Southern MultiMedia Communications, Inc. v. Commissioner

113 T.C. No. 27
UNITED STATES TAX COURT
SOUTHERN MULTI-MEDIA COMMUNICATIONS, INC., FORMERLY WOMETCO CABLE
CORP. AND SUBSIDIARIES f/k/a WEXA CABLE, INC. AND SUBSIDIARIES,
Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No 19455-96. Filed December 8, 1999.
Held: $1,927,396 in costs of certain
improvements to cable television systems does
not qualify for investment tax credit under
the “supply or service” transition rule of
sec. 204(a)(3) of the Tax Reform Act of 1986,
Pub. L. 99-514, 100 Stat. 2085, 2149.
Val J. Albright and Chester W. Grudzinski, Jr., for
petitioners.
Robert M. Morrison, Michael C. Prindible, and
George E. Gasper, for respondent.
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SWIFT, Judge: For the years in issue, respondent determined
deficiencies in petitioners' Federal income taxes as follows:
Year Deficiency
1990 $3,318,947
1991 1,512,979
1992 2,272,661
1993 2,727,882
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.
After settlement of some issues, the issue remaining for
decision is whether costs of certain improvements to petitioners’
cable television systems qualify for investment tax credit (ITC)
under the supply or service transition rule of section 204(a)(3)
of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085,
2149.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
Petitioners constitute an affiliated group of companies
engaged in the cable television business. During the taxable
years in issue, Wometco Cable Corp., a Delaware corporation, was
the common parent of the affiliated group of companies and
maintained its principal office in Miami, Florida. Hereinafter,
petitioners will be referred to simply as Wometco.
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Cable television companies seeking to establish cable
television service in particular communities enter into franchise
agreements with local municipal government entities for the right
to construct, operate, and maintain cable television systems
within the communities. The franchise agreements reflect the
cable television companies’ general obligations and commitments
regarding construction and maintenance of the cable television
systems and the service to be provided to customers.
As of 1985, under such franchise agreements, Wometco
operated cable television systems in 179 communities throughout
the Southeastern United States.
From 1989 through 1991, at a total cost of approximately $22
million, Wometco undertook extensive improvements to six
particular cable television systems that it operated in the
suburbs of Atlanta, Georgia (hereinafter sometimes referred to as
“the six systems”). These improvements involved replacement of
coaxial cable, power supplies, amplifiers, and other electronic
components and an increase in the maximum capacity of the six
systems from either 36 or 54 channels to 62 channels. In the
cable television industry, such improvements are typically
referred to as a “rebuild”.
With regard to Wometco's six cable television systems that
were rebuilt from 1989 through 1991 (hereinafter sometimes
referred to as “the six rebuilds”), three of the systems had been
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previously rebuilt in 1979. The evidence does not indicate
whether the other three cable television systems had been
previously rebuilt.
Wometco operated the six cable television systems under
approximately 42 separate, local franchise agreements. Wometco's
rights under the franchise agreements were nonexclusive and had
terms of 10 to 15 years. Most of the franchise agreements
contained general language that required Wometco to maintain its
cable television systems consistently with the highest accepted
standards of the cable television industry so that the customers
would receive the highest and most desirable form of service.
Also, most of the franchise agreements required Wometco to
maintain the systems at a minimum capacity of 20 channels.
Wometco's franchise agreements typically included language
that set forth the following requirements:
(a) The CATV system shall be installed and maintained in
accordance with the highest accepted standards of the
industry to the end that the subscriber may receive the
highest and most desirable form of service.
(b) In determining satisfactory compliance with the
provisions of this section, the following, among other
things, shall be considered:
(1) That the CATV system is installed and remains
capable of using all band equipment and of passing
the entire VHF and FM spectrum and that it shall have
the further capability of converting UHF for the
distribution to subscribers on the VHF band.
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(2) That the CATV system as installed is capable of
transmitting and passing the entire color television
signals without the introduction of material
degradation of color fidelity and intelligence.
