Telecom USA Inc v. United States

United States Court of Appeals FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued April 6, 1999 Decided October 15, 1999

No. 98-5361 Telecom*USA, Inc., and subsidiaries, Appellants v. United States of America, Appellee Consolidated with 98-5362

Appeals from the United States District Court for the District of Columbia (No. 96cv00258) (No. 96cv00259)

Albert H. Turkus argued the cause for appellants. With him on the briefs were Pamela F. Olson and Julia M. Kazaks.

Joan I. Oppenheimer, Attorney, U.S. Department of Jus- tice, argued the cause for appellee. With her on the brief were Loretta C. Argrett, Assistant Attorney General, Wilma A. Lewis, U.S. Attorney, and David I. Pincus, Attorney, U.S. Department of Justice.

Before: Wald, Randolph, and Garland, Circuit Judges. Opinion for the Court filed by Circuit Judge Garland. Garland, Circuit Judge: Telecom*USA, Inc. and its sub- sidiaries, and MCI Communications Corporation and its sub- sidiaries, (collectively, "Telecom"), appeal the district court's ruling that Telecom is not entitled to the income tax refund it seeks. The case concerns transition rules enacted by Con- gress in 1986 to cushion the impact of the repeal of the investment tax credit (ITC). Telecom's principal contention is that its basis in depreciable property should be reduced by the amount of ITC it received in the year to which it carried its ITC forward. Following the lead of the Federal Circuit and the Court of Federal Claims, the district court rejected this argument and held that Telecom must instead reduce its basis by the larger amount of ITC first available to it in the year in which it placed the property in service. We agree with the district court and the other courts that have consid- ered this issue, and affirm.

I

To put Telecom's claims in context, we begin with a brief history of the depreciation deduction and the ITC. The Internal Revenue Code has long provided for depreciation deductions through which a property owner can deduct the cost of its property over the property's useful life. See 26 U.S.C. s 167(a); 26 U.S.C. s 23(l ) (1934); United States v. Ludey, 274 U.S. 295, 297-300 (1927). Under the straight line method of depreciation, for example, an asset with an initial cost of $1,000,000, a salvage value of $50,000, and a useful life of 10 years would generate annual deductions of $95,000. See 26 U.S.C. s 167(b)(1) (1988); 26 C.F.R. s 1.167(b)-1. Vari- ous other methods of depreciation also have been permitted. See, e.g., 26 U.S.C. s 167(b)(2) (1988) (double declining bal- ance method); id. s 167(b)(3) (sum of the years-digits meth- od); see 26 C.F.R. ss 1.167(b)-2, 1.167(b)-3.

In the Economic Recovery Tax Act of 1981 (ERTA), Con- gress adopted a new set of depreciation rules called the Accelerated Cost Recovery System (ACRS). See Pub. L. No. 97-34, sec. 201(a), s 168, 95 Stat. 172, 203 (codified as amend- ed at 26 U.S.C. s 168). Intended to stimulate economic expansion, ACRS permits recovery of capital costs for most tangible depreciable property by using accelerated methods over predetermined periods that are generally shorter than the useful life of the asset. See 26 U.S.C. s 168(e)(1); S. Rep. No. 97-144, at 48 (1981). ACRS also eliminates the salvage value limitation, hence allowing the entire cost of the property to be depreciated. See ERTA, sec. 201, s 168(f)(9), 95 Stat. at 216.

Although not as old as the depreciation deduction, the investment tax credit dates back to the Kennedy Administra- tion and was also designed to stimulate the economy by encouraging investment. See Revenue Act of 1962, Pub. L. No. 87-834, s 2, 76 Stat. 960, 962-73; H.R. Conf. Rep. No. 87-2508, at 14 (1962). The most recent incarnation of the ITC, prior to amendment and repeal in 1986, gave taxpayers a one-time credit of 10% of the cost of the property. See 26 U.S.C. s 46 (1982). The credit was a dollar-for-dollar offset against a taxpayer's tax liability, see id. s 39(a), but could not be used if the taxpayer had insufficient tax liability for the year, see id. s 46(a)(3). The unused credits could, however, be carried back and carried forward a specified number of years to reduce the taxpayer's liabilities in those years. See id. s 46(b).

