Texas Instruments Inc. v. C.I.R., 052792 FEDTAX, 32707-88

Docket Nº:32707-88.
Opinion Judge:COHEN, JUDGE:
Party Name:TEXAS INSTRUMENTS INCORPORATED AND ITS CONSOLIDATED SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Attorney:John S. Nolan, Alexander Zakupowsky, Jr., Jean A. Pawlow, Robin L. Greenhouse, and Robert E. Liles, II, for petitioner. Deborah A. Butler, John S. Repsis, and Gary D. Kallevang, for respondent.
Case Date:May 27, 1992
Court:United States Tax Court
 
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63 T.C.M. (CCH) 3070

TEXAS INSTRUMENTS INCORPORATED AND ITS CONSOLIDATED SUBSIDIARIES, Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 32707-88.

United States Tax Court

May 27, 1992

John S. Nolan, Alexander Zakupowsky, Jr., Jean A. Pawlow, Robin L. Greenhouse, and Robert E. Liles, II, for petitioner.

Deborah A. Butler, John S. Repsis, and Gary D. Kallevang, for respondent.

TABLE OF CONTENTS
Issue 1: Long-Term Contract and Overhead Adjustments 5
FINDINGS OF FACT 5
Background 5
Overview of Petitioner's Accounting System 6
Costs Allocated Through Petitioner's 4000 and 6000 Series Accounts 11
Costs in Petitioner's 8000 Series Accounts 15
Casualty Loss 17
Profit in Asset Depreciation 17
Purchase Cash Discounts 19
Rework Labor and Scrap 19
Tax Treatment 20
OPINION 23
Completed Contract Rules 23
The Parties' Positions 25
Expert Testimony 26
Change in Method of Accounting 27
Respondent's Adjustments to Overhead Variances 41
Respondent's Affirmative Claim 46
Casualty Loss 49
PIA Depreciation 50
Purchase Cash Discounts 51
Rework Labor and Scrap 53
Issue 2: Petitioner's Rebate Program 54
FINDINGS OF FACT 54
Rebate History 54
TI-59 Rebate Program 55
The Home Computer Rebate Program 57
The Learning Aids Rebate Program 60
The Speech Synthesizer Rebate Program 62
OPINION 64
Issue 3: Investment Tax Credit Issue 72
FINDINGS OF FACT 72
Waste Treatment Facilities 73
Drywall Partitions 78
Miscellaneous Structures and Related Equipment 80
Floors 83
Window Walls 85
Ceilings 86
Air Conditioning 88
Plumbing 89
Emergency Doors 89
Fire Protection Systems 90
Security Fencing 92
Landscaping 93
Electrical Equipment 94
Category One 95
Category Two 97
Category Three 99
Category Four 101
OPINION 103
Waste Treatment Facilities 109
Drywall Partitions 116
Miscellaneous Structures and Related Equipment 120
Floors 125
Window Walls 128
Ceilings 131
Air Conditioning 133
Plumbing 134
Emergency Doors 135
Fire Protection Systems 136
Security Fencing 139
Landscaping 141
Electrical Equipment 142
Category One 146
Category Two 149
Category Three 153
Category Four 155
MEMORANDUM FINDINGS OF FACT AND OPINION COHEN, JUDGE: Respondent determined deficiencies of $34,450,765, $172,714, and $39,777,526 in petitioner's Federal income tax for 1980, 1981, and 1982, respectively. In its petition, petitioner affirmatively asserted that it was entitled to overpayments of $2,530,408, $1,460,668, and $1,645,219 for 1980, 1981, and 1982, respectively. By Amendment to Answer, respondent set forth additional allegations to support respondent's claim that the correct deficiencies in petitioner's Federal income tax for 1980, 1981, and 1982 were $53,465,355, $2,099,681, and $53,221,461, respectively. The issues discussed in this opinion are: (1) Whether petitioner's treatment of certain indirect costs and overhead variances under the long-term contract method of accounting set forth in section 1.451-3, Income Tax Regs., was proper and whether petitioner is entitled to other related adjustments, (2) whether petitioner's treatment of its rebate programs under section 1.451-4, Income Tax Regs., was proper, and (3) whether certain property used in petitioner's manufacturing operations was " section 38 property" eligible for the investment tax credit. A fourth issue has been separated and disposed of by separate opinion filed this date. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. Because the pretrial stipulation process in this case was not adequate, the Court suggested posttrial stipulation of agreed facts that could be incorporated in our opinion. Based on the evidence, which included 3,696 pages of transcript and over 775 exhibits, the parties filed with the Court 188 pages covering over 410 joint proposed findings of fact with respect to the issues for decision in this opinion. The parties also requested in 79 pages of their briefs that we find an additional 320 facts. It is not reasonable to reproduce here all of the findings requested by the parties. We have therefore endeavored to set forth only those findings that are necessary to explain and to dispose of the issues for decision in this opinion. The other agreed facts are incorporated in our findings by this reference. For convenience, we have set forth below separately our findings of fact and