to employ more men, machinery, construction equipment, tools, etc., if it determines that Baldwin Associates is not carrying on the work with the diligence necessary to complete it in accordance with the schedule provided in section 3 of the contract. Section 9 also sets forth 13 specifications and conditions, under which petitioner may terminate its contract with Baldwin Associates and take possession of the work or any part of the work for the purpose of completing it in such manner as petitioner may deem expedient. Such termination allows petitioner to take possession of all materials, equipment, tools, and appliances on the job site, and, in addition, gives petitioner the right to employ one or more of the joint venturers to complete the project. Baldwin Associates also agreed to indemnify and hold harmless and defend petitioner and Sargent & Lundy from all liability under the Illinois ‘Structural Work Act.‘ Baldwin Associates agreed to pay all damages, costs and expenses, including attorney's fees, that might arise in connection with any such action against either petitioner or Sargent & Lundy.

Exhibit A, Exhibit A-1, Exhibit B and Exhibit C to the contract between petitioner and Baldwin Associates were expressly incorporated into and made a part of such contract. Article 1 of Exhibit A to the contract provides that the work done by Baldwin Associates shall be in conformity with the instructions provided by Sargent & Lundy, and that Baldwin Associates shall not do any part of the work without proper drawings and instructions from Sargent & Lundy. Contractors and installers other than Baldwin Associates performed work on Unit 3. Baldwin Associates was not permitted to cut or alter the work of any other such contractor without the authorization of petitioner or Sargent & Lundy.

Sargent & Lundy had the authority to interpret the contract documents and all specifications and drawings issued by them, and was empowered to issue final and conclusive decisions with respect to the interpretation of the contract documents, or in resolving disputes which might arise between the contracting parties, or between Baldwin Associates and other contractors. Sargent & Lundy was also required to observe the work in progress on behalf of petitioner.

Baldwin Associates was required to furnish for approval samples of work as and when requested by Sargent & Lundy. Additionally, petitioner and Sargent & Lundy had the right at all reasonable times to inspect and test the work. Petitioner could reject any work it found defective or not in accordance with the contract specifications. If a dispute arose regarding petitioner's determination that the work was defective or not in conformity with the contract, Sargent & Lundy was empowered to issue a final and conclusive decision resolving such dispute. Baldwin Associates was required at its own expense to remove or replace any work so rejected. If Baldwin Associates did not remove, replace or restore such work within a reasonable time, petitioner was empowered to do so at Baldwin Associates' expense. Baldwin Associates was also required to cause its books and records to be audited by a firm of certified public accountants mutually agreed upon by it and petitioner.

Petitioner provided insurance against (or assumed the risk of) physical loss or damage to the work caused by fire and extended coverage perils, vandalism and malicious mischief, weather, explosion, and additional perils normally insured under an ‘all risk‘ form subject to the usual exclusions. Pursuant to such provision, petitioner paid Baldwin Associates approximately $710,000 for the additional costs incurred by the latter in connection with the repair of a cofferdam that collapsed during the construction of Unit 3. Baldwin Associates was not permitted to assign or subcontract any part of its work without petitioner's prior written approval.

Baldwin Associates was required to install, erect and finish the following work:

E. WORK INSTALLED ONLY: Contractor shall unload and place, or shall unload and store materials for, and shall remove materials from storage for, and shall, install, erect, perform and finish the following phases comprising this portion of the WORK: materials specified will be furnished, unless otherwise indicated, f.o.b. site by Purchaser:

a. Substructure Work: * * *

b. Piping Work: This shall include all control valves and miscellaneous local instrument panels.

c. Erection of Structural Steel.

d. Erection of Mechanical Equipment and Materials:

(1) Steam generating unit * * *.

(2) Turbine generator unit and two steam turbine boiler feed pump drives, and piping, wiring and trim furnished therewith * * *.

(3) This shall include all miscellaneous mechanical equipment listed in Article * * *.

e. Electrical Work: This shall include all electrical equipment * * * such as, but not limited to, the following:

(1) Turbine-generator, generator neutral grounding equipment, P.T. compartment, and exciter.

(2) Transformers, power and lighting.

(3) Isolated phase bust (sic) duct including all accessories; bus is forced air cooled.

(4) Switchboards and control panels, computers, and recording annunciator.

(5) Metal-clad switchgear.

(6) Motor control centers.

(7) Station battery charger.

(8) Precipitator.

(9) Motors (conduit and wiring only).

(10) Motor control panels and stations.

(11) Diesel generator.

(12) Pushbutton stations.

(13) Pressure switches, relays, window annunciators, meters, and indicating instruments mounted separately.

(14) Public address system.

(15) Telephone equipment.

(16) Cable pans and racks and computer trays.

(17) 345 kV and 138 kV substation equipment including 345 kV breakers and 138 kV circuit switcher.

(18) Power and control cables, nonsegregated bus and wire (except No. 8 and smaller single conductor for permanent or temporary lighting).

All equipment, components and materials specified above were owned by petitioner at the time of its installation and/or erection by Baldwin Associates. Baldwin Associates had no voice in the selection by petitioner of any of the suppliers of such equipment, components or materials.

Exhibit B to the contract between petitioner and Baldwin Associates specifies the following major items of equipment purchased by petitioner from various suppliers and manufacturers, which Baldwin Associates was required to erect: (1) steam generating unit; (2) turbine generating unit; (3) turbine-driver boiler and motor-driven feed pumps; (4) condenser equipment; (5) circulating water pumps; (6) main condensate pumps; (7) electrostatic dust precipitator; (8) vacuum pumps; (9) coal feeders; (10) fly ash and bottom ash; (11) deaerating heater; (12) supplement-coal handling; (13) fans; (14) closed feedwater heaters; (15) miscellaneous tanks; (16) heater drain pumps; (17) miscellaneous pumps; (18) miscellaneous heat exchangers; (19) combustion air preheat coils; (20) service water pumps; (21) extraction steam check valves; (22) water preventing and demineralizer equipment; (23) air dryer; (24) traveling screens; (25) butterfly valves; (26) service water strainers; (27) rubber expansion joint; and (28) piping work.

