Basin Elec. Power Coop. v. Comm'r

MEMORANDUM FINDINGS OF FACT AND OPINION

CHIECHI, Judge: Respondent determined the following deficiencies in petitioner's Federal income tax (tax):

   Taxable Year     Deficiency

     1992       $ 123,999

     1993        300,475

     1995        306,346

     1996       1,228,868

The issues remaining for decision are:

(1) Should the Court sustain respondent's determination that the expenditures at issue must be capitalized under section 263(a)? ¹ We hold that the Court should.

(2) Should the Court sustain respondent's determination that the period over which the expenditures at issue must*110 be amortized and deducted is the term of certain identical modified sale and leaseback agreements beginning with taxable year 1995 and ending with taxable year 2020? We hold that the Court should.

FINDINGS OF FACT

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

Petitioner had its principal office in Bismarck, North Dakota, at the time it filed the petition in this case.

During the years at issue, petitioner's principal business was the generation and transmission of electrical power to its member rural electrical systems located in an eight-State region of the upper Midwest. During the late-1970s through the mid1980s, petitioner constructed new electrical power generating and transmission facilities, including the facilities at Antelope Valley Station (AVS facilities).

The AVS facilities consisted of a two-unit electric generating station. The first unit was placed in service in two phases on January 1, 1982, and May 24, 1983. The second unit (AVS unit II) was placed in service on October 29, 1985. The total cost of constructing the AVS facilities was approximately $ 1.9 billion.

The AVS facilities included pollution control*111 facilities, certain portions of which related solely to the AVS unit II (AVS unit II pollution control facilities). The construction of the AVS unit II pollution control facilities was largely financed through certain tax-exempt bonds issued by Mercer County, North Dakota (Mercer County). In order to effect that financing, Mercer County executed a document, effective as of November 1, 1984, entitled "TRUST INDENTURE" (1984 bond indenture agreement). Pursuant to the 1984 bond indenture agreement, Mercer County issued the Pollution Control Revenue Bonds, 1984 Series (1984 tax-exempt bonds), in the aggregate amount of $ 112,750,000. The 1984 tax-exempt bonds had an interest rate of 10.5 percent, were payable semiannually on June 30 and December 30, and matured on June 30, 2013. Mercer County had the right to redeem the 1984 tax-exempt bonds prior to maturity but not before December 30, 1994. If Mercer County were to redeem the 1984 tax-exempt bonds between December 30, 1994, and December 29, 1995, the redemption price was to include a 2 percent, or $ 2,255,000, premium over the stated aggregate principal amount of such bonds.

On December 5, 1984, Mercer County and petitioner entered*112 into an agreement entitled "LEASE AND SUBLEASE", which was effective as of November 1, 1984 (1984 lease and sublease). Pursuant to the 1984 lease and sublease, petitioner agreed to lease the AVS unit II pollution control facilities to Mercer County, and Mercer County agreed to pay $ 112,750,000 to petitioner as rent at the beginning of the term of that lease. Pursuant to the 1984 lease and sublease, Mercer County agreed to sublease the AVS unit II pollution control facilities to petitioner, and petitioner agreed to pay to Mercer County as rent "an amount [of money] sufficient to pay, when due, the principal of and premium, if any, and interest on the [1984 tax-exempt] Bonds in funds available at such times to make all payments when due on the Bonds." (We shall refer to the amounts that petitioner was obligated to pay to Mercer County under the 1984 lease and sublease as the 1984 sublease rent.) Petitioner agreed to, and did, issue a promissory note (Basin Electric 1984 note) to evidence its obligation to Mercer County to pay the 1984 sublease rent.

At the time petitioner and Mercer County entered into the 1984 lease and sublease, petitioner intended to transfer by sale or otherwise*113 its interest in the AVS unit II to one or more transferees and to lease the AVS unit II back from such transferee(s). In this connection, the 1984 lease and sublease allowed petitioner to sell, convey, assign, or otherwise transfer to one or more transferees a percentage undivided interest in the AVS unit II provided that, inter alia, any such transferee assume a portion of petitioner's obligation to pay the 1984 sublease rent (i.e., to make payments when due of interest and principal on the 1984 tax-exempt bonds) which was proportionate to the percentage undivided interest in the AVS unit II that such transferee acquired from petitioner. Pursuant to the 1984 lease and sublease, if petitioner were to transfer in the aggregate 100 percent of its interest in the AVS unit II, petitioner was to be released from its obligations under the 1984 lease and sublease and the Basin Electric 1984 note.

Each of six unrelated entities (owner participants) wanted to, and did, acquire from and lease back to petitioner a percentage undivided interest in the AVS unit II. Those entities acquired in the aggregate 100 percent of petitioner's interest in that unit, and petitioner was released from its obligations*114 under the 1984 lease and sublease. In order to effect each acquisition and leaseback, on December 3, 1985, each of the six unrelated entities, inter alia, established a grantor trust (grantor trust), which was materially identical to each of the other five grantor trusts. ² The initial trustee (trustee) of each of the six grantor trusts was The Connecticut Bank and Trust Company, National Association (Connecticut Bank). Thereafter, State Street Bank & Trust Company succeeded Connecticut Bank as the trustee of each of such grantor trusts.

*115 The trustee of each grantor trust entered into various interrelated and interdependent agreements with petitioner, each of which was dated as of November 1, 1985. (We shall refer to all the various interrelated and interdependent agreements that petitioner and the trustee of each grantor trust entered into as the 1985 sale and leaseback or the 1985 sale and leaseback agreement.) ³ Pursuant to all six of the 1985 sale and leaseback agreements, petitioner sold to and leased back from the trustee of the six grantor trusts in the aggregate petitioner's entire interest in AVS unit II, including the AVS unit II pollution control facilities.

