Progress Energy 2004 Annual Report Download - page 108

IRS PROCEEDINGS
In September 2002, all of Progress Energy’s majority-
owned synthetic fuel entities were accepted into the IRS’s
Pre-Filing Agreement (PFA) program. The PFA program
allows taxpayers to voluntarily accelerate the IRS exam
process in order to seek resolution of specific issues.
In February 2004, subsidiaries of the Company finalized
execution of the Colona Closing Agreement with the IRS
concerning their Colona synthetic fuel facilities. The
Colona Closing Agreement provided that the Colona
facilities were placed in service before July 1, 1998, which
is one of the qualification requirements for tax credits
under Section 29. The Colona Closing Agreement further
provides that the fuel produced by the Colona facilities in
2001 is a “qualified fuel” for purposes of the Section 29 tax
credits. This action concluded the PFA program with
respect to Colona.
In July 2004, Progress Energy was notified that the IRS
field auditors anticipated taking an adverse position
regarding the placed-in-service date of the Company’s
four Earthco synthetic fuel facilities. Due to the auditors’
position, the IRS decided to exercise its right to withdraw
from the PFA program with Progress Energy. With the
IRS’s withdrawal from the PFA program, the review of
Progress Energy’s Earthco facilities is back on the normal
procedural audit path of the Company’s tax returns.
Through December 31, 2004, the Company, on a
consolidated basis, has used or carried forward
approximately $1.0 billion of tax credits generated by
Earthco facilities. If these credits were disallowed, the
Company’s one-time exposure for cash tax payments
would be $294 million (excluding interest), and earnings
and equity would be reduced by approximately
$1.0 billion, excluding interest. Progress Energy’s
amended $1.13 billion credit facility includes a covenant
that limits the maximum debt-to-total capital ratio to 68%.
This ratio includes other forms of indebtedness such as
guarantees issued by PGN, letters of credit and capital
leases. As of December 31, 2004, the Company’s debt-to-
total capital ratio was 60.7% based on the credit
agreement definition for this ratio. The impact on this ratio
of reversing approximately $1.0 billion of tax credits and
paying $294 million for taxes would be to increase the
ratio to 65.7%.
On October 29, 2004, Progress Energy received the IRS
field auditors’ report concluding that the Earthco facilities
had not been placed in service before July 1, 1998, and
that the tax credits generated by those facilities should be
disallowed. The Company disagrees with the field audit
team’s factual findings and believes that the Earthco
facilities were placed in service before July 1, 1998. The
Company also believes that the report applies an
inappropriate legal standard concerning what constitutes
“placed in service.” The Company intends to contest the
field auditors’ findings and their proposed disallowance of
the tax credits.
Because of the disagreement between the Company and
the field auditors as to the proper legal standard to apply,
the Company believes that it is appropriate and helpful to
have this issue reviewed by the National Office of the
IRS, just as the National Office reviewed the issues
involving chemical change. Therefore, the Company is
asking the National Office to clarify the legal standard
and has initiated this process with the National Office.
The Company believes that the appeals process,
including proceedings before the National Office, could
take up to two years to complete; however, it cannot
control the actual timing of resolution and cannot predict
the outcome of this matter.
In management’s opinion, the Company is complying with
all the necessary requirements to be allowed such credits
under Section 29, and, although it cannot provide certainty,
it believes that it will prevail in these matters. Accordingly,
while the Company adjusted its synthetic fuel production
for 2004 in response to the effects of expenses incurred
due to the hurricane damage and its impact on 2004 tax
liability, it has no current plans to alter its synthetic fuel
production schedule for future years as a result of the IRS
field auditors’ report. However, should the Company fail to
prevail in these matters, there could be material liability for
previously taken Section 29 tax credits, with a material
adverse impact on earnings and cash flows.
PROPOSED ACCOUNTING RULES
FOR UNCERTAIN TAX POSITIONS
In July 2004, the FASB stated that it plans to issue an
exposure draft of a proposed interpretation of SFAS No.
109, “Accounting for Income Taxes” (SFAS No. 109), that
would address the accounting for uncertain tax positions.
The FASB has indicated that the interpretation would
require that uncertain tax benefits be probable of being
sustained in order to record such benefits in the financial
statements. The exposure draft is expected to be issued in
the first quarter of 2005. The Company cannot predict what
actions the FASB will take or how any such actions might
ultimately affect the Company’s financial position or results
of operations, but such changes could have a material
impact on the Company’s evaluation and recognition of
Section 29 tax credits.
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Notes to Consolidated Financial Statements