Prior to the commencement of actual physical construction, Baldwin Associates was required to submit to Sargent & Lundy for review and approval a detailed construction progress plan. This plan consisted in part of a graphic network which depicted and described the interdependence of all activities of Baldwin Associates, including its subcontractors and its material suppliers, the subcontractors and material suppliers of petitioner, and the interdependence of these activities with significant activities of petitioner and Sargent & Lundy.

Baldwin Associates and Sargent & Lundy together prepared two preliminary construction schedules dated April 22, 1971 and June 25, 1971, which outlined the various phases of construction and estimated time required for the completion of each phase. These two preliminary construction schedules were submitted to petitioner for review and comment. Baldwin Associates also prepared its own preliminary construction schedule dated October 20, 1971, which it submitted to petitioner. This schedule followed the same general format as those which it had previously prepared together with Sargent & Lundy. This later schedule contained revisions by Baldwin Associates to accommodate the equipment delivery dates proposed by Sargent & Lundy, and reflected current estimates by Baldwin Associates of the time required to complete certain parts of the job. The construction schedule finally adopted is dated March 16, 1972. The revisions incorporated in that schedule were based upon agreements reached between petitioner and Baldwin Associates.

Petitioner was quite concerned about the timeliness of construction and in particular, that the proposed construction schedule meet the date it selected to bring the power plant into commercial operation. Petitioner wanted Unit 3 to be commercially operable in time to meet the summer 1975 peak demand for electricity and accordingly, Unit 3 was constructed under a very tight schedule.

Throughout the course of construction, Baldwin Associates hired subcontractors in areas where its own employees lacked expertise. For example, it hired subcontractors to glaze windows and to install the tile floor. When work was to be done by subcontractors, formal written specifications were to be prepared by Sargent & Lundy and provided to prospective bidders. Whenever Baldwin Associates would hire a subcontractor or purchase supplies, it would first obtain petitioner's approval. Baldwin Associates purchased construction materials such as steel, concrete, piping and roofing, but did not purchase any of the major plant equipment or components.

Baldwin Associates was required to erect or install the structural steel. Petitioner obtained the services of a testing laboratory, Pittsburgh Testing Lab, to inspect the strength, erection and connections of the structural steel as so installed. Baldwin Associates was required to correct defects when and as determined by the laboratory.

Baldwin Associates was required to clean all bearings of equipment it erected, and to clean and flush all lubricating oil systems of equipment that interconnected. Lubricating and flushing oil used for this purpose was furnished by petitioner, and the methods of cleaning and flushing had to be approved in advance by the equipment manufacturers and by Sargent & Lundy.

The contract between petitioner and Baldwin Associates required that the latter obtain from the manufacturers a detailed scope of the work required to completely erect the following equipment, all of which was purchased directly by petitioner:

(1) Steam Generator; (2) Turbine-Generator, B.F. Pump Turbine Drive; (3) Condensing Equipment; (4) Boiler Feed Pumps; (5) Electrostatic Dust Precipitator; (6) Fans; (7) Coal Feeders; (8) Coal Handling; (9) Vacuum Pumps; (10) Structural Steel.

On February 23, 1972, an amendment was executed to the contract between Baldwin Associates and petitioner, specifying those costs included in the fixed fee payable to Baldwin Associates and those payable directly by petitioner. Costs payable directly by petitioner, were as follows:

1. Cost of all labor, including supervisory personnel. Overtime work (other than ‘spot‘ overtime) shall only be performed when authorized by Purchaser; such overtime shall be paid for by Purchaser as a cost of the Work except when the same is necessitated by the neglect of Contractor.

2. Cost of all supplies, material, small tools, machinery and equipment used or incorporated in the Work. Small Tools, machinery and equipment included herein shall be limited to a cost of ONE THOUSAND ($1000.00) DOLLARS each (except as may be otherwise mutually agreed upon). All other items shall be included as rental equipment provided for in Paragraph 5 or 7 below.

3. Freight, cartage and transportation charges, including on-site loading, unloading and handling charges.

4. Subcontracts, subject to Purchaser's approval, which shall be lump-sum wherever practicable.

5. Rental charges for items of equipment, machinery or appliances furnished by any of the Joint Venture Partners, and assigned to the job site for ten (10) months, or longer, will be made at the monthly rate of 66 2/3% of the then current A.E.D. rental schedule. For periods of assignment less than ten (10) months, the rental charge shall be 75% of the current A.E.D. rental schedule. Pursuant to the February 23, 1972, amendment, Baldwin Associates routinely provided petitioner with a list of tools stolen from it during the construction of Unit 3. Petitioner would then reimburse it for the cost of such stolen items.

It was anticipated that certain changes in the scope of the work (‘Extras ‘) provided by individual contractors and manufacturers would occur as construction progressed. Some such changes were recommended by petitioner's employees operating Units 1 and 2. These proposed changes, after approval by petitioner and Sargent & Lundy, were incorporated into the design of Unit 3 to prevent a recurrence of certain problems which had developed during the operation of Units 1 and 2.

As of December 31, 1975, the total cost of the change orders authorized for Baldwin Associates approximated $3,500,000. Whenever such changes were required, Sargent & Lundy would furnish additional drawings and specifications to the contractor. The latter would then prepare a supplementary proposal, which Sargent & Lundy would review and forward to petitioner for acceptance. If petitioner agreed with Sargent & Lundy's recommendation, it would then issue a Purchase Order Change for the work.

If a supplier was a subcontractor of Baldwin Associates, the latter would transmit drawings to Sargent & Lundy for approval. Sargent & Lundy would review the drawings, make changes it deemed appropriate, and return them to Baldwin Associates for its use in construction.

Baldwin Associates was required to submit design drawings, as well as shop drawings showing such matters as erection layout, to Sargent & Lundy for approval. It was not permitted to commence work pertaining to any such shop drawing until notified by Sargent & Lundy. Baldwin Associates could not commence particular phases or parts of erection or construction until authorized by Sargent & Lundy through transmittal of the final drawing.

Mississippi Valley Structural Steel (MV) contracted with petitioner to supply the structural steel to be erected by Baldwin Associates, and was supplied with certain drawings by Sargent & Lundy, indicating the general nature and type of structural steel to be furnished. MV was required to prepare and submit shop drawings to Sargent & Lundy, and was not permitted to start fabrication until it obtained Sargent & Lundy's written approval.

