Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca5-09-50651/USCOURTS-ca5-09-50651-0/pdf.json

Nature of Suit Code: 870
Nature of Suit: Tax Suits
Cause of Action: 

---

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

No. 09-50651

AT&T, INC.,

Plaintiff - Appellant

v.

UNITED STATES OF AMERICA,

Defendant - Appellee

Appeal from the United States District Court

for the Western District of Texas

Before BARKSDALE, DENNIS, and OWEN, Circuit Judges.

DENNIS, Circuit Judge:

The issue in this federal income tax case is whether the plaintiff-taxpayer,

AT&T Inc., an interstate telecommunications company, must pay income taxes

on the funds it received from federal and state governmental entities for

providing “universal service”—viz., affordable telephone service mainly for

lower-income consumers and those in high-cost rural, remote or isolated

areas—or else is entitled to treat those funds as nonshareholder contributions

to capital under the Internal Revenue Code, see 26 U.S.C. § 118(a). The district

court held that the taxpayer was not entitled to a refund of income taxes paid on

the funds because the “universal service” support payments were income rather

than capital contributions. We affirm the judgment of the district court.

United States Court of Appeals

Fifth Circuit

F I L E D

January 4, 2011

Lyle W. Cayce

Clerk

 Case: 09-50651 Document: 00511339601 Page: 1 Date Filed: 01/04/2011
No. 09-50651

BACKGROUND

“Universal service” refers to the goal, first announced in the

Communications Act of 1934, “‘to make available, so far as possible, to all the

people of the United States, . . . a rapid, efficient, Nation-wide, and world-wide

wire and radio communication service with adequate facilities at reasonable

charges.’” Tex. Office of Pub. Util. Counsel v. FCC, 183 F.3d 393, 405-06 (5th Cir.

1999) (quoting 47 U.S.C. § 151) (alteration made to reflect 1934 text); see also

Alenco Commc’ns, Inc. v. FCC, 201 F.3d 608, 614 (5th Cir. 2000).

The FCC is charged with the authority and duty of carrying out the

universal service mandate. 47 U.S.C. §§ 151, 254, 256; Tex. Office of Pub. Util.

Counsel, 183 F.3d at 405-06. Originally, rather than relying on market forces

alone, the FCC “used a combination of implicit and explicit subsidies” to promote

universal service. Tex. Office of Pub. Util. Counsel, 183 F.3d at 406. “Explicit

subsidies provide carriers or individuals with specific grants that can be used to

pay for or reduce the charges for telephone service. This form of subsidy includes

using revenues from line charges on end-users to subsidize [service to] high-cost

[users] and to support the Lifeline Assistance program for low-income

subscribers.” Id. “Implicit subsidies are more complicated and involve the

manipulation of rates for some customers to subsidize more affordable rates for

others. For example,the regulators may require the carrier to charge ‘above-cost’

rates to low-cost, profitable urban customers to offer the ‘below-cost’ rates to

expensive, unprofitable rural customers.” Id.

“In 1996, Congress amended the Act to introduce competition into local

telephone service, Telecommunications Act of 1996, Pub. L. No. 104-104, 110

Stat. 56, which had traditionally been provided through regulated monopolies.”

Rural Cellular Ass’n v. FCC, 588 F.3d 1095, 1098 (D.C. Cir. 2009); see also 47

U.S.C. § 251 et seq. In doing so, “Congress recognized” that because the “system

of implicit subsidies can work well only under regulated conditions,” the existing

2

 Case: 09-50651 Document: 00511339601 Page: 2 Date Filed: 01/04/2011
No. 09-50651

system of universal service support payments needed “to be re-examined.” Tex.

Office of Pub. Util. Counsel, 183 F.3d at 406.

“To attain the goal of local competition while preserving universal service,

Congress directed the FCC to” (1) institute a Federal-State Joint Board to

recommend changes in the FCC’s regulations that define and implement

universal service; and (2) implement the recommendations from the Joint Board

by promulgating rules to carry them into effect. Id.; see also 47 U.S.C. § 254(a).

Further, by § 254(b), Congress “direct[ed] the Joint Board and the Commission

to base policies for the preservation and advancement of universal service on six

enumerated principles, plus such ‘other’ principles as the Joint Board and the

Commission may establish.” Rural Cellular Ass’n, 588 F.3d at 1098. The

enumerated principles are: (1) “Quality services should be available at just,

reasonable, and affordable rates”; (2) “Access to advanced telecommunications

and information services should be provided in all regions of the Nation”; (3)

“Consumers in all regions of the Nation, including low-income consumers and

those in rural, insular, and high cost areas, should have access to

telecommunications and information services . . . at rates that are reasonably

comparable to rates charged for similar services in urban areas”; (4) “All

providers of telecommunications services should make an equitable and

nondiscriminatory contribution to the preservation and advancement of

universal service”; (5) “There should be specific, predictable and sufficient

Federal and State mechanisms to preserve and advance universal service”; and

(6) “Elementary and secondary schools and classrooms, health care providers,

and libraries should have access to advanced telecommunications services.” 47

U.S.C. § 254(b).

The Telecommunications Act of 1996 also allowed the states to develop

their own universal service support systems, so long as those “regulations [are]

not inconsistent” with the FCC’s rules “to preserve and advance universal

3

 Case: 09-50651 Document: 00511339601 Page: 3 Date Filed: 01/04/2011
No. 09-50651

service” in telecommunications. Id. § 254(f). Pursuant to this authority,

California, Kansas and Texas adopted universal service regulations consistent

with the FCC’s rules.

The FCC mandate to provide universal service is now fulfilled through

payments to telecommunications providers by a universal service fund (“USF”).

