Opinion
No. 01-2200 Ma/A
April 7, 2003
ORDER DENYING PLAINTIFFS' MOTION FOR PARTIAL SUMMARY JUDGMENT
Before the court is Plaintiffs' motion for partial summary judgment filed on February 18, 2003. Defendant filed a response in opposition to this motion on March 20, 2003. Plaintiffs filed a reply on April 4, 2003. For the following reasons, the court DENIES Plaintiffs' motion for partial summary judgment.
I. Background
Plaintiffs Fedex Corporation and Federal Express Corporation are both incorporated in the State of Delaware and maintain their principal places of business in Memphis, Tennessee. Their subsidiaries are also Plaintiffs in the action. Collectively, the court will refer to Plaintiffs as "FedEx," Defendant is the United States of America.
This is a tax refund suit. It arises out of a dispute regarding the tax treatment of FedEx's off-wing engine maintenance program during the 1993 and 1994 tax years ("TY 1993" and "TY 1994"). The Internal Revenue Service ("IRS") contends that FedEx's expenses related to that maintenance are non-deductible capital expenditures under 26 U.S.C. § 263(a). FedEx argues that they are ordinary and necessary business expenses deductible pursuant to 26 U.S.C. § 162. On August 11, 2000, FedEx paid the IRS the disputed amount plus interest, but maintained that its legal interpretation was correct and demanded a refund. On January 4, 2001, the IRS informed FedEx of its intent to deny the refund request. On March 15, 2001, FedEx filed the instant action.
Treasury Reg. § 1.162-4 provides in pertinent part: "The cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinary efficient operating condition, may be deducted as an expense." Treasury Reg. § 1.263(a)-2(b) restates the same rule from the perspective of the Internal Revenue Code's capitalization requirements. In this motion, FedEx asks the court to hold as a matter of law that the completely assembled aircraft is the appropriate "unit of property" under the Repair Regulations. Otherwise stated, FedEx argues that the court's analysis at trial should focus on whether the ESVs materially added to the value of the assembled aircraft or appreciably prolonged the useful life of the assembled aircraft. In response, the United States maintains in the alternative: (1) that a genuine issue of material fact exists with respect to whether the assembled aircraft is the appropriate unit of property and (2) that the jet aircraft engines and auxiliary power units (APUs) serviced through the off-wing maintenance program during engine shop visits (ESVs), not the assembled aircraft, are the appropriate units of property to be evaluated under the Repair Regulations.
The court refers to Treasury Reg. § 1.162-4 and Treasury Reg. § 1.263(a)-2(b) collectively as the "Repair Reguations."
The following material facts are undisputed. As part of its business, FedEx operated and continues to operate a fleet of aircraft. (Pls.' Statement of Undisputed Facts ¶ 1.) During Fiscal Years 1993 and 1994 FedEx operated 205 and 202 aircraft, respectively, consisting of Boeing 727s ("727"), McDonnell Douglas DC-10s ("DC-b"), and McDonnell Douglas MD-11s ("MD-11"). (Id.) Propulsion power for each FedEx 727, DC-10, and MD-11 is provided by three installed jet aircraft engines. (Id. ¶ 2.) During TY 1993 and TY 1994, Pratt Whitney series JT8D engines were used to power FedEx 727s; General Electric ("GE") CF6-6D model engines were used to power FedEx DC-10-10s; GE CF6-50C2 model engines were used to power FedEx DC-10-30s; and GE CF6-8OC2DbF model engines were used to power FedEx MD-11s. (Id.) During TY 1993 and TY 1994, auxiliary power for FedEx 727s was provided by GTCP85 series APUs and auxiliary power for FedEx DC-10s and MD-11s was provided by TSCP700 series APUs. (Id. ¶ 3.)
Off-aircraft inspection, heavy maintenance, and repair of jet aircraft engines and APUs was conducted in almost all instances by third-party vendors during ESVs after removal of the engines or the APUs from the aircraft. (Id. ¶ 5.)
Jet aircraft engines and APUs cannot be utilized to transport air freight and packages in FedEx's business except as part of a completely assembled aircraft. (Id. ¶ 6.) Virtually all jet aircraft engines and APUs operated by FedEx in TY 1993 and TY 1994 were acquired or leased by FedEx as an installed component of a completely assembled aircraft or as spares in connection with the acquisition of a completely assembled aircraft. (Id. ¶ 7.) In TY 1993 and TY 1994, FedEx acquired only a small number of jet aircraft engines or APUs separately in stand-alone purchases. (Id. ¶ 8.)
