S Corporation Argues for Exception From Capitalization Requirements for Preproductive Development Costs for Citrus

Pelaez and Sons Inc. has engaged in commercial farming since 1955 and elected S corporation status in 1989. Pelaez engaged in different farming ventures from 1955 onward including cattle ranching and raising sugar cane. In the 1980s Pelaez began a citrus growing operation, using techniques to accelerate the reproduction time of the crops. In 1989, Pelaez planted 39,382 citrus trees. The parties agreed that the costs incurred in establishing the citrus grove, including purchase, bedding, installation of fertigation, and irrigation of the trees are depreciable costs deductible over a period of years.

At the end of a two-year productive period, Pelaez reviewed the sales of citrus, the potential for a 1991 crop and decided to deduct the developmental expenses for the 1989 and 1990 taxable years on its 1991 return. For 1992 and subsequent tax years, Pelaez deducted the developmental costs for the 1989 trees for each year as incurred. Additional citrus trees were planted in 1991, and based on the performance of the 1989 trees, the 1991 trees were expected to be productive in 2 years. Pelaez deducted the developmental expenses and depreciation for the 1991 trees in 1992 and subsequent years.

The IRS in a final S Corporation Administrative Adjustment disallowed the 1991 deduction of $1,171,949 for the 1989 trees. The IRS also disallowed the 1992 deductions of $244,692 for the 1989 trees and $90,513 for the 1991 trees and the 1993 deduction of $116,980 for the 1991 trees. The Tax Court, agreeing with the IRS, held that section 263A required Pelaez to capitalize the developmental costs for the grove even though there were no regs setting forth the nationwide weighted averages for citrus trees. The court also held that the statute was not invalid due to vagueness and that Pelaez was prohibited from using its historical experience to determine if the preproductive period for its grove ended two years after planting. (For a summary of this opinion, see Tax Notes, June 5, 2000, p. 1348; for the full text, see Doc 2000-15351 (26 original pages) or 2000 TNT 105-6 .)

Pelaez argues that in the absence of the nationwide weighted averages, it wasn't subject to the capitalization requirement because the exception provided by section 263A(d)(1)(A)(ii) clearly allowed it to deduct its costs under the exception for plants with a two year of less preproductive period, despite the inability of farmers to use the separate and distinct "opt-out" exception provided under section 263A(d)(3). Pelaez also argues that because its grove had a preproductive period of less than two years, it is within the section 263(d)(1) exception, regardless of the absence of specific proof as to the "nationwide weighted average preproductive period" for citrus crops at the time. Pelaez also asserts that the court should invalidate the portions of section 263A that indicate the preproductive period of a plant shall be based on the national weighted averages. Pelaez maintains that prior to the guidance promulgated in 2000, the statute was impermissibly vague and the IRS's FSAA was arbitrary and capricious in light of the lack of regulations.

[1] Pursuant to Eleventh Circuit Rule 26.1-1, Counsel for Petitioner/Appellant, Pelaez and Sons, Inc., Christina P. Hooker, Tax Matters Person, certify, to the best of their knowledge, that the following constitutes a complete list of all persons and entities who may have an interest in the outcome of this case.

1. Argrett, Loretta C. Esq.

[2] Appellant requests oral argument in this case. Appellant believes this Appeal presents a question of first impression as to whether a portion of the Internal Revenue Code is enforceable in the absence of statutorily mandated explanatory regulations. Oral argument may assist the Court in addressing these issues.

TABLE OF CONTENTS

[3] This Court has jurisdiction over this appeal pursuant to 26 U.S.C. section 7482 and Fed.R.App.P. 13.

PRELIMINARY STATEMENT

[4] In this Brief, Appellant Pelaez and Sons, Inc. will be referred to as "Taxpayer." Appellee, Commissioner of Internal Revenue will be referred to as "Commissioner."

[5] The Internal Revenue Service will be referred to as "Service." The Secretary of the United States Treasury will be referred to as "Secretary." The United States Treasury Department will be referred to as "Treasury Department" or "Treasury."

[6] The Notice of Final S Corporation Administrative Adjustment issued to Taxpayer by Commissioner is referred to as "FSAA."

[7] The "nationwide weighted average preproductive period" referenced in I.R.C. section 263A will be referred to as "nationwide weighted averages."

[8] Unless otherwise noted all emphasis is supplied.

[9] Citations to the Record are in the format prescribed by 11th Cir. Rule 28-4. The Record received from the Tax Court does not contain a notation as to volumes. Accordingly, Taxpayer refers to each matter as though it is contained within volume 1 such that all Record references begin "[R1]".

[10] The majority of the exhibits received into evidence were attached to the Stipulations [R1-22]. However, the fifth page of the Record states that exhibits 37 through 47 were separately certified presumably because they were not attached to the Stipulations. For consistency, those exhibits will be cited as if they were attached to the Stipulation by their Exhibit number.

[11] Taxpayer also advises the Court of an error on page five of the Record in which the clerk stated that "Respondent's exhibits 38-R thru 47-R admitted into evidence." Not all of those exhibits were Respondent's exhibits. Each exhibit was sequentially numbered regardless of which party introduced that particular exhibit. The identity of the party introducing a document is noted by the capital letter following the exhibit number ("P" for Petitioner and "R" for Respondent). For example, exhibits 40 and 41 designated as 40-P and 41-P were those of Petitioner/Taxpayer.

[12] STATEMENT OF THE ISSUES

1. Whether the Tax Court erred when it determined that citrus farmers

I. INTRODUCTION

[13] This appeal concerns I.R.C. section 263A which was newly enacted as part of the Internal Revenue Code of 1986. Generally, I.R.C. section 263A requires taxpayers to capitalize and depreciate certain costs rather than deduct those costs as current expenses. I.R.C. section 263A's capitalization requirements do not apply to plants grown in commercial quantities which have a preproductive period of two years or less as calculated by reference to the "nationwide weighted average preproductive period" for such plants.

[14] I.R.C. section 263A(i) states that "The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section . . ." No relevant regulations or guidance was promulgated which addressed I.R.C. section 263A's application to citrus trees until years after Taxpayer was required to determine whether I.R.C. section 263A applied to the tax returns at issue in this appeal.

[15] This appeal is from a Tax Court decision requiring Taxpayer to capitalize and depreciate certain developmental costs related to its citrus grove pursuant to I.R.C. section 263A rather than deducting the costs as expenses.

II. COURSE OF THE PROCEEDINGS AND DISPOSITION BELOW

[16] On June 2, 1997, the Commissioner issued the FSAA disallowing Taxpayer's deduction for the developmental costs paid or incurred to develop Taxpayer's citrus grove after it was planted. [R1-1-12-14]. On August 27, 1997, Taxpayer filed a Petition in the Tax Court contesting the FSAA. [R1-1]. ¹ In its Petition, Taxpayer contended that the Commissioner impermissibly required Taxpayer to capitalize and depreciate the developmental costs at issue in this appeal pursuant to I.R.C. section 263A. [Id.] Taxpayer contended that it was entitled to deduct the developmental costs pursuant to I.R.C. section 263A(d)(1)(A)(ii) and I.R.C. section 263A(e)(3)(A)(i) which permit the deduction of such costs if there is a marketable crop or yield within two years of planting [R1-1-6].

[17] When Taxpayer filed the income tax returns at issue, the statutorily mandated nationwide weighted averages had not been promulgated. Taxpayer maintained that the Commissioner's determination that it must capitalize its developmental costs was unsupported in law and was arbitrary and capricious. [R1-1-10]. In the absence of the nationwide weighted averages, Taxpayer maintained that it properly deducted the developmental costs based upon its own experience in producing at least one marketable crop within the two year preproductive period. [R1-1-10-11]. Taxpayer also contended that the FSAA was time barred as to its tax return for the year ended September 30, 1991 because the FSAA was issued more than two years after the deadline to do so passed. [R1-1-9].

[18] The Commissioner answered Taxpayer's Petition on October 31, 1997 and admitted that the Secretary had not published any listing of nationwide weighted averages for citrus crops. [R1-3-2]. Nonetheless, the Commissioner contended that Taxpayer improperly deducted the developmental costs because I.R.C. section 263A(e)(3)(B) states that " . . . In the case of a plant grown in commercial quantities in the United States, the preproductive period for such plant shall be based on the nationwide weighted average preproductive period for such plant." [R1-3-2-3]. The Commissioner contended that the FSAA was not time barred because Taxpayer's decision to deduct the developmental expenses constituted a method of accounting change, which so rendered the FSAA to be timely.

[19] Taxpayer replied to the Commissioner's answer on December 9, 1997 and denied that there had been a change of accounting method with respect to its 1991 tax return. [R1-4].

[20] A trial was held before the Tax Court on April 27, 1999. [R1-26]. At trial, the Court received into evidence the Stipulations executed by the parties which contained stipulated facts and documentary evidence. [R1-26-22-24]. In addition to the Stipulations, the Tax Court received into evidence the testimony of fact and expert witnesses called by both parties and other documentary evidence.

[21] On May 30, 2000, the Tax Court issued its opinion ruling against Taxpayer. [R1-31]. The Tax Court held that I.R.C. section 263A required Taxpayer to capitalize the developmental costs for its citrus grove even though neither the Secretary nor the Commissioner issued any regulations setting forth the nationwide weighted averages for citrus trees. [R1-31-9-20]. The Tax Court further held that, even in the absence of any such regulations, the statute was not invalid due to vagueness and Taxpayer was prohibited from using its own historical experience to determine whether the preproductive period for its grove ended within two years after planting. [R1-31-20-21]. The Tax Court further held that Taxpayer's decision to deduct the developmental costs constituted a change in accounting method which rendered the FSAA timely even though the FSAA would otherwise have been time barred. [R1-31-21-26]. The Tax Court entered a decision in accordance with its opinion on June 2, 2000. [R1-32].

[22] On August 28, 2000, Taxpayer timely filed its Notice of Appeal to this Court. [R1-36].

III. STATEMENT OF THE FACTS STATUTORY HISTORY

[23] I.R.C. section 263A was newly enacted in 1986 as part of the Internal Revenue Code of 1986. I.R.C. section 263A, which requires the capitalization of certain expenses, does not apply to plants produced in a farming business which have a preproductive period of two years or less. I.R.C. section 263A(d)(1)(A)(ii).

[24] I.R.C. section 263A(e)(3)(B) provides that the "preproductive period" shall be based on the "nationwide weighted average preproductive period" for each plant. I.R.C. section 263A(i) states that the "Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of the section."

