DocketNumber: No. 3110-98
Citation Numbers: 115 T.C. 1, 2000 U.S. Tax Ct. LEXIS 44, 115 T.C. No. 1
Judges: Gerber
Filed Date: 7/17/2000
Status: Precedential
Modified Date: 1/13/2023
*44 An order will be issued denying petitioner's motion for partial summary judgment.
Under the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat.
2085, Congress changed the reporting method for long-term
contracts from the completed contract method to the percentage
of completion method. Under the percentage of completion method
of
income during the years of construction a portion of the
"estimated contract price." In promulgating sec. 1.460-
6(c)(2)(vi), Income Tax Regs., the Secretary concluded that the
term "estimated contract price" includes amounts related to
contingent rights and obligations, regardless of whether the
"all events test" has been met. R, relying on the plain meaning
of the statute and its legislative history, contends that the
regulation is a valid interpretation of the statute that
satisfies congressional intent. P contends that the all events
test is a fundamental tax principle that cannot be ignored
without an express mandate from Congress.
HELD: *45
reasonable interpretation of the statute, comports with the
legislative history, and, accordingly, is valid.
*2 OPINION
GERBER, JUDGE: Pursuant to
Summary judgment may be granted if the*46 pleadings and other materials demonstrate that no genuine issue exists as to any material fact and that a decision may be entered as a matter of law. See
BACKGROUND
Petitioner was organized pursuant to the laws of the State of California on June 15, 1981. At the time its petition was filed, petitioner's principal place of business was in Sylmar, California.
Petitioner is a general contractor in the construction industry for public works projects, including highways and government-owned buildings, and large-scale private developments, such as office towers. Petitioner enters into contracts either on a fixed price basis or on a cost-plus basis. All of the contracts in issue in this case are fixed price contracts. In a fixed price contract, contractors formulate their bids on the basis of the information contained in the architectural and engineering*47 drawings, designs, and geological reports provided by the contracting agency. Due to changes in drawings or designs, customer-caused delays, errors in the specifications of the drawings, designs, or reports, or other unanticipated delays, additional work by the contractor is commonly required to complete the job satisfactorily.
*3 The contracts in question obligate petitioner to complete the job, and if it failed to do so, petitioner would be liable to the government agency that is a party thereto (contracting party) for damages. Each of the contracts provided for liquidated damages in the event petitioner failed to complete the job or did not otherwise fulfill its contractual obligations. The contracts also provided for a retention of a specified percentage of the contract price until the contracting party completed review of the job and accepted it as completed. Petitioner submitted certain change orders on the contracts in question that were denied by the other contracting party. Petitioner followed the required procedures for submitting claims and for appealing adverse determinations on disputed claims.
For Federal income tax purposes, petitioner was subject to
Respondent contends that the income from the disputed claims should be included in the total contract price as required by
*49 DISCUSSION
*50
Under the completed contract method, the entire gross contract price was included in income in the taxable year in which the contract was finally completed and accepted. All costs properly allocated to a long-term contract were deducted in the year of completion. See
*5
Under the percentage of completion method of accounting, income from the contract must be reported over the life of the contract, and expenses must be deducted in the year incurred. The reportable income for each year is calculated as follows: the total contract costs incurred through the end of the tax year are divided by the total estimated contract costs, and then multiplied by the total contract price; the product of this multiplication is reduced by gross income from the contract reported for prior years. See
Under
*6 If an amount of revenue or cost attributable to a completed long-term contract is properly taken into account in a postcompletion year,
Promulgated in October 1990,
(vi) AMOUNT TREATED AS CONTRACT PRICE -- (A) GENERAL RULE.
The amount that is treated as total contract price for purposes
of applying the percentage of completion method and reapplying
the percentage of completion method under*54 the look-back method
under Step One includes all amounts that the taxpayer expects to
receive from the customer. Thus, amounts are treated as part of
the contract price as soon as it is reasonably estimated that
they will be received, even if the all-events test has not yet
been met.
(B) CONTINGENCIES. Any amounts related to contingent rights
or obligations, such as incentive fees or amounts in dispute,
are not separated from the contract and accounted for under a
non-long-term contract method of accounting, notwithstanding any
provision in
1.451-3(d)(2), (3), and (4), to the contrary. Instead, those
amounts are treated as part of the total contract price in
applying the percentage of completion method and the look-back
method. For example, if an incentive fee under a contract to
manufacture a satellite is payable to the taxpayer after a
specified period of successful performance, the incentive fee is
includible in the total contract price at the time and to the
extent that it*55 can reasonably be predicted that the performance
objectives will be met, for purposes of both the percentage of
completion method and the look- back method. Similarly, a
portion of the contract price that is in dispute is included in
the total contract price at the time and to the extent that the
taxpayer can reasonably expect the dispute will be resolved in
the taxpayer's favor (without regard to when the taxpayer
receives payment for the amount in dispute or when the dispute
is finally resolved).