The following facts are disputed. FedEx claims that there was no stand-alone market for jet aircraft engines and APUs in TY 1993 and TY 1994. (Id. ¶ 9.) FedEx further asserts that the useful life of the jet aircraft engines and APUs are generally co-extensive with the aircraft model for which they are intended to be used. (Brasie Dep. Ex. A at 26.)
To the contrary, Defendant produced the following evidence with respect to the existence of a stand-alone market for jet aircraft engines and APUs: (1) Defendant's expert identified ten JT8D-15 and ten JT8D-17 stand-alone transactions in TY 1993 and TY 1994; (2) Defendant's experts identified eight companies that engage in stand-alone engine sales that were engaged in that business between 1992 and 1994; (3) Defendant's expert identified a market for used stand-alone jet aircraft engines during TY 1993 and TY 1994 in the form of classifieds in aviation industry periodicals and direct marketing. (Mem. of Facts and Law in Supp. of United States Opp'n to Pls.' Mot. for Partial Summ. J. at 9-10.)
Defendant also notes that FedEx's expert, while referring to the stand-alone market as "spot" and disorganized, did not deny the existence of the market altogether. (Id. at 8.) Further, FedEx's expert acknowledged the practice of engine appraisal and admitted engaging in engine appraisals for clients. (Id.)
Defendant also contends that, although the useful life of a FedEx aircraft is between thirty-two and forty-two years, depending on the model, the jet aircraft engines and APUs have a useful life of only twenty-four to sixty months, the period between ESVs. (Id. at 15.)
Finally, Defendant asserts that FedEx treated the jet aircraft engines and airframes separately for financial purposes, maintaining separate accounts in its books and records for jet aircraft engines and airframes. (Id. at 14.)
II. Summary Judqment Standard
Under Federal Rule of Civil Procedure 56(c), summary judgment is proper "if . . . there is no genuine issue as to any material fact and . . . the moving party is entitled to judgment as a matter of law." Fed.R.Civ.P. 56(c); see also Celotex Corp. v. Catrett, 477 U.S. 317, 322 (1986). The movant must meet its initial burden of "demonstrat[ing] the absence of a genuine issue of material fact." Celotex, 477 U.S. at 323.
In considering a motion for summary judgment, "the evidence as well as all inferences drawn therefrom must be read in a bight most favorable to the party opposing the motion." Kochins v. Linden-Alimak, Inc., 799 F.2d 1128, 1133 (6th Cir. 1986); see also Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986). "[S]ummary judgment will not lie if the dispute is about a material fact that is `genuine,' that is, if the evidence is such that a reasonable jury could return a verdict for the nonmoving party." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986).
III. Analysis
FedEx presents two arguments which suggest that the court can determine as a matter of law whether the jet aircraft engines/APUs or the fully assembled aircraft is the appropriate unit of property to analyze under the Repair Regulations. First, FedEx avers that other cases involving vehicles or vessels have consistently looked to the entire vehicle/vessel, rather than a component part, as the appropriate unit of property. Next, FedEx claims that the court should apply a "functional interdependence test" which, FedEx argues, requires the court to apply the Repair Regulations to the completely assembled aircraft.
The court first examines FedEx's arguments that the caselaw dictates a rule of law that work performed on a component part of an assembled transportation or construction vehicle must be attributed to the completely assembled vehicle. As FedEx notes, courts have consistently used the completely assembled vehicle as the appropriate unit of property when applying the Repair Regulations. See, e.g., Jacks v. Comm'r, No. 29297-87, 1988 Tax Ct. Memo LEXIS 267, at *8-9 (May 26, 1988) (court evaluated the impact of the cost of a replacement transmission and of a rebuilt engine on the value of the CAT loader);Maier Brewing Co. v. Comm'r, Nos. 8609-72, 6937-82, 7163-82, 1987 Tax. Ct. Memo LEXIS 383, at *80 (Aug. 5, 1987) (court evaluated the impact of the cost of repair and replacement of PT boat engines on the value of the ship); LaSalle Trucking Co. v. Comm'r, 22 T.C.M. (CCH) 1375 (1963) (court evaluated the impact of the cost of replacement of truck tanks and engines on the value of the truck).
The court will refer to the "rule" asserted by FedEx as the "entire vehicle rule."
