AT&T, Inc. v. U.S.

• Decision Date: 04 January 2011
• Docket Number: No. 09-50651,09-50651
• Citation: 629 F.3d 505,107 A.F.T.R.2d 2011
• Court: U.S. Court of Appeals — Fifth Circuit
• Parties: AT&T, INC., Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

629 F.3d 505 107 A.F.T.R.2d 2011 AT&T, INC., Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee. No. 09-50651. United States Court of Appeals, Fifth Circuit. Jan. 4, 2011.

Stephen Victor D'Amore, Robert F. Denvir, Christopher James Stathopoulos, Winston & Strawn, L.L.P., Chicago, IL, Gregory G. Rapaway, Michael K. Kellogg (argued), Kellogg, Huber, Hansen, Todd, Evans & Figel, P.L.L.C., Washington, DC, Danny S. Ashby, K&L Gates, L.L.P., Dallas, TX, for Plaintiff-Appellant.

Francesca Ugolini Tamami (argued), Richard Bradshaw Farber, Supervisory Atty., Tax Div., App. Section, Gilbert Steven Rothenberg, Deputy Asst. Atty. Gen., U.S. Dept. of Justice, Washington, DC, for U.S.

Appeal from the United States District Court for the Western District of Texas.

Before BARKSDALE, DENNIS and OWEN, Circuit Judges.

DENNIS, Circuit Judge:

The issue in this federal income tax case is whether the plaintiff-taxpayer, AT&T Inc., an interstate telecommunications company, must pay income taxes on the funds it received from federal and state governmental entities for providing "universal service"— viz., affordable telephone service mainly for lower-income consumers and those in high-cost rural, remote or isolated areas—or else is entitled to treat those funds as nonshareholder contributions to capital under the Internal Revenue Code, see 26 U.S.C. § 118(a). The district court held that the taxpayer was not entitled to a refund of income taxes paid on the funds because the "universal service" support payments were income rather than capital contributions. We affirm the judgment of the district court.

BACKGROUND

"Universal service" refers to the goal, first announced in the Communications Act of 1934, " 'to make available, so far as possible, to all the people of the United States, ... a rapid, efficient, Nation-wide, and world-wide wire and radio communication service with adequate facilities at reasonable charges.' " Tex. Office of Pub. Util. Counsel v. FCC, 183 F.3d 393, 405-06 (5th Cir.1999) (quoting 47 U.S.C. § 151) (alteration made to reflect 1934 text); see also Alenco Commc'ns, Inc. v. FCC, 201 F.3d 608, 614 (5th Cir.2000).

The FCC is charged with the authority and duty of carrying out the universal service mandate. 47 U.S.C. §§ 151, 254, 256; Tex. Office of Pub. Util. Counsel, 183 F.3d at 405-06 . Originally, rather than relying on market forces alone, the FCC "used a combination of implicit and explicit subsidies" to promote universal service. Tex. Office of Pub. Util. Counsel, 183 F.3d at 406. "Explicit subsidies provide carriers or individuals with specific grants that can be used to pay for or reduce the charges for telephone service. This form of subsidy includes using revenues from line charges on end-users to subsidize [service to] high-cost [users] and to support the Lifeline Assistance program for low-income subscribers." Id. "Implicit subsidies are more complicated and involve the manipulation of rates for some customers to subsidize more affordable rates for others. For example, the regulators may require the carrier to charge 'above-cost' rates to low-cost, profitable urban customers to offer the 'below-cost' rates to expensive, unprofitable rural customers." Id.

"In 1996, Congress amended the Act to introduce competition into local telephone service, Telecommunications Act of 1996, Pub.L. No. 104-104, 110 Stat. 56, which had traditionally been provided through regulated monopolies." Rural Cellular Ass'n v. FCC, 588 F.3d 1095, 1098 (D.C.Cir.2009); see also 47 U.S.C. § 251 et seq. In doing so, "Congress recognized" that because the "system of implicit subsidies can work well only under regulated conditions," the existing system of universalservice support payments needed "to be re-examined." Tex. Office of Pub. Util. Counsel, 183 F.3d at 406.