Petitioner argues that (i) the regulation does not implement the congressional mandate as required under applicable law; (ii) the regulation attempts to "repeal", without clear and explicit congressional support, the all events *7 test, which has been recognized as a fundamental tax principle; (iii) respondent attempts to usurp Congress and supersede the look-back method by issuance of the regulation to address*56 timing differences; and (iv) the regulation is not reasonable in view of prior law and usage and is not reasonable in application. 3 Respondent argues that it is reasonable to require a taxpayer to estimate the total contract price of a long- term contract and, thus, to include a disputed claim related to that contract as soon as it is reasonably estimated that income from the claim will be received. Respondent maintains that the regulation's inclusion of disputed claims in the percentage of completion method satisfies congressional intent and is therefore valid.
VALIDITY OF
Regulations are either legislative or interpretive in character. See
An interpretive regulation, while entitled to deference, is not entitled to as much deference as is accorded a legislative regulation. See
A regulation may not contradict the unambiguous language of a statute. See
Under the test articulated in
In deciding whether the regulation comports with the statute's plain language, we look to the ordinary usage or settled meanings of the words used in the statute by Congress. See
*61 The term "estimated" does not necessarily include, as respondent contends, revenues from disputed claims. The term "estimate," however, does not preclude the possibility that Congress intended that disputed claims be included. In any event, there is nothing in the regulation that contradicts the plain language of the statute.
As stated above, even if a regulation does not clearly contradict the language of the statute it purports to interpret, the regulation may still be invalid if it is fundamentally at odds with or inconsistent with the statute's origin and purpose. See
There is no doubt about Congress' concern that the completed contract method of accounting for long-term contracts permitted an unwarranted deferral of the income from those contracts. See S. Rept. 99-313 (1986), 1986-3 C.B. (Vol. 3) 140; Staff of the Joint Comm. *62 on Taxation, General Explanation of the Tax Reform Act of 1986, at 527 (J. Comm. Print *10 1987). Congress sought to limit the tax deferral obtainable through use of the completed contract method by requiring taxpayers to report income from long- term contracts on a percentage of completion method. It was recognized that use of the percentage of completion method could produce harsh results for taxpayers where an overall loss was experienced or where actual profits were significantly less than projected. Thus, Congress provided for a "look-back" to account for variances between the estimated and the actual figures.
Although there is no specific support in the legislative history for respondent's position, use of the terms "expected" and "anticipated" lends support to respondent's position and is helpful to our consideration. The House report described the intended operation of the percentage of completion method as follows:
Income from all long-term contracts must be reported under
the percentage of completion method based on the expected costs
rather than physical completion. Thus, the amount of gross
income from a long-term contract recognized*63 in a particular
taxable year generally is that proportion of the EXPECTED
CONTRACT PRICE that the amount of costs incurred through the end
of the taxable year bears to the total expected costs, reduced
by amounts of gross contract price that were included in gross
income in previous taxable years. [H. Rept. 99- 426 (1986),
1986-3 C.B. (Vol. 2) 630; emphasis added.]
In describing the operation of the look-back method, the Staff of the Joint Committee on Taxation added:
In the taxable year in which the contract is completed, a
determination is made whether the taxes paid with respect to the
contract in each year of the contract were more or less than the
amount that would have been paid if the actual gross contract
price and the actual total contract costs, rather than the
ANTICIPATED CONTRACT PRICE and costs, had been used to compute
gross income. [Staff of Joint Comm. on Taxation, General
Explanation of the Tax Reform Act of 1986, at 528 (J. Comm.
Print 1987); emphasis added.] * * *
While it is clear that Congress intended the total*64 contract price to be computed by means of an estimate, the legislative history contains no reference to disputed or contingent items. Furthermore, there is no explicit indication as to whether the all events test applies. There is a reference to contingent items in the General Explanation of the Tax Reform Act of 1986, which contains the statement that "For purposes of the 'look- back' method, the contract price shall reflect all *11 amounts received under the contract, including amounts received after the contract completion date as a result of disputes, litigation or settlements relating to the contract." 7 Id.
*65 Because disputed claims are includable in the look-back computation, an earlier inclusion of disputed claims will result in smaller underpayments and interest. Thus, requiring taxpayers to treat disputed claims as part of the contract price as soon as it is reasonably estimated that they will be received harmonizes with the statute's overall purpose, as reflected by its legislative history. Based on indications in the legislative history that Congress was concerned with taxpayer deferral of income, a regulation requiring all revenues to be reasonably estimated and included in the total contract price comports with that congressional intent. 8
*66 Petitioner makes several contrary arguments. First, it contends that implicit in the enactment of the look-back method is congressional approval of the all events test. The all events test, which was developed as case law and embodied in regulations, applies to accrual method taxpayers and is used in determining the taxable year in which items of income or deductions are properly reported by such taxpayers. Under
*67 It is true that Congress did not explicitly state that the all events test should not apply with respect to contingent items for purposes of long-term contracts. However, because the
Petitioner also contends that the
Furthermore, the language relied on by petitioner is employed in the context of how the look-back method operates. Taxpayers are required to apply the look-back method to any amounts that are taken into account after completion of the contract. Thus, if income is received and properly accounted for 5 or 10 years after completion of the contract, those revenues are discounted back to the year of completion, and the look-back method is applied. Such application would likely result in underpayment interest due by the taxpayer if post-completion revenues were not included in the estimated total contract price at the time it was reasonably expected that they would be received by the taxpayer.
