Ball, Ball and Brosamer, Inc. v. C.I.R.

• Citation: 964 F.2d 890
• Decision Date: 14 May 1992
• Docket Number: No. 91-70047,91-70047
• Parties: -1310, 92-1 USTC P 50,263 BALL, BALL AND BROSAMER, INC., Ball and Brosamer, J.V., a Joint Venture, Ball, Ball and Brosamer, Inc., Tax Matters Partner, Petitioners-Appellees, v. COMMISSIONER INTERNAL REVENUE SERVICE, Respondent-Appellant.
• Court: United States Courts of Appeals. United States Court of Appeals (9th Circuit)

Page 890

964 F.2d 890

69 A.F.T.R.2d 92-1310, 92-1 USTC P 50,263

BALL, BALL AND BROSAMER, INC., Ball and Brosamer, J.V., a Joint Venture, Ball, Ball and Brosamer, Inc., Tax Matters Partner, Petitioners-Appellees, v. COMMISSIONER INTERNAL REVENUE SERVICE, Respondent-Appellant.

No. 91-70047.

United States Court of Appeals Ninth Circuit.

Argued and Submitted March 10, 1992.

Decided May 14, 1992.

Fielding H. Lane, Thelen, Marrin, Johnson & Bridges, San Francisco, Cal., for petitioners-appellees.

Steven W. Parks, U.S. Dept. of Justice, Washington D.C., for respondent-appellant.

Appeal from a Decision of the United States Tax Court.

Before: REINHARDT, NOONAN and THOMPSON, Circuit Judges.

DAVID R. THOMPSON, Circuit Judge:

In this appeal we consider the question whether profit on a construction contract should have been reported in 1983 instead of 1984 for federal income tax purposes under the completed contract method of accounting.

In 1982, the partnership of Ball, Ball and Brosamer, Inc., and Ball and Brosamer ("the partnership"), contracted with the Army to construct an extended runway, and perform related work, as part of a $500 million project for the construction of a space shuttle complex at Vandenberg Air Force Base in California. By the end of 1983, the partnership had completed almost all of its work on the project. The remaining work was completed in 1984. In that year, the Army accepted the partnership's performance under the contract. The partnership reported its profit as income in 1984.

The Commissioner determined that under the completed contract method of accounting, the partnership should have reported its profit in 1983. By administrative adjustment, it increased the partnership's 1983 income by the profit reported in 1984.

The partnership filed a petition in the tax court for readjustment of partnership items under 26 U.S.C. § 6226. The tax court determined that the partnership had not completed the contract until 1984, and therefore it had properly reported its profit in that year. Ball, Ball & Brosamer v. Commissioner, 60 T.C.M. (CCH) 587 (1990). The Commissioner appeals. We have jurisdiction under 26 U.S.C. § 7482, and we affirm.

DISCUSSION

We review decisions of the tax court on the same basis as decisions in civil bench trials in district court, Mayors v. Commissioner, 785 F.2d 757, 759 (9th Cir.1986), with no special deference paid to the tax court's conclusions of law. Pacific First Fed. Sav. Bank v. Commissioner, 961 F.2d 800, 802-03 (9th Cir.1992).

The issue whether the partnership's contract was completed in 1983 or 1984 for income tax purposes presents a mixed question of law and fact subject to de novo review. Guy F. Atkinson Co. of Cal. v The partnership's obligations under its contract were specified as: "Removal of existing bituminous runway pavement and replacement with concrete pavement; concrete runway extension overruns and shoulders; airfield lighting and NAVAIDS; regulator building; drainage; utility relocation; laser tracking system; and other appurtenant work; towway (V-80 partial); apron (V-19)." Ball, Ball & Brosamer, 60 T.C.M. (CCH), at 588.

                Commissioner, 814 F.2d 1388, 1391 (9th Cir.1987) (Atkinson), cert. denied, 485 U.S. 970, 108 S.Ct. 1246, 99 L.Ed.2d 444 (1988).   We note, however, that the Commissioner has latitude in the interpretation of the Internal Revenue Code.  Id
                

The partnership bid all of the work as a unit for an initial contract price of $19,976,745. During the course of the partnership's work, 57 written change orders were issued. These changes increased the contract price to $22,152,866.50.

In August 1983, a ribbon-cutting ceremony was held on the runway at Vandenberg Air Force Base in recognition of the progress made on the project. A month later, the Army took beneficial occupancy of the runway, apron and appurtenant facilities, and placed them in regular service.

In 1984, pursuant to its contract, the partnership completed the removal of existing curbing and repaving in an apron area near the mate/de-mate facility, installed shields on the runway lights, corrected electrical problems with the regulator building's emergency generator, and painted numbers on power poles near the runway. The Army accepted completion of the contract in 1984.