In addition to the high-cost support program, which is designed mainly to

provide affordable telephone service to consumers in high-cost rural or isolated

areas, the USF supports programs for low-income customers, schools, libraries,

and health care providers. “High-cost support disbursements, however,

overwhelmingly represent the largest category of USF expenditures, accounting

for 61.6 percent of USF disbursements in 2007.” Rural Cellular Ass’n, 588 F.3d

at 1099 (citing Fed.-State Joint Bd. on Universal Serv., Universal Service

Monitoring Report tbl.1.11 (2008)). California, Kansas and Texas have instituted

similar USFs in each state. Only the 1998 and 1999 payments to AT&T by those

state USFs and by the federal USF are at issue in the instant case. AT&T claims

that both federal and state payments should be treated as capital contributions,

not income.

Support for the state and federal USFs comes from assessments, made by

the USF administrators, the FCC, and the state utility commissions, requiring

mandatory contributions to be paid by “all providers of telecommunications

services.” 47 U.S.C. § 254(b)(4); see also Tex. Util. Code Ann. § 56.022(a); Kan.

Stat. § 66-2008(a). “Every telecommunications carrier that provides interstate

telecommunications services [must] contribute, on an equitable and

nondiscriminatory basis, to the specific, predictable, and sufficient mechanisms

established by the [FCC] to preserve and advance universal service.” 47 U.S.C.

§ 254(d). Similarly, every “carrier that provides intrastate telecommunications

services [must] contribute, on an equitable and nondiscriminatory basis, in a

manner determined by the State to the preservation and advancement of

4

 Case: 09-50651 Document: 00511339601 Page: 4 Date Filed: 01/04/2011
No. 09-50651

universal service in that State.” Id. § 254(f). “[C]ontributors almost always pass

their contribution assessments through to their customers.” Rural Cellular

Ass’n, 588 F.3d at 1099 (citing Alenco Commc’ns, Inc., 201 F.3d at 620).

Pursuant to the statutory provisions and the FCC’s and the states’ rules,

disbursements are calculated by the respective commissions and paid to the

carriers providing federal and state universal services. The universal service

payments are designed to offset the telephone companies’ added costs or

decreased revenue associated with servicing high-cost and low-income users. The

USF payments for servicing high-cost users are based upon how much more than

the average it costs to integrate those users into the telephone system. See 47

C.F.R. § 36.631; see also 16 Tex. Admin. Code § 23.133 (1999); Kan. Stat. § 66-

2008(d); In re Rulemaking on the Commission’s Own Motion into Universal

Service and Compliance with the Mandates of Assembly Bill 3643, 68 CPUC 2d

524, 1996 WL 651546, at *1-2 (Cal. Pub. Util. Comm’n 1996). The USF payments

for servicing low-income users are designed to decrease or eliminate certain

charges that those users would otherwise have had to pay. 47 C.F.R.

§§ 54.403(b)-(c) (1997), 54.411(a); see also 16 Tex. Admin. Code § 23.142(d)(2)

(1999). To be eligible to receive these disbursements of USF funds, a carrier

must offer the services designated as “universal” by the FCC and advertise the

availability of those services and the charges for such services. 47 U.S.C.

§ 214(e)(1).

From the state and federal USFs, AT&T received USF payments of $723.5

million in 1998 and $831.3 million in 1999. AT&T recorded these amounts as

“revenue” for financial and regulatory accounting purposes. AT&T deposited

these USF payments into its general bank account, along with other customer

revenues, from which operating expenses and other costs were paid. AT&T did

not earmark or track its use of the USF payments it received. On its 1998 and

1999 federal income tax returns, however, AT&T did not include its USF receipts

5

 Case: 09-50651 Document: 00511339601 Page: 5 Date Filed: 01/04/2011
No. 09-50651

in its gross income. As a result, AT&T did not pay $505,245,517 in income taxes

on the payments it received from the USFs in 1998 and 1999. AT&T did,

however, treat the mandatory contributions it was required to make to the USFs

as deductible business expenses in 1998 and 1999. The IRS determined that

AT&T had incorrectly failed to report the USF payments as income. AT&T paid

the income tax deficiencies assessed by the IRS and filed administrative claims

for a refund, which were denied.

AT&T filed this suit in federal district court seeking tax refunds totaling

$505,245,517. AT&T contended that the USF payments were capital

contributions excludable from its gross income under 26 U.S.C. § 118(a). The

Government filed a motion for summary judgment, arguing that the undisputed

facts and applicable law demonstrate that the government payors of USF

support payments did not intend to make capital contributions to AT&T in

making payments from the USFs; and that they instead intended to supplement

the carriers’ operating income by compensating them for some of their costs of

servicing high-cost customers and by reimbursing carriers for discounts that

they were required to give low-income consumers. The Government further

relied on the Eleventh Circuit’s decision in United States v. Coastal Utilities,

Inc., 514 F.3d 1184 (11th Cir. 2008), adopting and affirming United States v.

Coastal Utilities, Inc., 483 F. Supp. 2d 1232 (S.D. Ga. 2007), which held that

payments from USFs to support high-cost users did not constitute capital

contributions.

AT&T opposed the motion, arguing that there was a genuine issue as to

a material fact, viz., whether the FCC and state payors intended to make

contributions to AT&T’s capital in making the USF payments, which required

a trial; that the USF payments were intended to pay for the expansion and

upgrading of the carriers’ network infrastructure and must be treated as capital

contributions; and that Coastal Utilities was erroneously decided because the

6

 Case: 09-50651 Document: 00511339601 Page: 6 Date Filed: 01/04/2011
No. 09-50651

court there did not examine the five requirements for a payment to be held to be

a capital contribution set forth in United States v. Chicago, Burlington & Quincy

Railroad Co., 412 U.S. 401, 413 (1973) (hereinafter CB&Q).