*116 The 1984 lease and sublease, the 1984 bond indenture agreement, the 1984 tax-exempt bonds, and the 1985 sale and leaseback agreements were agreements reflecting an integrated plan of interrelated and interdependent transactions or steps. Each of those transactions or steps was necessary in order to effectuate petitioner's objective of transferring by sale or otherwise the AVS unit II to one or more transferees and leasing that unit back from such transferee(s).

Under the 1985 sale and leaseback, part of the total consideration that the owner participant provided to petitioner to acquire a percentage undivided interest in the AVS unit II consisted of the owner participant's assumption of that portion of petitioner's obligation to pay the 1984 sublease rent (i.e., to make payments when due of interest and principal on the 1984 tax-exempt bonds) which was proportionate to the percentage undivided interest in the AVS unit II that such owner participant acquired from petitioner. The owner participants assumed in the aggregate 100 percent of petitioner's obligation to Mercer County to pay the 1984 sublease rent. Each owner participant agreed to, and did, issue a promissory note (series*117 B secured note) to evidence its obligation to pay that portion of the 1984 sublease rent that it assumed when it acquired from petitioner its percentage undivided interest in the AVS unit II. As a result, pursuant to the 1984 lease and sublease, petitioner was discharged from its obligation under the Basin Electric 1984 note, and the owner participants became the obligors under the 1984 tax-exempt bonds.

Under the 1985 sale and leaseback, the owner participant leased to petitioner its percentage undivided interest in the AVS unit II for a term that began on December 3, 1985, and that was to end on December 30, 2015. Petitioner had the right to extend that lease term for each of two five-year terms. The 1985 sale and leaseback required petitioner to pay a variable amount of money as rent (basic rent) semiannually on June 30 and December 30. ⁴ With respect to that variable amount of basic rent, the 1985 sale and leaseback provided:

*118    Notwithstanding any other provision of [the 1985 sale and

   leaseback] * * * the amount of Basic Rent payable [by

   petitioner] on each Basic Rent Payment Date shall be at least

   equal to the aggregate amount of principal and interest payable

   on all Notes then Outstanding * * *.

(We shall refer to the minimum amount of basic rent payable by petitioner under the above-quoted provision of the 1985 sale and leaseback as the "minimum annual basic rent".) The "Notes" referred to in the above-quoted provision of the 1985 sale and leaseback included the series B secured note, which evidenced the owner participant's obligation to pay that portion of petitioner's obligation to pay the 1984 sublease rent (i.e., to make payments when due of interest and principal on the 1984 taxexempt bonds) which was proportionate to the percentage undivided interest that such owner participant acquired from petitioner.

Under the 1985 sale and leaseback, the minimum annual basic rent was to be adjusted if, inter alia, Mercer County refinanced the 1984 tax-exempt bonds. The 1985 sale and leaseback did not contain a provision under which petitioner had the right to*119 request a refinancing of the 1984 tax-exempt bonds. However, each owner participant had the right under the 1984 bond indenture to require Mercer County to redeem those bonds.

It was petitioner's practice to examine and consider ways to reduce its operating expenses, including its lease expenses. In late 1991, petitioner focused on its rent obligations under the 1985 sale and leaseback, which were based in substantial part on the interest rates extant in 1984 when Mercer County issued the 1984 tax- exempt bonds, and not on interest rates for tax-exempt bonds issued in 1991. Specifically, on or about December 12, 1991, petitioner initiated a study (refinancing study) regarding the benefits that it would derive in the event of a modification of the 1985 sale and leaseback which would require calculation of the minimum annual basic rent payable by petitioner on the basis of the annual debt service of newly issued tax-exempt bonds bearing the interest rate for such bonds extant at that time.

By January 1992, when petitioner's board of directors met to consider the results of the refinancing study, interest rates on newly issued tax-exempt bonds had declined dramatically to approximately*120 6.5 percent from the 10.5 percent rate extant in 1984 when Mercer County issued the 1984 tax-exempt bonds. Petitioner determined from the refinancing study that if the 1985 sale and leaseback were modified to require petitioner to pay minimum annual basic rent calculated by reference to tax-exempt bonds issued in early 1992, its minimum annual basic rent obligation would be decreased by approximately $ 4.2 million. Consequently, petitioner concluded that it would attempt to effect a modification of the 1985 sale and leaseback in order to achieve such a substantial reduction in its minimum annual basic rent obligation.

There were three significant hurdles that petitioner faced in achieving its objective of modifying the 1985 sale and leaseback in order to reduce substantially its minimum annual basic rent obligation. First, pursuant to the terms of the 1984 tax-exempt bonds, such bonds were not redeemable before December 30, 1994. Second, the 1985 sale and leaseback did not allow petitioner to require Mercer County to redeem the 1984 tax-exempt bonds. Third, although each owner participant had the right under the 1984 bond indenture to require Mercer County to redeem those bonds, petitioner*121 did not have the right under the 1985 sale and leaseback to request that the owner participant exercise its right.

Petitioner, in consultation with its lease advisor Morgan Stanley, developed a strategy to overcome the foregoing hurdles. That strategy included petitioner's offering certain inducements to each owner participant and Mercer County in order to persuade them to agree to the modification of the 1985 sale and leaseback and the concomitant refinancing of the 1984 tax-exempt bonds. Thus, petitioner offered (1) to exercise its option under the 1985 sale and leaseback to elect to extend for five years the term of the lease and (2) to pay the costs associated with modifying the 1985 sale and leaseback and effecting the concomitant refinancing of the 1984 tax- exempt bonds.