[25] In enacting this law, the House Ways and Means Committee Report stated: "it is expected that the Treasury Department will publish periodically a list of the preproductive periods of various plants based on a weighted average for products produced in the United States in commercial quantities." (H. Rept. 99-426, at 628 (1985), 1986-3 C.B. (Vol. 2) 1, 628 & n.45. Nearly identical language was reiterated by the Staff of Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, at 513-14 (J. Comm. (1987) (the "Bluebook").

[26] In 1987, Treasury issued a temporary regulation indicating that the preproductive period of a plant was to be based on the weighted average preproductive period for such plant determined on a nationwide basis. However, the temporary regulation neither defined the term "nationwide weighted average preproductive period" nor identified what that period was for citrus plants. Temp. Treas. Reg. section 1.263A-1T(c)(4)(ii)(D), T.D. 8131, 1987-1 C.B. 98 (March 30, 1987) as amended by T.D. 8148, 52 Fed. Reg. 29375 (August 7, 1987).

[27] In 1994 Treasury issued a final regulation which stated that "For taxable years beginning before January 1, 1994, taxpayers must take reasonable positions on their federal income tax returns when applying Section 263A." Treas. Reg. section 1.263A-1(a)(2)(ii). That states that " . . . a reasonable position is a position consistent with the temporary regulations, revenue rulings, revenue procedures, notices and announcements concerning Section 263A applicable in taxable years beginning prior to January 1, 1994." Id. The 1994 temporary regulations, however, still failed to define the term "nationwide weighted average preproductive period" or set forth that period for citrus plants. Temp. Treas. Reg. 1.263A- 4T(c)(4)(ii)(D), T.D. 8559, 59 Fed. Reg. 39958 (August 5, 1994).

[28] In the preamble to the August 1997 temporary regulations (T.D. 8729, 62 Fed. Reg. 44542 (August 22, 1997)), Treasury announced that it ANTICIPATED issuing nationwide weighted average preproductive periods and noted that it expected that 37 crops (including citrus crops) would have nationwide weighted average preproductive periods in excess of two years. However, the 1997 Temporary Regulations still did not define the term nationwide weighted average preproductive period or how to determine such a period. Temp. Treas. Reg. section 1.263A-4T(b)(2)(i)(b), T.D. 8729, 62 Fed. Reg. 44542 (August 22, 1997). The 1997 temporary regulations did, however, state with respect to a crop not grown in commercial quantities that "the taxpayer is required, at or before the time the seed or plant is acquired or planted, to reasonably estimate the preproductive period of the plant." Id. The regulation also stated that "if the estimate is reasonable, based on the facts in existence at the time it is made, the determination of whether Section 263A applies is not modified at a later time even if the actual length of the preproductive period differs from the estimate." Id.

[29] Shortly after the Tax Court's decision in this case, Treasury issued Notice 2000-45 and final regulations with respect to I.R.C. section 263A. T.D. 8897, 65 Fed. Reg. 50638 (August 21, 2000); 2000-36 I.R.B. 256 (September 5, 2000). Although these regulations failed to define the term "nationwide weighted average preproductive period," Notice 2000-45 stated that thirty eight crops, including all of the crops at issue in this case have nationwide weighted averages greater than two years. For the first time, the nationwide weighted averages were promulgated.

FACTUAL HISTORY

[30] Taxpayer is a Florida corporation which elected "S" corporation status and was a cash basis taxpayer for the years at issue. [R1-31-31]. Taxpayer has continuously been engaged in the commercial farming business since its incorporation in 1955. Id. Commercial farming has always been Taxpayer's only business. [R1-26- 69-70].

[31] From 1955 until the early 1960's, Taxpayer focused strictly on producing cattle for the commercial market. In the early 1960's it also began commercially growing sugar cane. In the late 1980's Taxpayer decided to expand its farming operations by entering the commercial citrus business while continuing its cattle raising and sugar growing businesses. [R1-26-70]. Taxpayer entered the citrus business to increase profits and minimize business risk by diversifying its operations. [R1-31-3].

[32] From the time Taxpayer decided to enter the commercial citrus market, Taxpayer wished to maximize and expedite fruit production from its grove in order to accelerate and increase its profits. Taxpayer had previously successfully accelerated the reproduction time in its cattle business and, in a favorable citrus market, attempted to accelerate the production of citrus crops. [R1- 31-31. This favorable market encouraged Taxpayer to invest and innovate in order to cause its citrus grove to produce fruit as quickly as possible. [R1-26-48-51].

[33] Taxpayer's decision to promptly bring its citrus grove into production was part of its long established business plan and established history of expediting and increasing production in its farming operations. [R1-26-78-79].

[34] As a result of numerous innovations in the citrus industry, citrus fruit is now produced earlier and in greater quantities than has been the case historically. [R1-26-149-150; R1- 22, Ex. 41-P, p. 6]. As a result, citrus fruit is now produced in the second year of a citrus tree's life. [R1-26-165, 171, 183; R1-22 Ex. 41-P, p. 5]. Indeed, the Tax Court, while noting the experts differed in their views concerning its commercial viability, stated that the experts' opinions could permit the conclusion that citrus trees can produce a small amount of fruit within two years. [R1-31-19]. In fact, fruit production from two year old citrus trees using modern, advanced growing practices is roughly equivalent to fruit production from four year old trees using growing practices common in the 1960's and 1970's. [R1-22 Ex. 41-P, p. 6].

[35] Taxpayer designed and built its citrus grove to bring its citrus trees into production at the earliest possible time. The land Taxpayer selected to use for its citrus grove was particularly well suited for a grove. [R1-31-3]. Taxpayer also exploited techniques that would accelerate the growth of its citrus crop and maximize its output. [R1-31-4]. In doing so, it invested extensively in land preparation, water management, fertilization and other measures to maximize tree growth and fruit production. Id.

[36] For example, Taxpayer's trees were planted by a commercial tree planting service. Id. To irrigate and fertilize its grove, Taxpayer invested in a microjet irrigation system employing fertigation technology. In order to obtain superior tree stock, Taxpayer purchased its trees from a commercial nursery, and treated them with an aggressive regimen of nutritional and fungicidal sprays. Taxpayer also attempted to expedite production by using better rootstocks and varieties as well as higher density tree plantings. [R1-26-47-48, 52-54, 72; R1-22 Ex. 40-P, pp. 1-3, Ex. 41-P, pp. 1-2, 9-11].

[37] Taxpayer hired Henry Hooker, a graduate of the University of Florida with a degree in mechanized agriculture, to establish its citrus operations. [R1-31-4]. Prior to establishing Taxpayer's citrus grove, Mr. Hooker had extensive experience in the commercial citrus industry. [R1-26, 44-49, 67].

[38] Taxpayer planted its first citrus trees in May, June and July of 1989 (the "1989 Trees") [R1-31-4]. It planted additional trees in late 1991 ("the 1991 trees"). [R1-31-6].

[39] After citrus trees bloom, the blossoms fall to the ground thereby exposing the fruit on the trees. [R1-22-3 paragraph 11]. The crop is generally considered to be formed at the bloom date. [R1-22 Ex. 41-P, p. 7]. By April/May of any year, the exposed fruit can then be examined to determine if a marketable crop exists. [R1-26-60, 75].

[40] Taxpayer's 1989 Trees first bloomed in early 1990. [R1-31- 6]. Good quality, marketable fruit was clearly visible on these trees in April/May 1990. [R1-26-55-59, 75; R1-22 Ex. 37-P; Ex. 41-P, pp. 6- 7].

[41] In late 1990, Taxpayer sold approximately 80 boxes of fruit from the 1989 Trees for which it was paid $220 net of the costs of harvest which were borne by the purchaser. [R1-31-6]. Taxpayer reported the income from this sale on its 1991 tax return. [Id.] This fruit was purchased by an unrelated commercial fruit dealer licensed by the State of Florida. [R1-26-57-59].

[42] The 1989 Trees bloomed again in 1991 and fruit was visible by the Spring of 1991. [R1-31-6]. By May 1991 the fruit was approximately golf-ball sized. In the course of their frequent personal inspections of the citrus grove, Mr. Hooker and Ralph Pelaez, Taxpayer's President, both determined that a marketable crop of fruit existed on the trees by May 1991. [R1-26-54, 60, 75-76]. ² A photographic representation of the fruit in any given April/May time frame is contained in Exhibit 37-P. [R1-22 Ex. 41, pp. 6-7].

[43] Fruit from the 1991 bloom began to be harvested in October 1991. [R1-31-6]. Taxpayer sold its second crop for approximately $14,600 net of harvesting costs. [R1-31-6]. The purchaser was not related to Taxpayer. [R1-26-61]. Taxpayer reported this revenue as income on Taxpayer's 1992 Tax Return. [R1-26-91].

[44] The 1991 Trees bloomed in early 1993, fruit was visible in early 1993 and began to be harvested in October 1993. [R1-31-7]. The 1991 Trees would have been more productive during the first two years of their lives than the 1989 Trees were because the 1991 Trees were not adversely impacted by a severe freeze as the 1989 Trees had been. [R1-22 Ex.41-P, pp.3-4].

[45] Taxpayer has produced prize winning fruit. For example, samples of the Taxpayer's 1992/1993 fruit crop won a first place award at that year's County Fair. [R1-31-7; R1-26-61-62; R1-22 Ex. 16-J].

[46] After the 1989 Trees were planted, the developmental expenses including those for herbicides, fertilizer, pesticides, interest, depreciation and caretaking expenses were paid or incurred with regard to the 1989 Trees. [R1-22-2 paragraph 9].

[47] When it became time for Taxpayer to prepare its federal tax return for the year ending September 30, 1989 (the year of planting), Taxpayer was confronted with the issue of whether to capitalize its developmental expenses or deduct them pursuant to the provisions of I.R.C. section 263A. At this time, neither the nationwide weighted averages for citrus trees nor any other relevant guidance had been promulgated. [R1-31-9-10]. Taxpayer did not know at that time whether the grove would produce at least one marketable crop of citrus fruit within two years after planting the 1989 Trees. [R1-31-5]. ³ Accordingly, in consultation with its tax professional, Taxpayer decided to defer the decision to capitalize or deduct the developmental costs until the end of the two year period when it would possess sufficient facts to allow it to determine whether it was required to capitalize these costs. [R1-26-73, 86, 92- 94; R1-22 Ex. 18-J]. Taxpayer determined that it would be more prudent to defer the decision of whether to deduct the developmental expenses. [R1-31-8]

[48] At the end of the two-year preproductive period, Taxpayer reviewed the sale of citrus in late 1990 and the potential for a 1991 crop based on the spring bloom and decided to deduct the developmental expenses for the 1989 and 1990 tax years on its 1991 tax return. [R1-31-5; RI-22 Ex. 18-J]. For each tax year thereafter, Taxpayer has consistently deducted the developmental expenses for the 1989 Trees on the respective tax return for each such year. [R1-22-4 paragraph 15, 16, 17].