(3) That the CATV system is designed and capable of
twenty-four (24) hours a day continuous operation.
(4) That the CATV system is capable of and will
produce a picture upon any subscriber's television
screen in black and white or color (provided the
subscriber's television set is capable of producing a
color picture) that is undistorted and free from
ghost images and accompanied by proper sound,
assuming the technical, standard production
television set is in good repair and that the
television broadcast signal transmission is
satisfactory. In any event, the picture produced
shall be as good as the state of the art allows.
(5) That the CATV system shall transmit or distribute
signals of adequate strength to produce good pictures
with good sound in all television receivers of all
subscribers without causing cross modulation in the
cables or interference with other electrical or
electronic systems.
(6) That the CATV system as installed has a minimum
capacity of twenty (20) channels.
If Wometco failed to comply with requirements of the
franchise agreements, the franchise agreements could be
terminated by the local municipal governments.
As of December 31, 1985, and through January 1, 1991, all of
Wometco's cable television systems met the minimum channel
capacity requirements set forth in the franchise agreements.1
1
Two of Wometco's franchise agreements reflected a minimum
capacity of 35 channels, and a number of Wometco's franchise
agreements reflected no minimum channel capacity.
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As of December 31, 1985, neither the franchise agreements
nor any other contracts specifically required Wometco during the
years 1989 through 1991 to rebuild the six systems.
In addition to the requirements already set forth, Wometco's
franchise agreements generally contained line-extension
provisions specifying conditions under which Wometco was required
to build new cable lines to serve additional residents of a
community. In the cable television industry, such improvements
typically are referred to as “line extensions”.
Generally, the line-extension provisions provided that if
requests for new cable service were received from at least five
residents who resided within 660 feet of existing cable lines,
Wometco would be required to build a line extension and extend
service at no cost to those residents.
In 1990, also with regard to Wometco's six cable television
systems that were rebuilt from 1989 through 1991, Wometco spent
an additional $6 million to extend the cable lines of the six
systems to provide cable television service to additional
customers. As of December 31, 1985, Wometco was not by contract
or otherwise specifically required to build these particular line
extensions.
Wometco's franchise agreements reflected various specific
requirements relating to surety bonds, franchise fees, insurance
coverage, and other matters.
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No local government has terminated any of Wometco's
franchise agreements for noncompliance with the terms thereof,
has declined to extend any of Wometco’s franchise agreements
after expiration of the term, or has at any time specifically
requested Wometco to rebuild any of its cable television systems.
For 1990 through 1993, Wometco timely filed consolidated
U.S. Corporation income tax returns claiming $1,927,396 in
cumulative ITC relating to costs of the six rebuilds that were
undertaken from 1989 through December 31, 1990, the line
extensions that were built in 1990, and a small ITC carryforward
relating to costs of line extensions built in 1986, 1987, and
1989.
On audit, respondent disallowed the total $1,927,396 in ITC
claimed by Wometco relating to the six rebuilds and the line
extensions.
OPINION
Before 1986, ITC was allowed under section 46 for the costs
of certain types of property. In 1986, Congress eliminated ITC
for the costs of property placed in service after December 31,
1985. See Tax Reform Act of 1986 (TRA 1986), Pub. L. 99-514,
sec. 211(a), 100 Stat. 2085, 2166, adding Code sec. 49(a).
Several transition rules, however, were provided that
preserved ITC for the costs of qualified property placed in
service after December 31, 1985, and before January 1, 1991, as
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long as the contracts relating to the costs of the property were
entered into on or before December 31, 1985. See TRA 1986,
sec. 204(a), 100 Stat. 2146, as amended by TRA 1986, sec. 211,
100 Stat. 2167 (adding Code sec. 49(e)(1)(B)).
Under one of the transition rules that relates specifically
to “supply or service” contracts, taxpayers were allowed ITC for
qualified property costs that were “readily identifiable with and
necessary to carry out” written contracts that were binding on or
before December 31, 1985 (hereinafter referred to as “the supply
or service transition rule”). TRA 1986, sec. 204(a)(3), 100
Stat. 2149, as amended by TRA 1986, sec. 211, 100 Stat. 2167
(adding Code sec. 49(e)(1)(B)). The supply or service transition
rule, as amended and in effect for the years in issue, provided
as follows:
(3) Supply or service contracts.--The amendments made
by section 201 shall not apply to any property which is
readily identifiable with and necessary to carry out a
written supply or service contract, or agreement to lease,
which was binding on December 31, 1985.
