Corporation Disputes Capitalization of Office Furniture and Equipment Expense

PETITION

The Petitioner hereby petitions for a redetermination of the deficiencies set forth by the Commissioner of Internal Revenue in the Commissioner's notice of deficiency dated July 18, 2000, and as the basis for the petitioner's case alleges as follows:

1. Petitioner ITC Deltacom, Inc. (EIN [EIN omitted]) is a corporation, which is the successor in interest to a corporation, ITC Holding Company, Inc. and Subsidiaries (EIN [EIN omitted]). Petitioner is an alternative agent for ITC Holding Company, Inc. (E.I.N. [EIN omitted]) and subsidiaries. Petitioner's principal office and mailing address are 1791 O.G. Skinner Drive, West Point, Georgia. The return for the period here involved was filed with the Internal Revenue Service Center, Atlanta, Georgia.

2. The notice of deficiency, a photocopy of which is attached hereto as Exhibit A, was mailed to petitioner on July 18, 2000, and was issued by the Georgia Appeals Office at Atlanta, Georgia.

3. The deficiency-as determined by the Commissioner is in income tax for the taxable year ended December 31, 1996, in the amount of $909,893.30 and an addition to the tax pursuant to I.R.C. Section 6662(a) in the amount of $197,403.26, all of which is in dispute.

4. The determination of tax set forth in the notice of deficiency is based upon the following errors:

ITC HOLDING COMPANY, INC.

(a) The Commissioner erred in determining that $2,900,000.00 of the 2,914,883.00 shown on the income tax return of ITC Holding Company, Inc. as miscellaneous expense relates to an amount claimed due by BellSouth Telecommunications, Inc. for Feature Group A Delivery Switch Service, which liability was contested and contingent as of December 31, 1996, and does not meet the provisions set forth in section 461 of the Internal Revenue Code. The Commissioner erred in increasing taxable income by the amount of $2,900,000.00.

(b) The Commissioner erred in determining that the amount of $2,821.00 of the $2,914,833.00 shown on the income tax return as miscellaneous expense represents the amount for the Huguley Building remodeling work, which has an expected life of more than one year and thus is a capital expenditure that must be capitalized. The Commissioner erred by increasing taxable income by $2,821,00.

INTERSTATE TELEPHONE COMPANY

(c) The Commissioner erred in determining that $8,634.00 of the $128,397.00 shown on the income tax return as customer services represents the amount of various pieces of office furniture purchased in 1996, which have a useful life of more than one year and thus should be capitalized. The Commissioner erred in increasing taxable income by $8,634.00.

(d) The Commissioner erred in determining that $2,084.00 of the $175,766.00 shown on the income tax return as external relations represents the cost of the an original oil painting purchased in 1996, which has an expected life of more than one year and thus should be capitalized. The Commissioner erred in increasing taxable income by $2,084.00.

(e) The Commissioner erred in determining that $3,750.00 of the $175,766.00 shown on the income tax return as external relations represents the cost of the centennial party, which should be reduced by $1,875.00 (50%) of the cost of the activity under section 274 of the Internal Revenue Code. The Commissioner erred in increasing taxable income by $1,875.00.

(f) The Commissioner erred in determining that $1,200.00 of the $100,122.00 shown on the income tax return as land and building expense represents the cost of an awning purchased in 1996, which has an expected life of more than one year and thus should be capitalized. The Commissioner erred in increasing taxable income by $1,200.00.

INTERCALL, INC.

(g) The Commissioner erred in determining that $190,561.00 of the $402,419.00 shown on the income tax return as supplies represents the amounts of various pieces of office furniture, office equipment and software purchased in 1996, with an expected life of more than one year and thus should be capitalized. The Commissioner erred in increasing taxable income by $190,561.00.

(h) The Commissioner erred in determining that $175,126.00 of the $975,322.00 shown on the income tax return as travel and entertainment represents the cost of trips to Hawaii and Napa Valley and food costs at sales meetings in the total amount of $175,126.00 (as detailed in the notice of deficiency), which should be reduced by 50% pursuant to section 274 of the Internal Revenue Code. The Commissioner erred in increasing taxable income by $87,563.00.

(i) The Commissioner erred in determining that $76,424.00 shown on the return as legal expense represents the cost of acquiring an UK office, which is a capital expenditure and should be allowable at the time of disposal. The Commissioner erred in increasing taxable income by $76,424.00.

(j) The Commissioner erred in determining that $6,351.00 of the $796,855.00 shown on the return as miscellaneous expense represents the cost of furniture purchases in 1996, which have an expected life of more than one year and thus should be capitalized. The Commissioner erred in increasing taxable income by $6,351.00.

(k) The Commissioner erred in determining that $790.00 of the $796,855.00 shown on the return as miscellaneous expense represents the amount of membership dues paid to American Electronics Association that was used for political lobbying and is therefore not an ordinary and necessary business expense. The Commissioner erred in increasing taxable income by $790.00.

DELTACOM, INC.