FedEx correctly states that courts have consistently applied the Repair Regulations to entire vehicles. As a preliminary matter, however, the court notes that only one of the cases cited by FedEx considered the issue of whether the vehicle or a smaller component part was the appropriate unit of property. See Ingram Indus., Inc. v. Commissioner, No. 14175-98, 2000 Tax Ct. Memo LEXIS 381, at *26-27 (Oct. 18, 2000) (holding that the tugboat, not the tugboat engine, was the appropriate unit of property). The remaining cases merely assume on the facts that the vehicle was the appropriate unit of property. Further, most of the cases cited by FedEx do not involve fact situations in which the component part could be considered the appropriate unit of property.
In the cases cited by FedEx, there are two types of improvements to the component parts of the vehicles: replacement and repair. Ingram, like the case at bar, involved simultaneous repair to the component part and a resulting improvement in the larger vehicle. The majority of the cases cited by FedEx, however, are replacement cases involving the replacement of component parts resulting in an improvement to the larger vehicle. See West Virginia Steel Corp. v. Comm'r, 34 T.C. 851, 859 (1960) (improvement to the truck consisted of replacement of a motor); Maier Brewing Co., 1987 Tax. Ct. Memo LEXIS 383, at *80 (improvement to the ship consisted of replacement of two small six-cylinder engines with three twelve-cylinder engines); Hudlow v. Comm'r, Nos. 660-69, 661-69, 662-69, 663-69, 664-69, 6042-69, 1971 Tax Ct. Memo LEXIS 114, at *119-20 (Aug. 30, 1971) (improvement to the forklifts consisted of replacement of major parts of forklifts); LaSalle Trucking v. Comm'r, 22 T.C.M. (CCH) 1375 (1963) (improvements to the truck consisted of replacement of engines, petroleum tanks, and truck cabs); Shore v. Comm'r, Nos. 64818-64820, 64840, 64874, 71532, 71534, 1959 Tax Ct. Memo LEXIS 83, at *18-19 (Aug. 27, 1959) (improvements to the ship consisted of thereplacement of two marine engines). The component parts in the replacement cases are not candidates for application of the Repair Regulations because there is no increase in value to or addition to the useful life of a replaced part. Although the courts analyzed the replacement of the component part as a repair to the vehicle (in certain cases holding that the repair was sufficiently substantial to constitute a non-deductible capital improvement to the vehicle), it could not have considered them as a repair of the smaller component part and are thus inapposite.
The next group of cases cited by FedEx involves repair but does not involve a distinct component that the court could have considered as an alternative to the entire vehicle in identifying the appropriate "unit of property." In Bloomfield Steamship Co. v. Commissioner, the court examined the application of the Repair Regulations to substantial repairs made to eight cargo vessels, but the court did not detail what had been repaired. 33 T.C. 75, 84 (1959). In Harrah's Club v. United States, the court examined the application of the repair regulations to extensive restoration work performed on a fleet of antique vehicles. 661 F.2d 203 (Cl.Ct. 1981). In that case, the court noted that the restoration work included repairs to the body, engine, upholstery, lights, and paint of the cars. Id. at 206. Finally, in Standard Motors, Inc. v. united States, No. 1924, 1961 U.S. Dist. LEXIS 5606, at *7-8 (E.D. La. Aug. 25, 1961), the court treated the boat as the appropriate unit of property for improvements which consisted of overhauling the engines, replacing canvas on deck for waterproofing, and installing a small heater. It is difficult to extract an "entire vehicle rule" from Bloomfield, Harris, or Standard Motors because they are cases in which the improvements in the respective vehicles were broad in scope and in which there was no logical way to break the repairs into segments smaller than the entire vehicle.
The court recognizes that there are two components at issue here: the jet aircraft engines and the APUs, but they are logically considered together because they operate together and are both serviced during the ESVs.