The combined use of ITCs and depreciation deductions gave taxpayers generous benefits. For an asset costing $1,000,000, the taxpayer could both claim an ITC of $100,000 (10% of the cost) and deduct $1,000,000 worth of depreciation (the full cost of the asset). In 1982, Congress concluded that this combination was distorting the allocation of capital re- sources and determined to reduce the level of benefits. See S. Rep. No. 97-494, at 122 (1982). A new provision, enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), provided that an asset's "basis"--the value of the property used to determine the total available deprecia- tion deductions--would be reduced by 50% of the amount of the ITC. See Pub. L. No. 97-248, s 205(a), 96 Stat. 324, 427 (codified at 26 U.S.C. s 48(q)(1) (1982)). Hence, although an asset originally costing $1,000,000 would continue to yield an ITC of $100,000, it would generate a total of only $950,000 worth of depreciation ($1,000,000 minus 50% of the $100,000 credit).

In 1986, Congress concluded that the ITC was still distort- ing investment activity by channeling too much investment into tax-favored sectors. See S. Rep. No. 99-313, at 96 (1986). Thus, in the Tax Reform Act of 1986, Congress repealed the ITC for property purchased in 1986 and thereafter. See Pub. L. No. 99-514, s 211, 100 Stat. 2085, 2166-70 (codified as amended at 26 U.S.C. s 49(a) (1988)).1 It made an exception, however, for "transition property"--property purchased prior to 1986 but placed in service in 1986 or later. For such property, the ITC was phased out over a number of years. For calendar year taxpayers, transition property placed in service in 1986 received the full 10% credit; property placed in service in 1987 received a reduced credit of 8.25% of cost; and property placed in service in 1988 or later received a credit of only 6.5%. See 26 U.S.C. s 46; id. s 49(b), (c)(1), (c)(3)(A), (c)(5)(A) (1988).2 The phased reduction is known colloquially as the ITC "haircut."

The 1986 amendments included two other changes of signif- icance for this case. First, the haircut was also applied to credits carried forward from the year in which they were first available to the taxpayer. Credits carried forward for use in 1987 were reduced to 8.25%; those carried forward to 1988 87-113, and the IRS has treated it in precisely the same way. See Telecom Br. at 18 n.12. Telecom owned transition prop- erties placed in service in calendar years 1986 and 1987. The ITC percentages available for those properties in those years were 10% and 8.25%, respectively. When calculating its depreciation deductions in the years the properties were placed in service, Telecom reduced its bases by amounts that reflected those percentages. Telecom was unable to use its ITCs immediately, however, because it had insufficient tax liabilities in those years; it therefore carried the credits forward to 1989 and thereafter. Under the ITC haircut, the percentage received by Telecom in those years was only 6.5%.3

Telecom filed claims for refunds with the IRS, seeking the additional depreciation deductions it could have taken had it calculated its properties' bases using the ITCs it actually received. The IRS denied the claims, and Telecom filed refund actions in the district court. Telecom advanced one principal theory and two alternatives in support of its posi- tion. Its principal contention was that several interconnected provisions of the Internal Revenue Code permitted it to amend its earlier returns by adjusting its properties' bases upward to reflect the amounts of ITC it actually used. Alter- natively, Telecom argued that 26 U.S.C. s 168, as construed in a proposed treasury regulation, entitled it to adjust its bases in the carryforward years to reflect the effective change in the cost of its properties brought about by the haircut applied when its ITCs were carried forward. As a second alternative, Telecom contended that 26 U.S.C. s 196, which provides deductions for portions of tax credits that a taxpayer has not been allowed to use, entitled it to deductions for the difference between the amounts of ITC allowable in the initial and carryforward years.

The district court rejected Telecom's arguments on cross- motions for summary judgment. See MCI Communications Corp. v. United States, 26 F. Supp. 2d 6 (D.D.C. 1998). Relying both on Revenue Ruling 87-113 and on the opinion of the U.S. Court of Appeals for the Federal Circuit in B.F. Goodrich Co. v. United States, 94 F.3d 1545 (Fed. Cir. 1996), which denied a taxpayer's virtually identical claim, the court rejected Telecom's argument that it should be permitted to adjust its original basis. The court also rebuffed Telecom's alternative efforts to utilize sections 168 and 196, holding those sections inapplicable to the circumstances at issue here.

III

On appeal, Telecom presses all of the arguments it raised below. There are no factual disputes, and we review the district court's grant of summary judgment de novo. See Tao v. Freeh, 27 F.3d 635, 638 (D.C. Cir. 1994). To decide this case, we must analyze the interplay of three quite technical statutory provisions. Fortunately, we are not left wholly to our own devices, but rather are assisted by two important interpretive guides. Equally fortunate, the two point in the same direction.