The district court referred the Government’s motion for summary

judgment to a magistrate judge, who recommended that the court should grant

the motion. She indicated that “[t]he parties agree that the test for determining

whether a payment is a contribution to capital is the transferor’s intent.”

However, she rejected AT&T’s argument that the court is required to rigidly

apply the test identified in CB&Q. Instead, the magistrate judge determined

that the court could discern the state and federal governments’ intent by

examining the method by which the FCC and state utility commissions decided

to make payments from the USFs to support service to high-cost and low-income

subscribers. The magistrate judge stated that these payments were intended to

supplement “lost revenues” from servicing these customers and that “the cost of

capital improvements is not part of the calculation of the universal service

payments”; “[a]lthough the cost of capital improvements [such as building

telephone lines] undoubtedly affects the amount a carrier claims, the

computations of payments focuses on revenue (the amount of universal service

charges), not capital improvements.” Therefore, because “carriers provide service

at discounted rates and governments reimburse carriers for revenues lost in

providing discounted services,” nothing in the payment structure for servicing

high-cost or low-income customers directly implicates capital contributions.

Accordingly, the magistrate judge rejected AT&T’s contention that there was a

genuine issue of material fact requiring a trial. She stated that “AT&T [had]

submitted a large volume of summary-judgment evidence . . . but did not explain

why or how this evidence raises a material fact question” and that she had

“found nothing raising a fact question about whether universal service payments

to AT&T constitute non-shareholder contributions to capital.”

7

 Case: 09-50651 Document: 00511339601 Page: 7 Date Filed: 01/04/2011
No. 09-50651

After reviewing the record, the recommendations of the magistrate judge,

and the arguments of the parties, the district court accepted and adopted the

magistrate judge’s recommendation in its entirety, and granted the

government’s motion for summary judgment, rejecting AT&T’s claim for a refund

of income taxes paid. AT&T appealed.

STANDARD OF REVIEW

“[I]t is well settled that an appellate tribunal may affirm a trial court’s

judgment on any ground supported by the record.” Lee v. Kemna, 534 U.S. 362,

391 (2002). “In determining whether a district court properly granted summary

judgment, this Court must review the record under the same standards that

guided the district court.” Little v. Liquid Air Corp., 952 F.2d 841, 847 (5th Cir.

1992). “We must review the evidence, as well as the inferences that may be

drawn from the evidence, in the light most favorable to the party that opposed

the motion for summary judgment.” Id. “The court shall grant summary

judgment if the movant shows that there is no genuine dispute as to any

material fact and the movant is entitled to judgment as a matter of law.” Fed.

R. Civ. P. 56(a).

1

DISCUSSION

For the reasons assigned hereinafter, we agree with the district court that

the record reveals no genuine dispute as to any material fact and that the

defendant is entitled to judgment as a matter of law. In summary, under the

Supreme Court’s decisions and the Internal Revenue Code, whether a payment

to a corporation by a non-shareholder is income or a capital contribution to the

While this case was pending before this court, the text of Rule 56 changed. This 1

change was meant to “carr[y] forward the summary-judgment standard expressed in former

subdivision (c).” Fed. R. Civ. P. 56 advisory committee note (2010 Amendments). Thus, while

the district court and this court rely on slightly different language in concluding that summary

judgment is warranted and the United States is entitled to judgment as a matter of law, both

represent the same legal standard.

8

 Case: 09-50651 Document: 00511339601 Page: 8 Date Filed: 01/04/2011
No. 09-50651

corporation is controlled by the intention or motive of the transferor. When the

transferor is a governmental entity, its intent may be manifested by the laws or

regulations by which it effectuates the payment to the corporation. In the

present case, the statutes authorizing the universal service programs, the

administrative orders establishing the USFs, and the regulations implementing

the raising of revenues for the USFs and the payments from them to AT&T and

its subsidiaries,taken together, demonstrate an intent to supplement the income

of the telephone companies, rather than to make capital contributions to them.

In addition, in CB&Q, the Supreme Court indicated that five characteristics,

distilled from its jurisprudence, can serve as hallmarks for the transferor’s

intent. Four of the five, and ordinarily the fifth, must be satisfied before a court

can conclude that a transfer was a capital contribution. Applying that test, we

again conclude that the governmental transferors in the present case did not

intend to make capital contributions to the telephone companies because the

transfers fail to satisfy three of the five factors. Therefore, under either the

statutory-regulatory construction analysis or the CB&Q five-factor test, the

universal services payments were not contributions to capital but were income

to AT&T.

I.

“Section 61(a) of the Internal Revenue Code provides a broad definition

of ‘gross income’: ‘Except as otherwise provided in this subtitle, gross income

means all income from whatever source derived.’ 26 U.S.C. § 61(a).” Comm’r v.

Schleier, 515 U.S. 323, 327 (1995). The Supreme Court has “repeatedly

emphasized the ‘sweeping scope’ of this section and its statutory predecessors.”

Id. at 327-28 (quoting Comm’r v. Glenshaw Glass Co., 348 U.S. 426, 429 (1955))

(citing United States v. Burke, 504 U.S. 229, 233 (1992); Helvering v. Clifford,

309 U.S. 331, 334 (1940)). The Court has “also emphasized the corollary to

§ 61(a)’s broad construction, namely, the ‘default rule of statutory interpretation

9

 Case: 09-50651 Document: 00511339601 Page: 9 Date Filed: 01/04/2011
No. 09-50651

that exclusions from income must be narrowly construed.’” Id. at 328 (quoting

Burke, 504 U.S. at 248 (Souter, J., concurring in judgment)) (citing Burke, 504

U.S. at 244 (Scalia, J., concurring in judgment); United States v. Centennial Sav.