FedEx cites two cases in which there are discrete candidates for what should be construed as the appropriate "unit of property" under the Repair Regulations. In one of the cases, however, the court assumed without deciding that the entire vehicle was the appropriate unit of property, and the court does not indicate why it used the entire vehicle as the appropriate unit of property. Jacks, 1988 Tax Ct. Memo LEXIS 267, at *8-9 (CAT loader was treated as the appropriate unit of property when improvement involved was a substantially rebuilt engine). FedEx cites only one case which specifically addresses the "unit of property" issue as it appears in this case. See Ingram, 2000 Tax Ct. Memo LEXIS 381, at *26-27. In Ingram, the court held that the towboat, not the towboat engine, was the appropriate unit of property. Id. In making its finding, the court looked to the record and found that the engines should not be treated separately, stating:
[T]he record does not support a finding that, as a matter of industry practice or otherwise, the engines are purchased or treated separately from the tow boats. To the contrary, the life of a towboat is 40 years and it is expected that the engines, if properly maintained, will also last 40 years. Towboats are purchased with engines, albeit to the buyer's specifications, that are designed to be maintained without removing them from the boat. There was no showing that towboat owners regularly and periodically over the life of the vessel replaced the engines. Accordingly, we disregard any suggestion by respondent that the engines as a matter of fact or law, should be treated separately from the towboats.Id. Thus, while the Ingram court reached the unit of property issue, it did not do so as a matter of law but as a result of its analysis of the facts before it. This approach is echoed in Smith v. Commissioner, in which the Ninth Circuit examines the "unit of property" issue, and notes that its resolution was a question of fact subject to the clearly erroneous standard of review. 300 F.3d 1023, 1030 (9th Cir. 2002).
Significantly, a factual finding central to the court's holding on the "unit of property" issue in Ingram was its determination that the tugboat and its engine had the same useful life. 2000 Tax Ct. Memo LEXIS 381, at *26-27. In the case at bar, the parties dispute whether the jet aircraft engines and APUs have the same useful life as the airframes.
Based on the foregoing analysis of the cases cited by FedEx, the court concludes that there is no "entire vehicle rule" providing that, with respect to the Repair Regulations, work preformed on a component part of an assembled transportation or construction vehicle must be attributed to the completely assembled vehicle. Accordingly, the court will, consider FedEx's second argument that the completely assembled aircraft, and not the jet engines and APUs, should be considered the appropriate unit of property as a matter of law.
FedEx argues that, if the court applies the "functional interdependence test", it must conclude that the completely assembled aircraft is the appropriate "unit of property" as a matter of law. What FedEx refers to as the "functional interdependence test" is derived from a Treasury regulation concerning a set of capital rules not at issue in this case. Specifically, Treasury Reg. § 1.263A-10(c) provides in pertinent part:
Components of tangible personal property are a single unit of property if the components are functionally interdependent. Components of tangible personal property that are produced by, or for, the taxpayer, for use by the taxpayer or a related person, are functionally interdependent if the placing in service of one component is dependent on the placing in service of the other component by the taxpayer or a related person. In the case of tangible personal property produced for sale, components . . . are functionally interdependent if they are customarily sold as a single unit.
FedEx argues that the undisputed facts compel the court to find that the airframes are "functionally interdependent" with the APUs and jet aircraft engines because the APUs and jet aircraft engines are customarily sold with the airframes. To the contrary, the United States maintains that there is a genuine issue of material fact with respect to whether the APUs and jet aircraft engines are "functionally interdependent" with the airframes based on Defendant's evidence: that a stand-alone jet aircraft engine market existed in TY 1993 and TY 1994, that jet aircraft engines are separately marketed from aircraft, that the practice of engine appraisal is widespread in the aviation industry, that jet aircraft engines and airframes have different life expectancies, and that FedEx treats jet aircraft engines and airframes separately for financial purposes, maintaining separate accounts in its books and records for jet aircraft engines and airframes.
The United States has provided sufficient evidence to create a genuine issue of material fact with respect to whether FedEx's jet aircraft engines and APUs were functionally interdependent with FedEx's airframes during TY 1993 and TY 1994. Until the court resolves the disputed facts regarding the existence and nature of the stand-alone jet aircraft engine and APU markets in TY 1993 and TY 1994 and the disputed facts regarding FedEx's treatment of the jet aircraft engines and APUs as entities independent from the airframes, the court cannot determine whether the jet aircraft engines/APUs or the completely assembled aircraft are the appropriate units of property for applying the Repair Regulations.
The court notes that it is not necessarily adopting the "functional interdependence test."
As a final matter, the court notes that the United States argued in the alternative that the jet aircraft engines and APUs were the appropriate units of property for application of the Repair Regulations as a matter of law. Based on the foregoing discussion, the court finds that fact issues remain that preclude summary judgment for either side on this issue.
IV. Conclusion
For the foregoing reasons, the court DENIES FedEx's motion for partial summary judgment on the "unit of property" issue. To the extent that the response of the United States also constituted a cross-motion for summary judgment on the "unit of property" issue, the court likewise DENIES that cross-motion.