Opinion ID: 677026
Heading Depth: 3
Heading Rank: 2

Heading: Whether taxpayers' facilities are property in the nature of machinery.

Text: 38 Even an inherently permanent structure can qualify as tangible personal property so long as it is property in the nature of machinery. See Treas. Reg. Sec. 1.48-1(c). Taxpayers urge that the carwash facilities are property in the nature of machinery. In making this argument, they rely heavily upon the tax court's opinion in Weirick v. Commissioner, 62 T.C. 446, 1974 WL 2764 (1974). There the court reasoned that, where some of the property under examination is machinery, and other property is both inherently permanent yet also effectively inseparable from the machinery, the property is to be viewed unitarily. Under such a circumstance, all the property, viewed unitarily, although inherently permanent to at least some extent, will qualify as property in the nature of machinery. Id. at 453-54. In Weirick, the tax court concluded that intermediate line towers supporting a ski lift could not be viewed separately from the sheave assemblies, installed on each line tower, which supported or held down the line cable and which concededly qualified as machinery. In support of this conclusion, the tax court noted that the designers had envisioned and designed the line towers and sheave assemblies as a single device; that, economically, were it to become necessary to replace a sheave assembly, it would be prudent to simply replace the entire line tower and sheave assembly as one; and that, from a functional standpoint, neither the line towers nor the sheave assemblies alone could perform the purpose, of supporting or holding down the cables to which moving chairs are attached, for which the entire apparatus had been designed. Id. at 454. 7 39 Taxpayers urge that their carwash facilities should similarly be viewed unitarily and deemed to be property in the nature of machinery. They conceive of the facilities as nothing more than ... automatic vending machine[s] that sell[ ] water and collect[ ] and process[ ] the sewer water. Appellants' Br. 23. 8 We reject this notion. 40 The tax court determined that the portion of Weirick upon which taxpayers rely is factually distinguishable from the facts presented in the case at bar. The court reasoned that, here, there is no showing that the carwash machinery was designed as, or is envisioned as, part of a single unit including the supporting structure. Nor is there any showing that, were the carwash machinery to be replaced, it would be economical to replace at the same time the entire structure. Nor is there any showing that the carwash machinery cannot function as it was designed to function absent the supporting structure. The tax court concluded that, consequently, there was no basis for viewing the carwash structures as one with the carwash machinery and that, therefore, the facilities could not be viewed unitarily as property in the nature of machinery. 41 We agree with the tax court's reasoning. The facts in the present case more closely align themselves with those addressed in another portion of the Weirick opinion. There the tax court found that ramps used to allow skiers to access the skilift were not properly viewed as one with the skilift mechanism: the skilift worked the same way with or without the ramps even though, without the ramps, no skiers could in fact make use of the skilift. 62 T.C. at 455. 42 The facts in the instant case also parallel, as the court below found, the facts presented in Munford, Inc. v. Commissioner, 87 T.C. 463, 1986 WL 22010 (1986), aff'd, 849 F.2d 1398 (11th Cir.1988). There it was found that the structural components of a structure the interior of which was completely refrigerated were not properly viewed unitarily with the refrigeration equipment so as to constitute property in the nature of machinery. The tax court, 87 T.C. at 492-93, and the court of appeals, 849 F.2d at 1406-07, both distinguished the line towers in Weirick from the property there under consideration in much the same way that we do in this case. Munford, then, further buttresses our conclusion. 43 For these reasons, we agree with the tax court that taxpayers' facilities are not, taken as wholes, property in the nature of machinery, accord Rev.Rul. 79-406, 1979-2 C.B. 18, 19. 9 In light of the foregoing, then, the facilities do not, wholly, qualify as section 38 property under section 48(a)(1)(A). Still to be determined is whether the facilities qualify as section 38 property under section 48(a)(1)(B). 44 2. Whether taxpayers' facilities in their entirety qualify as section 38 property under section 48(a)(1)(B)(i). 45 To reiterate, section 48(a)(1)(B)(i) includes all tangible property, with the exception of buildings and structural components thereof, that is used as an integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services under the section 38 umbrella. As relevant here, Treasury Regulation Sec. 1.48-1(d) instructs: [A]ny ... tangible property (but not including a building and its structural components) used ... as an integral part of furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services by a person engaged in a trade or business of furnishing any such service ... may qualify as section 38 property. Treas. Reg. Sec. 1.148-1(d)(1). This statement allows us to isolate the five essential elements which a piece of property must meet for it to come under the section 38 umbrella by means of section 48(a)(1)(B)(i): the property must be (1) tangible property, (2) other than a building or its structural components, which (3) is used as an integral part (4) of furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services (5) by a person engaged in a trade or business of furnishing any such service. 