CBS CORPORATION & SUBSIDIARIES v. USA
Filing
41
PUBLISHED OPINION granting 25 Motion for Summary Judgment; denying 31 Cross Motion. The Clerk is directed to enter judgment. Signed by Judge Mary Ellen Coster Williams. (tb1) Copy to parties.
In the United States Court of Federal Claims
No. 10-153T
(Filed: May 11, 2012)
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CBS CORPORATION & SUBSIDIARIES
(f/k/a VIACOM INC. & SUBSIDIARIES),
Plaintiff,
v.
THE UNITED STATES,
Defendant.
Income Tax Refund; Calculation of
Gain Upon Sale of Property;
Reduction of Basis Due to
Depreciation Allocable to Exempt
Foreign Trade Income; 26 U.S.C. §§
161, 167, 261, 265, 921-927, 1001,
1011, 1012, and 1016(a)(2); Foreign
Sale Corporation Regime; P.L. 106516, 114 Stat. 2423.
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James P. Fuller, Kenneth B. Clark, Andrew J. Kim, and Matthew D. Noerper, Fenwick &
West LLP, 801 California Avenue, Mountain View, CA, 94041, for Plaintiff.
Fredrick C. Crombie, John A. DiCicco, Steven Frahm and Mary M. Abate, United States
Department of Justice, Tax Division, Washington, D.C. 20044, for Defendant.
________________________________________________________________________
OPINION AND ORDER GRANTING
PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT
________________________________________________________________________
WILLIAMS, Judge.
This tax refund case comes before the Court on the parties’ cross-motions for summary
judgment. At issue is whether, in calculating the gain realized upon the sale of an asset under the
Foreign Sales Corporation regime, the asset’s basis should take into account depreciation
deductions allocable to tax-exempt foreign trade income. This is an issue of first impression, but
because the Foreign Sales Corporation regime was repealed in 2000, not an issue likely to recur.
1
Background1
The Foreign Sales Corporation Regime
In 1984, Congress enacted the Foreign Sales Corporation (“FSC”) regime, 26 U.S.C. §§
921-927, which was designed “to provide American firms with a tax incentive to increase their
exports.” Boeing Co. v. United States, 537 U.S. 437, 456 (2003) (citing S. Rep. No. 92-437 at
13 (1971)). A qualifying FSC, as defined in 26 U.S.C. § 922 (1994), was permitted to treat
roughly 30 percent of its “foreign trade income” as “exempt foreign trade income.” 26 U.S.C. §
923(a) (1994). Exempt foreign trade income was not subject to taxation in recognition that such
income was “not effectively connected with the conduct of a trade or business within the United
States.” 26 U.S.C. § 921(a). Section 923(b) defined “foreign trade income” as “the gross
income of an FSC attributable to foreign trading gross receipts.” Such receipts included an
FSC’s gross receipts “from the sale, exchange, or other disposition of export property,” and
“from the lease or rental of export property for use by the lessee outside the United States.” 26
U.S.C. § 924(a)(1)-(2) (1994).
The FSC regime did not permit an FSC to reduce its taxable income using deductions
attributable to the generation of exempt foreign trade income. Section 921(b) thus required
deductions “derived by a FSC from any transaction [to] be allocated between (1) the exempt
foreign trade income derived from such transaction, and (2) the foreign trade income (other than
exempt foreign trade income) derived from such transaction, on a proportionate basis.” 26
U.S.C. § 921(b) (1994). The version of § 265(a)(1) in effect at the relevant time provided that in
computing taxable income, no deduction would be allowed for any amount “which is allocable to
one or more classes of income . . . wholly exempt from the taxes imposed by this subtitle.” 26
U.S.C. § 265(a)(1) (2000).2 Under the FSC regime, because 30 percent of an FSC’s income was
exempt from taxation, 30 percent of the FSC’s deductions were disallowed for purposes of
calculating taxable income.