Id.
With regard to the January 1, 1991, cutoff date, the
transition rules provided as follows:
(2) Requirement that certain property be placed in
service before certain date.--
(A) In general.--Paragraph (1) and section
204(a)(other than paragraph (8) or (12) thereof) shall
not apply to any property unless such property has a
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class life of at least 7 years and is placed in service
before the applicable date determined under the
following table:
In the case of property The applicable
with a class life of: date is:
At least 7 but less than 20 years . . January 1, 1989
20 years or more . . . . . . . . . . January 1, 1991.
* * * * * * *
(C) * * *
(ii) property described in section 204(a)
shall be treated as having a class life of 20
years * * *.
TRA 1986, sec. 203(b)(2), 100 Stat. 2144.
In interpreting statutory language, courts look first to
whether the relevant statutory language itself is plain and
unambiguous. See United States v. Ron Pair Enters., Inc., 489
U.S. 235, 241 (1989); Chevron, U.S.A. v. Natural Res. Def.
Council, 467 U.S. 837, 842 (1984). If the statutory language is
plain and unambiguous, courts ordinarily do not look beyond the
statutory language. See United States v. Ron Pair Enters., Inc.,
supra; Tele-Communications, Inc. v. Commissioner, 95 T.C. 495,
510 (1990), affd. 12 F.3d 1005 (10th Cir. 1993) (the “plain
language of a statute is the source of its interpretation.”). If
the statutory language is ambiguous, courts may consider the
legislative history. See Robinson v. Shell Oil Co., 519 U.S.
337, 340 (1997); Golden Rod Farms, Inc. v. United States, 115
F.3d 897, 899 (11th Cir. 1997); Greenberg Bros. Partnership #4 v.
Commissioner, 111 T.C. 198, 203 (1998).
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Wometco bears the burden of showing that it meets the
requirements of the supply or service transition rule and that it
is entitled to the tax credits sought. See Rule 142(a).
Wometco argues that the costs associated with the six
rebuilds and the line extensions in issue were readily
identifiable with, and necessary to carry out, its related
franchise agreements that were outstanding as of December 31,
1985. Wometco contends that the general language of the
franchise agreements that existed as of December 31, 1985,
requiring Wometco to maintain its cable television systems in a
state-of-the-art condition, is sufficient to qualify the six
rebuilds and the line extensions under the supply or service
transition rule.
Respondent argues that under Wometco's franchise agreements
Wometco was not expressly required to undertake particular
rebuilds or line extensions, that only 20-channel capacity
systems were generally required, that Wometco's systems already
met that requirement, and that as of December 31, 1985, the six
rebuilds and the line extensions were not necessary to carry out
and were not readily identifiable with Wometco's general
franchise agreements that existed on December 31, 1985.
The language of the supply or service transition rule
specifically used the words “necessary to carry out”. The word
“necessary” connotes essential, mandatory, indispensable, or
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requisite. See Webster's Third New International Dictionary 1510
(1986). The language in Wometco's franchise agreements does not,
as of December 31, 1985, mandate, make indispensable, or make
necessary the rebuilds in issue. Wometco's rebuilds that
occurred after December 31, 1985, and before January 1, 1991, may
reflect sound business decisions by Wometco in order to maintain
the competitiveness of its cable television systems and to
facilitate eventual renewal of the franchise agreements. As of
December 31, 1985, however, Wometco was not required by specific
contract to undertake the six rebuilds.