The first guide instructs that a taxpayer who seeks a deduction bears the burden of demonstrating a clear entitle- ment. See New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934) ("[O]nly as there is clear provision therefor can any particular deduction be allowed."); Lenkin v. District of Columbia, 461 F.2d 1215, 1225 (D.C. Cir. 1972) (applying New Colonial Ice rule to depreciation deductions); cf. United States v. Centennial Sav. Bank FSB, 499 U.S. 573, 583-84 (1991) (citing "rule that tax-exemption and -deferral provi- sions are to be construed narrowly"); United States v. Wells Fargo Bank, 485 U.S. 351, 354-55 (1988) ("[E]xemptions from taxation are not to be implied; they must be unambiguously proved."). At oral argument, Telecom agreed that it bears this burden, but insisted that its entitlement to deductions is clear.

The second interpretive guide requires us to accord at least some deference to the IRS' revenue ruling. Although a revenue ruling does not have the force and effect of Treasury Department Regulations, see 26 C.F.R. s 601.601(d)(2)(v)(d), it does constitute "an official interpretation by the Service," id. s 601.601(d)(2)(i)(a). Accordingly, the Supreme Court and virtually all of the Circuits have indicated that revenue rulings are entitled to some degree of deference.4

In Davis v. United States, 495 U.S. 472, 484 (1990), the Court indicated that revenue rulings are entitled to "consider- able weight where they involve the contemporaneous con- struction of a statute and where they have been in long use"5 --two conditions that are roughly satisfied here.6 Davis did

Telecom's first contention is that depreciation deductions are governed by a principle of "full cost recovery"--i.e., allowing taxpayers to use depreciation to deduct the full amount of their investments--and that only its interpretation of the interaction between depreciation deductions and the ITC ensures such recovery. Telecom argues that "[i]n eco- nomic terms, the investment tax credit can be viewed as the government's co-investment in a taxpayer's property." Tele- com Br. at 9. Thus, to determine the taxpayer's "share" of the investment, the ITC must be deducted from the proper- ty's initial cost. To ensure full cost recovery, the taxpayer must then be permitted to deduct the balance as depreciation.

Translating this analysis to our simplified example, Tele- com's contention is that, because it received a $65,000 credit on a $1,000,000 investment when it used its ITC in 1989 (when the ITC percentage was 6.5%), its share of the invest- ment in the property was $935,000. Accordingly, $935,000 should be the basis used to calculate its depreciation deduc- tions. Under the IRS' view, however, Telecom was required to subtract $100,000 from the asset's $1,000,000 cost to arrive at its basis, because the property was placed into service in 1986 (when the ITC percentage was 10%). According to Telecom, limiting its deductions to the resulting basis, $900,000, renders it unable to recover its full costs.

The government's first response is that depreciation deduc- tions and the tax basis upon which they are computed must be determined by application of the provisions of the Internal Revenue Code, and not by appeal to notions of "full cost recovery"--a concept unmentioned in the Code. Whatever the merit of this dispute regarding the policy underlying the depreciation deduction,22 however, the question at issue here involves the interrelationship between the depreciation deduc- tion and the ITC. While Telecom contends that the ITC __________

22 In Lenkin v. District of Columbia, we said that in interpreting a statutory section that "leaves for the courts the definition of basis for 'reasonable' depreciation allowances, their polestar is a basis that will enable the taxpayer to recover his investment in the asset." 461 F.2d at 1229 (interpreting D.C. Code s 47-1583e (Supp. IV should be viewed as "economically" equivalent to a govern- ment investment in the taxpayer's property, over the years Congress has offered a number of far more general rationales for the different combinations of depreciation deductions and ITCs it has enacted.23 Indeed, even Telecom concedes that a principle of full cost recovery cannot explain why in most years prior to the enactment of TEFRA (1982) basis did not have to be reduced by ITC at all, or why between TEFRA and the Tax Reform Act of 1986 basis had to be reduced by only 50% of ITC. Fine-tuning the principle assertedly at issue here, Telecom argues that although these provisions permitted more than full cost recovery, Congress has never permitted less. This fine-tuning, however, weakens the over- all coherence of the principle Telecom urges us to follow.

The government further argues that notwithstanding the basis adjustment Telecom was required to make, the company __________ 1971)). Sections 46, 48 and 49, however, do not leave the measure of basis "for the courts" to determine. Moreover, even Telecom concedes that a policy of full cost recovery cannot explain ERTA's 1981 elimination of the requirement that basis be reduced by salvage value, which plainly permits the recovery of more than the asset's full cost. See 26 U.S.C. s 168(f)(9) (1982). Telecom has a similar problem explaining ERTA's adoption of ACRS itself, which permits accelerated depreciation schedules over predetermined pe- riods generally shorter than the useful life of an asset, and hence permits taxpayers to take full depreciation deductions before an asset's true useful life has ended. See Simon v. Commissioner, 68 F.3d 41, 44-45 (2d Cir. 1995); Liddle v. Commissioner, 65 F.3d 329, 334 (3d Cir. 1995); S. Rep. No. 97-144, at 48.