After a panel of the World Trade Organization (“WTO”) agreed with the European Union
that the FSC regime was an export subsidy in violation of WTO law, Congress repealed the FSC
regime in 2000. Pub. L. No. 106-519, 114 Stat. 2423 (2000). Section 5(c)(1) of the repealing
act, however, contained a grandfather clause exempting certain FSC transactions from the repeal.
To qualify under the grandfather clause, the FSC must have been in existence on September 30,
2000, and the transaction must have occurred:
(A) before January 1, 2002; or
(B) after December 31, 2001, pursuant to a binding contact-(i) . . . between the FSC (or any related person) and any person . . . not a related
person; and
1
This background is derived from the Joint Stipulation and the parties’ motion papers.
There are no genuine issues of material fact.
2
Hereinafter, unless otherwise indicated, all short form citations refer to Title 26 of the
United States Code, (“Code” or “IRC”), as codified in 2000.
2
(ii) . . . in effect on September 30, 2000, and at all times thereafter.
Id. The transactions at issue here are subject to the FSC regime under the grandfather clause.
Plaintiff CBS is a corporation with its principal place of business in New York, New
York, and is the common parent of an affiliated group of corporations that file consolidated
federal income tax returns. During the 2005 tax year, Peak FSC, Ltd. (“Peak”) and
Westinghouse Credit Corporation, FSC V, Ltd. (“FSC V”), each a Bermuda corporation, were
both directly, wholly-owned subsidiaries of CBS. Both Peak and FSC V qualified as FSCs under
26 U.S.C. § 922 (1994).
In 1990, Peak and FSC V each purchased a single Boeing 747-467 aircraft (“the aircraft”)
for $127,500,000 each. Peak and FSC V then entered into separate leasing agreements with
Cathay Pacific Airlines. Under the agreements, Peak and FSC V leased the aircraft to Cathay
until 2005, when Cathay purchased the aircraft.
In each of tax years 1990-2005, Peak and FSC V depreciated the aircraft according to
§ 167(a), which allows a depreciation deduction for property used in “the trade or business” or
“held for the production of income.” Both Peak and FSC V also allocated these depreciations as
required by § 921(b), i.e., each FSC deducted only 70 percent of the aircraft’s total depreciation,
and did not take any deductions for depreciation allocated to exempt foreign trade income.
In 2005, Peak sold its 747 to Cathay for $114,750,000, reporting a gain of $45,729,588,
and FSC V sold its 747 to Cathay for $114,750,000, reporting a gain of $45,163,872. Peak and
FSC V calculated their gain by subtracting from the aircraft’s cost basis both the depreciation
allocated to nonexempt foreign trade income and the depreciation allocated to exempt foreign
trade income. Subsequently, Plaintiff discovered the error made on its original tax return in
calculating the gain from the 2005 aircraft sales. Plaintiff realized it had incorrectly reduced the
adjusted basis in the aircraft by depreciation allocated to exempt foreign trade income.
On November 24, 2009, Plaintiff filed a timely administrative claim with the IRS seeking
a refund of $8,554,919, which was equal to the reduction in tax attributable to the reduced gain.
In its Amended United States Corporation Income Tax Return, Plaintiff sought to increase the
aircraft’s bases by the amount of depreciation previously allocated to exempt foreign trade
income. In so doing, Plaintiff argued that such depreciation was neither an “allowed” nor
“allowable” deduction under § 1016(a). The adjustments led Plaintiff to recalculate the gain
realized by Peak on the sale of its aircraft from $45,729,588 to $28,185,712, and the gain
realized by FSC V on its sale from $45,163,872 to $27,789,710. After that claim was disallowed
by the IRS, Plaintiff filed the instant suit.
Discussion
Summary Judgment Standard
Summary judgment is appropriate where the evidence demonstrates that there is “no
genuine dispute as to any material fact and the movant is entitled to judgment as a matter of
law.” Rule 56(a) of the Rules of the United States Court of Federal Claims (“RCFC”); see also
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Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247 (1986). A genuine dispute is one that “may
reasonably be resolved in favor of either party.” Liberty Lobby, 477 U.S. at 250. A fact is
material if it “might affect the outcome of the suit.” Id. at 248.
