U.S. v. Coastal Utilities, Inc., CV404-90.

• Decision Date: 28 March 2007
• Docket Number: No. CV404-90.,CV404-90.
• Citation: 483 F.Supp.2d 1232
• Parties: UNITED STATES of America, Plaintiff, v. COASTAL UTILITIES, INC., Defendant.
• Court: U.S. District Court — Southern District of Georgia

Page 1232

483 F.Supp.2d 1232

UNITED STATES of America, Plaintiff, v. COASTAL UTILITIES, INC., Defendant.

No. CV404-90.

United States District Court, S.D. Georgia, Savannah Division.

March 28, 2007.

James L. Coursey, Jr., U.S. Attorney's Office, Savannah, GA, Michael N. Wilcove, U.S. Dept. of Justice, Washington, DC, for Plaintiff.

Inman Gregory Hodges, Timothy D. Roberts, Oliver, Maner & Gray, LLP, Savannah, GA, Patrick Connors DiCarlo, Philip C. Cook, Matthew Sperry, Alston & Bird, LLP, Atlanta, GA, for Defendant.

ORDER

MOORE, Chief Judge.

Before the Court are Defendant Coastal Utilities, Inc.'s and Plaintiff United States of America's cross motions for summary judgment. (Docs. 30 & 36, respectively.) After careful consideration and for the following reasons, Defendant's motion is DENIED and Plaintiffs motion is GRANTED. Plaintiffs Motion to Strike (Doc. 52) is DENIED AS MOOT.

I. BACKGROUND

A. Summary of Claims

On June 2, 2004, the United States of America ("the Government") filed the instant suit against Defendant Coastal Utilities, Inc. ("Coastal") to recover funds which it contends were erroneously refunded to Coastal after Coastal filed an amended income tax return for the 1998 calendar year. Specifically, the Government maintains that Coastal incorrectly excluded from income certain "universal service support" payments it received from the federal government and the State of Georgia.

The issue is whether the universal service support payments are includable in gross income or whether they constitute a nonshareholder contribution to capital, which is excludable from income under § 118 of the Internal Revenue Code. Coastal contends that these payments constitute a contribution to capital, and were therefore correctly excluded from income. The Government disagrees.

Additionally, the parties have filed extensive stipulations of fact, which the Court specifically adopts in this Order. However, so that it may fully assess the claims of the parties, the Court will now lay out many of these facts in the sections that follow, paying special attention to the creation of the universal service support plans and the mechanisms by which the amount of support is determined.

B. The Advent of Universal Service

In the early twentieth century, the president of the Bell System, Theodore Vail, introduced a new and popular slogan: "One Policy, One System, Universal Service." The concept of universal service was based on Vail's belief that everyone should have access to a telephone for outgoing calls and that a single telephone company was necessary to meet that goal. Years later, the federal government embraced Vail's idea, in part, and incorporated his vision of universal service into the Federal Communications Act of 1934.¹ As Section 1 of the 1934 Act stated, the Federal Communications Commission ("the FCC") was created:

for the purpose of regulating interstate and foreign commerce in communication by wire and radio so as 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. ...

Texas Office of Pub. Util. Counsel v. Fed. Commc'ns Comm'n., 183 F.3d 393, 405-406 (5th Cir.1999)(quoting 47 U.S.C. § 151).

Sixty-two years later, the 104th Congress of the United States approved the Telecommunications Act of 1996 ("the 1996 Act"). This Act, like its predecessor, championed the idea of universal service, stating, "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." 1996 Act § 254(b)(3), 47 U.S.C. § 254(b)(3)(originally enacted June 19, 1934, c. 652, Title II, § 254, as added Feb. 8, 1996, Pub.L. 104-104, Title I, § 101(a), 110 Stat. 71; and amended Sept. 30, 1996, Pub.L. 104-208, Div. A, Title I, § 101(e) [Title VII, § 709(a)(8)], 110 Stat. 3009-313). However, "[b]ecause opening local telephone markets to competition is a principal objective of the [1996] Act, Congress recognized that the [then existing] universal service system of implicit subsidies would have to be reexamined." Texas Office, 183 F.3d at 406.