[49] Based upon the actual production history of the 1989 Trees, at the time Taxpayer planted its 1991 Trees, it believed they would produce a marketable crop within two years. [R1-26-76]. Taxpayer reasonably believed that the 1991 Trees would be at least as productive, if not more productive, in their first two years than the 1989 Trees were in their first two years because the 1989 Trees had been subjected to a serious freeze. [R1-22 Ex. 41-P, pp. 3-4].

[50] Accordingly, the developmental expenses for the 1991 Trees for the Tax Year ended September 30, 1992 (the tax year the 1991 Trees were planted), were deducted on the 1992 Tax Return. [R1-22-4 paragraph 15].

[51] For each tax year thereafter, Taxpayer consistently deducted the developmental expenses for the 1991 Trees in the year in which these expenses were paid or incurred. [R1-22-4 paragraph 15, 16, 17].

[52] Taxpayer made its decisions to: (1) initially defer and, (2) subsequently deduct the developmental expenses from its grove in consultation with its tax professional Albert W. Todd, CPA. [R1-31- 8]. Mr. Todd's nearly forty years of professional experience as a certified public accountant includes significant experience with both national and local accounting firms. Approximately 95% of his practice is devoted to tax accounting. Further, approximately 75-80% of his practice has been devoted to clients in the agricultural industry. [R1-26-89].

[53] In trying to advise Taxpayer, Mr. Todd researched I.R.C. section 263A as well as the related congressional committee reports. [R1-31-8; R1-26-94]. Mr. Todd's research confirmed that the Secretary had not issued any regulations listing nationwide weighted averages for citrus plants at such time. [R1-26-94-]. Mr. Todd was not aware of any other authority in existence that would have provided guidance on that question. [R1-26-94-95]. Moreover, Mr. Todd was not aware of any requirement that taxpayers must themselves determine nationwide weighted averages. [R1-31-8]. As part of his research, Mr. Todd also consulted with other tax professionals to assist him in advising Taxpayer as to what course to take to comply with the requirements of I.R.C. section 263A. [R1-26-94-95].

[54] When that he advised Taxpayer to defer the decision to deduct the developmental expenses, Mr. Todd believed such was a prudent course of conduct. [R1-31-8]. Mr. Todd based this advice on the absence of guidance regarding the proper treatment of these expenses on Taxpayer's tax return. [R1-31-8]. Mr. Todd and Taxpayer were not the only tax professional and citrus growers placed in a quandary by the absence of regulations. In October 1993, the Florida Citrus Liaison Team was formed, among other objectives, to reduce barriers to compliance and reduce taxpayers' burdens. [R1-26-103]. This Team consisted of five Florida citrus industry representatives, two tax practitioners and six Service representatives. [R1-31-7]. Service representative, Roger Wenner, was the Specialization Program Coordinator for the citrus industry for the Service's North Florida District and represented the Service's interests on the Team in his official capacity as an agent of the Service. [R1-26-109; R1-22 Ex. 21-P, pp. 3-5].

[55] Mr. Wenner was the primary drafter of a document entitled "Request for Guidance on the Uniform Capitalization of Citrus Groves" dated March 28, 1996. [R1-26-104; R1-22 Ex. 21-P, p.1 of Ex. B]. The Service's Jacksonville, Florida office transmitted the Request for Guidance to the Service's Chief Counsel of the Service in order to obtain answers to questions regarding I.R.C. section 263A. [R1-26- 104; R1-22 Ex. 21-P, pp. 3-5].

[56] The Request for Guidance admits that at least until 1996 (the date of the Request for Guidance and after the tax returns at issue in this appeal were filed), the provisions of I.R.C. section 263A were not being uniformly applied by Service examiners in the North and South Florida Districts. [R1-22 Ex. 21-P, p. 6-7]. The Tax Court found that there was a belief within the liaison group that Service examiners "were not uniformly applying the Section 263A provisions." [R1-31-7].

[57] The Request for Guidance also noted that, the provisions of I.R.C. section 263A were not being uniformly applied by Florida citrus growers and tax practitioners and that there were no judicial decisions or formal Service guidance available to aid taxpayers or Service personnel in interpreting the provisions of I.R.C. section 263A. [R1-22 Ex. 21-P, pp. 6-7]. As a result, the Request for Guidance noted that the application of the Uniform Capitalization Provisions of I.R.C. section 263A constituted the most pressing compliance concern of the citrus industry, tax practitioners, and the Service. [R1-22 Ex. 21-P, p. 3].

[58] The Request for Guidance noted that because the nationwide weighted averages had not been promulgated, and the Service had not furnished sufficient guidance to enable growers to uniformly apply the provisions of I.R.C. section 263A, each individual grower and tax practitioner was forced to individually determine the answers to the many unresolved I.R.C. section 263A issues and apply them to the factual situation of each individual grower. [R1-22 Ex. 21-P, pp. 6-7 of Ex. B].

[59] Finally, the Request for Guidance shows that that Service believed that the nationwide weighted averages referenced in I.R.C. section 263A would be promulgated by the Service or the Secretary. [R1-22 Ex. 21-P, p. 9; Ex. 21-P, p. 58]. Mr. Wenner never received a response to the questions raised in the Request for Guidance. [R1-26- 104].

[60] Taxpayer's 1991 tax return was filed on or about January 10, 1992 and was received by the Internal Revenue Service on January 13, 1992. [R1-31-8]. The Commissioner's FSAA was mailed to Taxpayer on June 2, 1997. Id.

[61] In the FSAA, the Commissioner determined that the expenses listed below should have been capitalized pursuant to I.R.C. section 263A. ⁴

Amount of Expense Claimed on:                Amount Allocable To

STANDARD OF REVIEW

[63] The Tax Court's conclusions of law are subject to de novo review. Davis v. C.I.R., 210 F.3d 1346 (11th Cir. 2000). The Tax Court's rulings on the interpretation and application of statutes are conclusions of law which are subject to de novo review. Sleiman v. C.I.R., 187 F.3d 1353 (11th Cir. 1999). The Tax Court's findings of ultimate fact which result from the application of legal principles to subsidiary facts are subject to de novo review. Id. The Tax Court's other findings of fact are reviewed for clear error. Id.

SUMMARY OF ARGUMENT

[64] By its plain language, I.R.C. section 263A(d)(1) allowed Taxpayer to deduct its citrus grove's developmental costs. Taxpayer's grove had a preproductive period of less than two years and there is no provision contained within this paragraph excluding citrus farmers from its scope. Accordingly, the Tax Court erred when it concluded that, as a matter of law, I.R.C. section 263A(d)(1) has no application to citrus farmers.

[65] The Tax Court's reasoning that I.R.C. section 263A(d)(3)(C) precludes citrus farmers from deducting their developmental expenses is incorrect. This subparagraph merely precludes citrus farmers from making a separate independent election to opt out of I.R.C. section 263A treatment. Moreover, the fact that Congress excluded accrual basis taxpayers from the provisions of both I.R.C. section 263A(d)(1) and (d)(3) but did not do so exclude citrus farmers from both clearly shows Congress intended to allow citrus farmers to utilize the exception contained within I.R.C. section 263A(d)(1). Further, because the Secretary failed to issue any regulations determining that the nationwide weighted average for citrus trees was greater than two years, Taxpayer was entitled to deduct its developmental costs pursuant to the exception set forth at I.R.C. section 263A(d)(1).

[66] At the time Taxpayer decided to deduct its developmental costs, there was absolutely no guidance to assist it in determining whether I.R.C. section 263A required Taxpayer to capitalize its developmental costs. Further, the term "nationwide weighted average preproductive period" had never been defined. As a result, great uncertainty existed in the citrus industry, among tax professionals and within the Service itself. This great uncertainty was manifested by the Service's own inconsistent enforcement of the provisions of I.R.C. section 263A. In the absence of the statutorily mandated regulations, Taxpayer properly and reasonably determined that its grove produced a marketable crop within two years by reference to its own growing experience. This is especially true in light of subsequently issued regulations and temporary regulations which analogously sanctioned Taxpayer's decision to deduct its developmental costs pursuant to I.R.C. section 263A(d)(1). As a result, the Tax Court erred when it determined that Taxpayer could not deduct its developmental costs because it did not prove at trial that the nationwide weighted average for citrus plants was two years or less.

[67] The Tax Court erred when it determined that Taxpayer could not prevail in this case, no matter how reasonable Taxpayer's actions may have been, because Taxpayer failed to establish at trial that the nationwide weighted average for citrus plants was two years or less. To the contrary, this burden fell on the Secretary who was directed by statute to promulgate the nationwide weighted averages. The fact that the statute did not explain the consequences of the Secretary's failure, in no way absolved him of his obligation to issue the nationwide weighted averages. Indeed, though disavowed by his litigation strategy, the Commissioner has subsequently agreed that the Secretary bore the responsibility for issuing the nationwide weighted averages and the Tax Court erred when it concluded to the contrary. The Secretary has had the longstanding responsibility to promulgate regulations. Public policy requires that the Secretary promulgate these regulations in order to create the congressionally intended uniform capitalization rules. The Secretary is best suited to promulgate these rules based upon the expertise of the Treasury Department. The Courts are ill-equipped to determine the nationwide weighted averages by the litigation process. Indeed, such a procedure would require the Courts to become embroiled in the legislative process and would improperly transform an executive function into a judicial one in violation of the Separation of Powers clause of the Constitution.

[68] The Tax Court should have invalidated the portions of I.R.C. section 263A and the regulations in effect for the years at issue because, in the absence of the statutorily mandated regulations, the phrase "nationwide weighted average preproductive period" was impermissibly vague. The Commissioner's actions in this case were arbitrary and capricious in light of the lack of regulations.

[69] Finally, the FSAA upon which this case is based was time barred by the statute of limitations. The Tax Court erred when it determined Taxpayer's decision to deduct its developmental costs constituted a change in method of accounting so as to allow the Commissioner's adjustment to Taxpayer's 1991 tax return. Contrary to the conclusion of the Tax Court, simply choosing to deduct or capitalize expenses does not constitute a change in a Taxpayer's method of accounting. Rather than a change of accounting method, there was a change in underlying facts which properly allowed Taxpayer to deduct the developmental costs. This change in underlying facts, as a matter of law, does not constitute a change of accounting method which would have allowed the Commissioner to issue the FSAA.