The moving party bears the burden of establishing the absence of any material fact, and
any doubt over factual disputes will be resolved in favor of the non-moving party. Mingus
Constructors, Inc. v. United States, 812 F.2d 1387, 1390 (Fed. Cir. 1987). Once this burden is
met, the onus shifts to the non-movant to point to sufficient evidence to show a dispute over a
material fact that would allow a reasonable finder of fact to rule in its favor. Liberty Lobby, 477
U.S. at 256-57. A court does not weigh each side’s evidence when considering a motion for
summary judgment, but “‘the inferences to be drawn from the underlying facts . . . must be
viewed in the light most favorable to the party opposing the motion.’” Matsushita Elec. Indus.
Co. v. Zenith Radio Corp., 475 U.S. 574, 587-88 (1986) (quoting United States v. Diebold, Inc.,
369 U.S. 654, 655 (1962)). When opposing parties both move for summary judgment, “the court
must evaluate each party’s motion on its own merits, taking care in each instance to draw all
reasonable inferences against the party whose motion is under consideration.” Mingus
Constructors, 812 F.2d at 1391.
Pertinent Provisions of the Internal Revenue Code
The parties dispute the amount of gain Peak and FSC V should have realized upon the
sale of their aircraft. With respect to that calculation, the Supreme Court has observed that:
Section 1016 is one of a number of general provisions [in the Internal Revenue
Code] that together determine the amount of gain or loss a taxpayer must
recognize when he sells or otherwise disposes of any type of property. Section
1001(a) provides the basic rule: gain or loss is determined by subtracting
“adjusted basis” from “amount realized.” Section 1011(a) defines “adjusted
basis” as “basis . . . adjusted as provided in section 1016.”
United States v. Hill, 506 U.S. 546, 554-55 (1993).
Section 1016(a) requires that:
Proper adjustment in respect of the property shall in all cases be made
....
(2) in respect of any period since February 28, 1913, for exhaustion, wear and
tear, obsolescence, amortization, and depletion, to the extent of the amount-(A) allowed as deductions in computing taxable income under this subtitle or
prior income tax laws, and
(B) resulting (by reason of the deductions so allowed) in a reduction for any
taxable year of the taxpayer's taxes under this subtitle (other than chapter 2,
relating to tax on self-employment income), or prior income, war-profits, or
excess-profits tax laws,
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but not less than the amount allowable under this subtitle or prior income tax
laws.
§ 1016(a)(2).
As the Supreme Court has recognized, “whether or not the taxpayer ever took a
depreciation, amortization, or depletion deduction with respect to the item he is selling, he must,
for purposes of § 1016, determine whether such deductions were allowable with respect to that
item, and reduce his basis by at least that allowable amount.” Hill, 506 U.S. at 557. The Court
construes the term “allowable” in § 1016(a)(2) by first examining the plain meaning of the
statute. Cf. Energy East Corp. v. United States, 92 Fed. Cl. 29, 33 (2010), aff’d, 645 F.3d 1358
(Fed. Cir. 2011) (“The language of the statute itself is the starting place for the Court’s inquiry
into the statute’s meaning. . . . Where the intent is unambiguously expressed by the plain
meaning of the statutory text, the Court gives effect to that clear language without rendering any
portion of it meaningless.”); Jade Trading, LLC v. United States, 65 Fed. Cl. 188, 192 (2005)
(“When interpreting a statute, courts must first examine the plain language of the statute.”).
As the Ninth Circuit explained, the term “allowable” in § 1016(a)(2) refers to a deduction
that is permitted, and not otherwise forbidden, by the Code. The Ninth Circuit reasoned:
The problem with the IRS’s position is that it misconstrues the meaning of
“allowable as a deduction.” Although not explicitly defined in the tax code, these
words are a term of art, with a fixed meaning in the tax arena. . . .
There are two elements to this definition. First, the deduction must be
“permitted” by the tax code. . . . Second, the deduction must not be otherwise
limited or forbidden in the tax code.