23 See, e.g., S. Rep. No. 99-313, at 96 (concluding that repeal of ITC would permit "[a] large reduction in the top corporate tax rate" and thereby "encourag[e] the efficient allocation of all resources"); S. Rep. No. 97-494, at 123 (concluding that under TEFRA, the combination of ACRS deductions and the ITC would "provide investment incentives comparable to those in a system without an income tax"); cf. Simon, 68 F.3d at 44-45 (noting that ERTA "altered the depreciation scheme" for "reasons other than sound accounting practice," particularly "as a stimulus for economic growth"). has already recovered more than the full cost of its invest- ments. As the government notes, a tax credit is a dollar-for- dollar reduction in a taxpayer's tax liability. A deduction, on the other hand, is a dollar-for-dollar reduction in the taxable income used to compute tax liability, and thus only reduces taxes by an amount equal to the deduction multiplied by the taxpayer's marginal rate. Hence, for a taxpayer like Telecom which was in the 34% marginal bracket, a tax credit of $10 is roughly equivalent to a tax deduction of $30. Applying this analysis to Telecom's actual tax situation, the government calculates that the combination of Telecom's depreciation deductions and the deduction-value of its ITCs substantially exceeded its total investment in the transition properties. See Gov't Br. at 40 (citing First Stipulation of Facts at 7 (J.A. 65)). Although Telecom rightly notes that (at least initially) Congress intended the ITC to have an incentive effect in addition to the benefit of depreciation deductions, the govern- ment's argument does take some of the air out of Telecom's claim not to have recovered its economic costs. Moreover, we must be cognizant of the fact that we are dealing with transition rules here, and that regardless of Congress' initial rationale for the combination of the ITC and depreciation deduction, we have little indication of what Congress' inten- tions were for the transition--other than there be a phase-out period that would inevitably involve some compromise be- tween the goal of more efficient resource allocation, see S. Rep. No. 99-313, at 96, and a concern for fair treatment of investors' reasonable expectations.

Telecom contends that its interpretation of the statute is compelled by a second principle of tax policy as well--i.e., that similarly situated taxpayers must be treated in the same way. Taxpayers who place property in service in the same year should be treated the same, Telecom argues. This assertedly can only be accomplished if a taxpayer who cannot use a credit in that year is permitted to recover as much of his investment cost as one who can.

We are not persuaded by Telecom's argument. Taxpayers who place property in service in the same year are treated the same under Revenue Ruling 87-113. All such taxpayers have available to them the same ITC and the same basis reduction, if they can use the credit in that year. The differential impact of which Telecom complains is not due to the revenue ruling, but rather to Telecom's individual tax situation--that is, to the fact that it had insufficient tax liability in the current year to make the ITC useful. Indeed, many of the Internal Revenue Code's provisions, although neutral on their face, have a differential impact depending upon taxpayers' individual circumstances, yet we generally do not regard that as a sign of inequitable disparate treatment.24 In any event, the indeterminacy of the application of this principle to the question before us makes it an insufficient ground for rejecting the IRS' reasonable interpretation of the statutory language. See B.F. Goodrich, 94 F.3d at 1550 ("Nor are we convinced by Goodrich's hypotheticals that the alleged inconsistencies between so-called 'similarly situated taxpayers' warrant a construction which departs from the language enacted by Congress.").

In sum, we conclude that neither of Telecom's appeals to tax policy generates a principle sufficiently clear either to meet its burden of showing an entitlement to the deduction it seeks, or to overcome even a minimal level of deference to Revenue Ruling 87-113.25

V

As alternatives to its argument under sections 46, 48, and 49, Telecom offers two other grounds for its refund claims. __________

24 Even the ITC, in its pre-1986 incarnation, had such a differen- tial effect. Although a company that had to carry its credit forward several years would ultimately receive nominally the same ITC as a company that could use it immediately, it would enjoy significantly less present value.

25 In light of our resolution of this issue, we need not consider the weight of the government's reference to its own "principle of tax policy"--namely, the principle that tax accounting generally pro- ceeds on a year-by-year basis, and that tax determinations general- ly are based on events occurring in the taxable year. See Gov't Br. at 45 (citing 26 U.S.C. s 441).

First, it contends that even if those sections do not entitle it to reach back to the years it put its property into service, "section 168 and its accompanying regulations" entitle it to increase its basis beginning in 1989--the year it actually used the ITC. Telecom, however, does not point to any specific language in section 168, which sets out the details of the Accelerated Cost Recovery System, to support this proposi- tion. Indeed, its briefs do not quote the language of section 168 at all.