In interpreting the supply or service transition rule,
Wometco relies heavily on discussions that occurred on June 24,
1986, on the floor of the U.S. Senate as part of the
congressional debate over provisions of the Tax Reform Act of
1986 as follows:
Mr. FORD: * * * I simply want to make sure that
those agreements to build and rebuild cable systems
under cable franchise are treated as transition
property under the supply or service contract rule. * *
* Was it the intention of the Finance Committee to
include cable television franchise agreements within
the service and supply contract rule?
Mr. PACKWOOD: The Senator is correct. The
committee intends that cable television franchises
generally do qualify as “supply or service contracts”
for purposes of section 202(d)(3) relating to
transition rules. * * *
132 Cong. Rec. 15039 (1986).
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Mr. MATSUNAGA: I would like to ask the bill
managers to clarify another point. The supply or
service contract transition rule requires that the
property be readily identifiable with and necessary to
carry out the contract. The committee report explains
that the specifications and the amount of the property
must be readily ascertainable from the terms of the
contracts or from related documents.
Is this Senator's understanding correct that the
requirement is met when a binding power purchase
contract specifies the type of generating equipment in
terms of primary energy source and specifies the amount
of generating equipment in terms of total generating
capacity of the turbines necessary to produce the
contracted power? In other words, the rule does not
require the technical details of the generating
property to be spelled out.
Mr. PACKWOOD: The Senator from Hawaii is correct.
132 Cong. Rec. 15028 (1986).
Wometco argues that the above discussions between Senators
bolsters its argument that (in order to qualify under the supply
or service transition rule) specific rebuilds and line extensions
need not be expressly identified in construction contracts
outstanding as of December 31, 1985, but rather that the general
language of its franchise agreements that were outstanding as of
December 31, 1985 (requiring that Wometco's systems be maintained
according to the “highest accepted standards of the industry”,
the “highest and most desirable form of service”, and the “state
of the art”), is sufficient to bring the six rebuilds and line
extensions that in fact were undertaken and built between
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December 31, 1985, and January 1, 1991, within the supply or
service transition rule.
Although this Court has not yet interpreted the supply or
service transition rule, three other Federal courts have. In
Bell Atl. Corp. v. United States, 82 AFTR 2d 98-7375, at 98-7379,
99-1 USTC par. 50,119, at 87,037 (E.D. Pa. 1998), the taxpayer
argued that because franchise agreements outstanding as of
December 31, 1985, required that it broadly “maintain, expand,
and improve their telephone networks” to meet industry standards,
property purchased after December 31, 1985, to upgrade telephone
network equipment satisfied the supply or service transition
rule. The Federal District Court for the Eastern District of
Pennsylvania, however, concluded that none of the property was
necessary to carry out any of the taxpayer's franchise
agreements. The court stated that the general language of the
franchise agreements involved in that case was not sufficient to
qualify under the supply or service transition rule.
In United States v. Zeigler Coal Holding Co., 934 F. Supp.
292, 295 (S.D. Ill. 1996), the Federal District Court for the
Southern District of Illinois, in denying summary judgment,
stated that “in order to be eligible * * * [under the supply or
service transition rule] the property must have been specifically
described.” The court noted that it could not find language in
the taxpayer's relevant contracts as they existed as of
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December 31, 1985, that sufficiently described most of the
property upon which ITC was claimed.
In United States v. Commonwealth Energy Sys., 49 F. Supp. 2d
57 (D. Mass. 1999), after December 31, 1985, the taxpayer
installed new power generating equipment in its power plant. The
taxpayer claimed that the new equipment was necessary to carry
out specific power supply contracts that had been entered into
before December 31, 1985. Language of the contracts indicated
the type of power generating equipment to be installed in terms
of primary energy source and total generating power. The
contracts specifically stated that the taxpayer agreed and was
bound under the contracts “to cause to be built a new
conventional steam plant * * * of an expected net economic
capability of approximately 560 megawatts”. Id. at 59. The
Federal District Court for the District of Massachusetts
concluded that despite the absence in the contracts of explicit
language describing the precise equipment to be installed, the
new generating equipment that was to be installed was readily
identifiable with the contracts and was plainly required to
fulfill the specific additional power commitments that were
explicitly set forth in the contracts.
