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Bell Atlantic has lost a $77 million battle with Uncle Sam, now that a federal appeals court has ruled that the Baby Bell was not entitled to a refund under a capital investment tax credit in the Tax Reform Act of 1986. Prior to the enactment of the Tax Reform Act, the law said that qualifying taxpayers were entitled to an income tax credit, or ITC, for qualified investments in certain tangible property. The Tax Reform Act changed all that, reducing corporate tax rates, while also eliminating many deductions, exclusions and credits. Among the credits that were eliminated were investment tax credits on property brought into service after Dec. 31, 1985. But the law included “transitional rules” that ameliorated this change to some extent. One of the transitional rules was the “supply or service contract” rule, which allowed an investment tax credit for property that is “readily identifiable with and necessary to carry out a written supply or service contract” which was binding on Dec. 31, 1985. In other words, a taxpayer could still claim ITC if it had agreed to perform some service that required it to purchase otherwise-qualified property and if that service contract was binding as of the end of 1985. Bell Atlantic claimed that it was entitled to ITC for hundreds of millions of dollars of property put into service after 1985, because it purchased the property “in order to satisfy its written obligations to provide telecommunications services.” The contracts, Bell argued, were its utility franchises, tariffs and contracts with other local telephone companies and long-distance carriers. Seizing on the language of the transitional rule, Bell argued that much of the property purchased in the course of its telephone service business is “readily identifiable with and necessary to carry out” the franchises, tariffs and contracts and, therefore, is eligible for ITC. But Justice Department lawyers argued that Bell Atlantic’s franchises and tariffs are not contracts but simply laws. Citing the U.S. Supreme Court’s 1985 decision in National R.R. Passenger Corp. v. Atchison, Topeka and Santa Fe Railway Co., the government argued that a law does not create any private contractual or vested rights, but merely declares a policy, “absent some clear indication that the legislature intends to bind itself contractually.” While Bell Atlantic’s tariffs often state that they represent the contract between Bell Atlantic and its customers, the government insisted that no written contract actually passes between the two parties. Since the tariffs are modified on a regular basis by the state utility commissioners without the consent of Bell Atlantic or its customers, the government argued that Bell Atlantic’s tariffs are more like regulations than contracts. But Bell’s lawyers pointed to the company’s own internal “estimate files” as proof that written documents existed outlining all of the estimates, budgets, projections and forecasts of the property it had to purchase to meet its obligations. Those files, Bell said, showed exactly what property was “readily identifiable with and necessary to carry out” its contracts. In December 1998, Senior U.S. District Judge Louis C. Bechtle sided with the government, saying “the court does not find that the franchises are contracts. However, even accepting arguendo that Bell Atlantic’s franchises are contracts under the ordinary definition of that term, the franchise agreements do not constitute the types of supply or service contracts that the court believes Congress contemplated would qualify under this transitional rule.” Bell’s customer agreements “are often not written,” Bechtle noted, and the franchise obligations “are entirely voluntary — the agreement is terminable at will by the customer, and Bell Atlantic, from the beginning, need not provide services.” Now a unanimous three-judge panel of the 3rd U.S. Circuit Court of Appeals has upheld Bechtle’s ruling on somewhat narrower grounds. U.S. Circuit Judge Samuel A. Alito said the court did not find it necessary to decide whether Bell Atlantic’s tariffs, franchises and contracts with other telephone companies are “written service contracts” within the meaning of the Tax Reform Act. Instead, Alito said, the court focused on the question of whether any of the property was “readily identifiable with and necessary to carry out” the contracts. The franchises and tariffs, he said, contain service quality standards that regulate telephone service, impose conditions on service and set service goals. The estimate files, Alito said, were generated whenever Bell was required to put new property into service to meet a service quality standard. Bell argued that the estimate files allow the courts to determine what property is “readily identifiable with and necessary to carry out” the contracts. Alito disagreed, saying the Tax Reform Act imposed two conditions that had to be met before property was eligible for ITC — the property must be both “necessary to carry out” the service contract and “readily identifiable with” it. In the case of Bell’s tariffs and franchises, Alito found, it was impossible to make such determinations. “This is because these alleged ‘contracts’ speak only of service quality standards, never mentioning property of any sort. The property, therefore, must be ‘readily identifiable with’ the contracts by some other means,” Alito wrote. Bell, he said, argued that “the estimate files bridge the gap.” But Alito found that “the tariffs, franchises and contracts do not direct the preparation of estimate files; nor do they direct what they should contain.” Alito agreed with Bechtle’s finding that the link between the estimate files and the contracts was “too attenuated.” “The estimate files did not have a binding effect on anyone. As the District Court observed, the estimate files were prepared for internal forecasting, planning and budgeting. They were not prepared contemporaneously with the contracts, and they were not provided to any party to the alleged contracts,” Alito wrote. Bell’s argument, Alito said, is inconsistent with Congress’s choice of the term “readily identifiable.” “Obviously Congress did not want to extend ITC to all property that was identifiable and necessary to carry out a service contract. Instead, Congress demanded that the property be ‘readily’ identifiable with the contract. ‘Readily’ means ‘promptly,’ ‘quickly’ or ‘easily.’” The law’s use of a two-prong test, he said, “presumes that there will be property that fails to qualify for ITC under the transitional rule because it meets only one of the two requirements.” Under Bell’s reading of the test, Alito said, “it is doubtful that any property that was ‘necessary to carry out’ the contract would ever fail the ‘readily identifiable with’ prong. When property is necessary to carry out a contract, a taxpayer could almost always generate some sort of document detailing this relationship. The taxpayer could then point to this document to demonstrate that the property was ‘readily identifiable with’ the contract.” Bell Atlantic was represented by attorneys Thomas E. Zemaitis and Gordon R. Downing of Philadelphia-based Pepper Hamilton, along with Thomas P. Marinis Jr., John D. Taurman, Thomas S. Leatherbury, Sarah A. Duckers, Debra J. Duncan and H. Mallory Caldwell of Vinson & Elkins in Houston. Justice Department Tax Division attorney Thomas J. Sawyer argued the case for the government and was joined on the brief by Assistant Attorneys General Loretta C. Argrett and Bruce R. Ellisen and Philadelphia U.S. Attorney Michael R. Stiles.

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