The Profit and Loss statement of Baldwin Associates as of December 31, 1975 indicates that costs incurred for labor in the performance of its contract with petitioner, were in the amount of $25,283,320, exclusive of charges for extra work. The same statement reveals that Baldwin Associates incurred costs of $22,489,063.96 for materials, which included $10,944,530.79 for overhead, plant, insurance and taxes.

Petitioner and Baldwin Associates discussed progress throughout the course of the construction of Unit 3 at regularly scheduled monthly meetings. These meetings were held at petitioner's offices in Decatur, Illinois, and were attended by the Board of Directors of Baldwin Associates, representatives from Sargent & Lundy, and various employees of petitioner. The general purpose of such meetings was to enable petitioner and Baldwin Associates to discuss job progress, and to fully apprise petitioner of any problems affecting the project. The project manager would present a job progress report to petitioner at each such meeting. Topics of discussion at such meetings included problems with the various unions, manpower needs, delays in equipment installation, delivery of materials and equipment, changes in specifications, shipping schedules, Sargent & Lundy specifications and drawings, general problems regarding specific equipment installations, plant security, start-up procedures and schedule changes.

Robert Born, an employee of Power Systems (the sponsoring partner of Baldwin Associates), was the project manager for the construction of the Baldwin Power Plant from August 1, 1969 through March 31, 1974. As of April 1, 1974, he was transferred to a power plant at Clinton, Illinois, which was also being constructed by Baldwin Associates for petitioner. His assignment to the Clinton project was with petitioner's approval.

Ivan Cochran, an employee of a subsidiary of Fruin-Colnon, assumed the position of project manager on April 1, 1974. As project manager, he had overall responsibility for managing the employees of Baldwin Associates and the craftsmen and laborers involved in the actual field construction work. His duties were primarily administrative, and most of his responsibilities were delegated to subordinates, to whom were assigned specific areas of responsibility.

The project manager had a staff that consisted of an office manager, assistant project manager, safety engineer, and project engineer. Each member of the staff, in turn, supervised employees subordinate to him. The assistant project manager was responsible for the field operations, and had a staff consisting of the electrical superintendent, civil superintendent, piping superintendent, equipment and batch plant superintendent, boilermaker superintendent, and turbine superintendent.

All members of the supervisory staff were employees of the various partners to the joint venture, as were most of the engineers and assistant superintendents. The supervisors of the joint venture were furnished by the partners, based upon their respective specialties. Fruin-Colnon furnished civil engineering superintendents; Power Systems provided boilermaker and turbine superintendents; piping superintendents were provided by McCartin-McAuliffe; and Kelso-Burnett furnished the electrical superintendents.

The persons furnished by the individual partners or venturers remained employees of the same respective entity while assigned to the Baldwin Project, and were paid directly by their respective employers. Determinations as to the salaries and any increases in salary payable to such employees were within the sole discretion of the respective employers of such persons.

Baldwin Associates itself employed various craftsmen, such as boilermakers, carpenters, welders, and ironworkers, hiring such persons out of union halls. Under typical hiring procedure, a superintendent would call a union business agent and specify the number and type (by craft or specialty) of craftsmen desired. Foremen were also obtained by Baldwin Associates through the union halls. Such foremen were directed by the various superintendents provided to the joint venture by the partners. The number of craftsmen working at any given time on Unit 3 varied, ranging from approximately 700 in March of 1974 to an average of 200 from September, 1972 to January, 1973.

Wes Divin was an engineer assigned by Sargent & Lundy as its field representative on the Baldwin project. Sargent & Lundy was paid by petitioner for the cost of his salary, plus specified allowances. One of Divin's functions was to interpret Sargent & Lundy field drawings when requested by a contractor. When unable to solve a design problem himself, he would obtain help from Sargent & Lundy's home office. Mr. Divin had no authority to give orders to a contractor.

As part of his job duties, Divin prepared a document entitled: ‘Construction Progress Report‘ on a weekly basis. Each such report summarized the major construction activity that had occurred since the last prior report. He also prepared a construction manpower report which was attached to each progress report and, inter alia, lists the manpower on the job site supplied by various contractors and by petitioner.

It was important that suppliers of material and equipment make deliveries in conformance with their contracts with petitioner, so that construction would proceed in accordance with the schedule. Petitioner obtained, through a contract with Power Systems, an ‘expediter‘ for the project, who was stationed at the power plant, and whose sole function was to assure the delivery of supplies and equipment to the job site as and when needed. The expediter, Harold Carmichael, used petitioner's stationery, and wrote letters on petitioner's behalf to suppliers, coordinating the delivery of equipment to the job-site.

It was petitioner's policy to assign engineers from its Construction Department to monitor the construction and design of new generating units. Three such engineers in petitioner's office in Decatur, Illinois involved in the construction of Unit 3 were R.L. Martin, Manager of Construction, Thomas E. Daggett, Assistant Manager of Construction, and John Steinman, Power Plant Design Engineer. The collective responsibility of Martin and Daggett was to review and monitor the work of Sargent & Lundy, and to supervise other persons from petitioner's construction department who had been assigned to the job-site in order to more directly monitor construction activity on Unit 3.

Steinman was involved in the budgeting for Unit 3, and reviewed billings, as well as drawings prepared by Sargent & Lundy. The drawings were reviewed to assure that the plant would operate as desired by petitioner.

Al Ruey, an engineer in petitioner's engineering department, reviewed electrical design drawings prepared by Sargent & Lundy. His function was to make certain that the electrical systems as proposed by Sargent & Lundy would conform with petitioner's operational needs. Ruey, assisted by another employee of petitioner, Mr. S.C. Patel, reviewed Sargent & Lundy's electrical drawings, and suggested changes pertaining to relay settings, electrical connections and electrical circuits.