The District Court in Commonwealth Energy Sys., however, did
not allow ITC for all of the costs associated with the new power
generating equipment. The court disallowed ITC for costs of
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certain property that was not “intimately connected to the
generation of power at the plant”. Id. at 61. Property that was
too tenuously tied to generation of the new power commitment
reflected in the contracts as of December 31, 1985, was held not
to qualify under the supply or service transition rule.
Under Wometco's argument, most if not all of its otherwise
eligible property costs incurred after December 31, 1985, and
before January 1, 1991, would likely qualify under the supply or
service transition rule because all improvements to its systems
arguably would be readily identifiable with and necessary to
carry out the broad franchise agreements that were in effect as
of December 31, 1985. As we read the supply or service
transition rule, however, the plain meaning of the statute does
not permit this interpretation. Congress granted only limited,
transition relief to businesses that, as of December 31, 1985,
had binding commitments to undertake specific investments in
qualified property. See Bell Atl. Corp. v. United States, 82
AFTR 2d at 98-7378, 99-1 USTC at 87,036; H. Conf. Rept. 99-841
(Vol. II), 1986-3 C.B. (Vol. 4) 60.
Much like the franchise agreements involved in Bell Atl.
Corp. v. United States, supra, the general language of Wometco's
franchise agreements, without more, reflects only broad industry
standards, not specific contractual commitments to undertake
rebuilds.
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The language of Wometco's franchise agreements does reflect
various specific requirements for surety bonds, franchise fees,
and insurance coverage. Specific language, however, regarding
rebuilds is conspicuously absent from the franchise agreements.
The only language in Wometco's franchise agreements expressly
referencing channel capacity, the key factor triggering rebuilds,
is the language that requires maintenance of a minimum channel
capacity.
Technology growth in the cable television industry has been
particularly rapid. As of the time of trial, utilizing new
digital video compression and fiber optic cable, the latest
technology would enable cable television companies to rebuild
their systems to a capacity of 500 channels and to provide high
speed Internet access. To maintain, during each year, completely
state-of-the-art systems, cable television companies would have
had to rebuild their systems every few years.2 To the contrary,
with regard to the six cable television systems in issue, Wometco
2
The schedule below reflects the changing cable television
technology available throughout the years with regard to channel
capacity:
Maximum
Year Channel Capacity
1967 23
1979 40
1981 54
1982 60
1984 80
1993 115
1995 136
1999 500
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has rebuilt three of the systems only twice since the late
1970's.
Wometco notes that since franchise agreements entered into
by cable television companies in the 1970's and 1980's rarely
included express rebuild requirements, few companies would
receive any benefit under a narrow interpretation of the supply
or service transition rule. We disagree. Rebuilds and line
extensions that were specifically under contract as of
December 31, 1985, would be readily identifiable with and would
be treated as necessary to carry out specific contracts for such
improvements and would qualify for ITC under the supply or
service transition rule.
We conclude that Wometco is not entitled to ITC for the
costs of the six rebuilds. As of December 31, 1985, Wometco was
not under contract to install the six rebuilds, and the rebuilds
were not necessary to carry out Wometco's extant franchise
agreements. With regard to the line extensions, no evidence
indicates that Wometco had specific binding commitments, as of
December 31, 1985, to install the line extensions.3
Wometco is not entitled to the claimed ITC for the costs of
the rebuilds and the line extensions.
3
As indicated, we decide this case on the basis that the six
rebuilds and line extensions were not necessary to carry out
Wometco's franchise agreements. We do not decide the issue of
whether the six rebuilds and line extensions were “readily
identifiable with” Wometco's franchise agreements.
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To reflect the foregoing,
Decision will be entered
under Rule 155.