Payments to the partnership were based upon estimates of the partnership's progress on the job. The Army's performance report for the period ending December 31, 1983, reflected that all elements of the contract were approximately 100% complete. Using the percentage of completion method to determine substantial completion of long-term contracts, the partnership reported the entire contract price as earned on its financial statements for the period ending November 30, 1983. This resulted in a gross profit of $3,391,053. For income tax purposes, this profit was reported as earned in 1984.

Treasury Regulation § 1.451-3(d) provides that under the completed contract method of reporting income, "gross income derived from long-term contracts must be reported by including the gross contract price of each contract in gross income for the taxable year in which such contract is completed," as defined in section 1.451-3(b)(2). A long-term contract will not be "considered 'completed' until final completion and acceptance have occurred." Treas.Reg. § 1.451-3(b)(2)(i)(A) (as amended in 1986). "[A] taxpayer may not delay the completion of a contract for the principal purpose of deferring Federal income tax." Id.

Prior to 1982, the tax courts and the circuit courts of appeals differed in their interpretation of the words "final completion and acceptance." The tax courts interpreted the regulations as requiring only "substantial completion." See Ehret-Day Co. v. Commissioner, 2 T.C. 25, 34 (1943) (the regulations require that a building substantially completed in all important particulars except for minor defects be considered "completed"); Wohlfeld v. Commissioner, 17 T.C.M. (CCH) 677 (1958) (contract 98.26% complete is considered "complete" for purposes of the completed contract method of accounting); Gerwick v. Commissioner, 13 T.C.M. (CCH) 314 (1954) (contract in which 3/10 of 1% remained to be completed was "complete").

The circuit courts of appeals interpreted the phrase "finally completed and accepted" literally, requiring absolute completion. In E.E. Black, Ltd. v. Alsup, 211 F.2d 879, 880 (9th Cir.1954), we rejected the "substantial completion" doctrine applied in Ehret-Day because the doctrine imported "into the tax law an unwarranted and undesirable uncertainty." We held that even though a taxpayer received $44,000 in 1945, on a request for final payment, the contract was not finally completed and accepted until 1946 when thermostat units for the building's fire alarm system were installed and the remaining $553.50 due on the contract In 1982, Congress directed the Secretary of the Treasury to modify existing regulations in order to "clarify the time at which a contract is to be considered completed." Tax Equity and Fiscal Responsibility Act, Pub.L. No. 97-248, § 229(a)(1), 96 Stat. 324, 493 (1982). The Senate Finance Committee explained that the purpose of the legislation was to prevent unreasonable deferral of recognition of income "by reason of contractual obligations that are merely incidental to the taxpayer's obligation to build, construct, install, or manufacture the subject matter of the contract." S.Rep. No. 494, 97th Cong., 2d Sess. 200 (1982), U.S.Code Cong. & Admin.News 1982, pp. 781, 958.

was paid. Id.; see also Thompson-King-Tate, Inc. v. United States, 296 F.2d 290, 293-94 (6th Cir.1961) (following E.E. Black, Ltd. in holding that substantial completion is not "final completion and acceptance" under the regulations); Rice, Barton & Fales Inc. v. Commissioner, 41 F.2d 339, 341 (1st Cir.1930) (substantial completion of a contract is not the same as finally "completed and accepted").

In contrast to the old regulations, the amended ¹ regulations provide a new, factual test for determining when "completion" occurs:

Final completion and acceptance of a contract for Federal income tax purposes is determined from an analysis of all the relevant facts and circumstances, including the manner in which the parties to the contract deal with each other and with the subject matter of the contract, the physical condition and state of readiness of the subject matter of the contract, and the nature of any work or costs remaining to be performed or incurred on the contract.

Treas.Reg. § 1.451-3(b)(2)(i)(B). ² We apply this test and consider its three elements in order.

1. Did the parties deal with each other and with the subject matter of the contract as if the contract were completed in 1983?

The Commissioner argues that the partnership's financial statements establish that the contract was completed and accepted in 1983, because these statements reflect that 100% of the income from the job was "earned" as of November 30, 1983. We reject this argument.

Neil Wiley, a tax partner with the accounting firm that prepared the partnership's 1983 federal income tax return, testified that the partnership's 1983 financial statements were prepared under the "substantial completion" method of accounting. This accounting method does not purport to reflect the time of completion for tax purposes, nor does it reflect when the work required by a contract was actually completed and accepted.

We also reject the Commissioner's argument that the ribbon-cutting ceremony in 1983 establishes that the contract was completed at that time. The organizer of this event, Colonel Steven West, testified that the ceremony was designed as a media event. He testified that the purpose of the ceremony was to demonstrate the progress made on the runway, and on other work that was continuing with respect to the space shuttle complex. There is no evidence that the parties intended the ribbon-cutting event to signify completion...