Flood v. United States, 33 F.3d 1174, 1177 (9th Cir. 1994) (citations omitted).
The Federal Circuit applied this same definition in construing the terms “allowable” in
another Code provision, § 163(d)(1), stating:
In common usage, the word “allowable” means “permissible: not forbidden: not
unlawful or improper.” Webster’s Third New International Dictionary (1986).
Thus, a deduction is “allowable” under the Code if some provision of the Code
permits it to be taken as a deduction and no other provision of the Code acts to
limit or forbid it as a deduction. See Perrin v. United States, 444 U.S. 37, 42, 100
S. Ct. 311, 314, 62 L. Ed. 2d 199 (1979) (“A fundamental canon of statutory
construction is that, unless otherwise defined, words will be interpreted as taking
their ordinary, contemporary, common meaning.”). . . .
Not only is such a construction consistent with the common meaning of the word,
it is consistent with the usage of the word in the context of the IRC. . . . Thus,
“allowable” deductions are those deductions permitted and not otherwise
forbidden or limited by the IRC, whether or not they are actually used and
regardless of their lack of tax benefit.
5
Sharp v. United States, 14 F.3d 583, 587-88 (Fed. Cir. 1993) (emphasis added).
While adjustments to basis must be made to the extent of the amount of depreciation
either allowed or allowable as deductions, no adjustment is permitted or required to the extent of
disallowed deductions. § 1016(a)(2); Petrich v. Comm’r, 40 T.C.M. (CCH) 303, 306 (T.C.
1980), aff’d, 676 F.2d 712 (9th Cir. 1982) (Table) (holding that it was improper for the Service
to adjust basis under § 1016(a)(2) where the property at issue was not property on which
depreciation deductions were allowable).
Section 161 of the Code prohibits deductions for amounts of depreciation allocable to tax
exempt income, stating:
In computing taxable income under section 63, there shall be allowed as
deductions the items specified in this part, subject to the exceptions provided in
part IX (sec. 261 and following, relating to items not deductible).
§ 161.
The general rule governing deductions is stated in § 261:
In computing taxable income no deduction shall in any case be allowed in respect
of the items specified in this part.
§ 261. Section 265(a)(1) states further:
No deduction shall be allowed for (1) Expenses. -- any amount otherwise
allowable as a deduction which is allocable to one or more classes of income
other than interest (whether or not any amount of income of that class or classes is
received or accrued) wholly exempt from the taxes imposed by this subtitle . . . .
§ 265(a)(1). Thus, under the clear language of §§ 161, 261 and 265(a)(1), deductions for
depreciation allocable to tax exempt income are expressly forbidden.
Under the FSC Regime, Each Aircraft’s Adjusted Basis Should Not Reflect the 30-Percent
Depreciation Deductions Allocable to Tax Exempt Foreign Trade Income.
Plaintiff correctly argues that because the FSC regime disallowed 30 percent of the
depreciation deductions generated during the aircraft’s lease, those deductions were not
“allowable” under § 1016. “[A] deduction is ‘allowable’ under the Code if some provision of the
Code permits it to be taken as a deduction and no other provision of the Code acts to limit or
forbid it as a deduction.” Sharp, 14 F.3d at 587-588 (citing Perrin, 444 U.S. at 42). Because
§ 921(a) allocated deductions to exempt foreign trade income and because deductions allocable
to tax-exempt income are forbidden under § 265(a)(1), 30 percent of the aircraft’s depreciation
deductions were not “allowable” under § 1016. Therefore, as Plaintiff concludes, each aircraft’s
adjusted basis should not reflect the 30 percent of the aircraft’s depreciation deductions allocated
to the tax-exempt foreign trade income. Rather, this basis should take into account only the
deductions allowable in proportion to the aircraft’s non-exempt foreign trade income. Because
Plaintiff mistakenly decreased the basis in each aircraft by amounts representing the 30 percent
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depreciation deductions, their adjusted bases generated erroneous inflated gains, warranting the
claimed tax refund.