Bank FSB, 499 U.S. 573, 583 (1991); Comm’r v. Jacobson, 336 U.S. 28, 49

(1949)).

AT&T recognizes § 61(a)’s “sweeping” definition and concedes that its

receipts of universal services payments constitute gross income unless they are

expressly excepted by 26 U.S.C. § 118(a), which provides: “In the case of a

corporation, gross income does not include any contribution to the capital of the

taxpayer.”

“‘[C]ontribution to capital’ is not expressly defined by statute.” Coastal

Utils., 514 F.3d 1184, aff’g 483 F. Supp. 2d at 1238. But “the legislative history

of § 118 explicitly states that the statute was meant to ‘place[] in the Code the

Court decisions on this subject.’” Id. (second alteration in original) (quoting H.R.

Rep. No. 83-1337, at A-38 (1954), reprinted in 1954 U.S.C.C.A.N. 4017, 4042; S.

Rep. No. 83-1622 (1954), reprinted in 1954 U.S.C.C.A.N. 4621, 4648). Therefore,

a brief history tracing the development of the Supreme Court’s jurisprudence is

essential to an understanding of the meaning of the term “contribution to

capital” and thus, the tax character of the instant payments.

In Edwards v. Cuba Railroad Co., the Supreme Court held that money

from the Cuban government paid to a railroad to “subsid[ize] up to $6,000 per

kilometer” of track laid, “and [which was] used for capital expenditures,” was a

capital contribution, not income. 268 U.S. 628, 629, 630-31 (1925); see also

Springfield St. Ry. Co. v. United States, 577 F.2d 700, 702 (Ct. Cl. 1978). The

Supreme Court explained,

The subsidy payments were proportionate to mileage completed;

and this indicates a purpose to reimburse plaintiff for capital

expenditures. . . . Neither the laws nor the contracts indicate that

10

 Case: 09-50651 Document: 00511339601 Page: 10 Date Filed: 01/04/2011
No. 09-50651

the money subsidies were to be used for the payment of dividends,

interest or anything else properly chargeable to or payable out of

earnings or income.

Edwards, 268 U.S. at 632-33 (emphasis added).

Later, in Texas & Pacific Railway v. United States, 286 U.S. 285 (1932),

and Continental Tie & Lumber Co. v. United States, 286 U.S. 290 (1932), the

question was whether the federal government’s payments, which were meant to

“guarantee[]” the companies “an operating income,” were income or capital

contributions. Tex. & Pac. Ry., 286 U.S. at 288; see also Cont’l Tie & Lumber Co.,

286 U.S. at 293-94. The Court concluded that the monies were income, stating:

The sums received under the act were not subsidies or gifts—that

is, contributions to the capital of the railroads—and this fact

distinguishes cases such as Edwards. . . . Here the[ sums] were to

be measured by a deficiency in operating income, and might be used

for the payment of dividends, of operating expenses, of capital

charges, or for any other purpose within the corporate authority,

just as any other operating revenue might be applied.

Tex. & Pac. Ry., 286 U.S. at 289-90; see also Cont’l Tie & Lumber Co., 286 U.S.

at 293-94 (stating that payments that “guaranteed the payment of any deficiency

below a fixed minimum of operating income” and were motivated by an effort to

compensate for “losses in income due to” government programs were income).

Subsequently, in Detroit Edison Co. v. Commissioner, 319 U.S. 98, 99

(1943), the Court ruled on the tax character of payments by customers to the

company for the “estimated cost of the necessary construction” for extending

“facilities” to service those customers. The Court indicated that the transfers

could be taxed as income and therefore “[t]he Commissioner was warranted in

adjusting the” company’s basis in certain items purchased with these monies

from the customers. Id. at 103. The Court stated that “[t]he payments were to

the customer the price of the service” and thus they should be treated as such,

i.e., income. Id.

11

 Case: 09-50651 Document: 00511339601 Page: 11 Date Filed: 01/04/2011
No. 09-50651

In Brown Shoe Co. v. Commissioner, 339 U.S. 583, 584 (1950), the Court

concluded that “the payment of cash and the transfer of other property to [the

company] by certain community groups as an inducement to the location or

expansion of [the company’s] factory operations in the communities” were capital

contributions. The Court explained that “[u]nder these circumstances the

transfers manifested a definite purpose to enlarge the working capital of the

company.” Id. at 591 (emphasis added).

The latest guidance from the Supreme Court on the subject of what

constitutes a nonshareholder contribution to capital was provided in CB&Q.

There, the Court held that “the intent or motive of the transferor . . . determined

the tax character of the transaction.” CB&Q, 412 U.S. at 411. The Court

reasoned that “the decisional distinction between Detroit Edison and Brown

Shoe rested upon the nature of the benefit to the transferor, rather than to the

transferee, and upon whether that benefit was direct or indirect, specific or

general, certain or speculative.” Id.; see also G.M. Trading Corp. v. Comm’r, 121

F.3d 977, 980 (5th Cir. 1997); Deason v. Comm’r, 590 F.2d 1377, 1378 (5th Cir.

1979); Springfield St. Ry. Co., 577 F.2d at 702-03.

Moreover, adverting to Detroit Edison and Brown Shoe, the CB&Q Court

concluded, “[w]e can distill from these two cases some of the characteristics of a

nonshareholder contribution to capital under the Internal Revenue Codes”:

[1] It certainly must become a permanent part of the transferee’s

working capital structure. [2] It may not be compensation, such as

a direct payment for a specific, quantifiable service provided for the

transferor by the transferee. [3] It must be bargained for. [4] The

asset transferred foreseeably must result in benefit to the transferee

in an amount commensurate with its value. [5] And the asset

ordinarily, if not always, will be employed in or contribute to the

production of additional income and its value assured in that

respect.