ARGUMENT

A. IN THE ABSENCE OF THE NATIONWIDE WEIGHTED AVERAGES,

[72] First, under (d)(1), taxpayers who produce plants with preproductive periods of two years or less may deduct their costs, rather than capitalizing them as would otherwise be required under I.R.C. section 263A. I.R.C. section 263A(d)(1)(A)(ii). Notably, this exception itself is further limited by the provision that it does not apply to taxpayers required to use the accrual method of accounting. I.R.C.

[73] section 263A(d)(1)(B). Subsection (d)(1), however, contains no provision excluding citrus farmers from its scope.

[74] A second exception is found in subsection (d)(2) which provides that plants replacing plants lost by reason of casualty are not subject to I.R.C. section 263A. This exception is not applicable here.

[75] Third, and finally, subsection (d)(3) provides an exception for taxpayers who otherwise are subject to the capitalization rules of I.R.C. section 263A but who make an election to opt out of I.R.C. section 263A treatment.

[76] Under this third exception, taxpayers engaged in a farming business may make an election that I.R.C. section 263A not govern the treatment of the costs of the crops they produce. However, I.R.C. section 263A (d)(3)(C), provides that citrus farmers may not make this election to avoid I.R.C. section 263A's capitalization requirements with respect to costs incurred before the close of the fourth taxable year. Subsection (d)(3) contains an additional restriction, as well: taxpayers required to use the accrual method may not use this election to avoid I.R.C. section 263A's capitalization requirement. I.R.C. section 263A(d)(3)(B).

[77] The Tax Court determined that Congress did not intend for citrus farmers to be able to take advantage of the "2 years or less" standard set forth in I.R.C. section 263A(d)(1)(A)(ii). The Tax Court based its reasoning on the language contained in (d)(3)(C) which prohibits citrus farmers from making an election not to have I.R.C. section 263A apply to them. In light of the foregoing statutory scheme, it can readily be seen why the Tax Court was incorrect in concluding that the inability of citrus farmers to utilize the election offered under (d)(3) precludes Taxpayer from deducting its costs under I.R.C. section 263A(d)(1).

[78] First, the language of subparagraph (d)(3)(C) relating to citrus farmers, by its plain terms, merely precludes citrus farmers from making an "election" to opt out of I.R.C. section 263A treatment. Nothing in that subparagraph suggests that citrus farmers may not deduct their costs under subsection (d)(1), if they are otherwise within the express terms of subsection (d)(1). Clearly, if Congress had wanted to preclude citrus farmers from using the exception provided by (d)(1), it could have done so expressly. See, e.g. Louisiana-Pacific Corp. v. ASARCO, Inc., 24 F. 3d 1565, 1573 (9th Cir. 1994) (where Congress set forth exception in one subsection of CERCLA but not in another, and did not include broad exception to all subsections, no exception would be read into the subsections where it was not so expressed), and Eagle-Picher Industries, Inc. v. EPA, 759 F 2d. 922, 927 (D.C. Cir. 1985).

[79] In fact, Congress clearly knew how to write exceptions limiting the applicability of subsection (d)(1) when that was its intent: it expressly created an exclusion under (d)(1) for taxpayers required to use the accrual method of accounting. I.R.C. section 263A(d)(1)(B). Accordingly, the omission of any provision excluding citrus farmers from the operation of (d)(1) shows that no such exclusion was intended, and citrus farmers ARE permitted to take advantage of that provision, if it is otherwise applicable, notwithstanding their inability to make an election under a separate subsection (i.e., (d)(3)) to opt out of I.R.C. section 263A treatment.

[80] The Tax Court concluded that (d)(1) has no application to citrus farmers by reading (d)(1) in light of (d)(3)'s exclusion of citrus farmers. In fact, as shown above, reading these two subsections together demonstrates why the Tax Court's view of the statute is wrong. Not only is there no express exclusion of citrus farmers from the operation of (d)(1), this omission is all the more striking by the fact that there IS an express exclusion for certain accrual method taxpayers under (d)(1), IN ADDITION TO the exception for those same accrual method taxpayers provided under (d)(3). Thus, the structure of the statute plainly negates any suggestion that the unavailability of an election under (d)(3) should be read more broadly, or applied to subsection (d)(1), as the Tax Court did.

[81] Had Congress intended the exclusions of (d)(3) to be read broadly and applied to section (d)(1) as well, there would have been no need to include the same exclusion relating to those accrual method taxpayers in (d)(1).

[82] The fact that Congress expressly provided the exclusion for accrual method taxpayers under BOTH (d)(1) AND (d)(3) demonstrates that Congress intended (d)(1) and (d)(3) to operate as separate and distinct exceptions with separate and distinct limitations, and did not intend the exclusions applicable under (d)(3) to be applied -- as the Tax Court held -- under (d)(1).

[83] Of course, at the time Taxpayer filed the tax returns at issue, there was absolutely no guidance to assist it in determining whether I.R.C. section 263A required the capitalization of its developmental costs. Had regulations providing that citrus trees had a nationwide weighted average preproductive period exceeding two years existed, Taxpayer concedes that it would have been required to capitalize its developmental costs. However, the failure to issue such regulations prior to the filing of Taxpayer's tax returns allowed Taxpayer to avail itself of the exception contained within I.R.C. section 263A(d)(1) which contains absolutely no language otherwise excluding citrus farmers from its application.

B. THE TAX COURT'S DECISION IS NOT SUPPORTED BY TREASURY

C. THE TAX COURT'S RELIANCE ON REPEALED I.R.C. SECTION 278 WAS

II. THE TAX COURT ERRED IN RULING FOR THE COMMISSIONER WHEN TAXPAYER

1. TAXPAYER REASONABLY AND PROPERLY DETERMINED THAT IT

[88] In this confused state of affairs Taxpayer was forced to attempt to comply with a new law with absolutely no guidance. Understandably, and reasonably, Taxpayer determined the preproductive period of its citrus grove by reference to its own experience.

[89] When the Tax Court measured the results of Taxpayer's grove against a nationwide weighted average that had not been promulgated, it acted in a manner which was fundamentally unfair and contrary to both established precedent and all notion of fair play. This Court should reverse the Tax Court because -- even in the total absence of any regulations or guidance to assist it -- Taxpayer acted reasonably in determining that I.R.C. section 263A did not require it to capitalize its developmental expenses. In the absence of regulations, this Court should not allow Commissioner or the Tax Court to second guess Taxpayer's reasonable actions.

[90] The Tax Court's own decision in Gottesman & Co., Inc. v. Commissioner, 77 T.C. 1149 (1981), shows why reversal is proper. In Gottesman, the Commissioner failed to define the statutory term "consolidated accumulated taxable income" but nonetheless challenged that taxpayer's reasonable interpretation of that term. However, the Tax Court held that because the Commissioner had failed to define the term and to supply a method of calculating the consolidated figures, it was impossible for a taxpayer to ensure it had complied with the law. In the absence of a promulgated definition, the Tax Court upheld that taxpayer's reasonable interpretation of the statute, stating: "We cannot fault Taxpayer for not knowing what the law was in this area when the Commissioner, charged by Congress to announce the law (Sec. 1502), never decided what it was himself." ⁶

[91] Likewise, in Pittway Corp. v. United States, 102 F.3d 932, 936 (7th Cir. 1996), the Seventh Circuit, while affirming a summary judgment in favor of the United States, noted that the Secretary's failure to promulgate the regulations directed by Congress could cause a provision of the tax code to be unenforceable in circumstances where the statute is unclear.

[92] A similar result is warranted here. Here, of course, even the Request for Guidance admits that the Service had not furnished sufficient guidance to enable grovers to uniformly apply the provisions to I.R.C. section 263A. [R1-22; Ex. 21-P, pp. 6-7 of Ex. B]. Just as in Gottesman, there are undefined statutory terms in this case which Taxpayer was required to construe to comply with the law. Yet, as in Gottesman, the Commissioner utterly failed to define these terms in spite of clear Congressional direction to do so. Due to the Commissioner's failure, Taxpayer was forced to attempt to comply with the law as best as it was able. As the evidence introduced at trial made crystal clear, Taxpayer adopted a reasonable interpretation of the statute and reported its income accordingly. Neither the Commissioner nor the Tax Court should be allowed to now second guess Taxpayer's attempt to comply with the law. ⁷

2. SUBSEQUENTLY ISSUED REGULATIONS SHOW TAXPAYER ACTED

[94] Taxpayer's actions were also analogously supported by the 1997 temporary regulations which provided guidance to taxpayers growing crops in noncommercial quantities and stated: " . . . taxpayer is required, at or before the time the seed or plant is acquired or planted, to reasonably estimate the preproductive period of the plant." The regulation notes that "If the estimate is reasonable, based on the facts in existence at the time it is made, the determination of whether Section 263A applies is not modified at a later time even if the actual length of the preproductive period differs from the estimate." Temp. Treas. Reg. section 1.263A- 4T(b)(2)(i)(B), T.D. 8729, 62 Fed. Reg. 44542 (August 22, 1997).

[95] Taxpayer's actions were actually more conservative than the objective guidelines established by subsequently issued regulations. In the face of no regulations, and in consultation with its certified public accountant, Taxpayer conservatively chose to wait until the end of the two year statutory period to determine whether I.R.C. section 263A applied. That is inherently more conservative, reasonable and accurate than making an "estimate" at the beginning of the two year period.

[96] It is especially illuminating to review the understanding of the industry, tax practitioners and the Commissioner at the time Taxpayer filed its returns in order to understand the burden facing Taxpayer in complying with I.R.C. section 263A. Certainly, Taxpayer's assertions that it was not sure how to treat the developmental expenses would not be reasonable if the law had been settled. However, the evidence demonstrates that there was no agreement on this issue as would have occurred if the Secretary had issued the nationwide weighted averages. Indeed, the Service itself admits it was enforcing this law in an inconsistent manner within the State of Florida. In recognition of this confusion, the special citrus liaison team was formed to address the many unresolved I.R.C. section 263A questions including the very issues confronted by Taxpayer.