Petitioner's strategy to overcome the hurdles that it faced in achieving its objective of modifying the 1985 sale and leaseback was successful, and petitioner, the owner participants, and Mercer County agreed to take the steps necessary to modify and enhance ⁵ the 1985 sale and leaseback, which included the concomitant refinancing of the 1984 tax-exempt bonds, in order to achieve a substantial rent reduction*122 for petitioner. Specifically, they agreed to certain modifications (1992 amendments) to the 1985 sale and leaseback and to the concomitant transactions necessary to achieve that objective.

On or about December 28, 1992, petitioner and each owner participant ⁶ modified, effective as of October 1, 1992, the various agreements that comprised the 1985 sale and leaseback. (We shall refer to the 1985 sale and leaseback as modified by the 1992 amendments as the modified 1985 sale and leaseback or the modified 1985 sale and leaseback agreement.)⁷ Under the modified 1985 sale and leaseback, petitioner agreed to, and did: *123 (1) Exercise its right under the 1985 sale and leaseback to elect a five-year extension of the term of the leasen ⁸ and (2) pay the reasonable costs incurred by the owner participant and Mercer County in refinancing the 1984 tax-exempt bonds. With respect to petitioner's agreement to pay such reasonable costs, the modified 1985 sale and leaseback provided in pertinent part:

*124    Any Bond Premium and accrued interest in respect of a redemption

   permitted by * * * [the modified 1985 sale and leaseback] shall

   be paid * * * by the Lessee [petitioner] * * *. The Lessee shall

   pay, or shall reimburse the Owner Participant, the Owner

   Trustee, the County, the Bank, the Funding Corp and the

   Indenture Trustee * * * for all out-of-pocket costs and expenses

   paid to unrelated third parties at arm's length (including

   counsel fees, investment banking fees, fees of financial

   advisors, underwriting fees, * * *) incurred by any of such

   parties in connection with any refunding or attempted refunding

   permitted by or requested pursuant to * * * [the modified 1985

   sale and leaseback]. * * * the Lessee shall [also] pay to the

   Owner Participant, as additional Supplemental Rent, a tax gross-

   up payment * * *.

In addition, pursuant to all six modified 1985 sale and leaseback agreements, petitioner agreed to, and did, share with all the owner participants 20 percent in the aggregate of the annual interest savings attributable to the refinancing of the 1984 taxexempt*125 bonds after petitioner recouped, through a reduction in its minimum annual basic rent obligation, its payment of the costs associated with modifying the 1985 sale and leaseback and effecting the concomitant refinancing of the 1984 tax-exempt bonds. ⁹

*126 The 1992 amendments to the 1985 sale and leaseback agreements and the concomitant refinancing of the 1984 tax-exempt bonds, which was achieved through the redemption of those bonds and the issuance of new tax-exempt bonds, were interrelated and interdependent transactions or steps in an integrated plan to achieve petitioner's objective of modifying the 1985 sale and leaseback agreements in order to reduce substantially petitioner's minimum annual basic rent obligation to the owner participants. That integrated plan required execution of not only the 1992 amendments but also other interrelated and interdependent agreements as discussed below.

The 1992 amendments detailed the refinancing of the 1984 tax-exempt bonds, which was to be accomplished through the issuance of new tax-exempt bonds (1995 tax-exempt bonds) by Mercer County in January 1995, in pertinent part as follows:

   Anticipated Refunding of Initial Series B Secured Note with

   Proceeds of Refunding Series B Secured Note.

   Lessee [Basin Electric] Election to Initiate Refunding

   of Initial Series B Secured Note . In accordance with

   Subsection 4(c)(i) of the Participation Agreement*127 [of the

   modified 1985 sale and leaseback], the Lessee has elected to

   request a refunding of the Initial Series B Secured Note

   [evidencing the owner participant's obligation to make payments

   of interest and principal on the 1984 tax-exempt bonds] with the

   proceeds of an Additional Note issued pursuant to Section 3.5 of

   the [Trust] Indenture. Such Refunding Series B Note will be

   purchased by the County [Mercer County] with the proceeds of the

   sale of its Mercer County, North Dakota, Pollution Control

   Refunding Revenue Bonds, Series 1995 (the Refunding

   Bonds) [i.e., the 1995 tax-exempt bonds]. The Refunding

   Bonds will be sold pursuant to a Forward Purchase Contract

   (the Refunding Bond Purchase Agreement) between the

   County and Morgan Stanley & Co. Incorporated (the date of

   execution of such Refunding Bond Purchase Agreement hereinafter

   called the Refunding Bond Sale Date) providing for the

   future delivery of Refunding Bonds on a date (the Refunding

   Bond Delivery Date) shortly after the first optional call

   date [December 30, 1994] for*128 the [1984 tax-exempt] Bonds. * * *

   On the Refunding Bond Delivery Date, (i) the County will issue

   the Refunding Bonds and purchase the Refunding Series B Secured

   Note from the Owner Trustee with the proceeds of the Refunding

   Bonds, (ii) the Owner Trustee will prepay the Initial Series B

   Secured Note with the proceeds of the sale of the Refunding

   Series B Secured Note and Supplemental Rent paid by the Lessee,

   (iii) the County will use the funds received from the Owner

   Trustee in respect of the prepayment of the Initial Series B

   Secured Notes to redeem the Bonds * * *.