Petitioner stationed several other employees, in addition to those already mentioned, at the Baldwin Power Plant during the construction of Unit 3. Those employees, and their job titles, were as follows:

+-----------------------------------------------------+ ¦Robert J. Canfield ¦Powerplant construction engineer¦ +--------------------+--------------------------------¦ ¦William L. Calhoun ¦Electrical engineer ¦ +--------------------+--------------------------------¦ ¦John M. King ¦Electrical engineer ¦ +--------------------+--------------------------------¦ ¦Michael L. Keckritz ¦Mechanical engineer ¦ +--------------------+--------------------------------¦ ¦Gary A. Schenck ¦Electrical engineer ¦ +--------------------+--------------------------------¦ ¦Thomas L. Stomberski¦Electrical engineer ¦ +--------------------+--------------------------------¦ ¦James T. Koeper ¦Assistant mechanical engineer ¦ +--------------------+--------------------------------¦ ¦Robert J. Fuhrmann ¦Junior accountant ¦ +--------------------+--------------------------------¦ ¦Leo Hinton ¦Storekeeper ¦ +-----------------------------------------------------+

Fuhrmann and Hinton were the only clerical employees assigned by petitioner to the Unit 3 job site. The latter was responsible for maintaining an inventory of all items stored in the warehouse at the job site. The warehouse contained equipment and supplies owned by petitioner, to be installed in Unit 3, except that items too large for the warehouse were kept on the plant floor. Petitioner inspected equipment prior to its storage in the warehouse, and made certain that the necessary paperwork was completed to support the billings. It was petitioner's own responsibility to make certain that goods shipped to it were received in good condition.

Canfield, Calhoun, Grammer, King, Keckritz, Schenck, Stromberksi and Koeper were engineers employed in petitioner's construction department. Canfield was assigned to the construction site of the Baldwin Power Plant from the spring of 1967 to July 1975, and was petitioner's senior representative at that site. A major part of his responsibilities was to make certain that Unit 3 was built in accordance with petitioner's plans, and that the work on Unit 3 was in accordance with the specifications set forth in the various contracts.

The principal duty of Canfield, Calhoun, King and Grammer with respect to Baldwin Unit 3 was to monitor the work of Baldwin Associates as Unit 3 was being constructed. Their principal task was to assure that Unit 3 was timely built in accordance with the contract specifications, and at a reasonable cost. They were required to walk around the job site several times a day in order to be certain that they were familiar with the work currently being done.

Canfield held numerous meetings at the job site with representatives of Baldwin Associates to coordinate the progress of the work and discuss any anticipated problems. To insure that he was fully informed of the day-to-day problems, he spent approximately fifty percent of his time touring the plant site and checking on actual construction, and he discussed job progress on almost a daily basis with the project manager and assistant project manager of Baldwin Associates.

Canfield was provided with a complete set of Sargent & Lundy design drawings for his use at the job site. These drawings would be used in discussions he would have with Baldwin Associates regarding a particular field or engineering problem. He would also receive copies of all Sargent & Lundy drawings released for fabrication or construction, and manufacturers' detailed and shop drawings approved by Sargent & Lundy, as well as copies of the manufacturers' instruction books for major equipment. Canfield's discussions with Baldwin Associates frequently focused on problems relating to the scheduling of the work, as it was his responsibility to make certain that work schedules were met. Whenever delays caused by power outages, work stoppages or strikes required revision of work schedules, Canfield would work with Baldwin Associates in making necessary revisions.

As provided in its fixed-fee contract with Baldwin Associates, petitioner paid the cost of all labor on the job-site. Canfield was consequently concerned with the productivity of the craftsmen, and that they adhere to starting, quitting and coffee break times. Whenever he believed that the craftsmen were not working properly or with sufficient diligence, he would so advise the contractor responsible. On one occasion, Canfield was concerned with the job attitude and demeanor of a craftsman who had gotten into a fight with another craftsman, and recommended to the employing contractor that the offending employee be terminated.

Petitioner had a contract with Marsh & McClennan, insurance specialists, requiring periodic inspection of the plant site for fire hazards. Canfield would receive a copy of inspection reports prepared by Marsh & McClennan, and would order individual contractors to correct any problem noted. He would make recommendations concerning job safety to the safety engineer for Baldwin Associates, and fully expected Baldwin Associates to comply with his recommendations.

Contractors were not permitted to perform any work beyond the scope of work specified in their respective contracts with petitioner, without first obtaining petitioner's approval. Both Canfield and Sargent & Lundy's field representatives would first have to agree that the work was necessary and not covered by an existing contract, before an ‘extra‘ or change could be authorized. If it was so approved, Canfield would then issue a field requisition. The contractor could not start such work unless first issued a purchase order, or specifically notified by requisition that it could proceed. Any change in excess of $500 required the approval of Martin, petitioner's manager of construction.

Canfield would review all invoices submitted for payment by manufacturers, suppliers and contractors. It was his responsibility to determine that the equipment and materials specified on the invoice were received in good condition, and that any field work was actually performed. He was also required to determine that unit prices, wage rates and hours of labor specified on an invoice were correct. If Canfield was satisfied that an invoice was correct, he would initial a copy and forward it to Sargent & Lundy. Sargent & Lundy would advise petitioner of their agreement to its payment by issuing a certificate of payment. An invoice approved by both Canfield and Sargent & Lundy would then be given to Daggett, petitioner's assistant manager of construction, before payment would be made.

Equipment installations completed by Baldwin Associates were turned over to petitioner in discrete units. As and when Baldwin Associates would complete the installation of certain components, equipment and systems, petitioner would be notified by memorandum referred to as a ‘release‘. The specific purpose of the release was to inform petitioner that Baldwin Associates had completed the installation of the equipment, and that it was ready to be checked out by petitioner. After receipt of such release, petitioner's employees would examine the equipment to determine if it had been properly installed. Once this was done, the specific items and equipment listed in the release became the sole responsibility of petitioner.

Installation of the equipment was routinely inspected by engineers from petitioner's construction department. In some instances, petitioner's engineer would be accompanied by an employee from its operations department who was familiar with the particular piece of equipment installed. An operations department employee of petitioner was one who at that time was permanently assigned to a position in the operation of either Unit 1 or Unit 2.

‘Check-out reports‘ are prepared by engineers from petitioner's construction department when, during the check-out, it is determined that equipment is defective, or must be removed or altered for design changes. Each ‘check-out report‘ specifies the problem or imperfection detected by the engineer, and any action taken by him to correct the problem. Some corrections were made on the spot by the engineer.