[97] In order to obtain guidance on the "pressing" I.R.C. section 263A issues, Service employee Roger Wenner, in his official capacity as a Service employee, drafted the Request for Guidance which sought answers to a variety of I.R.C. section 263A issues including the issues raised in this case from the Chief Counsel of the Service. This tremendous uncertainty within the industry and the Service further confirms the propriety of Taxpayer's actions inasmuch as the Request for Guidance notes that each farmer was forced to individually apply the unresolved I.R.C. section 263A issues to the factual situation of each farmer. [R1-22; Ex. 21-P, pp. 6-7 of Ex. B].

B. IT WAS NEVER TAXPAYER'S RESPONSIBILITY TO DETERMINE THE

1. THE SECRETARY WAS REQUIRED TO PROMULGATE THE

[100] Ironically, within three months after the Tax Court's decision, the Secretary and the Commissioner issued the long-awaited nationwide weighted averages thereby confirming Taxpayer's contention that taxpayers were not required to determine the nationwide weighted averages. This action constitutes a complete repudiation of the Commissioner's litigation strategy in which he maintained that Taxpayer was required to prove the nationwide weighted averages at trial. Accordingly, it now appears that Commissioner agrees with Taxpayer that the trial court erred when it held that Taxpayer could not prevail at trial unless it was able to show that the nationwide weighted average for citrus was two years or less.

[101] Even in the absence of the Commissioner's now apparent agreement that the Tax Court erred when it held that Taxpayer was required to prove the nationwide weighted averages, the Tax Court ruling should nonetheless be reversed.

[102] The Tax Court's belief that Congress did not "mandate" the Secretary to calculate the national averages is directly contradicted by the statute's nondiscretionary language. I.R.C. section 263A(i) plainly states that "the Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section. . ." . The word "shall" is by its nature nondiscretionary. See Manatee County v. Train, 583 F.2d 179, 182 (5th Cir. 1978) ("'shall' generally indicates a mandatory intent unless a convincing argument to the contrary is made"); United States ex rel. Siegel v. Thoman, 156 U.S. 353, 360 (1895) ("shall" indicates a command whereas "may" connotes permission). It stretches credulity for the Tax Court to implicitly hold that the nationwide weighted averages are not regulations "necessary or appropriate to carry out the purposes of" I.R.C. section 263A when the statute cannot operate without them. Undeniably, the statute specifically refers to THE nationwide weighted average preproductive period. It does not refer to A nationwide weighted average preproductive period. Nor does the statute contain any direction or suggestion that every farming taxpayer in the country is responsible for calculating the nationwide weighted average preproductive period for the crops that taxpayer produces. Moreover, it was especially important for the Secretary to issue the nationwide weighted averages because that phrase was newly created by the legislation enacting I.R.C. section 263A and, neither the phrase nor any definition of the phrase had existed before I.R.C. section 263A's enactment.

[103] The Tax Court's conclusion that Taxpayer should determine the nationwide weighted average preproductive period for citrus trees flies in the face of the Secretary's longstanding responsibility to promulgate regulations. As I.R.C. section 7805(a) states:

"Except where such authority is expressly given by this title to

[105] Further, the Secretary acknowledged his obligation to issue the nationwide weighted averages. In the preamble to the 1997 Temporary Regulations, Treasury announced that it anticipated issuing the nationwide weighted averages and that it and the Commissioner expected that some thirty seven crops would have nationwide weighted average preproductive periods in excess of two years. (T.D. 8729, 62 Fed. Reg. 44542 (August 22, 1997).

[106] Temp. Treas. Reg. section 1.263A-4T(b)(2)(i)(B), T.D. 8729, 62 Fed. Reg. 44542 (August 22, 1997), temporary regulations, further supports the contention that the Secretary (rather than individual taxpayers) must promulgate THE nationwide weighted average preproductive periods:

"For purposes of determining whether a plant has a preproductive

[108] Treasury's public pronouncement in 1997 matches the Service's understanding contained in the Request for Guidance that the Secretary would be promulgating the nationwide weighted average preproductive periods. [R1-22; Ex. 21-P, p. 9; Ex. 21-P, p. 58].

[109] As a result, there can be no doubt that the Secretary bore the responsibility of determining the nationwide weighted averages. The Commissioner has now agreed and the Tax Court erred when it held to the contrary.

2. PUBLIC POLICY STRONGLY REQUIRES THAT TREASURY SHOULD

[111] Moreover, the Secretary is far better suited to promulgate nationwide weighted averages. Treasury has employees experienced in developing national standards as well as the resources to obtain the information necessary to promulgate the averages. Treasury can also ensure that consistent standards are utilized from crop to crop. The Secretary's rule-making process allows any party to participate in the development of regulations. ⁹

[112] The Tax Court's ruling that the nationwide weighted averages should be proven in the courtroom where no regulation exists is flawed. ¹⁰ The statute, the legislative history and Treasury's pronouncements and regulations all lead a reasonable person to believe that the nationwide weighted averages would be promulgated by the Secretary. In contrast, the establishment of a particular weighted average in a particular piece of litigation could not be made known to every other farmer of that crop in the country because neither this Court nor any other court with federal tax jurisdiction possesses appropriate notice and comment procedures with respect to all other potential interested parties. It is clear that given the variety of forums and crops grown in this country that the Tax Court's determination that it was the proper forum to determine the nationwide weighted average for citrus could only lead to inconsistent and unpredictable results. ¹¹ Such a procedure would improperly transform an executive function into a judicial one in violation of the separation of powers clause of the United States Constitution and clearly frustrate Congress's intent to promote uniform capitalization.

[113] To the contrary, the promulgation of national standards with respect to the Internal Revenue laws has long been the province of the Secretary. The Tax Court has recognized the Secretary's responsibility for issuing such standards. For example, in Elwood v. Commissioner, 72 T.C. 264 (1979), the Tax Court determined that the standard mileage rate promulgated by the Commissioner for medical care transportation costs should not be modified to include depreciation as suggested by the taxpayer. Elwood illustrates the principle that standard setting is the proper responsibility of the executive branch.

[114] As noted by the United States Supreme Court in United States v. Correll, 389 U.S. 299, 306-307 (1967):

Alternatives to the Commissioner's . . . rule are of course

C. THE ACTUAL PREPRODUCTIVE PERIOD OF TAXPAYER'S GROVE WAS

[117] As the term "marketable crop" is not defined in the Code or the legislative history, the ordinary and common usage of the term should be used in applying the provisions of I.R.C. section 263A. Texaco Inc. and Subsidiaries v. Commissioner, 101 T.C. 571, 575 (1993); Commissioner v. Brown, 380 U.S. 563, 570-571 (1965); Crane v. Commissioner, 331 U.S. 1 (1947); Rome I. Ltd. v. Commissioner, 96 T.C. 697, 704 (1991); Union Pacific Corp. v. Commissioner, 91 T.C. 32, 38-40 (1988); First Savings & Loan Association v. Commissioner, 40 T.C. 474, 482 (1963). Expert witnesses for Taxpayer and the Commissioner, including a representative of the United States Department of Agriculture, variously testified at trial that the definition of a marketable crop of citrus fruit employed by the United States Department of Agriculture and the citrus industry is one in which: (1) any money is received for the sale or (2) where the value of the crop exceeds the cost to pick the fruit from the trees and transport the fruit to market (such costs are commonly referred to as "pick and haul" costs). [R-22 Ex. 40-P p. 1; R1-26-179, 183- 184, 187-188].

[118] The undisputed evidence demonstrates that Taxpayer produced two marketable crops of citrus fruit from its 1989 Trees within the two-year preproductive period. The first crop was sold to an unrelated citrus dealer, in January 1991. By definition this crop was marketable because a willing, unrelated purchaser paid all of the pick and haul costs related to the crop and also paid the Taxpayer for the crop.

[119] The second marketable crop was produced in early 1991. By May 1991, the crop was clearly visible and golf-ball sized and could have been sold to a citrus fruit buyer at that time. See footnote 2 supra. This crop was harvested and sold later that year to another unrelated buyer, who paid the pick and haul costs for this crop and also paid the Taxpayer for the crop. Thus, the value of the crop necessarily exceeded the total of pick and haul costs and the amount paid to the Taxpayer. ¹²

[120] While meeting the citrus industry's definition of marketable crop, other analogous authority also shows Taxpayer produced a marketable crop. An analogy can be drawn with the concept of commercial quantities under Treas. Reg. 1.616-1(a) (1960) in which a taxpayer can begin deducting development expenses for the development of a mine when mineral deposits are shown to exist in sufficient quantity and quality to reasonably justify commercial exploitation of such mineral. The relevant determinative factors are listed in Schouten v. Commissioner, T.C. Memo. 1991-155.

[121] The first relevant factor is the price of the commodity. Prices for citrus were high during the years at issue.

[122] The next factor is the commodity's quantity. In the instant case, both the crop that developed in 1990 and the crop that developed in 1991 consisted of sufficient fruit to be marketable inasmuch as the crops were undisputedly sold to willing, unrelated third party purchasers.

[123] The third factor is location. In the instant case, the Taxpayer's grove is located close to commercial citrus markets.

[124] Another factor is access. Here, by virtue of high density tree planting, the fruit to be harvested was more accessible (and thus more marketable) because the trees were closer together and therefore, harvesters could pick the fruit from the trees more quickly and cost effectively.

[125] The last relevant factor is the quality of the commodity. It is undisputed that the Taxpayer produced high quality and, inherently more marketable fruit.

[126] An analysis of these factors confirms that Taxpayer produced two marketable crops of citrus fruit within two years after planting the 1989 Trees. Thus, the capitalization rules of I.R.C. section 263A are inapplicable to the developmental expenses incurred by the taxpayer after the establishment of Taxpayer's grove. As set forth above, the Tax Court noted that Taxpayer produced "only limited amounts of citrus from a limited number of its trees within the first 2 years". [R1-31-16]. Yet, while the Tax Court did not analyze whether this limited amount of fruit constituted a marketable crop, Taxpayer's expert witness testified that Taxpayer produced at least one marketable crop within the two year period from Taxpayer's 1989 trees. [R1-22; Ex. 41-P, p. 7-8]. Commissioner's witnesses tacitly agreed because they acknowledged that a marketable crop is one in which any money is paid for fruit. [R1-26-179, 183-184, 187-188].