The modified 1985 sale and leaseback detailed the calculation of petitioner's annual basic rent obligation in pertinent part as follows:

   (3) the amount of Basic Rent payable on each Basic Rent Payment

   Date following such refinancing [of the 1984 tax-exempt bonds]

   shall be reduced by the amount of Bond Premium, Owner

   Participant's Refunding Transaction Expenses and Lessee's

   [petitioner's] Refunding Transaction Expenses paid by the Lessee

   in connection with such refinancing and not previously*129 taken

   into account in any adjustment to Basic Rent plus interest at

   the Weighted Average Cost of Capital [8.34 percent], compounded

   semi-annually, on any such amounts paid by the Lessee from the

   date of payment by the Lessee to the date of recovery through a

   reduction in Basic Rent pursuant to this Clause 3;

   (4) after the Lessee has recovered the amounts described in

   paragraph (3) above, the amount of Basic Rent payable on any

   Basic Rent Payment Date following such refinancing shall be

   reduced by an amount equal to 80% of the difference between the

   interest that would have been payable on such Basic Rent Payment

   Date with respect to the prepaid Series B Secured Note and the

   interest payable on such Basic Rent Payment Date with respect to

   the Series B Refunding Note;

As described in the foregoing excerpt from the modified 1985 sale and leaseback, the 1992 amendments did not effect a reduction in petitioner's minimum annual basic rent obligation until the redemption of the 1984 tax-exempt bonds and the issuance of the new tax-exempt bonds (i.e., the 1995 tax-exempt bonds), which*130 occurred on January 1, 1995. ¹⁰

Pursuant to the modified 1985 sale and leaseback, in 1992 petitioner paid $ 423,736 to Morgan Stanley for lease advisory fees associated with modifying the 1985 sale and leaseback and $ 397,339.79 to Mudge, Rose, Guthrie, Alexander & Ferdon (Mudge, Rose) for legal services associated with*131 modifying the 1985 sale and leaseback and as bond counsel for Mercer County in the concomitant refinancing of the 1984 tax-exempt bonds.

The modified 1985 sale and leaseback granted petitioner the right to request the owner participants to take reasonable actions to refinance the 1984 tax-exempt bonds. That modified sale and leaseback required the owner participants to cooperate in order to ensure that such refinancing was implemented. ¹¹

*132 The 1992 amendments expressly stated that petitioner exercised its right to request that the owner participants take reasonable actions to refinance the 1984 tax-exempt bonds. Each owner participant exercised its right under the 1984 bond indenture agreement to require Mercer County to redeem the 1984 taxexempt bonds.

Pursuant to the plan detailed in the 1992 amendments, Mercer County executed a document entitled "TRUST INDENTURE" (1995 bond indenture agreement), effective as of October 1, 1992, which provided that in order to refinance the 1984 tax-exempt bonds Mercer County was to issue new tax-exempt bonds (i.e., the 1995 tax- exempt bonds) pursuant to the terms of that indenture agreement. Pursuant to that plan, on January 20, 1993, Mercer County entered into a forward purchase contract (forward purchase contract) with Morgan Stanley, pursuant to which Morgan Stanley agreed to offer the 1995 tax-exempt bonds for sale to the public.

Pursuant to the modified 1985 sale and leaseback agreements, in 1993 petitioner paid $ 984,551.50 to Morgan Stanley for underwriting fees and $ 113,510.22 to Mudge, Rose for legal services associated with the forward purchase contract and $ 891,572*133 in the aggregate to the owner participants for so-called tax gross-up payments required by those agreements.

On January 1, 1995, the refinancing of the 1984 tax-exempt bonds was effected by the simultaneous redemption of the 1984 tax- exempt bonds and issuance of the 1995 tax-exempt bonds. The 1995 tax- exempt bonds had an interest rate of 7.2 percent, were payable semiannually on June 30 and December 30, and matured on June 30, 2013. Because of the 7.2-percent interest rate on the 1995 tax-exempt bonds, the annual interest payment on those bonds was $ 3,720,750 less than the annual interest payment that would have been due on the 1984 tax-exempt bonds.

During each of the years 1995 and 1996, petitioner's aggregate minimum annual basic rent obligation under the modified 1985 sale and leaseback agreements was reduced by 100 percent of the interest savings attributable to the refinancing of the 1984 taxexempt bonds, i.e., by $ 3,720,750. After 1996 and until June 30, 2013, when the 1995 tax-exempt bonds were to mature, petitioner's aggregate minimum annual basic rent obligation under the modified 1985 sale and leaseback agreements was reduced by, inter alia, 80 percent of the interest*134 savings attributable to such refinancing, i.e., by $ 2,976,600. ¹²

Pursuant to the modified 1985 sale and leaseback agreements, in 1995 petitioner paid $ 54,672.28 to Mudge, Rose for services rendered as bond counsel and other legal services associated with the refinancing of the 1984 tax-exempt bonds, $ 40,218.22 to Sherman & Sterling for legal services associated with the refinancing of such bonds, $ 3,499 to Bingham, Dana & Gould for legal services associated with representing the trustee during the refinancing of such bonds, $ 2,255,000 to First National Bank of Chicago for the redemption premium due on the redemption of such bonds, $ 14,595.88 to Morgan Stanley for services associated with the issuance of the 1995 tax-exempt bonds, and $ 17,896.08 to Arthur Andersen for a comfort letter associated with the issuance of such bonds.

Petitioner paid the expenditures described above in order to modify and enhance the 1985 sale and leaseback agreements so that petitioner's aggregate minimum*135 annual basic rent obligation under those modified agreements would be substantially less than its minimum annual basic rent obligation under the 1985 sale and leaseback agreements.