In addition, requiring the inclusion of an estimate*70 of disputed claims in the total contract price as soon as the taxpayer reasonably expects to receive them will reduce the likelihood that a taxpayer will have to pay look-back interest. The purpose of the look-back method is to offset the time-value effects of using estimates during the life of a contract that may differ from the actual amounts determined upon completion. Because the all events test does not recognize income until it is fixed and determinable, requiring use of the all events test would render moot any "estimating" of the total contract price, lead to additional timing differences (income deferrals) and likely require taxpayers to pay more look-back interest. Moreover, the statute by its plain language calls for the use of "estimated" contract price and costs.
Petitioner relies on
*72 Finally, petitioner argues that the subject regulations should be declared invalid because of the alleged difficulty for taxpayers to determine when they have a reasonable expectation of recovery on a disputed claim. We recognize that the regulation's "reasonable expectancy" standard may result in difficulties in the determination of when a contingent item can be reasonably expected to be received. By promulgating such a regulation, respondent may be called upon to determine when it is reasonably foreseeable that a contingent item will be received by a taxpayer. This may not be an easy task, and in petitioner's case, there is no indication whether respondent will prevail in such a controversy. However, difficulty of this kind is not a reason to invalidate the regulation; the determination of when a contingent item can be reasonably expected to be received can be made on a *15 case-by-case basis. The regulation is a reasonable interpretation of, and plainly consistent with, the underlying statute. 11
*73 In light of the foregoing, we hold that section 1.460- 6(c)(2)(vi), Income Tax Regs., is valid because it harmonizes with the plain language, origin, and purpose of
We have considered the parties' remaining arguments and find them either irrelevant or unnecessary for resolving the parties' controversy. To reflect the foregoing,
An order will be issued denying petitioner's motion for partial summary judgment.
1. Unless otherwise indicated, all Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code in effect for the taxable years at issue.↩
2.
(2) Look-back method. -- The interest computed under the
look-back method of this paragraph shall be determined by --
(A) first allocating income under the contract among
taxable years before the year in which the contract is completed
on the basis of the actual contract price and costs instead of
the estimated contract price and costs,
(B) second, determining (solely for purposes of computing
such interest) the overpayment or underpayment of tax for each
taxable year referred to in subparagraph (A) which would result
solely from the application of subparagraph (A), and (C) then
using the overpayment rate established by section 6621,
compounded daily, on the overpayment or underpayment determined
under subparagraph (B).
For purposes of the preceding sentence, any amount properly
taken into account after completion of the contract shall be
taken into account by discounting (using the Federal mid-term
rate determined under section 1274(d) as of the time is so
properly taken into account) such amount to its value as of the
completion of the contract. The taxpayer may elect with respect
to any contract to have the preceding sentence not apply to such
contract.↩
3. Petitioner is not arguing that income arising out of contingencies and disputes be excluded from the look-back method.↩
4. We are mindful that the choice among reasonable statutory interpretations is for the executive branch of Government and not the courts. See
5. The parties do not dispute the definition of the term "estimated". According to the dictionary, "estimate" means to judge tentatively or approximately the value, worth or significance of; to determine roughly the size, extent, or nature of; or to produce a statement of the approximate cost of. See Merriam-Webster's Tenth Collegiate Dictionary 397 (1997).↩
6. Furthermore, in a number of tax accounting cases, the Supreme Court has decided that estimates of anticipated expenses are not accruable as deductions under the all events test. See
7. While the General Explanation of the Tax Reform Act of 1986 does not rise to the level of legislative history because it is prepared by congressional staff after enactment of the statute, it has been considered highly indicative of what Congress did, in fact, intend and we take it into consideration. See Staff of Joint Comm. on Taxation, General Explanation of the Tas Reform Act of 1986 (J. Comm. Print 1987);
8. We also note that the regulation has been in existence without relevant change since its promulgation in 1990, and during its existence Congress has amended
9. Petitioner's use of the term "repealed" is a misnomer because the all events test was developed as a principle of case law and embodied in regulations. Congress has implicitly approved of this principle by not subsequently legislating otherwise.↩
10. The Court also noted that the regulation was "tortuously complex" and was not compatible with the goals of the statute.↩
11. Although petitioner's position may also be a reasonable interpretation, we are constrained to uphold the regulation if it has a reasonable basis in the statutory history, even though petitioner's challenge may have some logical force. See
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