2. A MARKETABLE CROP OF CITRUS FRUIT WAS ALSO PRODUCED

[128] Moreover, developmental expenses with respect to the 1991 Trees were deducted in a manner subsequently sanctioned by the final regulation which stated that ". . . taxpayers must take reasonable positions on their federal income tax returns when applying Section 263A." Treas. Reg. section 1.263A-1(a)(2)(ii) (1994). While Taxpayer did not have the benefit of this regulation at the time the 1991 Trees were planted, its reasonable actions conformed to the subsequently issued regulation. Taxpayer made its determination that the 1991 Trees would have a preproductive period of less than two years at the time the 1991 Trees were planted based on the actual growing history of the 1989 Trees. It was eminently reasonable to estimate that the 1991 Trees would have been at least as successful as the 1989 Trees (or even more successful given the freeze that impacted the 1989 Trees). Accordingly, all developmental expenses with respect to the 1991 Trees were deducted from the time the trees were planted.

III. THE COURT SHOULD INVALIDATE THE PORTIONS OF I.R.C. SECTION 263A

B. THE COMMISSIONER'S FSAA AND ACTIONS WERE ARBITRARY AND

[131] The FSAA has the equivalent of a "heads I win, tails you lose" analysis. The FSAA claims that Taxpayer's grove was in a preproductive period during the years at issue. Of course, the Commissioner has never explained what facts he relied upon to come to this conclusion. Yet, at trial, after apparently realizing that Taxpayer would present evidence to clearly prove that its grove's preproductive period ended within two years, the Commissioner shifted gears and (rather than presenting any evidence to rebut Taxpayer's contention) claimed, in essence, that the evidence before the Tax Court regarding the grove's actual preproductive period would be irrelevant because Taxpayer could not prove that the nationwide weighted average preproductive period for citrus would be two years or less. Of course, the Tax Court agreed even though neither the Commissioner nor the Secretary had issued the nationwide average in the thirteen years prior to the trial.

[132] Amazingly enough, shortly after the Tax Court issued its Opinion, the Commissioner shifted gears yet again and finally (after fourteen years) issued the nationwide weighted averages for citrus trees. These breathtaking shifts in the Commissioner's positions should be viewed with great suspicion. "Sharp changes of agency course constitute 'danger signals' to which a reviewing court must be alert." West v. Bowen, 879 F.2d 1122, 1127 (3d Cir. 1989).

[133] The Commissioner's actions were arbitrary and capricious and should have been recognized as such by the Tax Court. Analogously, in Pearson v. Shalala, 164 F.3d 650, 660-661 (D.C. Cir. 1999), suggestion for reh'g en banc denied, 172 F.3d 72 (D.C. Cir. 1999), the court invalidated four Food and Drug Administration ("FDA") sub-regulations and the FDA's interpretation of a general regulation because the FDA violated the Administrative Procedure Act by arbitrarily and capriciously failing to define the phrase "significant scientific agreement" contained in its own regulations. The court stated that: "To refuse to define the criteria it is applying is equivalent to simply saying no without explanation."

[134] Here, the Commissioner clearly said "no" without any explanation and, as a result, acted arbitrarily and capriciously. As a result, the Tax Court should be reversed.

[135] That administrative agencies articulate standards to guide the actions of the citizens they regulate is of crucial importance, and simply a matter of fundamental fairness. This principle has been recognized by numerous courts. See, e.g., Port Terminal RR Ass'n v. United States, 551 F.2d 1336 (5th Cir. 1977), in which the Fifth Circuit held it was improper for the Interstate Commerce Commission to compare studies supporting requested rate hikes to an unannounced standard:

[t]he carriers were not apprised of the standard by which they

"[t]he responsibility to promulgate clear and unambiguous

[137] Based upon the Commissioner's failure to issue the regulations, the Tax Court erred when it determined that Taxpayer could not avail itself of the exception provided by I.R.C. section 263A(d)(1)(A).

IV. ALTERNATIVELY, I.R.C. SECTION 263A's CAPITALIZATION REQUIREMENTS

[139] Taxpayer suggests that this constitutes an alternative ground by which the Tax Court should be reversed. Even if this Court subscribes to the "whether" versus "how" dichotomy, the guidance and regulations which are missing in this case are clearly of a "whether" characterization because in their absence, it is impossible to determine whether Taxpayer was required to capitalize its developmental costs pursuant to I.R.C. section 263A. See also Temp. Treas. Reg. section 1.263A-4T(b)(2)(i)(B), T.D. 8729, 62 Fed. Reg. 44542 (August 22, 1997) (nationwide weighted averages show "whether" I.R.C. section 263A applies).

V. THE STATUTE OF LIMITATIONS PRECLUDED COMMISSIONER FROM MAKING

[141] The Tax Court held that the FSAA was not time barred because a change in Taxpayer's accounting method occurred and therefore, an I.R.C. section 481(a) adjustment could properly be made to Taxpayer's 1991 tax return.

[142] The Tax Court's ruling was erroneous because no change in Taxpayer's accounting method occurred and the Tax Court's conclusion that an I.R.C. section 481(a) adjustment was permissible is simply wrong.

[143] The undisputed evidence demonstrates that Taxpayer never intended to change its method of accounting. [R1-26-91, 95]. At the time of filing its 1989 tax return, Taxpayer chose to defer its developmental expenses because it simply was unable to conclusively determine whether its grove would produce a marketable crop within two years. In the absence of any nationwide weighted averages for citrus trees, a taxpayer who simply did not know whether I.R.C. section 263A would apply could either aggressively deduct amounts that it ultimately may not have been entitled to or; conservatively assess the actual results of its operations (and hope for IRS guidance) over a two-year period. Taxpayer did the latter. Only after it had determined it produced a marketable crop did it deduct the deferred developmental costs.

A. UTILIZING THE PROVISIONS OF TREAS. REG. SECTION 1.162-12(a)

[145] Treas. Reg. section 1.162-12(a) and the law in effect for the years involved in Wilbur clearly set forth the rules for capitalizing or expensing developmental expenses incurred by a citrus farmer during those years. In contrast, after I.R.C. section 263A was enacted (and I.R.C. section 278 was simultaneously repealed) the law was unclear. Treas. Reg. section 1.162-12(a) referred to repealed I.R.C. section 278 until 1997 (when that regulation was amended by T.D. 8729, 62 Fed. Reg. 44542 (August 22, 1997)), well after the relevant years at issue here. Taxpayer had no guidance from Treasury or Commissioner or any historical track record from its own grove to follow in determining how to treat these expenses. Therefore, Taxpayer was entitled to act reasonably as it did. While Treas. Reg. section 1.162-12(a) would provide flexibility in determining the treatment of developmental expenses, I.R.C. section 263A would have presumably overridden Taxpayer's right to utilize Treas. Reg. section 1.162-12(a) if the preproductive period of Taxpayer's grove was greater than two years. Thus, Taxpayer could not have confirmed its ability to utilize Treas. Reg. section 1.162-12(a) until it first confirmed that it was not subject to I.R.C. section 263A. In the absence of guidance, it could not conclusively determine whether or not I.R.C. section 263A applied until after the end of the two year period.

B. TAXPAYER'S TREATMENT OF THE DEVELOPMENTAL EXPENSES WAS NOT

[147] Because Taxpayer was unable to determine at the time it established its grove in 1989 whether its grove would be productive within two years, and in the absence of any guidance, Taxpayer decided to determine its grove's preproductive period after the two- year period set forth in I.R.C. section 263A had expired. During that time, the underlying facts clearly changed. The grove clearly changed from a non-productive grove to a productive grove. Due to this change in facts, Taxpayer was thus able to assess the grove's performance and status and determine that the grove's preproductive period ended within the two-year period. As a result, there was no change of accounting method. See, also Southern Pacific Transportation Company v. Commissioner, 75 T.C. 497, 807 (1980), where the Tax Court held that a change in underlying facts occurred with respect to that taxpayer's railroad grading. The change in facts allowed that taxpayer to assign a useful life to that grading even though the grading's useful life had previously been indeterminable.

[148] Taxpayer here, like the taxpayer in Southern Pacific, reviewed the underlying facts when it was possible to determine the ultimate issue that would control the federal income tax consequences of a transaction. See also Kansas City Southern Railway Company v. Commissioner, 76 T.C. 1067, 1156 (1981) where the Tax Court held that an accounting method change did not occur where taxpayer assigned a useful life to an asset whose life was previously indeterminate. Instead, the Tax Court determined that action was based on a change in underlying facts.

[149] Moreover, a change in underlying facts also occurred throughout the two-year period as Taxpayer's ability and methods to assess the grove's production become more refined. As the grove changed it more clearly evinced the characteristics of a productive economic unit that could be evaluated by Taxpayer. See Baltimore and Ohio Railroad Company v. United States, 221 Ct. Cl. 16, 603 F.2d 165 (1979) where the court held that taxpayer's use of more accurate estimates of rail salvage value was due to change in underlying facts by adoption of more accurate valuation formula and Esco Corp. v. United States, 750 F.2d 1466 (9th Cir. 1985) where the court held that accounting method change did not occur when taxpayer began using a more sophisticated method to estimate worker's compensation claim expenses.

CONCLUSION

[150] For all of the reasons set forth above, Taxpayer requests that this Court reverse the Tax Court's Decision, and find that there are no adjustments to Taxpayer's federal income tax returns for the Taxpayer's fiscal years ending September 30, 1992, September 30, 1993 and September 30, 1994.

Dated October 16th, 2000.

[151] I HEREBY CERTIFY that this brief complies with the typeface and type volume limitation set forth in Federal Rule of Appellate Procedure 32(a). This brief is presented in 14 point typeface and contains 13,895 words.

[Signed]

[152] I HEREBY CERTIFY that the original and six copies of this brief have been furnished by Federal Express to the Clerk of the Eleventh Circuit Court of Appeals and two copies of this brief have been furnished by U. S. Mail postage prepaid to Randolph L. Hutter, Post Office Box 502, Washington, D.C. 20044 this 16th day of October, 2000.

[Signed]

A-1. I.R.C. section 263A (Due to its central role in this case I.R.C.

Section 1.162-12 Expenses of farmers. (a) Farms engaged in for profit. A farmer who operates a farm for profit is entitled to deduct from gross income as necessary expenses all amounts actually expended in the carrying on of the business of farming. . . . For provisions relating to citrus and almond groves, see section 278 and the regulations thereunder. The cost of farm machinery, equipment, and farm buildings represents a capital investment and is not an allowable deduction as an item of expense. Amounts expended in the development of farms, orchards, and ranches prior to the time when the productive state is reached may, at the election of the taxpayer, be regarded as investments of capital . . . .