In Forms 1120, U.S. Corporation Income Tax Return, for the taxable years indicated, petitioner deducted the following amounts with respect to its payment in 1992, 1993, and 1995 of the expenditures described above (expenditures at issue) relating to the 1992 amendments to the 1985 sale and leaseback agreements and the concomitant refinancing of the 1984 tax-exempt bonds:

   Taxable Year           Amount



     1992           $ 821,075.79



     1993           1,989,633.72

     1995           ¹2,228,381.46

FOOTNOTE TO TABLE

*136 Respondent issued a notice of deficiency (notice) to petitioner for its taxable years 1992, 1993, 1995, and 1996. In that notice, respondent determined that the expenditures at issue must be capitalized and amortized and deducted over the term of the modified 1985 sale and leaseback beginning with taxable year 1995 and ending with taxable year 2020. Consequently, respondent further determined in the notice that petitioner is entitled to a deduction of $ 199,869 for each of its taxable years 1995 and 1996.

OPINION

Petitioner bears the burden of proving that the determinations in the notice that remain at issue are erroneous. See Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84, 117 L. Ed. 2d 226, 112 S. Ct. 1039 (1992); Welch v. Helvering, 290 U.S. 111, 115, 78 L. Ed. 212, 54 S. Ct. 8 (1933). Deductions are strictly a matter of legislative grace, and petitioner bears the burden of proving that it is entitled to any deductions claimed. INDOPCO, Inc. v. Commissioner, supra.

Section 162(a) generally allows a deduction for ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. In general, an*137 expense is ordinary if it is considered normal, usual, or customary in the context of the particular business out of which it arose. Deputy v. du Pont, 308 U.S. 488, 495, 84 L. Ed. 416, 60 S. Ct. 363 (1940). Ordinarily, an expense is necessary if it is appropriate and helpful to the operation of the taxpayer's trade or business. Commissioner v. Tellier, 383 U.S. 687, 689, 16 L. Ed. 2d 185, 86 S. Ct. 1118 (1966); Carbine v. Commissioner, 83 T.C. 356, 363 (1984), affd. 777 F.2d 662 (11th Cir. 1985).

Section 263(a) provides that "No deduction shall be allowed for--(1) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate." Section 263(a) denies a deduction under section 162(a) when the amount paid or incurred: (1) Creates or enhances a separate and distinct asset, see Commissioner v. Lincoln Sav. & Loan Association, 403 U.S. 345, 354, 29 L. Ed. 2d 519, 91 S. Ct. 1893 (1971); Wells Fargo & Co. and Subs. v. Commissioner, 224 F.3d 874, 882 (8th Cir. 2000), affg. in part and revg. in part 112 T.C. 89 (1999); (2) produces a significant benefit beyond the current taxable year (significant future benefits), see INDOPCO, Inc. v. Commissioner, supra at 87-89;*138 Wells Fargo & Co. and Subs. v. Commissioner, supra at 887; or (3) is in connection with the acquisition of a capital asset, Commissioner v. Idaho Power Co., 418 U.S. 1, 13, 41 L. Ed. 2d 535, 94 S. Ct. 2757 (1974).

It is petitioner's position that the expenditures at issue should be deducted under section 162(a) and not capitalized under section 263(a). In support of that position, petitioner argues that it paid the expenditures at issue in order to reduce its future operating costs, viz., the future minimum annual basic rent that the 1985 sale and leaseback required petitioner to pay to the owner participants for the use of the AVS unit II, and that, under Metrocorp, Inc. v. Commissioner, 116 T.C. 211 (2001), and T.J. Enters., Inc. v. Commissioner, 101 T.C. 581 (1993), such expenditures are deductible under section 162(a).

It is respondent's position that the expenditures at issue should be capitalized under section 263(a) and not deducted under section 162(a). In support of that position, respondent argues that petitioner paid the expenditures at issue in order to modify and enhance a capital asset, viz., the 1985 sale and leaseback, and that, under U.S. Bancorp & Consol. Subs. v. Commissioner, 111 T.C. 231 (1998),*139 such expenditures must be capitalized.

The "decisive distinctions" between current expenses and capital expenditures "'are those of degree and not of kind'", INDOPCO, Inc. v. Commissioner, supra at 86 (quoting Welch v. Helvering, supra at 114), with each individual case "'[turning] on its special facts.'" Id. (quoting Deputy v. du Pont, supra at 496). In the instant case, the material facts on which we must determine whether the expenditures at issue should be capitalized are not in dispute. Under the 1985 sale and leaseback,¹³ the amount of basic rent due from petitioner was dependent upon, inter alia, the amount of interest payable on the 1984 tax-exempt bonds.¹⁴The annual interest rate on the 1984 tax-exempt bonds was 10.5 percent, and the annual amount of interest payable on such bonds was $ 11,838,750. Thus, the 1985 sale and leaseback agreements required petitioner to pay in the aggregate at least $ 11,838,750 per year in basic rent to the owner participants.

*140 On or about December 12, 1991, petitioner initiated a refinancing study regarding the benefits that it would derive in the event of a modification of the 1985 sale and leaseback which would require calculation of the minimum annual basic rent payable by petitioner on the basis of the annual debt service of newly issued tax-exempt bonds bearing the interest rate for such bonds extant at that time. By January 1992, interest rates on newly issued tax-exempt bonds had declined dramatically to approximately 6.5 percent from the 10.5 percent rate extant in 1984 when Mercer County issued the 1984 tax-exempt bonds. Petitioner determined from the refinancing study that if the 1985 sale and leaseback were modified to require petitioner to pay minimum annual basic rent calculated by reference to tax-exempt bonds issued in early 1992, its minimum annual basic rent obligation would be decreased by approximately $ 4.2 million. Consequently, petitioner concluded that it would attempt to effect a modification of the 1985 sale and leaseback in order to achieve such a substantial reduction in its minimum annual basic rent obligation.