12

 Case: 09-50651 Document: 00511339601 Page: 12 Date Filed: 01/04/2011
No. 09-50651

CB&Q, 412 U.S. at 413. The Court then proceeded to reject CB&Q’s contention

that it had received capital contributions because the transfers at issue failed to

satisfy the third and fourth characteristics, even though the Court noted that the

transfers satisfied the second. Id. at 413-15. Thus, the Court indicated that

although the tax character of a transfer was ultimately determined by the

transferor’s intent, for a court to hold that a transfer was a capital contribution,

each of the first four, and ordinarily the fifth, characteristics must also be

satisfied. This is how our circuit has interpreted CB&Q’s holding. G.M. Trading,

121 F.3d at 980-81; see also Deason, 590 F.2d at 1378-79 (“[T]he Supreme Court

in [CB&Q] enumerated certain requisite characteristics common to

nonstockholder contributions to capital under the Internal Revenue Code . . . .”).

From the foregoing review of the Supreme Court’s cases, we derive these

principles: (1) Whether a payment to a corporation by a non-shareholder is

income or a capital contribution is controlled by the intention or motive of the

transferor. (2) When the transferor is a governmental entity, its intent may be

manifested by the laws or regulations that authorize and effectuate its payment

to the corporation. (3) Also, a court can determine that a transfer was not a

capital contribution if it does not possess each of the first four, and ordinarily the

fifth, characteristics of capital contributions that the Supreme Court distilled

from its jurisprudence in CB&Q. Applying these principles to the facts of this

case, we conclude that, either by construing the controlling statutes and

regulations or by applying the CB&Q five-factor test, the governmental entities

in making universal service payments to AT&T did not intend to make capital

contributions to AT&T; and thus, that the payments were income to AT&T.

Thus, in this case, we need not pause to determine whether one method

of determining the intention or motive of the transferor is more appropriate than

the other. By alternately bringing each method to bear on this case, we reach the

same result in both applications, thereby reinforcing our conclusion that the

13

 Case: 09-50651 Document: 00511339601 Page: 13 Date Filed: 01/04/2011
No. 09-50651

universal service payments were intended and must be treated as income to

AT&T.

II.

As we read the statutes authorizing the USF payments, the administrative

orders implementing those statutes, and the resulting regulations, the USF

payments were not intended to be capital contributions to AT&T, but to be

supplements to AT&T’s gross income to enable it to provide universal service

programs while meeting competition newly introduced by the 1996 Act.

A. The Telecommunications Act articulates six “principles” on which the

federal USF payment “policies” are to be “base[d].” 47 U.S.C. § 254(b). These

principles establish that the payments are intended to “offset” recipients’

increased costs or lost revenue in servicing high-cost and low-income users, so

that the recipients can provide and expand universal service while remaining

competitive in the telecommunications market. See H.R. Rep. No. 103-560, at 41

(1994) (stating that the federal USF was intended to “offset[] the high cost of

providing local telephone service to rural areas” and “offset the initial telephone

installation charge and also defray[] interest expense[s]” for low-income users);

see also S. Rep. No. 104-23, at 29 (1995). For instance, the first principle on

which the federal USF payments are to be based is that “services should be

available at just, reasonable, and affordable rates.” 47 U.S.C. § 254(b)(1). The

third principle states that “[c]onsumers in all regions of the Nation, including

low-income consumers and those in rural, insular, and high cost areas, should

have access to telecommunications and information services . . . that are

reasonably comparable to those services provided in urban areas and that are

available at rates that are reasonably comparable to rates charged for similar

services in urban areas.” Id. § 254(b)(3). As explained in the background section,

the USF system was developed in recognition of the fact that high-cost and lowincome individuals could not readily afford telephone services in the absence of

14

 Case: 09-50651 Document: 00511339601 Page: 14 Date Filed: 01/04/2011
No. 09-50651

rate regulation. By seeking to assure that these customers receive “comparable”

telephone services at “affordable rates,” which are also “comparable” to the rates

charged to non–high-cost or low-income users, these principles indicate that the

USF payments are intended to compensate the telecommunications companies

for the difference between the costs of providing service to high-cost and lowincome customers and what those customers can afford to pay, so that the

customers can receive service and the companies can remain competitive. See id.

§ 254(b)(1), (3). Of course, the Act’s general principles do not specifically address

whether the USF payments are intended as capital contributions or income nor

how the payments are to be made. However, by linking the payments to the

recipient companies’ rates charged to non–high-cost or low-income customers,

the principles narrowed the mechanisms by which the USF payments could be

distributed, making it more likely that they would take the form of income

supplements rather than capital contributions.

B. The foregoing statutory principles were implemented by the FCC’s Report

and Order on universal service. In the Matter of Federal-State Joint Board on

Universal Service, 12 FCC Rcd. 8776, ¶ 2 (May 8, 1997) (stating that its

decisions were “[c]onsistent with the explicit statutory principles”); id. ¶ 17

(stating that it was modifying its payment “mechanisms . . . to make them more

consistent with the statutory requirements and principles”). The FCC’s decision

to directly implement the principles, tying USF payments to companies’ rates

charged to customers for universal services, furthered the likelihood that the

USF payments would become part of the companies’ income. For example,

repeating the language of the first principle, quoted above, in its introduction to

the Report and Order, the FCC declared that its “[u]niversal service support

mechanisms . . . are designed to increase subscribership by keeping rates

affordable.” Id. ¶ 8. Consistent with the third principle from the

Telecommunications Act, the Report and Order described how the FCC would

15

 Case: 09-50651 Document: 00511339601 Page: 15 Date Filed: 01/04/2011
No. 09-50651

achieve the goal of keeping universal service consumers’ bills affordable, stating

that for high-cost users, the high-cost support payments would be equal to “the

cost of providing universal service for high cost areas because it best reflects the

cost of providing service in a competitive market for local exchange telephone

service.” Id. ¶ 26. Likewise, the FCC explained that the low-income support

program known as Lifeline assistance would be “condition[ed] . . . on the state

permitting its carriers to reduce intrastate charges paid by the end user.” Id.