opinion with respect to each issue. Texas Instruments Incorporated (petitioner) was a publicly held corporation organized under the laws of Delaware with its principal place of business in Dallas, Texas. Petitioner was an accrual method taxpayer that employed other specialized accounting methods in reporting various items of income and expenses for Federal income tax purposes. Petitioner timely filed consolidated Federal income tax returns (Forms 1120) for the taxable years ended December 31, 1980, December 31, 1981, and December 31, 1982. ISSUE 1: LONG-TERM CONTRACT AND OVERHEAD ADJUSTMENTS FINDINGS OF FACT BACKGROUND Petitioner's Equipment Group division (EG) contracted to manufacture equipment for various departments of the United States Government and some foreign governments. Eighty to eighty-five percent of the EG's business, in terms of value, was long-term contracts, and a majority of those contracts (over 2,000) were with the United States Government. Prior to 1979, petitioner used the percentage of completion method of accounting for cost plus contracts and the accrual shipment method of accounting for fixed price contracts, with inventories valued at the lower of cost or replacement cost. In 1979, petitioner filed with respondent a Form 3115, Application for Change in Accounting Method, requesting permission to change its method of accounting for long-term contracts in the EG to the completed contract method. On January 4, 1980, respondent granted to petitioner permission to change to the completed contract method. OVERVIEW OF PETITIONER'S ACCOUNTING SYSTEM Petitioner maintained a uniform chart of accounts for financial planning and reporting purposes that was organized in the following nine major account groups or series:
Series Number Accounts
1000 Assets
2000 Liability and Stockholders Equity
3000 Revenue, Cost, and Adjustment
4000 Manufacturing Overhead
5000 Service Operations Expense
6000 Research and Engineering Overhead
7000 Marketing Expense
8000 General and Administrative
9000 Other Income and Deductions
Indirect costs were initially charged to the 4000, 5000, 6000, 7000, or 8000 series accounts, depending on the type of cost. Subsequent reclassifications were made to the initial account charges. Certain types of accounts, known as clearing accounts, were used to collect costs in one series and the costs were then charged to other accounts in other series to account for the use of a service or property. Petitioner charged direct labor and direct materials to its 1000 series accounts directly or through adjustments from other accounts. At the beginning of each year, the EG developed overhead application rates for the 4000 and 6000 series accounts. The purpose of those rates was to charge to petitioner's long-term contracts certain indirect costs (overhead) by reference to actual direct labor costs charged to those contracts. Petitioner set its overhead application rates high to motivate its managers and because it was petitioner's policy not to overstate its inventory. To determine the overhead application rates, petitioner estimated the annual overhead costs expected to be incurred, aggregated the accounts into pools, and divided the expected dollars in each pool by the expected direct labor costs for that year. The total estimated costs of all the 4000 and 6000 pools were divided by the total of estimated direct manufacturing and engineering labor dollars, respectively, to derive the overhead application rates. Those rates were expressed as percentages. By application of the manufacturing overhead rate, each dollar incurred for direct manufacturing labor resulted in an automatic charge (debit) of manufacturing overhead (4000 series account) to the same 1000 series account as the manufacturing direct labor dollar was charged. Similarly, by application of the engineering overhead rate, each dollar incurred for direct engineering labor resulted in an automatic charge of engineering overhead (6000 series account) to the same 1000 series account as the engineering direct labor dollar was charged. Thus, through the overhead rates, costs in accounts and cost centers in the manufacturing and engineering pools (4000 and 6000 series accounts, respectively) were applied to and became a part of the costs of long-term contracts with manufacturing and engineering direct labor hours. As each debit was made to a 1000 series account for application of the manufacturing and engineering overhead, a corresponding credit was made to account 4910 (manufacturing) or 6910 (engineering). This applied overhead was charged to project inventory and credited to accounts 4910 and 6910 at the standard overhead rates. Actual manufacturing and engineering overhead costs were charged to all...

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