There were three significant hurdles that petitioner faced in achieving*141 its objective of modifying the 1985 sale and leaseback in order to reduce substantially its minimum annual basic rent obligation. First, pursuant to the terms of the 1984 tax-exempt bonds, such bonds were not redeemable before December 30, 1994. Second, the 1985 sale and leaseback did not allow petitioner to require Mercer County to redeem the 1984 tax-exempt bonds. Third, although each owner participant had the right under the 1984 bond indenture to require Mercer County to redeem those bonds, petitioner did not have the right under the 1985 sale and leaseback to request that the owner participant exercise its right.

Petitioner developed a strategy to overcome the foregoing hurdles. That strategy included petitioner's offering certain inducements to each owner participant and Mercer County in order to persuade them to agree to the modification of the 1985 sale and leaseback and the concomitant refinancing of the 1984 taxexempt bonds. Thus, petitioner offered (1) to exercise its option under the 1985 sale and leaseback to elect to extend for five years the term of the lease and (2) to pay the costs associated with modifying the 1985 sale and leaseback and effecting the concomitant*142 refinancing of the 1984 tax-exempt bonds.

Petitioner's strategy to overcome the hurdles that it faced in achieving its objective of modifying the 1985 sale and leaseback was successful, and petitioner, the owner participants, and Mercer County agreed to take the steps necessary to modify and enhance the 1985 sale and leaseback, which included the concomitant refinancing of the 1984 tax-exempt bonds, in order to achieve a substantial rent reduction for petitioner. Specifically, they agreed to the 1992 amendments to the 1985 sale and leaseback agreements and to the concomitant transactions necessary to achieve that objective.

On or about December 28, 1992, petitioner and each owner participant modified, effective as of October 1, 1992, the various agreements that comprised the 1985 sale and leaseback. Under the modified 1985 sale and leaseback, petitioner agreed to, and did: (1) Exercise its option under the 1985 sale and leaseback to elect a five-year extension of the term of the lease ¹⁵ and (2) pay the expenditures at issue. With respect to petitioner's agreement to pay the expenditures at issue, the modified 1985 sale and leaseback provided in pertinent part:

*143    Any Bond Premium and accrued interest in respect of a redemption

   permitted by * * * [the modified 1985 sale and leaseback] shall

   be paid * * * by the Lessee [petitioner] * * *. The Lessee shall

   pay, or shall reimburse the Owner Participant, the Owner

   Trustee, the County, the Bank, the Funding Corp and the

   Indenture Trustee * * * for all out-of-pocket costs and expenses

   paid to unrelated third parties at arm's length (including

   counsel fees, investment banking fees, fees of financial

   advisors, underwriting fees, * * *) incurred by any of such

   parties in connection with any refunding or attempted refunding

   permitted by or requested pursuant to * * * [the modified 1985

   sale and leaseback]. * * * the Lessee shall [also] pay to the

   Owner Participant, as additional Supplemental Rent, a tax gross-

   up payment * * *.

In addition, pursuant to all six modified sale and leaseback agreements, petitioner agreed to, and did, share with all the owner participants 20 percent in the aggregate of the annual interest savings attributable to the refinancing of the 1984 taxexempt*144 bonds after petitioner recouped the expenditures at issue through a reduction in its minimum annual basic rent obligation. ¹⁶

We have found that the 1992 amendments to the 1985 sale and leaseback agreements and the concomitant refinancing of the 1984 tax-exempt bonds, which was achieved through the redemption of those bonds and the issuance of the 1995 tax-exempt bonds, were interrelated and interdependent transactions or steps in an integrated plan to achieve petitioner's objective of modifying the 1985 sale and leaseback agreements in order to reduce substantially petitioner's minimum annual basic rent obligation to the owner participants. That integrated plan required execution of not only the 1992 amendments but also other interrelated and interdependent agreements, including the 1995 bond indenture agreement and the forward purchase contract.

The 1992 amendments detailed the refinancing of the 1984 tax-exempt bonds, which was to be accomplished through the issuance of the 1995 tax-exempt*145 bonds by Mercer County in January 1995, in pertinent part as follows:

   Anticipated Refunding of Initial Series B Secured Note with

   Proceeds of Refunding Series B Secured Note.

   Lessee [Basin Electric] Election to Initiate Refunding

   of Initial Series B Secured Note . In accordance with

   Subsection 4(c)(i) of the Participation Agreement [of the

   modified 1985 sale and leaseback], the Lessee has elected to

   request a refunding of the Initial Series B Secured Note

   [evidencing the owner participant's obligation to make payments

   of interest and principal on the 1984 tax-exempt bonds] with the

   proceeds of an Additional Note issued pursuant to Section 3.5 of

   the [Trust] Indenture. Such Refunding Series B Note will be

   purchased by the County [Mercer County] with the proceeds of the

   sale of its Mercer County, North Dakota, Pollution Control

   Refunding Revenue Bonds, Series 1995 (the Refunding

   Bonds) [i.e., the 1995 tax-exempt bonds]. The Refunding

   Bonds will be sold pursuant to a Forward Purchase Contract

   (the Refunding Bond Purchase Agreement) *146 between the

   County and Morgan Stanley & Co. Incorporated (the date of

   execution of such Refunding Bond Purchase Agreement hereinafter

   called the Refunding Bond Sale Date) providing for the

   future delivery of Refunding Bonds on a date (the Refunding

   Bond Delivery Date) shortly after the first optional call

   date [December 30, 1994] for the [1984 tax-exempt] Bonds. * * *

   On the Refunding Bond Delivery Date, (i) the County will issue

   the Refunding Bonds and purchase the Refunding Series B Secured

   Note from the Owner Trustee with the proceeds of the Refunding

   Bonds, (ii) the Owner Trustee will prepay the Initial Series B

   Secured Note with the proceeds of the sale of the Refunding

   Series B Secured Note and Supplemental Rent paid by the Lessee,

   (iii) the County will use the funds received from the Owner

   Trustee in respect of the prepayment of the Initial Series B

   Secured Notes to redeem the Bonds * * *.