"To attain the goal of local competition while preserving universal service, Congress directed the FCC to" (1) institute a Federal-State Joint Board to recommend changes in the FCC's regulations that define and implement universal service; and (2) implement the recommendations from the Joint Board by promulgating rules to carry them into effect. Id.; see also 47 U.S.C. § 254(a). Further, by § 254(b), Congress "direct[ed] the Joint Board and the Commission to base policies for the preservation and advancement of universal service on six enumerated principles, plus such 'other' principles as the Joint Board and the Commission may establish." Rural Cellular Ass'n, 588 F.3d at 1098. The enumerated principles are: (1) "Quality services should be available at just, reasonable, and affordable rates"; (2) "Access to advanced telecommunications and information services should be provided in all regions of the Nation"; (3) "Consumers in all regions of the Nation, including low-income consumers and those in rural, insular, and high cost areas, should have access to telecommunications and information services ... at rates that are reasonably comparable to rates charged for similar services in urban areas"; (4) "All providers of telecommunications services should make an equitable and nondiscriminatory contribution to the preservation and advancement of universal service"; (5) "There should be specific, predictable and sufficient Federal and State mechanisms to preserve and advance universal service"; and (6) "Elementary and secondary schools and classrooms, health care providers, and libraries should have access to advanced telecommunications services." 47 U.S.C. § 254(b).

The Telecommunications Act of 1996 also allowed the states to develop their own universal service support systems, so long as those "regulations [are] not inconsistent" with the FCC's rules "to preserve and advance universal service" in telecommunications. Id. § 254(f). Pursuant to this authority, California, Kansas and Texas adopted universal service regulations consistent with the FCC's rules.

The FCC mandate to provide universal service is now fulfilled through payments to telecommunications providers by a universal service fund ("USF"). In addition to the high-cost support program, which is designed mainly to provide affordable telephone service to consumers in high-cost rural or isolated areas, the USF supports programs for low-income customers, schools, libraries, and health care providers. "High-cost support disbursements, however, overwhelmingly represent the largest category of USF expenditures, accounting for 61.6 percent of USF disbursements in 2007." Rural Cellular Ass'n, 588 F.3d at 1099 (citing Fed.-State Joint Bd. on Universal Serv., Universal Service Monitoring Report tbl.1.11 (2008)). California, Kansas and Texas have instituted similar USFs in each state. Only the 1998 and 1999 payments to AT&T by those state USFs and by the federal USF are at issue in the instant case. AT&T claims that both federal and state payments should be treated as capital contributions, not income.

Support for the state and federal USFs comes from assessments, made by the USF administrators, the FCC, and the state utility commissions, requiring mandatory contributions to be paid by "all providers of telecommunications services." 47 U.S.C. § 254(b)(4); see also Tex. Util.Code Ann. § 56.022(a); Kan. Stat. § 66-2008(a). "Every telecommunications carrier that provides interstate telecommunicationsservices [must] contribute, on an equitable and nondiscriminatory basis, to the specific, predictable, and sufficient mechanisms established by the [FCC] to preserve and advance universal service." 47 U.S.C. § 254(d). Similarly, every "carrier that provides intrastate telecommunications services [must] contribute, on an equitable and nondiscriminatory basis, in a manner determined by the State to the preservation and advancement of universal service in that State." Id. § 254(f). "[C]ontributors almost always pass their contribution assessments through to their customers." Rural Cellular Ass'n, 588 F.3d at 1099 (citing Alenco Commc'ns, Inc., 201 F.3d at 620).

Pursuant to the statutory provisions and the FCC's and the states' rules, disbursements are calculated by the respective commissions and paid to the carriers providing federal and state universal services. The universal service payments are designed to offset the telephone companies' added costs or decreased revenue associated with servicing high-cost and low-income users. The USF payments for servicing high-cost users are based upon how much more than the average it costs to integrate those users into the telephone system. See 47 C.F.R. § 36.631; see also 16 Tex. Admin. Code § 23.133 (1999); Kan. Stat. § 66-2008(d); In re Rulemaking on the Commission's Own Motion into Universal Service and Compliance with the Mandates of Assembly Bill 3643, 68 CPUC 2d 524, 1996 WL 651546, at *1-2 (Cal.P.U.C.1996). The USF payments for servicing low-income users are designed to decrease or eliminate certain charges that those users would otherwise have had to pay. 47 C.F.R. §§ 54.403(b)-(c) (1997), 54.411(a); see also 16 Tex. Admin. Code § 23.142(d)(2) (1999). To be eligible to receive these disbursements of USF funds, a carrier must offer the services designated as "universal" by the FCC and advertise the availability of those services and the charges for such services. 47 U.S.C. § 214(e)(1).

From the state and federal USFs, AT&T received USF payments of $723.5 million in 1998 and $831.3 million in 1999. AT&T recorded these amounts as "revenue" for financial and regulatory accounting purposes. AT&T deposited these USF payments into its general bank account, along with other customer revenues, from which operating expenses and other costs were paid. AT&T did not earmark or track its use of the USF payments it received. On its 1998 and 1999 federal income tax returns, however, AT&T did not include its USF receipts in its gross income. As a result, AT&T did not pay $505,245,517 in income taxes on the payments it received from the USFs in 1998 and 1999. AT&T did, however, treat the...