46 The carwash structures clearly meet the first prong of this test and we will assume, for purposes of discussion, that the taxpayers' facilities are not buildings. Taxpayers contend that the carwash facilities furnish water and sewage disposal service, that taxpayers are in the business of furnishing water and sewage disposal services, and that the carwash facilities are integral parts of furnishing such services. We may assume, for purposes of discussion, that taxpayers, in fact, furnish water and sewage disposal services, 10 for we conclude that taxpayers' facilities, taken as wholes, nevertheless fail to qualify as section 38 property under section 48(a)(1)(B). 47 We turn first to taxpayers' contention that they are in the business of furnishing sewage disposal services. 48 [I]t is ... clear that Congress did not intend that every service performed by a taxpayer would constitute a separate trade or business for the purpose of investment tax credit computations. Thus, in determining the nature of the trade or business in which a taxpayer is engaged for purposes of the investment tax credit, we must distinguish between a taxpayer's real or primary business and activities that are merely incidental to or supportive of the operations of that primary business. 49 Hub City Foods, Inc. v. Commissioner, 884 F.2d 320, 324-25 (7th Cir.1989) (citations omitted). 50 We easily conclude that disposal of wastewater is incidental to Peninsula's primary business of providing self-service carwash facilities. Customers come to a self-service carwash to wash their cars. To accomplish this goal, all that is needed is water, soap, and various items of cleaning equipment. While taxpayers may be obligated to ensure that certain sediments are removed from the resulting wastewater before they can dispose of it in the various municipal sewage systems, customers do not patronize the taxpayers' facilities for this service. Cf. Mt. Mansfield Co. v. Commissioner, 50 T.C. 798, 1968 WL 1527 (1968) (operators of ski resort are not in business of furnishing transportation ... services merely because they provide a skilift to transport patrons up the mountain), aff'd per curiam, 409 F.2d 845 (2d Cir.1969); Evans v. Commissioner, 48 T.C. 704, 1967 WL 1300 (1967) (provision of water, electricity and gas is incidental to primary business of operating motor home park), aff'd per curiam, 413 F.2d 1047 (9th Cir.1969). Consequently, taxpayers are not in the business of furnishing sewage disposal services. 51 Taxpayers' only remaining argument in favor of classifying the carwash facilities as section 38 property under section 48(a)(1)(B) is that they are in the business of furnishing water services, and that the facilities are an integral part of furnishing such services. Even assuming that taxpayers, in fact, furnish water services, i.e., furnishing pressurized water, see supra note 10, and that they are in the business of furnishing such services, however, we cannot conclude that the facilities are an integral part of furnishing such services. 52 Treasury Regulation Sec. 1.48-1(d)(4) explains: Property is used as an integral part of one of the specified activities if it is used directly in the activity and is essential to the completeness of the activity. It is clear that the carwash structures are neither used directly in furnishing water services nor essential to the completeness of furnishing a water service. The dispensation of pressurized water, which we have assumed to qualify as furnishing ... water ... services, is accomplished completely by the carwash equipment and the plumbing and electrical systems, independent of the presence of the structures. 53 Thus, taxpayers' carwash structures do not qualify, wholly, as section 38 property under section 48(a)(1)(B). Therefore, and in light of our earlier conclusion that the facilities also do not qualify, wholly, under section 48(a)(1)(A), we must conclude that the carwash facilities, as wholes, do not qualify as section 38 property. Rather, as the Commissioner and the tax court found, only some portion of taxpayers' property qualifies as section 38 property. 54 B. Determination of what portions of the carwash facilities qualify as section 38 property. 