(l) The Commissioner erred in determining that $29,964.00 of the $357,513.00 shown on the return as supplies represents the amounts of various system, equipment, and software installations purchased in 1996, which have an expected life of more than one year and thus should be capitalized. The Commissioner erred in increasing taxable income by $29,964.00.

(m) The Commissioner erred in determining that $14,477.00 of the $968,411.00 shown on the return as advertising represents the amount of food and entertainment costs in promoting business (as detailed in the notice of deficiency), which should be reduced pursuant to the 50% limitation under section 274 of the Internal Revenue Code. The Commissioner erred in increasing taxable income by $7,238.00.

(n) The Commissioner erred in determining that $210.00 of the $968,411.00 shown on the income tax return as advertising expense represents the amount of membership dues paid to Montgomery Chamber of Commerce that was used for political lobbying and is therefore not an ordinary and necessary business expense. The Commissioner erred in increasing taxable income by $210.00.

INTERQUEST (DIVISION OF EASTERN TELECOM)

(o) The Commissioner erred in determining that the IQ remodeling job had a useful life of 39 years rather than 31.5 as claimed. The Commissioner further erred in determining that the refurbished modular panels had a useful life of 7 years rather than 5 years as claimed. The Commissioner erred in increasing taxable income by $1,224.00.

(p) The Commissioner erred in determining that the accuracy- related penalty imposed under section 6662(a) of the Internal Revenue Code is applicable. The Commissioner erred in imposing a penalty of 20% of the $987,016.30.

5. The facts upon which the petitioner relies, as the basis for petitioner's case are as follows:

ITC HOLDING COMPANY, INC.

(a)(1) ITC Holding Company, Inc. ("ITC") is, and was during the taxable year 1996, an accrual basis taxpayer.

(a)(2) During the period April 1, 1994 through November 30, 1996, ITC incurred expenses for access termination services provided by BellSouth Telecommunications, Inc. ("BellSouth").

(a)(3) The terms and conditions pursuant to which ITC and BellSouth provide access and related services to each other for the purpose of originating and terminating telecommunications traffic are governed by various agreements, contracts, tariffs, and understandings (referred to collectively as "Interconnection Agreements").

(a)(4) By letter dated December 4, 1996, BellSouth indicated to ITC that Interstate Telephone Company and Valley Telephone Company, both subsidiaries of ITC, had neither paid nor reported with respect to certain terminating access to BellSouth's network, and stated that such actions constituted an "improper scheme" since at least April, 1994, in violation of FCC mandates, NECA tariffs and existing agreements.

(a)(5) BellSouth demanded in its letter the sum of $6,874,180.00 for terminating services provided by BellSouth for the period April 1, 1994 through November 30, 1996, but did not provide any detail supporting the calculation of that amount.

(a)(6) Interconnection agreements and tariffs are subject to interpretation. There have always been questions regarding, and modifications of, interconnection and settlement practices between connecting telephone companies. "Settlements" is a standard industry term for allocation sharing in the telecommunications industry. For telephone companies to interpret settlement of a specific service differently is common in the industry.

(a)(7) To imply that a member of the settlement pool is involved in an "improper scheme" is not common in the industry. Such an assertion by BellSouth in its letter was without merit and thus was taken very seriously by ITC. During its greater than 100 years' existence, ITC's professional reputation has been built with business acumen, driven by character and integrity, and thus it takes exception to any inferences to the contrary.

(a)(8) On December 13, 1996, ITC, through its representative, notified BellSouth by telephone that a written response would be forthcoming on the same date. ITC acknowledged and did not dispute that it had liability for additional fees in the minimum amount of $2,000,000.00 as a result of preliminary review and its current interpretation of the tariffs, but disputed the charge that Interstate and Valley were involved in an improper scheme. ITC requested a meeting to discuss that issue.

(a)(9) ITC prepared a written response, requesting that BellSouth furnish specific data regarding its allegations and support for its claim for payment. A request for documentation to support a claim for payment is standard practice in the telecommunications industry. It is a fact gathering process, and not a dispute or contest as to liability.

(a)(10) ITC conducted its own internal review of the data and other facts. As a result of such internal review and renewed interpretation of the interconnection agreements, it was determined that there was an additional liability to BellSouth with respect to the Feature Group A charges.

(a)(11) Although ITC disputed the "improper scheme" allegation, ITC did not deny or contest at any time that it had an additional liability to BellSouth in the minimum amount of $2,000,000.00. This was communicated to a representative of BellSouth on December 13, 1996.

(a)(12) Based upon ITC's review and renewed interpretation of the interconnection agreements, the amount of additional liability was determinable with reasonable accuracy prior to the end of the taxable year, December 31, 1996.

(a)(13) ITC determined and accrued the amount of $2,900,000.00 upon closing of its books for the taxable year ending December 31, 1996. That is the amount that was eventually paid to BellSouth.

(a)(14) The liability of ITC for the additional fees was incurred in the taxable year, ending December 31, 1996. The amount of the liability as of December 31, 1996, was determinable with reasonable accuracy. Economic substance had occurred with respect to that liability.

(a)(15) The liability was not disputed or contested as of the end of the taxable year December 31, 1996, to the extent of the amount of $2,900,000.00.