¶ 326; see also id. ¶¶ 351-53, 367 (describing similar principles for the lowincome support programs).

 In this manner, the implementing administrative document directly put

into effect the Act’s intention that the USF payments should be equivalent to

customers’ fees for services. It indicated that USF payments would be designed

to offset a portion of the telecommunications company’s real cost of providing

discounted services to low-income and high-cost customers, thus providing the

company with revenue associated with universal service comparable to what it

could gain from servicing more affluent low-cost urban customers. Again, it did

not specifically state whether the payments were intended as income or capital

contributions, but by designing the payment mechanisms to directly implement

the Act’s policy principles, the Report and Order further narrowed the possibility

that the payments could be viewed as anything but income.

C. What is more, the FCC’s Report and Order promulgated new regulations

and endorsed certain existing regulations related to universal service. See, e.g.,

id. ¶¶ 300, 986. These regulations included the specific mechanisms used to

calculate disbursements from the federal USF to the recipient companies, which

directly effectuated the principles and policies as described in the Act and Report

and Order. Accordingly, as the Eleventh Circuit recognized in Coastal Utilities,

these mechanisms are fully and finally indicative of the intent underlying the

payments: that they were designed to supplement income. 514 F.3d 1184, aff’g

16

 Case: 09-50651 Document: 00511339601 Page: 16 Date Filed: 01/04/2011
No. 09-50651

483 F. Supp. 2d at 1241-42. For example, the regulations explained that the

federal high-cost user support program would provide the recipient company

75%, plus a multiplier, of the cost incurred in servicing high-cost users that

exceeds “150 percent of the national average for this cost.” 47 C.F.R.

§ 36.631(c)(2). Similarly, the regulation regarding low-income Lifeline assistance

stated that the program would provide money so that the recipient companies

could “waive” certain charges for Lifeline customers. Id. § 54.403(b) (1997).

Therefore, as indicated by the statute’s principles and the FCC’s universal

service policy principles, the regulations dictated that the federal USF would

directly compensate AT&T for its lost revenue or increased expenses in servicing

high-cost and low-income users, assuring AT&T of competitive rates of income

from these services. Therefore, USF payments were clearly intended to be

income for AT&T and not capital contributions.

D. The functions of the California, Kansas and Texas state USFs are

consistent with and analogous to those of the FCC’s federal USF. These states’

legislators and utility commissions expressly adopted universal service policies

similar to and consistent with the federal policies and goals in raising and using

USFs. The state USFs are funded by mandatory assessments on companies

providing universal service; payments from the USFs to the companies provide

telecommunications carriers with money to offset their increased costs or

reductions in revenues resulting from servicing high-cost or low-income users

and thus provide the companies with competitive rates of return for their

services. See, e.g., Cal. Pub. Util. Code § 270(b), 2004 historical note (stating that

payments from the current California USF are meant to “compensate telephone

corporations for their costs of providing universal service” and that this program

is merely a “re-authoriz[ation]” of prior USFs); Kan. Stat. § 66-2008(d) (stating

that USF funding is “for the purpose of providing services to and within the

service area of the qualified telecommunications [company]”); Tex. Util. Code

17

 Case: 09-50651 Document: 00511339601 Page: 17 Date Filed: 01/04/2011
No. 09-50651

§ 58.001(1) (stating that the policy underlying Texas’s USF is to “provide a

framework for an orderly transition from the traditional regulation of return on

invested capital to a fully competitive telecommunications marketplace,” thereby

suggesting that Texas USF payments are intended to ensure that

telecommunications companies receive competitive returns on their

investments); Tex. Util. Code § 56.022(a). Moreover, the state USFs use

mechanisms similar to the federal mechanisms described above to calculate the

amount of universal service support they provide. See, e.g., Kan. Stat. § 66-

2008(d); 16 Tex. Admin. Code § 23.133 (1999); In re Rulemaking on the

Commission’s Own Motion into Universal Service and Compliance with the

Mandates of Assembly Bill 3643, 1996 WL 651546, at *2.

In this manner, the authorizing statutes, administrative orders and

regulations demonstrate a consistent governmental intent that the USF

payments were designed to provide the telephone companies with supplemental

revenue to offset their extra costs in or decreased revenue resulting from

providing high-cost and low-income customers with affordable telephone

services. That intent was implemented by the payment mechanisms, which

distribute the USF payments in a manner so as to supplement the recipient

companies’ revenue from services.

The Supreme Court’s decision in Texas & Pacific Railway confirms that

such a regulatory and legislative framework dictates that the payments were

income. As noted above, there the United States had agreed that “[i]f the fruits

of [i.e., revenue of] the [company] should fall below a fixed minimum, then the

government [would] make up the deficiency.” 286 U.S. at 289. The Court

explained that these payments were designed to provide the railway with

sufficient funds to “rehabilitate[] . . . the road[] as [a] privately owned and

operated organization[]” by “stabiliz[ing] [its] credit position . . . by assuring [it]

a minimum operating income” and thereby allowing it to seek out loans and

18

 Case: 09-50651 Document: 00511339601 Page: 18 Date Filed: 01/04/2011
No. 09-50651

develop its business. Id. at 288-89. Because the mechanism for calculating the

payment to the railway was based upon the railway’s revenue, the Court

concluded, “[c]learly, then, the amount paid to bring the yield from operation up

to the required minimum was as much income from operation as were the

railroad’s receipts from fares and charges. The sums received under the act were

not subsidies or gifts—that is, contributions to the capital of the railroad[]. . . .