The modified 1985 sale and leaseback detailed the calculation of petitioner's annual basic rent obligation in pertinent part as follows:

   (3) the amount of*147 Basic Rent payable on each Basic Rent Payment

   Date following such refinancing [of the 1984 tax-exempt bonds]

   shall be reduced by the amount of Bond Premium, Owner

   Participant's Refunding Transaction Expenses and Lessee's

   [petitioner's] Refunding Transaction Expenses paid by the Lessee

   in connection with such refinancing and not previously taken

   into account in any adjustment to Basic Rent plus interest at

   the Weighted Average Cost of Capital [8.34 percent], compounded

   semi-annually, on any such amounts paid by the Lessee from the

   date of payment by the Lessee to the date of recovery through a

   reduction in Basic Rent pursuant to this Clause 3;

   (4) after the Lessee has recovered the amounts described in

   paragraph (3) above, the amount of Basic Rent payable on any

   Basic Rent Payment Date following such refinancing shall be

   reduced by an amount equal to 80% of the difference between the

   interest that would have been payable on such Basic Rent Payment

   Date with respect to the prepaid Series B Secured Note and the

   interest payable on such Basic*148 Rent Payment Date with respect to

   the Series B Refunding Note;

As described in the foregoing excerpt from the modified 1985 sale and leaseback, the 1992 amendments did not effect a reduction in petitioner's minimum annual basic rent obligation until the redemption of the 1984 tax-exempt bonds and the issuance of the new tax-exempt bonds (i.e., the 1995 tax-exempt bonds), which occurred on January 1, 1995. ¹⁷

The modified 1985 sale and leaseback granted petitioner the right to request the owner participants to take reasonable actions to refinance the 1984 tax-exempt bonds. That modified sale and leaseback required the owner participants to cooperate in order to ensure that such refinancing was implemented. ¹⁸

*149 The 1992 amendments expressly stated that petitioner exercised its right to request that the owner participants take reasonable actions to refinance the 1984 tax-exempt bonds. ¹⁹ Each owner participant exercised its right under the 1984 bond indenture agreement to require Mercer County to redeem the 1984 tax- exempt bonds.

*150 Pursuant to the plan detailed in the 1992 amendments, Mercer County executed the 1995 bond indenture agreement, effective as of October 1, 1992, which provided that in order to refinance the 1984 tax-exempt bonds Mercer County was to issue new tax-exempt bonds (i.e., the 1995 tax-exempt bonds) pursuant to the terms of that indenture agreement. Pursuant to that plan, on January 20, 1993, Mercer County entered into a forward purchase contract with Morgan Stanley, pursuant to which Morgan Stanley agreed to offer the 1995 tax-exempt bonds for sale to the public.

On January 1, 1995, the refinancing of the 1984 tax-exempt bonds was effected by the simultaneous redemption of the 1984 tax- exempt bonds and issuance of the 1995 tax-exempt bonds. The 1995 tax- exempt bonds had an interest rate of 7.2 percent, were payable semiannually on June 30 and December 30, and matured on June 30, 2013. Because of the 7.2-percent interest rate on the 1995 tax-exempt bonds, the annual interest payment on those bonds was $ 3,720,750 less than the annual interest payment that would have been due on the 1984 tax-exempt bonds.

During each of the years 1995 and 1996, petitioner's aggregate minimum annual basic*151 rent obligation under the modified 1985 sale and leaseback agreements was reduced by 100 percent of the interest savings attributable to the refinancing of the 1984 taxexempt bonds, i.e., by $ 3,720,750. After 1996 and until June 30, 2013, when the 1995 tax-exempt bonds were to mature, petitioner's aggregate minimum annual basic rent obligation under the modified 1985 sale and leaseback agreements was reduced by, inter alia, 80 percent of the interest savings attributable to such refinancing, i.e., by $ 2,976,600. ²⁰

We have found that petitioner paid the expenditures at issue in order to modify and enhance the 1985 sale and leaseback agreements so that petitioner's aggregate minimum annual basic rent obligation under those modified agreements would be substantially less than its minimum annual basic rent obligation under the 1985 sale and leaseback agreements.

We conclude that the material facts outlined above bring the expenditures at issue within the purview of U.S. Bancorp & Consol. Subs. v. Commissioner, 111 T.C. 231 (1998).*152 On the record before us, we reject petitioner's argument that Metrocorp, Inc. v. Commissioner, 116 T.C. 211 (2001), and T.J. Enters., Inc. v. Commissioner, 101 T.C. 581 (1993), require that such expenditures be deducted under section 162(a). ²¹ The material facts in Metrocorp, Inc. v. Commissioner, supra, and T.J. Enters., Inc. v. Commissioner, supra, are distinguishable from the material facts in the instant case, and petitioner's reliance on those cases is misplaced.²²

*153 In U.S. Bancorp & Consol. Subs. v. Commissioner, supra at 233-234, the taxpayer had a lease for a mainframe computer and paid a fee (rollover fee) in order to cancel that lease and enter into a new lease for a second, more powerful mainframe computer. The Court held that the taxpayer was required to capitalize the rollover fee. Id. at 239. In reaching that holding, the Court observed:

     The cases brought to our attention * * * occupy opposite

   ends of a spectrum. At one end is the case where a lessee pays a

   lessor to terminate a lease and no subsequent lease is entered

   into between the parties. In such a case the termination fee is

   clearly deductible in the year incurred, as there is no second

   lease raising the possibility that the lessee will realize

   significant future benefits beyond the current taxable year as a

   result of the termination payment. At the opposite end is the

   case of a lessee that cancels a lease and then immediately

   enters into another lease with the same lessor, covering the

   same property. In substance, the first lease is not canceled but

*154    continues in modified form, and any unrecovered costs of the

   first lease, or costs incurred to cancel the first lease, are

   not currently deductible but rather are costs of continuing the

   first lease in modified form. [Id.]

In U.S. Bancorp & Consol. Subs., the Court analogized the cancellation of a lease and the execution of a new lease for the same property as in substance a modification of the original lease, which requires that the costs incurred in order to effect such modification be capitalized. Under U.S. Bancorp & Consol. Subs. v. Commissioner, supra at 240 (citing Pig & Whistle Co. v. Commissioner, 9 B.T.A. 668 (1927); Phil Gluckstern's, Inc. v. Commissioner, T.C. Memo. 1956-9), costs paid or incurred to modify a lease, like the expenditures at issue here, must be capitalized and may not be deducted when paid or incurred.

Petitioner argues that U.S. Bancorp & Consol. Subs. is distinguishable from the instant case because in U.S. Bancorp & Consol. Subs. the new lease covered property (i.e., a new more powerful mainframe computer) different from the property that the old lease covered, while in the instant*155 case the modified 1985 sale and leaseback covered the same property that the 1985 sale and leaseback covered. We reject that argument. In U.S. Bancorp & Consol. Subs., the Court found unpersuasive the taxpayer's argument that it was significant that the new lease involved there covered property different from the property that the original lease covered. That argument, according to the Court, ignored the integrated nature of those two leases. U.S. Bancorp & Consol. Subs. v. Commissioner, supra at 240-241. If the rollover fee in U.S. Bancorp & Consol. Subs. paid or incurred to cancel the original lease covering certain property and to enter into a new lease covering different property must be capitalized, a fortiori fees or costs paid or incurred to modify an existing lease covering the same property, like the expenditures at issue here, must be capitalized. See id.; Pig & Whistle Co. v. Commissioner, supra; Phil Gluckstern's, Inc. v. Commissioner, supra.

On the record before us, we hold that petitioner must capitalize the expenditures at issue. ²³

*156 We turn now to the dispute between the parties regarding the period over which the expenditures at issue, which we have held must be capitalized, should be amortized and deducted. Petitioner argues that, under section 1.167(a)-3, Income Tax Regs., it should amortize and deduct the expenditures at issue over the two-year period 1995 and 1996. In support of that argument, petitioner points out that 1995 and 1996 are the years during which petitioner recouped the expenditures at issue. ²⁴ Respondent counters that petitioner should amortize and deduct the expenditures at issue over the term of the modified 1985 sale and leaseback beginning with taxable year 1995 ²⁵ and ending with taxable year 2020.

We turn first to petitioner's argument that the appropriate period over which to amortize and deduct the expenditures*157 at issue is 1995 and 1996. Section 1.167(a)-3, Income Tax Regs., on which petitioner relies in support of that argument, states that an intangible asset may be the subject of a depreciation allowance if that intangible asset has an ascertainable, limited useful life. Petitioner has not offered any evidence establishing that the useful life of the modified 1985 sale and leaseback is only the two-year period 1995 and 1996. That petitioner in effect recouped the expenditures at issue over 1995 and 1996 pursuant to the terms of the modified 1985 sale and leaseback agreements does not establish that the useful life of each of those agreements is that two-year period. On the record before us, we reject petitioner's argument that section 1.167(a)-3, Income Tax Regs., requires that the expenditures at issue be amortized and deducted over the two-year period 1995 and 1996.

We turn now to respondent's argument that the appropriate period over which to amortize and deduct the expenditures at issue is the term of the modified 1985 sale and leaseback agreements beginning with 1995 and ending with 2020. The Supreme Court of the United States*158 has concluded that "a capital expenditure usually is amortized and depreciated over the life of the relevant asset". INDOPCO, Inc. v. Commissioner, 503 U.S. at 83-84. Petitioner cites no authority that would take the instant case outside the purview of that general rule. ²⁶Moreover, U.S. Bancorp & Consol. Subs. v. Commissioner, 111 T.C. at 242, and Pig & Whistle Co. v. Commissioner, 9 B.T.A. at 670, held that costs paid or incurred to cancel a lease and enter into a new lease must be amortized and deducted over the term of the new lease. On the record before us, we find that petitioner is required to amortize and deduct the expenditures at issue over the term of the modified 1985 sale and leaseback agreements ending with taxable year 2020.²⁷

*159 Based on our examination of the entire record before us, we find that petitioner has failed to carry its burden of establishing that the Court should not sustain respondent's determinations that the expenditures at issue should be capitalized and amortized and deducted over the term of the modified 1985 sale and leaseback agreements beginning with taxable year 1995 and ending with taxable year 2020. ²⁸

We have considered all of the contentions and arguments of petitioner and respondent that are not discussed herein, and we find them to be without merit, irrelevant, and/or moot.

To reflect the foregoing and the concessions of the parties,

Decision will be entered under Rule 155.