Defendant’s Two-Assets Theory3
Defendant does not contest Plaintiff’s position that 30 percent of the aircraft’s
depreciation deductions were not “allowable” under § 1016. Rather, in a novel argument,
Defendant posits that each individual aircraft should be treated as two separate assets: a
depreciable aircraft generating non-exempt foreign trade income, and a nondepreciable aircraft
generating exempt foreign trade income.
According to Defendant, “[w]hen each aircraft is treated as two separate properties
pursuant to § 1016, Treas. Reg. § 1.167(a)-5, and Hill, the resultant computations reveal that
plaintiff has not made any overpayment of tax.” Def.’s Cross Mot. for Summ. J. at 23.
Defendant elaborates:
Peak purchased its aircraft for $127,500,000 in 1990 and then sold that aircraft in
2005 for $114,750,000. During the intervening time, Peak took a total of
$40,935,712 in depreciation deductions allocated to nonexempt [foreign trade
income]. The $17,543,876 in depreciations deductions allocated to exempt
[foreign trade income], were disallowed pursuant to § 265(a)(1). Thus, the
relevant computations with respect to the aircraft sold by Peak are as follows:
Sale of Peak Aircraft
Asset No. 1
(70% Nonexempt)
Asset No. 2
(30% Exempt)
Initial Purchase Cost
Allowed/Allowable
Depreciation
$89,250,000
$40,935,712
$38,250,000
$04
Tax Basis
Proceeds/Sale
Taxable Gain (Loss)
$48,314,288
$80,325,000
$32,010,712
$38,250,000
$34,425,000
$05
Consequently, with respect to the sale of the Peak aircraft, plaintiff would record
in its Subpart F income, $32,010,712 in gain realized upon the sale of that portion
of the aircraft that generated nonexempt [foreign trade income] (Asset No. 1, in
3
Defendant did not raise this two-assets theory in the administrative proceedings or in
the stipulation. Defendant raised this argument for the first time in briefing the subject motions.
4
Asset No. 2 has $0 of allowed/allowable depreciation because the $17,543,876 of
depreciation deductions allocated to exempt [foreign trade income] were disallowed pursuant to
§ 265(a)(1). (footnote in quoted text).
5
While plaintiff has suffered a loss of $3,825,000 upon sale of Asset No. 2, that loss is
disallowed pursuant to § 265(a)(1). (footnote in quoted text).
7
the chart above). Plaintiff, however, would include none of the loss sustained on
the sale of the portion of the aircraft that generated exempt [foreign trade income]
(Asset No. 2, above), because deductions allocated to exempt [foreign trade
income] are expressly disallowed by § 265(a)(1). Inasmuch as plaintiff properly
paid tax on $32,010,711.60 in gain on the sale of the Peak aircraft . . . it is not
entitled to a refund of that tax.
The relevant computations with respect to FSC V are substantially identical and
confirm that plaintiff properly paid tax on $31,614,710.40 in gain on the sale of
the FSC V aircraft and is, thus, not entitled to a refund.
Def.’s Cross Mot. for Summ. J. at 23-24 (citations omitted).
Using its two-assets theory, Defendant submits that Treasury Regulation 1.167(a)-5
would apply to the aircraft to justify the above construct. This regulation provides:
In the case of the acquisition on or after March 1, 1913, of a combination of
depreciable and nondepreciable property for a lump sum, as for example,
buildings and land, the basis for depreciation cannot exceed an amount which
bears the same proportion to the lump sum as the value of the depreciable
property at the time of acquisition bears to the value of the entire property at that
time.
26 C.F.R. § 1.167(a)-5 (2011). Treasury Regulation 1.167(a)-5 applies to a combination of
property that is “depreciable” and “nondepreciable” at the “time of acquisition.” As the Federal
Circuit has stated, whether an asset is of a character subject to depreciation depends on whether
the property is subject to ‘“exhaustion, wear and tear (including . . . obsolescence),”’ Arkla, Inc.
v. United States, 37 F.3d 621, 624 (Fed. Cir. 1994), and whether it is “used in a trade or
business” or “held for the production of income,” § 167(a).