"To attain the goal of local competition while preserving universal service, Congress directed the FCC to replace the patchwork of explicit and implicit subsidies with `specific, predictable, and sufficient Federal and State mechanisms to preserve and advance universal service.'" Id. (quoting 1996 Act § 254(b)(5), 47 U.S.C. § 254(b)(5)). The FCC was given the authority to take the appropriate regulatory action to define the system envisioned by Congress and to establish a timetable for implementation of the 1996 Act. Additionally, Congress provided for the creation of a Federal-State Joint Board on Universal Service (the "Joint Board") to coordinate federal and state regulatory interests. 1996 Act § 254(a), 47 U.S.C. §§ 254(a), 410(c). The Joint Board drafted non-binding recommendations pertaining to universal service.

Congress did not legislate which services must be universally offered, nor did it dictate any specific methods to support universal service. That responsibility was delegated to the FCC. See Alenco Commc'ns. v. Fed. Commc'ns. Comm'n, 201 F.3d 608, 615 (5th Cir.2000).² But Congress did not leave the FCC and the Joint Board without direction. Rather, it set forth six principles upon which the FCC was to base its policies for the preservation and enhancement of universal support.³ 1996 Act § 254(b), 47 U.S.C. § 254(b). Finally, Congress authorized the FCC to develop any additional principles that the FCC deemed appropriate.⁴ Id.

On May 8, 1997, the FCC issued its order establishing which services must be universally available and how they will be supported ("Universal Service Order"). In the MATTER OF FED.-STATE JOINT BD. ON UNIVERSAL SERV., 12 F.C.C.R. 8776, 1997 WL 236383 (1997). The types of services that must be available and are thus eligible to be supported by universal service programs include "single party-service; voice grade access to the public switch network; Dual Tone Multifrequency (`DTMF'); signaling or its functional equivalent; access to emergency services....; access to operator services; access to interexchange service; access to directory assistance; and toll limitation services for qualifying low-income consumers." Id. ¶ 22. Carriers who provide these services are eligible to receive federal universal service support. Id. ¶ 56; 1996 Act §§ 214(e), 254(e), 47 U.S.C. §§ 214(e), 254(e). A carrier who receives this support may only use it "for the provision, maintenance, and upgrading of facilities and services for which the support is intended." 1996 Act § 254(e), 47 U.S.C. § 254(e).

The FCC adopted four programs to implement the directives of the 1996 Act: Low Income, Schools and Libraries, Rural Health Care, and High Cost. Id. at ¶ 18. This case involves the tax character of payments received by Coastal under the High Cost Program.

C. Coastal's Network

Coastal is a "local" telephone company that serves residential and business customers ("subscribers") in and around Liberty County, Georgia. By subscribing to Coastal's telephone service, these subscribers are able to place and receive "local calls" and "long distance calls." With exceptions not relevant here, a local call is one that begins and ends within the region that Coastal serves. A long distance call is one that begins or ends outside of Coastal's service area.

Coastal's network consists of loops, switches, and trunks. A "loop" is the circuit that connects a subscriber to Coastal's central switching office.⁵ In the past, each loop generally consisted of a twisted pair of cooper wires that extended from the subscriber's premises to the telephone company's central office switch. By 1998, however, loops in Coastal's network often utilized both fiber optic cables and copper wires. In 1998, Coastal's service area had approximately 38,000 loops.

A "switch" is the piece of equipment that routes each call to the proper recipient based on the digits dialed by the initiator of the call. If the call is a local call, the switch directs the call to the loop that connects to the recipient's premises. If the call is long distance, the switch directs the call to a trunk. A "trunk" is the facility that connects Coastal's network with the networks of other providers, such as long distance companies.

A significant portion of the cost of a local telephone network is the provision of loop facilities. For example, in 1998 over 60% of Coastal's capital investment was represented by loop facilities. The cost per subscriber of loop facilities in rural areas is generally higher than the cost in more densely populated areas. The reason for the price differential is three-fold. First, rural telephone companies often serve subscribers who live far apart from one another. Thus, the companies cannot take advantage of the scale economies that carriers enjoy by installing loop facilities in more densely populated urban and suburban areas. Second, longer loop lengths are necessary in rural areas, because subscribers may be located quite far from the central switching office. Finally, challenges of rural topography may add to the cost of loop facilities.

Rural telephone companies also face a higher cost per subscriber to install switches in sparsely populated areas. Each switch consists in large part of a sophisticated computer and software system, the fixed cost of which is spread over the number of access lines connected to it. In rural areas, there are fewer subscribers, which results in a higher switching cost per subscriber. Additionally, the cost of trunk lines that connect rural telephone companies with interexchange carriers and other network...