Throughout the course of the construction of Unit 3, Baldwin Associates and petitioner would inform the plant manager of petitioner's power plant by joint memorandum as and when a given equipment installation by Baldwin Associates was complete. Such memoranda were sent only after both Baldwin Associates and engineers from petitioner's construction department had examined the equipment and determined it to be operational. The specific purpose of such joint memoranda was to inform the plant manager that the designated equipment should be examined and tested by operations personnel who were responsible for operating similar types of equipment. Tests were then subsequently completed by employees of petitioner to assure that the equipment was fully operational.

The check-out of Unit 2 required 6,599 man-hours of electrical personnel and 7,042 man-hours of control and instrumentation personnel. The electrical personnel consisted of petitioner's check-out engineers, and control and instrumentation personnel consisted of technicians employed by petitioner in the operations department of the power plant. Whenever operating personnel were needed to assist in checking the various components, one of petitioner's check-out engineers would contact the plant manager and request assistance.

The record does not fully disclose the total check-out time required for Unit 3. Petitioner's estimate as of April 3, 1974, of man-hours required for its engineers to complete the electrical check-out of Unit 3 was 8,248 hours. Its estimate as of April 3, 1974 of man-hours required for its control and instrumentation personnel to complete the check-out of Unit 3 was 8,802 hours. More personnel and greater involvement by petitioner was required in the check-out of Unit 3 than was true for Unit 2, because petitioner needed more time to inspect the turbine and boiler for Unit 3. When petitioner's check-out engineers located a problem with respect to a particular piece of equipment, they frequently dealt directly with the equipment manufacturer to resolve it. This generally proved to be the fastest and most efficient way to proceed.

From November of 1971 through March of 1974, Sargent & Lundy prepared monthly engineering reports for petitioner, essentially consisting of a detailed summary of progress on the job. Such reports, inter alia, summarized the status of the Sargent & Lundy design work, listed the major equipment purchased since the previous report, informed petitioner of specifications currently being prepared by Sargent & Lundy, and outlined the status of the drawings being prepared by various departments within Sargent & Lundy.

On two occasions petitioner was the defendant named in personal injury suits arising from the construction of the Baldwin Power Station. One such case was filed in the Third Judicial Circuit Court of Illinois, Madison County, and the other in the Twentieth Judicial Circuit Court of Illinois, St. Clair County. It was alleged in each case that petitioner was liable under the Illinois Structural Work Act for injuries sustained by the plaintiff while working on the construction of the Baldwin Power Station. In each case the court found in favor of the plaintiff and against petitioner, holding petitioner liable to the plaintiff for the injuries sustained, following the finding that petitioner was in charge of or had the right to be in charge of construction at the Baldwin Power Station.

In the notice of deficiency dated July 18, 1979, respondent determined that Illinois Power was entitled to a ten percent investment tax credit for only that portion of Unit 3 of the Baldwin Power Station constructed after January 21, 1975. For the portion of Unit 3 constructed prior to that date, petitioner was allowed only a four percent credit.

RIDER R

As a regulated public utility, Illinois Power must obtain approval from the Illinois Commerce Commission (ICC) prior to implementing changes in rates, service classifications, or other conditions or circumstances of service to its gas customers. To obtain such approval, petitioner must file proposals with the ICC, which normally renders a decision within eleven months thereafter. During that period, Illinois Power and any interested parties opposed to the requested change may offer evidence or present arguments in support of their respective positions.

Petitioner's gas customers comprise several different classifications, including residential (the largest and highest priority class), general service, industrial and interruptible. Each of such classifications are subject to different rates. A classificatory distinction existing during and prior to the taxable years here in controversy was between ‘firm‘ and ‘interruptible‘ gas service customers. These categories related to priority of service during times of gas shortages. Interruptible gas customers consisted generally of industrial customers using gas for boilers and having alternate fuel capability. These customers had the lowest priority and were charged a lower rate because the gas sold to this class consisted of that available within petitioner's system, but for which no additional investment in facilities was required.

The priority rules governing service during periods of shortage first became effective in 1970, pursuant to a petition filed by Illinois Power with the ICC on July 7, 1970. By order dated March 3, 1971, the ICC formally approved the priority rules sought by petitioner in that proceeding, with certain modifications. Those rules, however, only established a priority system for controlling the addition of any significant new gas demand, by authorizing the deferral of action on applications for service during periods of insufficient gas supply. They did not provide for limitation of gas service to existing customers to meet deficits due to shortages resulting from curtailments imposed upon petitioner by its suppliers.

Petitioner obtains gas from several interstate pipeline companies. In the early l970's, these suppliers experienced difficulties in meeting their commitments to customers, and accordingly, curtailed deliveries. On September 18, 1973, petitioner filed an application with the ICC (Docket No. 58559 (later consolidated with Docket No. 58582)) seeking certain amendments to the priority rules governing its sales of gas, by which it proposed to curtail or discontinue and to limit increases in certain existing services. The requested changes included the reduction or termination of interruptible gas service contracts during the periods of insufficient gas supply in order to facilitate the extension of service to new residential customers. Petitioner's interruptible gas service customers intervened in the proceeding and objected to the proposed revisions. On January 30, 1974, while that proceeding was pending, the ICC instituted a proceeding on its own motion (Docket No. 58818), for the purpose of establishing guidelines for all gas utilities in Illinois governing the filing of rules and regulations with respect to the curtailment of gas service during periods of insufficient supply. Accordingly, on August 14, 1974, the ICC issued an order disposing of Docket Nos. 58559 and 58582 and providing in pertinent part as follows:

IT IS FURTHER ORDERED that Petitioner inform each of its interruptible customers that it has 20 days to accept an offer to convert to a limited firm service if it so desires and such notice shall be given on the date of the filing of the new tariff sheets herein ordered to be filed.

IT IS FURTHER ORDERED that Petitioner shall, within ten (10) days from the entry of this order, file new tariff sheets limiting annual sales to large firm customers as set forth in Finding (11).

The ICC order entered in Docket Nos. 58559 and 58582 also directed petitioner to establish a new limited firm service rate referred to as Service Classification 79 (SC 79), as an option to interruptible gas service customers. This new classification provided for a rate substantially higher than that for interruptible gas service which would, moreover, continue to escalate over the next three years. It guaranteed a level of gas service equal to that received during the twelve-month period ending June 30, 1974. The new rate became effective August 22, 1974. Of petitioner's 97 interruptible gas service customers, 87 elected to change to SC 79.