Nor does Telecom point to any "accompanying regula- tions," at least not to any that have been enacted. Instead, it rests its claim upon the language of a proposed Treasury regulation, Prop. Treas. Reg. s 1.168-2(d)(3), 49 Fed. Reg. 5940, 5945-46 (1984). That regulation, proposed in 1984, cannot serve as the basis of any entitlement because it was never adopted. But even if it could, it would have no application here. The proposed regulation provides for the redetermination of an asset's depreciable basis when the cost of the asset changes in a subsequent year, "e.g., due to contingent purchase price or discharge of indebtedness." Id. It offers as an example the case of a buyer who pays additional consideration for an asset after the year of its initial purchase because the purchase price was partially contingent on gross profits from the operation of the asset. Notwithstanding Telecom's claim that the haircut on ITC carryforwards represents the same "economic reality," there is no indication that the proposed regulation was intended to cover such a statutorily required reduction. That is hardly surprising, of course, since the Treasury Department pro- posed the regulation two years before Congress enacted the haircut.

As a second alternative, Telecom contends that it is entitled to a deduction pursuant to section 196(a), which permits taxpayers to take a deduction for certain unused business credits. That section provides:

If any portion of the qualified business credits deter- mined for any taxable year has not, after the application of section 38(c), been allowed to the taxpayer as a credit under section 38 for any taxable year, an amount equal to the credit not so allowed shall be allowed to the taxpayer as a deduction for the first taxable year following the last taxable year for which such credit could, under section 39, have been allowed as a credit.

26 U.S.C. s 196(a). Section 38(c), referenced in section 196, bars a taxpayer from taking the ITC in excess of its income tax liability in a given year, and is the reason Telecom could not use the credit in 1986 or 1987. Telecom contends that section 38(c), "in conjunction with the application of the ITC haircut to the ITC carryforwards," barred it "from taking the full ITC to which it was originally entitled." Telecom Br. at 33. According to Telecom, "[s]ection 196(a) provides a reme- dy for this incomplete cost recovery: it allows taxpayers to take deductions in the amounts of the ITC reduced by the haircut, thereby fully recovering their investment costs." Id.

Without deciding whether section 196(a) can ever provide a deduction to make up for the amount of the ITC haircut,26 we agree with the Federal Circuit that the deduction contemplat- ed by section 196(a) simply does not apply until, in the words of the section, "the first taxable year following the last taxable year for which such credit could, under section 39, have been allowed as a credit." Since section 39 provides that Telecom's credits may be carried forward for fifteen __________

26 The district court held that "[s]ection 196(a) authorizes deduc- tions for carryforward credits that have expired" because the taxpayer had insufficient tax liabilities against which to offset them during the allowable carryforward period, "not for credits that are disallowed by reason of s 49(c)" and its statutory haircut. MCI, 26 F. Supp. 2d at 13; see S. Rep. No. 97-494, at 123 ("A deduction will be allowed equal to the amount of the basis adjustment in the event a credit for which a basis adjustment has been made expires at the end of the 15-year carryover period."); Rev. Rul. 87-113 (conclud- ing that "section 196 only applies to credits disallowed by reason of section 38(c), pertaining to tax limitation, and not to credits disal- lowed by reason of section 49(c)(1), (2) or (3)"); see also 26 U.S.C. s 49(c)(4) (1988) ("The amount of the reduction of the regular investment credit under paragraphs (1) and (2) shall not be allowed as a credit for any taxable year."). years,27 the section 196 deduction is not available until the expiration of that fifteen-year period. See B.F. Goodrich, 94 F.3d at 1550-51; see also S. Rep. No. 97-494, at 123.

In support of the claim that it is nonetheless entitled to take the deduction in 1989, Telecom argues that the "unique nature" of the ITC haircut for carryforwards, which once applied reduces the ITC forever, should make the year before the haircut the "last taxable year" for which the full credit could have been allowed. Telecom Br. at 33-34. Whatever the reasonableness of this argument as a matter of tax policy, it cannot overcome section 39's express reference to the fifteen-year carryforward period. Accordingly, we reject Telecom's final effort to secure a deduction.

VI

We uphold the interpretation of the Tax Reform Act re- flected in Revenue Ruling 87-113, and reject the two alterna- tive grounds Telecom offers in support of its refund claims. The decision of the district court, granting summary judg- ment for the United States, is therefore affirmed. __________

27 See 26 U.S.C. s 39(a)(1) (1988). Under the current Code, the carryforward period is 20 years. See id. s 39(a)(1) (Supp. III 1997).