Here they were to be measured by a deficiency in operating income, and might

be used for the payment of dividends, of operating expenses, of capital charges,

or for any other purpose within the corporate authority, just as any other

operating revenue might be applied. The government’s payments were not in

their nature bounties, but an addition to a depleted operating revenue . . . .” Id.

at 289-90; see also Cont’l Tie & Lumber Co., 286 U.S. at 293-94 (stating that

payments that “guaranteed the payment of any deficiency below a fixed

minimum of operating income” and were motivated by an effort to compensate

for “losses in income due to” government programs were income).

Similarly, the policies and payment mechanisms underlying the state and

federal USFs demonstrate that the payments were intended to compensate the

telecommunications companies for lost revenue and thus were income to the

companies. Further supporting this conclusion, like the payments at issue in

Texas & Pacific Railway, the USFs can be used for the payment of a wide variety

of expenses, with the only condition being that the funds go toward costs that fit

within the infinitely broad category of payments “for the provision, maintenance,

and upgrading of facilities and services for which the support is intended.” 47

U.S.C. § 254(e). Therefore, the state and federal USF payments are not

2

The state funds at issue have slightly different formulations of how the USF monies 2

were to be used by the recipient companies. However, AT&T does not argue that the payments

from the state and federal funds should be treated differently. Moreover, as noted above, the

Telecommunications Act establishes that the state funds’ regulations cannot be “inconsistent

with the Commission’s rules to preserve and advance universal service.” 47 U.S.C. § 254(f).

19

 Case: 09-50651 Document: 00511339601 Page: 19 Date Filed: 01/04/2011
No. 09-50651

excludable from AT&T’s income as nonshareholder contributions to capital

under 26 U.S.C. § 118.

III.

Application of the CB&Q five-factor test to the facts of this case leads to

the same conclusion. In CB&Q the Supreme Court stated that while the intent

of the transferor is the ultimate test for whether a transfer is a capital

contribution, the Court’s cases teach that a capital contribution must have at

least four, ordinarily five, characteristics. 412 U.S. at 413. The USF payments

fail to satisfy three of the four mandatory characteristics, showing that they

were not capital contributions but must be recognized as income to AT&T.

A. AT&T fails to show that it “bargained for” the USF payments rather than

simply having accepted the unilaterally imposed law and regulations

determining the USF payments. See id. at 413. AT&T demonstrates only that

it submitted comments to and conducted ex parte meetings with the FCC as part

of the agency’s consideration of how to structure the USF payments. Likewise,

prior to the establishment of the state USFs by California, Kansas, and Texas,

an AT&T spokesperson testified before legislative and regulatory committees,

made presentations, submitted documents and comments, and attended

meetings. In Kansas, a company representative sat on “a telecommunications

strategic planning committee” during the development of the Kansas universal

service support system. However, the Kansas resolution establishing that

committee specified that the committee was merely “advisory in nature,” helping

only to recommend a plan for “future actions by the legislature.” Kan. Senate

Con. Res. No. 1627 (1994). Therefore, AT&T’s evidence demonstrates only that

its participation in the development of the state and federal USFs amounted to

lobbying and advocacy designed to influence independent legislative and

Therefore, any differences must be insignificant.

20

 Case: 09-50651 Document: 00511339601 Page: 20 Date Filed: 01/04/2011
No. 09-50651

administrative decisions. Essentially, the statutes and the regulations were

unilaterally imposed by law upon AT&T and other carriers and not enacted in

exchange for the carriers’ quid pro quo.

Accordingly, AT&T’s lobbying and advocacy did not amount to bargaining

in the CB&Q sense. A bargain requires mutual “negotiat[ion]” or “haggl[ing].”

See Coastal Utils., 514 F.3d 1184, aff’g 483 F. Supp. 2d at 1234 (quoting

Webster’s Collegiate Dictionary 99 (11th ed. 2003)) (internal quotation marks

omitted). Accordingly, the Supreme Court stated in CB&Q that a transaction

that “in substance was unilateral” cannot be bargained for. 412 U.S. at 414; see

also Springfield St. Ry. Co., 577 F.2d at 703. As a result, taking all of AT&T’s

arguments and cited evidence in the light most favorable to it, the record

demonstrates that the state and federal USFs may have been influenced by

AT&T’s efforts, but not that they were bargained for by the company. The

company sought only to influence the governmental entities’ unilateral decisionmaking, not to engage in a mutual exchange of commitments. Coastal Utils., 514

F.3d 1184, aff’g 483 F. Supp. 2d at 1249 (“[I]t appears that the FCC and the

[local utility commission] established, by orders and regulations, the amount of

support that Coastal was entitled to receive. Such circumstances do not in any

real sense constitute a bargain.” (footnote omitted)); see also Lehnert v. Ferris

Faculty Ass’n, 500 U.S. 507, 528 (1991) (noting that in the First Amendment

context, lobbying activities are distinct from collective bargaining); 520 S. Mich.

Ave. Assocs., v. Shannon, 549 F.3d 1119, 1132-33 (7th Cir. 2008) (drawing a

distinction between lobbying and collective bargaining).

B. Notwithstanding AT&T’s assertion to the contrary,the USF payments also

were paid to AT&T to compensate it for providing certain specific services. Thus,

AT&T fails to demonstrate the payments satisfy the second CB&Q characteristic

of a capital contribution—that the transfer not be made as “compensation . . . for

21

 Case: 09-50651 Document: 00511339601 Page: 21 Date Filed: 01/04/2011
No. 09-50651

a specific, quantifiable service provided for the transferor by the transferee.”