(a)(16) ITC deducted in its return as originally filed for the taxable year ending December 31, 1996, certain terminating access charges. Included in this deduction was the $2,900,000.00 determined to be incurred between April, 1994 and November, 1996, in connection with the additional Feature A terminating access charges for services provided by BellSouth.

(a)(17) ITC properly accrued and deducted the amount of $2,900,000.00 on its Federal income tax return for the taxable year ending December 31, 1996.

(b) ITC incurred and was entitled to deduct the amount of $2,821.00 of the $2,914,833.00 shown on the income tax return as a miscellaneous expense. The amount of $2,821.00 represents the amount paid for the Huguley Building remodeling work, which ITC is entitled to expense.

INTERSTATE TELEPHONE COMPANY

(c)(1) Interstate Telephone Company incurred miscellaneous expenses related to customer service functions, which directly relate to the active conduct of a trade or business. The amount of $8,634.00 was properly deducted in accordance with section 162 of the Internal Revenue Code.

(c)(2) Interstate Telephone Company incurred and is entitled to deduct $2,084.00 of the $175,766.00 claimed on its income tax return as external relations in 1996.

(c)((3) Interstate Telephone Company incurred the amount of $3,750.00 for external relations, which it is entitled to deduct as a current expense.

(c)(4) Interstate Telephone Company incurred miscellaneous expenditures for land and building expense, which directly relate to the active conduct of a trade or business. The amount of $1,200.00 is deductible under section 162 of the Code as an ordinary and necessary business expense.

INTERCALL, INC.

(d)(1) Intercall, Inc. incurred miscellaneous expenses for supplies, which directly relate to the active conduct of a trade or business. Intercall properly deducted the amount of $190,561.00 for 1996 pursuant to section 162 of the Code.

(d)(2) Intercall, Inc. incurred miscellaneous expenses relating to sales, which directly relate to the active conduct of a trade or business. Intercall properly deducted $175,126.00 for 1996 pursuant to section 162 of the Code.

(d)(3) Intercall, Inc. incurred expenditures for miscellaneous expenses relating to legal expenses, which directly relate to the active conduct of a trade or business. Intercall properly deducted $6,424.00 for 1996 pursuant to section 162 of the Code.

(d)(4) Intercall, Inc. expended $6,351.00 for furniture which it reported on its return as a miscellaneous expense. The amount of $76,351.00 is a currently deductible expense.

(d)(5) Intercall incurred expenditures in the amount of $790.00 in 1996, which it properly deducted as an ordinary and necessary business expense.

DELTACOM, INC.

(e)(1) Deltacom incurred expenditures for supplies in the amount of $29,964.00 in 1996, which directly relate to the active conduct of a trade or business. Deltacom properly deducted the amount of $29,964.00 as a current expense in 1996.

(e)(2) Deltacom incurred expenditures in the amount of $14,477.00 in 1996, which directly relate to the active conduct of a trade or business. Deltacom properly deducted $14,477.00 as an ordinary and necessary business expense.

(e)(3) Deltacom incurred expenditures in the amount of $210.00 in 1996 as an advertising advertising expense, which was directly related to the active conduct of a trade or business. Deltacom properly deducted $210.00 as an ordinary and necessary business expense.

INTERQUEST (DIVISION OF EASTERN TELECOM)

(f) The IQ remodeling job had a useful life of 31.5 as claimed. The refurbished modular panels had a useful life of 5 years as claimed.

PENALTY

(g)(1) Based upon the facts alleged in the subparagraphs of paragraph 5 above, which are incorporated herein by reference, ITC and its subsidiaries acted in good faith and with reasonable cause and are not liable for the accuracy-related penalty imposed by section 6662(a) of the Internal revenue Code as determined by the Commissioner.

(g)(2) ITC and its subsidiaries adequately disclosed the deductions, which are at issue, on its income tax return for the taxable year 1996.

(g)(3) ITC and its subsidiaries had a reasonable basis for its position in claiming the accrual of $2,900,000.00 and other deductions for the taxable year 1996. The facts and substantial authority support the position that ITC and its subsidiaries were entitled to accrue the $2,900,000.00 for the taxable year 1996. Petitioner had an uncontested and undisputed liability prior to the end of the taxable year 1996 and the amount of the liability was determinable with reasonable accuracy.

(g)(4) ITC and its subsidiaries did not act in a careless or reckless manner, and did not intentionally disregard the rules and regulations.

(g)(5) The accrual of the $2,900,000.00 is a timing issue. The facts and substantial authority support petitioner's position that ITC and its subsidiaries are entitled to an accrual and deduction in the taxable year ending 1996.

(g)(6) The accuracy-related penalty under section 6662(a) is not applicable.

WHEREFORE, it is prayed that the Court may try this case, determine that there is no deficiency in income tax nor addition to the tax under section 6662(a) of the Code, and give such other further relief as the Court may deem fit and proper.

Date August 31, 2000

[Editor's Note: The attachment has been omitted. However, this document in its entirety can be obtained through our Tax Analysts' Access Service as Doc 2000-24108 (33 pages).]