TREAS. REG. SECTION 1.162-12(a)(1972) (AFTER AMENDMENT BY T.D. 8729, 62 FED. REG. 44542 (AUGUST 22, 1997) AND T.D. 8897, 65 FED. REG. 50638 (AUGUST 21, 2000))

Section 1.162-12. Expenses of farmers. (a) Farms engaged in for profit. A farmer who operates a farm for profit is entitled to deduct from gross income as necessary expenses all amounts actually expended in the carrying on of the business of farming . . . For rules regarding the capitalization of expenses of producing property in the trade or business of farming, see section 263A and the regulations thereunder . . . For rules regarding the capitalization of expenses of producing property in the trade or business of farming, see 263A of the Internal Revenue Code and section 1.263A-4. The cost of farm machinery, equipment, and farm buildings represents a capital investment and is not an allowable deduction as an item of expense. Amounts expended in the development of farms, orchards, and ranches prior to the time when the productive state is reached may, at the election of the taxpayer, be regarded as investments of capital . . .

TEMP. TREAS, REG. SECTION 1.263A-1T(c)(4)(ii)(D), T.D, 8131, 1987-1 C.B. 98 (MARCH 30, 1987) AS AMENDED BY T.D. 8148, 52 FED. REG. 29375 (AUGUST 7, 1987)

(D) The preproductive period of plants grown in commercial quantities in the United States shall be based on the weighted average preproductive period for such plant, determined on a nationwide basis.

TEMP. TREAS. REG. SECTION 1.263A-IT(c)(6), T.D. 8131, 1987-1 C.B. 98 (MARCH 30, 1987) AS AMENDED BY T.D. 8148, 52 FED. REG. 29375 (AUGUST 7, 1987)

6) Election not to have this section apply.

(i) Introduction. This paragraph (c)(6) permits certain taxpayers to make an election not to have the rules of this section apply to any plant or animal produced in a farming business conducted by the electing taxpayer.

(ii) Availability of the election. The election described in this section is available to any farmer except that no election may be made by a corporation, partnership or tax shelter required to use an accrual method of accounting under section 447 or 448(a)(3). Moreover, no election may be made with respect to the planting, cultivation, maintenance or development of pistachio trees. In addition, the election described in this section does not apply to any costs incurred for the planting, cultivation, maintenance or development of any citrus or almond grove (or any part thereof) to the extent that such costs are incurred within the first four years in which such trees were planted. If a citrus or almond grove is planted in more than one taxable year, the portion of the grove planted in any one taxable year is treated as a separate grove for purposes of determining the year of planting.

TEMP. TREAS. REG. SECTION 1.263A-4T(c)(4)(ii)(D), 59 FED. REG. 39958 (AUGUST 5, 1994)

(D) The preproductive period of plants grown in commercial quantities in the United States shall be based on the weighted average preproductive period for such plant, determined on a nationwide basis.

TEMP. TREAS. REG. SECTION 263A-4T(c)(6), 59 FED. REG. 39958 (AUGUST 5, 1994)

(6) Election not to have this section apply. (i) Introduction. This paragraph (c)(6) permits certain taxpayers to make an election not to have the rules of this section apply to any plant or animal produced in a farming business conducted by the electing taxpayer.

(ii) Availability of the election. The election described in this section is available to any farmer except that no election may be made by a corporation, partnership or tax shelter required to use an accrual method of accounting under section 447 or 448(a)(3). Moreover, no election may be made with respect to the planting, cultivation, maintenance or development of pistachio trees. In addition, the election described in this section does not apply to any costs incurred for the planting, cultivation, maintenance or development of any citrus or almond grove (or any part thereof) to the extent that such costs are incurred within the first four years in which such trees were planted. If a citrus or almond grove is planted in more than one taxable year, the portion of the grove planted in any one taxable year is treated as a separate grove for purposes of determining the year of planting.

TEMP. TREAS. REG. SECTION 1.263A-4T(b)(2)(i)(B), T.D. 8729, 62 FED. REG. 44542 (AUGUST 22, 1997)

(B) Applicability of section 263A. For purposes of determining whether a plant has a preproductive period in excess of 2 years, the preproductive period of plants grown in commercial quantities in the United States is based on the nationwide weighted average preproductive period for such plant. For all other plants, the taxpayer is required, at or before the time the seed or plant is acquired or planted, to reasonably estimate the preproductive period of the plant. If the taxpayer estimates a preproductive period in excess of 2 years, the taxpayer must capitalize preproductive period costs. If the estimate is reasonable, based on the facts in existence at the time it is made, the determination of whether section 263A applies is not modified at a later time even if the actual length of the preproductive period differs from the estimate. The actual length of the preproductive period will, however, be considered in evaluating the reasonableness of the taxpayer's future estimates. Thus, the nationwide weighted average preproductive period or the estimated preproductive period are only used for purposes of determining whether the preproductive period of a plant is greater than 2 years.

TEMP. TREAS. REG. SECTION 1.263A-4T(d), T.D, 8729, 62 FED. REG. 44542 (AUGUST 22, 1997)

(d) Election not to have section 263A apply -- (1) Introduction. This paragraph (d) permits certain taxpayers to make an election not to have the rules of this section apply to any plant produced in a farming business conducted by the electing taxpayer. The election is a method of accounting under section 446, and once an election is made, it is revocable only with the consent of the Commissioner.

(2) Availability of the election. The election described in this paragraph (d) is available to any taxpayer that produces plants in a farming business, except that no election may be made by a corporation, partnership, or tax shelter required to use the accrual method under section 447 or 448(a)(3). Moreover, the election does not apply to the costs of planting, cultivation, maintenance, or development of a citrus or almond grove (or any, part thereof) incurred prior to the close of the fourth taxable year beginning with the taxable year in which the trees were planted in the permanent grove (including costs incurred prior to the permanent planting). If a citrus or almond grove is planted in more than one taxable year, the portion of the grove planted in any one taxable year is treated as a separate grove for purposes of determining the year of planting.

TREAS. REG. SECTION 1.263A-1(a)(2)(ii)(1994)

(ii) For taxable years beginning before January 1, 1994, taxpayers must take reasonable positions on their federal income tax returns when applying section 263A. For purposes of this paragraph (a)(2)(iii), a reasonable position is a position consistent with the temporary regulations, revenue rulings, revenue procedures, notices, and announcements concerning section 263A applicable in taxable years beginning before January 1, 1994. See section 601.601 (d)(2)(ii)(b) of this chapter.

TREAS. REG. SECTION 1.263A-4(b)(2)(B)(2000)

(B) Applicability of section 263A. For purposes of determining whether a plant has a preproductive period in excess of 2 years, the preproductive period of plants grown in commercial quantities in the United States is based on the nationwide weighted average preproductive period for such plant. The Commissioner will publish a noninclusive list of plants with a nationwide weighted average preproductive period in excess of 2 years. In the case of other plants grown in commercial quantities in the United States, the nationwide weighted average preproductive period must be determined based on available statistical data. For all other plants, the taxpayer is required, at or before the time the seed or plant is acquired or planted, to reasonably estimate the preproductive period of the plant. If the taxpayer estimates a preproductive period in excess of 2 years, the taxpayer must capitalize the costs of producing the plant. If the estimate is reasonable, based on the facts in existence at the time it is made, the determination of whether section 263A applies is not modified at a later time even if the actual length of the preproductive period differs from the estimate. The actual length of the preproductive period will, however, be considered in evaluating the reasonableness of the taxpayer's future estimates. The nationwide weighted average preproductive period or the estimated preproductive period is only used for purposes of determining whether the preproductive period of a plant is greater than 2 years.

TREAS. REG. SECTION 1.263A-4(d)(2000)

(d) Election not to have section 263A apply.

(1) INTRODUCTION. This paragraph (d) permits certain

(b) A change in method of accounting does not include correction of mathematical or posting errors, or errors in the computation of tax liability (such as errors in computation of the foreign tax credit, net operating loss, percentage depletion or investment credit). Also, a change in method of accounting does not include adjustment of any item of income or deduction which does not involve the proper time for the inclusion of the item of income or the taking of a deduction. For example, corrections of items that are deducted as interest or salary, but which are in fact payments of dividends, and of items that are deducted as business expenses, but which are in fact personal expenses, are not changes in method of accounting. In addition, a change in the method of accounting does not include an adjustment with respect to the addition to a reserve for bad debts or an adjustment in the useful life of a depreciable asset. Although such adjustments may involve the question of the proper time for the taking of a deduction, such items are traditionally corrected by adjustments in the current and future years. For the treatment of the adjustment of the addition to a bad debt reserve, see the regulations under section 166 of the Code; for the treatment of a change in the useful life of a depreciable asset, see the regulations under section 167(b) of the Code. A change in the method of accounting also does not include a change in treatment resulting from a change in underlying facts. On the other hand, for example, a correction to require depreciation in lieu of a deduction for the cost of a class of depreciable assets which had been consistently treated as an expense in the year of purchase involves the question of the proper timing of an item, and is to be treated as a change in method of accounting.

TREAS. REG. SECTION 1.616-1(a) (1960)

Section 1.616-1. Development expenditures. (a) General rule. Section 616 prescribes rules for treating expenditures paid or incurred during the taxable year by the taxpayer for the development of a mine or other natural deposit (other than an oil or gas well). Development expenditures under section 616 are those which are made after such time when, in consideration of all the facts and circumstances (including actions of the taxpayer), deposits of ore or other mineral are shown to exist in sufficient quantity and quality to reasonably justify commercial exploitation by the taxpayer . . . .

H. Rept. 99-426, at 628 (1985), 1986-3 C.B. (Vol. 2) 1, 628 & n.45.

. . . .

d. SPECIAL RULES FOR FARMERS AND RANCHERS

CAPITALIZATION RULES GENERALLY

Under the committee bill, the uniform capitalization rules, including those requiring capitalization of interest, generally apply to all crops and livestock (other than animals held for slaughter) having a preproductive period of more than two years. For this purpose, the preproductive period of plants is deemed to begin when the plant or seed is first planted or acquired by the taxpayer, and to end when the plant becomes productive or is sold. The preproductive period of animals begins at the time of acquisition, breeding, or embryo implantation, and ends when the animal is ready to perform its intended function. Thus, for example, in the case of a cow used for breeding, the preproductive period ends when the first calf is dropped.