The sale of a single aircraft in the FSC regime does not fit within the plain language of
Treasury Regulation 1.167(a)-5. Clearly, each airplane when acquired was not “a combination
of depreciable and nondepreciable property.” Each airplane was fully depreciable, and the
proper tax consequences on the sale of these aircraft have nothing to do with which
characteristics of these aircraft were theoretically not depreciable. Rather, the tax consequences
stem from the FSC regime which addresses a scenario substantially different from the acquisition
of “a combination of depreciable and nondepreciable property for a lump sum” addressed in
Treasury Regulation 1.167(a)-5. In the situation sub judice, Congress implemented a policy to
promote exports by bestowing tax benefits on exports -- a policy which had nothing whatsoever
to do with assessing the character of property as depreciable or nondepreciable or segregating
such property into two assets for tax purposes. The policy, the FSC regime, bestowed a tax
incentive on American firms to increase their exports in the form of exempting 30 percent of
foreign trade income from tax. This statutory exemption had consequences for depreciation
deductions and the calculation of gain upon sale. Defendant has not shown that Congress, by
designating 30 percent of foreign trade income as exempt, transformed a single asset generating
foreign trade income into two separate assets, one “depreciable” and one “nondepreciable”
within the meaning of Treasury Regulation 1.167(a)-5. Defendant’s effort to import Treasury
Regulation 1.167(a)(5) into the FSC regime is untenable.
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Defendant also attempts to find parallels in situations involving the allocation of basis
within a single asset used for both income-generating and non-income generating purposes,
relying on Sharp v. United States, 199 F.Supp. 743 (D.C. Del. 1961) (“Sharp II”). In Sharp II,
the District Court for the District of Delaware addressed the proper treatment of tax basis for an
aircraft, used partly for pleasure and partly to generate income, which was sold at a loss. The
Sharp II court treated the aircraft as two assets for tax purposes and proportioned the basis
according to the percentage of time the aircraft was used for each purpose. In support of its
ruling, the Court cited Revenue Ruling 286, 1953-2 C.B. 20, which defined a tax-deductible
“loss” (under then-§ 23 of the Code) as including “[o]nly that part of a loss resulting from the
sale of property used for both personal and income-producing purposes that can be allocated to
the income-producing portion of the property . . . .” Sharp II, 199 F.Supp at 745 & n.7 (quoting
Rev. Rul. 286, 1953-2 C.B. 20). The Third Circuit, in a two-sentence per curiam opinion,
affirmed. Sharp v. United States, 303 F.2d 783 (3d Cir. 1962) (per curiam). Defendant also
relies upon Snyder v. Commissioner, 34 T.C.M. (CCH) 965 (1975), which applied the same
rationale as Sharp II to apportion the basis of an airplane according to the airplane’s dual use for
pleasure and for business purposes.
Sharp II and Snyder are inapposite. This is not a situation where the aircraft were used
for pleasure as well as business -- they were exclusively business-use, fully depreciable and
subject to wholly unrelated statutory largess. The Sharp II court invoked Revenue Ruling 286,
but Defendant has cited no pertinent regulatory authority to support its construct here.
Defendant makes much of Sharp II’s statement that “taxpayers are clearly in error if it is their
contention that courts will not regard a thing, normally accepted as an entity, as divisible for tax
purposes.” Sharp II, 199 F.Supp. at 745. However, there must be some legal basis for dividing
up a single entity for tax purposes. Here, nothing in the Code or Treasury Regulations required
Plaintiff to treat each aircraft as two distinct assets for purposes of calculating the amount
realized upon sale, and no authority supports the retroactive judicial imposition of such a
methodology.
Conclusion
Plaintiff’s cross-motion for summary judgment is GRANTED, and Defendant’s crossmotion is DENIED.
The Clerk of the Court is directed to enter judgment for Plaintiff in the amount of
$8,554,919, representing an income tax refund for tax year 2005, plus such interest as is
provided by law.
s/Mary Ellen Coster Williams
MARY ELLEN COSTER WILLIAMS
Judge
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