On March 15, 1974, petitioner filed an application (Docket No. 58907) with the ICC seeking a general rate increase together with certain changes in the rules, regulations and conditions applicable to its gas and electric service. Implementation of the new rates proposed by petitioner were suspended through February 13, 1975, by interim orders of the ICC. Various intervenors in Docket No. 58907 noted that petitioner was collecting substantial additional revenues from its SC 79 customers. However, the principal purpose of that new rate classification had been to induce such customers to convert to an alternative fuel (other than gas), rather than to produce additional gas revenues. Thus, the level of future collections from SC 79 customers was speculative.

By order dated February 13, 1975, the ICC concluded that revenues collected from SC 79 customers in excess of interruptible gas rates should inure to the benefit of petitioner's firm gas service customers. Accordingly, the ICC ordered that such excess revenues be applied as follows:

(1) That portion needed to maintain the rate of return authorized by the ICC was to be retained by petitioner.

(2) Remaining SC 79 revenues, over and above the amount needed to maintain existing residential rates, were to be credited (referred to in the order as ‘refunded‘), as a per therm adjustment on the bills of petitioner's nonresidential firm customers, subject to certain limitations expressed in the order. Such customers were in service classifications other than SC 79, and were not the same customers who paid the SC 79 revenues.

(3) Any further excess SC 79 revenues remaining were to be accumulated in a special fund, on a quarterly basis, and reported to the ICC for such disposition as a refund to all firm customers or as the ICC may otherwise direct.

Subsequent to the entry of the February 13, 1975 order, it was discovered that a sentence had been omitted from one of the paragraphs. On February 26, 1975, an order was issued amending such paragraph to read as follows:

Excess revenues generated by Rate 79, over and above that retained by Respondent to maintain an 8.56% rate of return, and that portion refunded to the firm non-residential customers, shall be accumulated by the Company in a special fund, on a quarterly basis, and reported to the Commission for such disposition as a refund to all firm customers or as the Commission may otherwise direct. Said return should be applied to the rate base established hereinafter, but CONSIDERATION MAY BE GIVEN TO SUBSEQUENT CHANGES IN OPERATING REVENUES AND EXPENSES WHICH WILL OCCUR IN THE FUTURE. (Emphasis supplied)

In 1975, revenues were received from SC 79 customers in the total amount of $25,046,902, of which $2,019,127 was in excess of the amount needed to provide the rate of return then authorized by the ICC. Of this excess amount, $880,529 was credited to firm non-residential customers during 1975. The remainder (Rider R income), in the amount of $1,138,598, was retained by petitioner pending further order of the ICC.

In 1976, revenues were received from SC 79 customers in the total amount of $33,466,376, of which $4,097,245 was in excess of the amount needed to provide the rate of return authorized by the ICC. Of this excess amount, $3,414,399 was credited to firm nonresidential customers during 1976. The remainder, in the amount of $682,846, was retained by petitioner pending further order of the ICC. The foregoing 1975 and 1976 Rider R income items, in the respective amounts of $1,138,598 and $682,846, were commingled with other funds in Illinois Power's general bank accounts, and were available for use for its general corporate purposes. Such amounts were not physically segregated from petitioner's general corporate funds or made the subject of any separate escrow or other account. Petitioner was merely required to keep bookkeeping entries establishing the amounts of such retained revenues.

On March 14, 1975, petitioner filed a proposed plan with the ICC (Docket No. 59733) to achieve common residential gas rates throughout its service territory. On February 11, 1976, the ICC issued its order in Docket No. 59733, which provided, inter alia, for a consolidation of residential rates. It was anticipated that this consolidation would result in a loss of revenue to petitioner, of which fact cognizance was taken by the following reference to revenues from SC 79 customers:

The Commissioner is aware that * * * consolidating residential rates will cause a revenue loss to Illinois Power from residential service. The Commission is also aware that Rate 79 has and may continue to produce substantial additional revenue for Illinois Power above that required to satisfy the 8.56% rate of return condition of our order in Docket No. 58907. This Commission is of the opinion that Illinois Power SHOULD BE AUTHORIZED TO USE THESE EXCESS FUNDS to offset the temporary loss of revenue imposed by the consolidation specified herein prior to making additional refunds to the non-residential classification or accumulating further excess funds. (Emphasis supplied)

Under date of July 23, 1976, petitioner filed an application with the ICC (Docket No. 76-0435), seeking certain changes in the rules, regulations and conditions applicable to its gas and electric service, and further seeking ‘changes in the provisions of Rider R, * * *, which would permit it to retain a larger amount of the revenues collected from its limited firm (SC 79) gas sales.‘ Petitioner's application included the following statement:

RIDER R

RIDER R (Adjustment for Refunds to Non-Residential Firm Customers) has been revised to CHANGE THE RATE OF RETURN from the existing 8.56% to a proposed 9.85% rate of return on the gas utility rate base. THE gas utility RATE BASE designated ‘B‘ IN THE EXISTING AND PROPOSED RIDER IS MODIFIED to incorporate the most recent

gas utility rate base determination available for the year ending the month preceding the month during which a calculation is made. This change is intended to substitute a current gas utility rate base determination in place of the historic rate base for the twelve month period ended June 30, 1974, which is utilized in the present Rider R. (Emphasis supplied)

On June 15, 1977, the ICC issued its order in Docket No. 76-0435, which states in part as follows:

PROPOSED CHANGES IN GAS RATE SCHEDULES

Respondent proposes to modify its gas tariffs by increasing the allowed rate of return from 8.56% to 9.85% and by updating the rate base from $195,117,000 authorized in its last rate case to a current rate base. Respondent proposes to DETERMINE A NEW RATE BASE QUARTERLY, each time a filing is made under the provisions of Rider R.

The Commission's purpose for establishing Rate 79 (stated in the order in Consolidated Docket Nos. 58559 and 58582) was to allow those customers who had no choice to remain on gas but primarily to ultimately make gas service available to the small user.