The committee intends that the preproductive period of a plant grown in the United States be determined on the basis of the national average preproductive period for the particular crop. It is expected that the Treasury Department will publish periodically a list of the preproductive periods of various plants based on a weighted average for products produced in the United States commercial quantities. ⁴⁵

⁴⁵ The Treasury Department may make reasonable

The committee bill provides an exception to the rules requiring capitalization of productive period expenses for certain farmers. Under this exception, a farmer may elect to deduct currently all preproductive costs of plants and animals that may be deducted under present law. If the election is made, gain from disposition of the product is recaptured (that is, taxed as ordinary income) to the extent of prior deductions that otherwise would have been required to be capitalized. In addition, the electing farmer is required to use the nonincentive depreciation system for all farm assets placed in service in taxable years for which the election is in effect.

For this purpose, the term "farmer" includes producers of livestock, nursery stock, and Christmas and other ornamental trees, as well as agricultural crops. It does not include tax shelters (as defined in section 6161(b)(C)(ii)), taxpayers required to use the accrual method of accounting (under section 447), farming syndicates (as defined in section 464(c)), and producers of pistachio nuts.

The election to deduct preproductive costs currently does not apply with respect to any item of cost which is attributable to the planting, cultivation, maintenance, or development of any citrus or almond grove which is incurred before the close of the fourth taxable year beginning with the taxable year in which the trees were planted. If a citrus or almond grove is planted in more than one taxable year, the portion of the grove planted in any one taxable year is treated as a separate grove for purposes of determining the year of planting. Producers of timber are subject to special rules described below.

. . . .

NOTICE 88-24, 1988-1 C.B. 491

. . . .

Taxpayers may use reasonable assumptions and estimates in determining whether animals produced in a farming business have a preproductive period of more than 2 years. For example, assume a taxpayer raises cattle that may be either sold by the taxpayer before the end of the 2-year preproductive period, or alternatively, kept by the taxpayer beyond the 2-year period. Assume also that the taxpayer is not required to use an accrual method of accounting under section 447 or 448, and thus the taxpayer is required to capitalize costs under section 263A only with respect to cattle with a preproductive period of more than 2 years. In determining the cattle that have a preproductive period of more than 2 years, the taxpayer may reasonably estimate, based on past experience and other factors, the percentage of total cattle raised that are reasonably expected to be kept beyond the 2-year period; the provisions of section 263A would then apply to these cattle. Similar estimates may be made by the taxpayer with respect to the sex of cattle that are conceived, but not yet born as of the end of the taxable year.

NOTICE 2000-45, 2000-36 I.R.B. 256 (September 5, 2000)

. . . .

Based upon information provided by the United States Department of Agriculture, the Service and Treasury Department have determined that plants producing the following crops or yields have a nationwide weighted average preproductive period in excess of 2 years:

almonds, apples, apricots, avocados, blackberries, blueberries,

STAFF OF JOINT COMMITTEE ON TAXATION, GENERAL EXPLANATION OF THE TAX REFORM ACT OF 1986, AT 513-14 (J. COMM. PRINT 1987)

. . . .

[154] The preproductive period of a plant grown in the United States is determined on the basis of the national average preproductive period for the particular crop. It is expected that the Treasury Department periodically will publish a list of the preproductive periods of various plants based on a weighted average for products produced in the United States in commercial quantities. ⁶⁹

⁶⁹ The Treasury Department may make reasonable

T.D. 8729, 62 FED. REG. 44542 (AUGUST 22, 1997)

. . . .

Preparatory and Developmental Costs

. . . .

Taxpayers that are required by section 447 or 448(a)(3) to use an accrual method must capitalize all preproductive period costs of plants (without regard to the length of the preproductive period) and animals. Taxpayers that are not required by section 447 or 448(a)(3) to use an accrual method qualify for an exception to this general rule. Under this exception, taxpayers are not required to capitalize preproductive period costs incurred with respect to animals, or with respect to plants that have a preproductive period of 2 years or less. Thus, under this exception, taxpayers are required to capitalize only those preproductive period costs incurred with respect to plants that have a preproductive period in excess of 2 years. The temporary regulations clarify that, for purposes of determining whether a plant has a preproductive period in excess of 2 years, in the case of a plant grown in commercial quantities in the United States, the nationwide weighted average preproductive period of such plant is used.

The IRS and Treasury Department are considering the publication of guidance with respect to the length of the preproductive period of certain plants that will have more than one crop or yield. At the present time, the IRS and Treasury Department anticipate that such guidance would provide that plants producing the following crops or yields have a nationwide weighted average preproductive period in excess of 2 years: almonds, apples, apricots, avocados, blueberries, blackberries, cherries, chestnuts, coffee beans, currants, dates, figs, grapefruit, grapes, guavas, kiwifruit, kumquats, lemons, limes, macadamia nuts, mangoes, nectarines, olives, oranges, peaches, pears, pecans, persimmons, pistachio nuts, plums, pomegranates, prunes, raspberries, tangelos, tangerines, tangors, and walnuts. The IRS and Treasury Department invite comments on this issue.

. . . .

ELECTION NOT TO CAPITALIZE COSTS

Certain taxpayers, other than those required to use an accrual method by section 447 or 448(a)(3), may elect not to capitalize the preproductive period costs of certain plants even though such plants have a preproductive period in excess of 2 years and would otherwise be subject to the capitalization requirements of section 263A. Taxpayers making this election may continue to deduct (subject to other limitations of the Code) the preproductive period costs that were deductible under the rules in effect before the enactment of section 263A. The temporary regulations clarify that although a taxpayer producing a citrus or almond grove may make this election, the election does not apply to the preproductive period costs of a citrus or almond grove that are incurred before the close of the fourth taxable year beginning with the taxable year in which the trees were planted.

If a taxpayer makes this election with respect to any plant, the taxpayer must treat the plant as section 1245 property. In addition, the taxpayer, and any person related to the taxpayer, must use the alternative depreciation system of section 168(g)(2) For any property used predominantly in a farming business that is placed in service in a taxable year for which the election is in effect.

. . . .

Taxpayers generally must capitalize direct costs and an allocable portion of indirect costs of producing all plants (without regard to the length of the preproductive period) and animals. Qualified taxpayers, however, are eligible for an exception to this general rule. Under this exception, qualified taxpayers are not required to capitalize under section 263A the costs of producing plants that have a preproductive period of 2 years or less or with respect to animals. Thus, under this exception, qualified taxpayers are required to capitalize only those costs of producing plants that have a preproductive period in excess of 2 years.

. . . .

The proposed regulations provided that, for purposes of determining whether a plant has a preproductive period in excess of 2 years, in the case of a plant grown in commercial quantities in the United States, the nationwide weighted average preproductive period of such plant is used. One commentator requested that a list of plants with nationwide weighted average preproductive periods in excess of 2 years be published and kept current as needed. Notice 2000-45 (2000-36 I.R.B. (Sept. 5, 2000)) issued contemporaneously with the publication of these final regulations, provides a list of plants grown in commercial quantities in the United States that have a nationwide weighted average preproductive period in excess of 2 years. Notice 2000-45 will be modified and superseded as needed.

Tax shelters, within the meaning of section 448(a)(3), are not qualified taxpayers and are therefore not eligible for the special rules of section 263A(d). A tax shelter, for purposes of section 448(a)(3), means a farming business that is a farming syndicate as defined under section 464(c) or any partnership, entity, plan or arrangement that is a tax shelter within the meaning of section 6662(d)(2)(C)(iii) (that is, its principal purpose is to avoid or evade Federal income tax). See section 1.448-1T(b)(1)(iii). There is a presumption under section 448 that marketed arrangements, in which persons carry on farming activities using the services of a common managerial or administrative service, will fall within the meaning of a tax shelter if a substantial portion of farming expenses are prepaid with borrowed funds. See section 1.448-1T(b)(4). The proposed regulations repeated the text of section 1.448-1T(b)(1)(iii) and (4) to explain which farming businesses are tax shelters.

² It is not uncommon for buyers to purchase fruit at that point of development. [R1-22; Ex. 40-P, p. 4].

³ It is customary to measure a citrus tree's life from the date it is permanently planted. [R1-31-4].

⁴ The parties agreed that notwithstanding their disagreement over the potential applicability of I.R.C. section 263A to these expenses, the expenses were properly paid by Taxpayer and represent ordinary and necessary business expenses. [R1-22-4-5 paragraph 17].

⁵ $649,126.11 of this amount was paid in the year ending September 30, 1991. The remainder was paid in the years ending September 30, 1989 and September 30, 1990.

⁶ The Commissioner did not appeal Gottesman. Indeed, the Commissioner's Action on Decision admits he would be unsuccessful on appeal due to the admitted "failure on the part of the Service" to publish final regulations on the relevant issues. (AOD 1985-018 (September 17, 1985))

⁷ See also Corn Belt Hatcheries of Arkansas, Inc. v. Commissioner, 52 T.C. 636, 639-640 (1969) where the Tax Court refused to disturb taxpayer's "plausible" interpretation of a revenue ruling regarding taxpayer's ability to elect tax treatment for which Commissioner failed to clearly specify conditions which the Tax Court found were incumbent on Commissioner to define.

⁸ I.R.C. section 263A(d)(1)(A), prior to amendment by P.L. 100-647, originally required the capitalization of costs for animals with preproductive periods in excess of two years but did not provide any guidance on how these preproductive periods should be determined. However, in Notice 88-24 (1988-1 C.B. 491), the Commissioner permitted taxpayers to use "reasonable assumptions and estimates" in determining whether animals produced in a farming business had a preproductive period greater than two years. Notice 88-24 therefore provides further analogous support to Taxpayer's contention that it complied with the statute by reasonably interpreting I.R.C. section 263A.

⁹ Of course since the statute refers to only one -- "the" -- nationwide weighted average, the Tax Court apparently would hold the taxpayer at peril if the taxpayer computed an average which was subsequently determined by the Commissioner to be wrong.

¹⁰ In this case, none of the experts were able to provide empirical or statistical evidence on the nationwide weight averages for citrus plants. [R1-31-19].

¹¹ For example, farmers growing the same crop in Iowa and Illinois could face different outcomes in the litigation process because, for appellate purposes, they are located in the Eighth and Seventh Circuits respectively. Yet, the Tax Court's reasoning in this case provides the potential for such inequitable and inconsistent results. Such a result should be rejected because it would clearly frustrate congressional intent for uniform capitalization rules.

¹² Taxpayer's ability to produce marketable crops in such a short time is not to be unexpected. From the outset, Taxpayer desire to produce fruit as quickly as possible was made possible by numerous innovations, enhancements and technological advancements that enabled well managed groves such as Taxpayer's to expedite citrus fruit production. Indeed, Commissioner's own witnesses testified that citrus trees produce fruit within two years of planting. [R1-26-165, 171, 183].