CB&Q, 412 U.S. at 413.

Whether a payment is compensation for a specific, quantifiable service is

illustrated by the Supreme Court’s pair of decisions in Detroit Edison and Brown

Shoe. In the former, the Court found the transfers to be compensation for

services and therefore income; in the latter, the Court concluded that the

transfers were not compensation for services and thus, could be capital

contributions. The payments in Detroit Edison resulted from the company’s

agreement with customers that if the customers “pa[id] the estimated cost of the

necessary construction,” the company would expand previously unavailable

services to reach those individuals. 319 U.S. at 99. The Court held that these

payments, either from single individuals or shared among several customers,

were income and not capital contributions because “[t]he payments were to the

customer the price of the service. . . . It is enough to say that it overtaxes

imagination to regard the farmers and other customers who furnished these

funds as makers either of donations or contributions to the Company.” Id. at

102-03. This was true even though “[c]ustomers’ payments [were] not

appropriated to the particular construction nor earmarked for it, but [went] into

the Company’s general working funds.” Id. at 100. By contrast, in Brown Shoe,

the transfers resulted from philanthropic efforts “by certain community groups

as an inducement to the location or expansion of petitioner’s factory operations”

in the community. 339 U.S. at 584. The Court explained that these transfers

were capital contributions because the philanthropic groups “neither sought nor

could have anticipated any direct service or recompense whatever, their only

expectation being that such contributions might prove advantageous to the

community at large.” 339 U.S. at 591. In this manner, the Court indicated that

to be compensation for services, a transfer does not need to be directly or

immediately used for the provision of services; nor does it need to benefit all

22

 Case: 09-50651 Document: 00511339601 Page: 22 Date Filed: 01/04/2011
No. 09-50651

transferors commensurately with their individual contributions. Instead,

consistent with the Court’s statements that a transferor’s intent ultimately

determines the tax character of the transfer, whether a payment is

compensation for services turns on whether it is given in expectation of a specific

service to the transferor or whether it is given simply to pay for or generate a

service to others.

Applying those precepts here, the USF payments were compensation to

AT&T for the specific and quantifiable services it performed for high-cost and

lower-income users as well as for developing and maintaining universal service,

which renders a service for all consumers by making the telecommunications

system more useful and valuable to every customer. The state and federal USFs

draw their monies from assessments levied by the FCC and state utility

commissions against the telecommunications companies, which are then passed

3

along to customers. See Rural Cellular Ass’n, 588 F.3d at 1099; see also Citizens’

Util. Ratepayer Bd. v. State Corp. Comm’n, 956 P.2d 685, 713 (Kan. 1998). AT&T

acknowledges, consistent with the FCC’s independent findings, that the

expansion of universal telephone service provides a service to all telephone users

by “mak[ing] the network more valuable to all,” in that it allows all customers

to reach a greater number of individuals. See Federal-State Joint Board on

Universal Service, 12 FCC Rcd. 8776, ¶ 8. Thus, the USFs are in effect a vehicle

or conduit by which the telecommunications carriers are compensated for the

specific, quantifiable services that they provide directly to high-cost and

lower-income customers and for the universal, system-wide service they provide

in making those customers accessible to other consumers in the system. It is

enough to say that it overtaxes imagination to regard customers who furnished

funds for telecommunications service, which are then used by the

See 47 U.S.C. § 254(d); Cal. Pub. Util. Code § 270(b); Kan. Stat. § 66-2008(a); Tex. 3

Util. Code Ann. § 56.022(a). 

23

 Case: 09-50651 Document: 00511339601 Page: 23 Date Filed: 01/04/2011
No. 09-50651

telecommunications companies to improve services, as makers either of

donations or contributions to the company. Cf. Detroit Edison, 319 U.S. at 102.

C. Finally, AT&T fails to demonstrate that the payments it received from the

federal and state USFs became a permanent part of AT&T’s working capital

structure, as is demanded by the first CB&Q requirement. See CB&Q, 412 U.S.

at 413. AT&T acknowledges that a payment becomes “a permanent part of its

‘working capital structure’ if the funds are committed for investment and use in

the business.” AT&T Opening Br. 24-25 (emphasis added). AT&T does not

contest, however, that the USF payments went, un-earmarked, into its general

revenue accounts where they were available for a multitude of purposes other

than contributions to capital. AT&T argues that the legislative and regulatory

background for the payments indicates that they were intended to increase

AT&T’s investment in capital assets. However, universal service support did not

provide money exclusively for the specific purpose of making capital

improvements, such as building an airport or locating and constructing a plant.

Instead of providing the money only for that type of investment, the

governments provided supplemental income so as to provide the telephone

companies an enhanced return on their investment. Through universal support,

the governments provided an incentive for taxpayers such as AT&T to extend

the network by investing in additional construction. But the payments were

made as supplements to income, not direct contributions to capital committed

exclusively to such construction. See Coastal Utils., 514 F.3d 1184, aff’g 483 F.

Supp. 2d at 1248.

Therefore, having failed to demonstrate that the USF payments had more

than one or two of the essential characteristics of a capital contribution instead

of four or more as prescribed by CB&Q, AT&T has not carried its burden to show

that the USF support payments were capital contributions under the CB&Q

test.

24

 Case: 09-50651 Document: 00511339601 Page: 24 Date Filed: 01/04/2011
No. 09-50651

CONCLUSION

For these reasons, the judgment of the district court is AFFIRMED.

25

 Case: 09-50651 Document: 00511339601 Page: 25 Date Filed: 01/04/2011