The Commission is of the opinion that the rate should be continued to be increased until it ultimately does become higher than alternative fuels. The rate should be increased at a pace that enables Illinois Power to dispose of the gas which becomes available to firm customers. Rate 79 charges should continue to be increased in amounts that will make Rate 79 10% higher than No. 2 fuel oil after five years.

Respondent proposes to maintain a current rate base in calculating excess revenues in accordance with Rider R. The Commission is of the opinion that the rate base used for such purposes should be approved by this Commission and only after audit and review as performed during a rate case. To allow Respondent to determine its own rate base and then use that rate base to calculate any excess revenues would be inconsistent with the statutory responsibility envisaged by this Commission. Respondent should be allowed to establish a new rate base consistent with the provisions of this order but should not be permitted to increase said rate base above the amount established herein without further order of the Commission.

DISPOSITION OF THE SPECIAL FUND

RESPONDENT PROPOSED THE DISPOSITION OF THE SPECIAL FUND OF $1,821,000 BY RETAINING IT to earn its proposed rate of return. Respondent has also proposed disposition of the fund in Docket No. 58907 Supp. The Commission is of the opinion that the special fund should be disposed of in Docket No. 58907 Supp. The temporary handling of the special fund for the purposes of this proceeding is determined herein. IF AND WHEN RESPONDENT DISPOSES OF THE SPECIAL FUND it may petition this Commission for specific rate base

On January 9, 1979, petitioner filed an application with the ICC (Docket No. 79-0071) seeking certain rate increases, service classification changes, and a further change in the method of computing the application of excess revenues from SC 79 customers. The latter proposal was expressed as follows:

REVISIONS TO RIDER R

The Company proposes a new Rider R under which excess revenues will be determined as revenues received from Service Classification 79 customers less the revenues which would have been received for the same consumption had these customers been billed at the rates proposed in Service Classification 75. Estimated excess revenues, forecasted each November for the upcoming calendar year and adjusted for any over or under-refund during the preceding twelve months, will be refunded on a levelized monthly basis during the upcoming year as a credit to the facilities charges under Service Classifications 51, 55 and 63. In addition, the balance in the ‘Special Fund‘ will be refunded as a $0.50 per month credit against the facilities charges due under Service Classifications 51, 55 and 63, until exhausted. Until such time as the facilities charge under Service Classification 51 or the ‘Special Fund‘ is exhausted, the Company will recover the difference in the facilities charge from the ‘Special Fund‘. After the ‘Special Fund‘ is exhausted, the Company will recover any difference between these facilities charges from Service Classification 79 excess revenues.

By order dated November 28, 1979 in Docket No. 79-0071, the ICC provided for the disposition of the remaining balance of excess SC 79 revenues still held by petitioner in the amount of $4,095,761, as follows:

The Commission, after reviewing the entire record, is of the opinion that the deferred Rider R balance of $4,095,761 should accrue interest at an annual rate equal to the rate of return allowed herein for gas operations computed monthly on the unrefunded balance of the deferred Rider R special fund, commencing with interest computed on the date of this Order. The Commission is of the opinion that the special fund, including interest as specified, should be refunded by deducting equal amounts each month for 12 months from each bill issued under Service Classifications 51 and 63. The Special Fund should no longer be deducted from rate base for ratemaking purposes.

Under date of January 9, 1981, petitioner filed an application with the ICC, seeking to cancel SC 79 and the Rider R Income account, since it no longer had any SC 79 customers. This application summarizes the history of SC 79 and the excess revenues derived therefrom in the following language:

The purpose of this filing is to cancel Service Classification 79 - Limited Firm Gas Service, and Rider R - Adjustment to Residential and General Gas Service Charges.

Service Classification 79 was initiated on August 22, 1974 by order of the Illinois Commerce Commission in Docket Nos. 58582 and 58559 Consolidated for the purpose of allowing former interruptible customers to receive a continuing supply of gas service, but at increasingly higher prices intended to encourage such customers to find alternate fuel supplies. * * * Since under the terms of this tariff, no additional customers may be served, Illinois Power Company proposes to cancel Service Classification 79 by this filing.

Rider R - Adjustment to Residential and General Gas Service Charges, was initiated on February 26, 1975, by order of the Illinois Commerce Commission in Docket No. 58907 entered February 13, 1975, as a mechanism to refund on a quarterly basis Service Classification 79 revenues that were in excess of those granted to interruptible gas service customers in Docket No. 58907 to firm non-residential gas customers on a per term basis. Since the refund was limited to the average increase granted such customers in that docket, a special fund was established for excess revenues over and above the amount refundable to firm non-residential customers.

Effective on November 29, 1979, as provided in the Commission's order in Docket No. 79-0071, Rider R was revised to refund excess Service Classification 79 revenues as a Facilities Charge Refund to residential and general service gas customers on an annual basis using forecasted sales and revenues for the subsequent calendar year adjusted for the difference between estimated and actual sales for the previous twelve month period. In addition, the Commission directed the Company to refund the balance in the special fund established under the superseded Rider R with interest to residential and general service customers over a twelve month period.

On July 28, 1980, the Commission permitted the Company to revise Rider R so that the amount of the Rider R refund could be adjusted in the event the Rider R refund was expected to exceed the balance in the Special Fund and the excess revenues from Service Classification 79 customers. Since the sales to Limited Firm Gas Service customers used for determining the Facilities Charge Refund were considerably below the level forecasted for 1980, it was necessary to terminate the Rider R refund on that date.

As of December 31, 1980, the net balance in the Special Fund and the deferred Rider R Liability Account is ($718,999.06). This balance indicates that Illinois Power Company has over-refunded actual excess revenues by approximately $719,000 including interest at that date.

Since the final sales under Service Classification 79 occurred during the billing month of November, 1980, there will be no future excess Rider R revenues to offset the amount of over-refund. In lieu of recovering this over-refund by a negative refund or a surcharge through the Facilities Charge Refund, Illinois Power Company, by this filing, proposes to cancel Rider R and to offset the over-refund of $718,999.06 against a pipeline supplier refund initiated on September 1, 1980 under Rider A (Purchased Gas Adjustment). The balance in the September 1, 1980 refund account is more than $1,500,000 at December 31, 1980.