55 Taxpayers contend that, even if the carwash facilities are not, in their entirety, section 38 property, various components of the carwash facilities are. For the carwashes constructed by Peninsula, the Commissioner allocated some of the taxpayers' construction costs to the category of carwash equipment, in accordance with the recommendation of an auditor who visited one of these carwashes. Under this allocation, the full cost of some components of the facilities were allocated, in their entirety, as carwash equipment. In addition, 50% of the labor cost, 60% of the cost of the plumbing system, and 50% of the cost of the electrical system was allocated as carwash equipment. The remaining costs were allocated to the carwash structures. For the facilities purchased by Peninsula, the Commissioner allocated costs to structure and equipment in accordance with the allocations contained in an invoice prepared by the seller. The tax court held that the taxpayers failed to prove that they are entitled to a credit greater than that determined by [the Commissioner], as they have failed to introduce sufficient evidence to prove the amount and nature of such expenditures, ... or that such expenditures are for tangible property which qualifies for an investment credit. Schrum v. Commissioner, 1993 T.C.M. (RIA) p 93,124, at 550, 1993 WL 91293 (Mar. 30, 1993) (citation omitted). As a consequence, it upheld the allocations adopted by the Commissioner. 56 Any allocation of costs to equipment must be justified under either section 48(a)(1)(A) or section 48(a)(1)(B). We consider first whether some portion of the facilities qualifies as section 38 property under section 48(a)(1)(A). Under section 48(a)(1)(A), any tangible personal property, which includes any nonstructural property classifiable as equipment, qualifies as section 38 property. It is clear that some portion of taxpayers' facilities falls within this class of property. Our only duty, then, is to examine the propriety of the allocation adopted by the tax court. 57 We consider first the carwashes constructed by Peninsula, and focus on the 60% of plumbing expenses and 50% of electrical expenses which the Commissioner allocated to carwash equipment. This allocation must be examined in light of our decision in A.C. Monk & Co., supra. There, addressing the question of whether and when an electrical system is a structural component of a building as opposed to section 38 property under section 48(a)(1)(B), we stated: 58 [W]e find no justification for allocating a portion of a single system as structural. The regulations never speak of such an allocation, and it seems difficult to conceive of a single bus duct, transformer, or piece of wiring being both a structural component and other property.... 686 F.2d at 1065 (footnote omitted). 11 59 The allocation of expenses adopted by the Commissioner and endorsed by the tax court necessarily assigns portions of the various components of the carwash facilities to the carwash structures; these structures, as determined above, are inherently permanent in nature. We see no reason why our proscription against allocating an electrical system in part to a building would not extend to barring allocations which assign portions of various systems to inherently permanent structures. 12 As a consequence, the Commissioner's allocation runs afoul of our circuit precedent. 13 60 The Commissioner does not appeal the tax court's determination in this regard; effectively, then, she concedes that the electrical and plumbing components of taxpayers' facilities described above are properly allocated, at least in part, as section 38 property. In light of this concession and our holding that such components are either, in their entirety, structural or not, we vacate the tax court's determination in this regard. On remand, the tax court should allocate the components in question entirely as non-structural. The court should also re-examine the allocation of labor costs incurred by Peninsula in the construction of the carwashes to see if such allocations need to be disturbed in light of our holding herein. 14 61 With respect to the carwashes purchased intact by Peninsula, the Commissioner's allocation, based upon the invoice prepared by the seller, assigns percentages of cost to structures and to equipment without further elucidation. As a consequence, we cannot verify that such allocation is consistent with A.C. Monk & Co. The tax court, on remand, should examine this allocation in light of our holdings in A.C. Monk & Co. and herein. 62 We turn to whether any greater portion of the facilities might qualify as section 38 property under section 48(a)(1)(B). 15 In light of our conclusion above that taxpayers are not engaged in the business of furnishing sewage disposal services, any portion of the facilities can qualify as section 38 property under section 48(a)(1)(B) only to the extent that the taxpayers furnish water services, that taxpayers are in the business of providing such services, and that the property in question is integral to the provision of such services and is not a structural component of a building. Of all the components of the carwash facilities, at most, only the plumbing and electrical equipment might meet all these qualifications. Because, as we conclude above, the plumbing and electrical equipment qualify as section 38 property under section 48(a)(1)(A), we need not further address the potential for qualification under section 48(a)(1)(B). 63 Except as discussed above, we find no merit in taxpayers' challenge to the allocation of costs adopted by the tax court. In accordance with the foregoing, we affirm in part and vacate in part the tax court's holding as to the allocation of taxpayers' property for investment tax credit purposes, and remand for further proceedings.