192 1068 1999 Usa v. Usa 1068 192 1068 1999 Usa v. 98 5362 For the District of Columbia Circuit

• Decision Date: 15 October 1999
• Docket Number: No. 98-5361,98-5361
• Citation: 192 F.3d 1068
• Parties: Page 1068 192 F.3d 1068 (D.C. Cir. 1999) Telecom*USA, Inc., and subsidiaries, Appellants v. United States of America, Appellee Consolidated with 98-5362 United States Court of Appeals FOR THE DISTRICT OF COLUMBIA CIRCUIT
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 1068

192 F.3d 1068 (D.C. Cir. 1999)

Telecom*USA, Inc., and subsidiaries, Appellants v United States of America, Appellee

No. 98-5361 Consolidated with 98-5362

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued April 6, 1999

Decided October 15, 1999

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 Justice, 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 subsidiaries, and MCI Communications Corporation and its subsidiaries, (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 Congress 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 considered 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. 167(a); 26 U.S.C. 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. 167(b)(1) (1988); 26 C.F.R. 1.167(b)-1. Various other methods of depreciation also have been permitted. See, e.g., 26 U.S.C. 167(b)(2) (1988) (double declining balance method); id. 167(b)(3) (sum of the years-digits method); see 26 C.F.R. 1.167(b)-2, 1.167(b)-3.

In the Economic Recovery Tax Act of 1981 (ERTA), Congress adopted a new set of depreciation rules called the Accelerated Cost Recovery System (ACRS). See Pub. L. No. 97-34, sec. 201(a), 168, 95 Stat. 172, 203 (codified as amended at 26 U.S.C. 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. 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, 168(f)(9), 95 Stat. at 216.

Although not as old as the depreciation deduction, the investment tax credit dates back to the Kennedy Administration and was also designed to stimulate the economy by encouraging investment. See Revenue Act of 1962, Pub. L. No. 87-834, 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. 46 (1982). The credit was a dollar-for-dollar offset against a taxpayer's tax liability, see id. 39(a), but could not be used if the taxpayer had insufficient tax liability for the year, see id. 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. 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 resources 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 depreciation deductions--would be reduced by 50% of the amount of the ITC. See Pub. L. No. 97-248, 205(a), 96 Stat. 324, 427 (codified at 26 U.S.C. 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 distorting 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, 211, 100 Stat. 2085, 2166-70 (codified as amended at 26 U.S.C. 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. 46; id. 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 significance 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 and subsequent years were reduced to 6.5%. See id. 49(c)(2), (c)(3)(B), (c)(5)(A). Second, the amount of the basis adjustment for purposes of determining depreciation was changed from 50% to 100% of the amount of the ITC. See id. 49(d)(1).

The following year, the Internal Revenue Service (IRS, or "the Service") issued a revenue ruling to guide taxpayers with respect to the operation of the 1986 amendments. See Rev. Rul. 87-113, 1987-2 C.B. 33. Example 1 of that ruling considered the case of a $1,000,000 machine purchased in 1985 and placed in service in 1986, the final 10% year. The ruling stated that under those circumstances, the taxpayer was entitled to an ITC of $100,000 (10% of the $1,000,000 cost) and had to reduce the machine's depreciable basis by 100% of that amount, (i.e., to $900,000).

But what if the taxpayer were unable to use the credit in 1986, and could not use it until 1988? Did the basis for depreciation deductions have to be reduced by the 10% credit available in 1986, the year the property was placed in service, or by the 6.5% credit available in 1988, the year to which the taxpayer carried the credit forward? Example 3 of Revenue Ruling 87-113 addressed that issue, and concluded that the basis had to be reduced by the amount of the credit available in the year the property was placed in service. In the example, the credit available to the company when the property was placed in service in 1986 was $100,000. Accordingly, following the 100% basis reduction rule, the basis had to be reduced to $900,000. This, the IRS concluded, was the case even though the amount of the credit the company received was only $65,000 when it was eventually used in 1988. The company, the IRS said, was "not allowed to increase its basis in the property to reflect the reduction in the investment credit carryforward." Id. at 35.

II

As Telecom acknowledges, its case presents the same situation as that addressed in Example 3 of Revenue Ruling 87-113, and the IRS has treated it in precisely the same way. See Telecom Br. at 18 n.12. Telecom owned transition properties 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 position. 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. Alternatively, Telecom argued that 26 U.S.C. 168, as construed in a proposed treasury regulation, entitled it to adjust its bases in the carryforward years to reflect the effective...