We believe that this is a matter that may be acted upon without a formal evidentiary hearing. Illinois Power Company will supply any additional information or data necessary for the Commission's Staff to complete its review of this matter.

All amounts received by petitioner in 1975 and 1976 from SC 79 customers were for gas or related services furnished or delivered. Such customers were liable for the payment of all such amounts, and petitioner had a right to demand and receive them from the payors. A part of the total revenues received from SC 79 customers in each of the years 1975 and 1976 was in excess of the amounts which the ICC believed necessary to provide petitioner with a reasonable rate of return. A portion of such excess was, pursuant to ICC order, credited in each respective year to non-residential firm customers in certain service classifications other than SC 79, and is not here in controversy.

The remainder of such excess revenues (the ‘Rider R Income‘ amounts) remained in petitioner's possession at the end of each respective taxable year of receipt. These amounts in 1975 and 1976 totalled $1,138,598 and $682,846, respectively. At all times here pertinent, Rider R Income was commingled in petitioner's general bank accounts and available for use for its general corporate purposes. Ultimate application of amounts equal to Rider R Income remained subject to ICC jurisdiction, and the ICC at various times issued orders affecting such application. Credits of Rider R Income, although sometimes referred to as ‘refunds‘ by the ICC, were not made to the same customers or class of customers who paid such amounts.

In the notice of deficiency dated July 18, 1979, respondent determined that petitioner received additional taxable income from Rider R of $1,138,598 and $682,846 in its 1975 and 1976 taxable years, respectively.

OPINION

Simply stated, the primary issue for our consideration in this case is whether Unit 3 of the Baldwin Power Station was CONSTRUCTED BY or ACQUIRED BY petitioner Illinois Power for purposes of computing the section 38 investment tax credit.

Section 38 allows a credit against income tax otherwise imposed for qualified investment in certain depreciable property. Section 301(a) of the Tax Reduction Act of 1975 (Pub. L. 94-12, 89 Stat. 36) which became effective on March 29, 1975, increased the investment tax credit available to public utilities from four to ten percent for property ACQUIRED and placed in service after January 21, 1975 and prior to January 1, 1977. Section 46(a)(1). For property CONSTRUCTED by the taxpayer, however, the increased credit was available only for that portion of the depreciable asset constructed after January 21, 1975 and before January 1, 1977. These provisional rules of section 46(a)(1)(D) provided in pertinent part as follows:

(D) TRANSITIONAL RULES. — (The ten percent credit) * * * shall apply only to:

(i) property * * * the construction, reconstruction, or erection of which is completed by the taxpayer after January 21, 1975, but only to the extent of the basis thereof, attributable to the construction, reconstruction, or erection after January 21, 1975, and before January 1, 1977,

(ii) property * * * acquired by the taxpayer after January 21, 1975, and before January 1, 1977, and placed in service by the taxpayer before January 1, 1977 * * *

The construction of Unit 3 of the Baldwin Power Station began in 1971. Unit 3 was completed and placed in service on June 20, 1975 at a total cost of approximately $127,309,500. The cost basis of Unit 3 as of December 31, 1975 was approximately $110,000,000. Petitioner contends that it ACQUIRED Unit 3 within the period specified in section 46(a)(1)(D)(ii) and, accordingly, is entitled to the ten percent investment tax credit for its entire cost basis in Unit 3. Respondent argues that Illinois Power CONSTRUCTED Unit 3 and, therefore is allowed the ten percent credit only for that portion of the basis attributable to construction after January 21, 1975. Section 46(a)(1)(D)(i). For the portion of the basis attributable to construction prior to that date respondent allowed the four percent credit.

The investment tax credit provisions were first added to the Code by the Revenue Act of 1962 (Pub. L. 87-834, 76 Stat. 960). By the addition of section 48(b) the credit was limited to ‘new section 38 property‘ defined as follows:

(b) NEW SECTION 38 PROPERTY.—For purposes of this subpart, the term ‘new section 38 property‘ means section 38 property,

(1) the construction, reconstruction, or erection of which is completed by the taxpayer after December 31, 1961, or

(2) acquired after December 31, 1961, if the original use of such property commences with the taxpayer and commences after such date.

In applying section 46(c)(1)(A) in the case of property described in paragraph (1), there shall be taken into account only that portion of the basis which is properly attributable to construction, reconstruction, or erection after December 31, 1961. The investment tax credit was terminated by the enactment of section 49(a) of the Tax Reform Act of 1969 for property which was acquired or whose physical construction, reconstruction or erection was begun after April 18, 1969 (Pub. L. 91-172, 83 Stat. 487, 660). In 1971, however, the investment tax credit was restored by the Revenue Act of 1971 (Pub. L. 92-178, 85 Stat. 497) and the addition to the Code of section 50 which provides in relevant part:

SEC. 50. RESTORATION OF CREDIT.

(a) GENERAL RULE.—Section 49(a) (relating to termination of credit) shall not apply to property,

(1) the construction, reconstruction, or erection of which

(A) is completed by the taxpayer after August 15, 1971, or

(B) is begun by the taxpayer after March 31, 1971, or

(2) which is acquired by the taxpayer,

(A) after August 15, 1971, or

(B) after March 31, 1971, and before August 16, 1971, pursuant to an order which the taxpayer establishes was placed after March 31, 1971.

(b) TRANSITIONAL RULE.—In applying section 46(c)(1)(A) (defining ‘qualified investment‘) in the case of property described in subsection (a)(1)(A) the construction, reconstruction, or erection of which is begun before April 1, 1971, there shall be taken into account only that portion of the basis which is properly attributable to construction, reconstruction, or erection after August 15, 1971.

Section 1.48-2(b), Income Tax Regs., which has remained unchanged and in effect since May 7, 1964, provides special rules for determining date of acquisition, original use and basis attributable to construction, reconstruction or erection of section 38 property, including the following relevant definitions:

(1) Property is considered as constructed, reconstructed, or erected by the taxpayer if the work is done for him in accordance with his specifications.

(5) Construction, reconstruction, or erection by the taxpayer begins when physical work is started on such construction, reconstruction, or erection.

(6) Property shall be deemed to be acquired when reduced to physical possession, or control.

SIMPSON and GERBER, JJ., did not participate in the consideration of this case.