The opinion of the court was delivered by: NEALON
William J. Nealon, Chief Judge, Middle District of Pennsylvania.
Plaintiffs filed this action pursuant to 28 U.S.C. § 1346 on May 17, 1983 for recovery of income taxes erroneously assessed and collected. The precise issue presented is whether the plaintiff-taxpayers, having erroneously claimed an investment tax credit as non-corporate lessors may "pass-through" that tax credit to their corporation-lessee. On April 12, 1985 the defendant filed a Motion for Summary Judgment and Motion to Strike Names from the Caption along with a brief in support thereof. The plaintiffs filed a brief in opposition to the defendant's motion on May 17, 1985 and their own Motion for Summary Judgment and brief in support thereof on May 21, 1985. On June 21, 1985, the Government filed a reply brief and brief in opposition to plaintiffs' cross motion for summary judgment. The plaintiffs, thereafter, filed their reply brief dated July 10, 1985. Oral argument on the motions was heard September 6, 1985. The motions for summary judgment are now ripe for disposition. For the reasons set forth below, the Government's motion for summary judgment will be denied and the plaintiffs' cross motion for summary judgment will be held in abeyance pending submission of supplemental briefs.
Maid-Rite Steak Company, Inc. (Maid-Rite), a Pennsylvania corporation, is engaged in the business of producing and processing frozen portion-controlled meat products. Donald Bernstein is the President and principal shareholder of Maid-Rite, owning 70% of its outstanding shares.
In 1978, Donald and Elaine Bernstein, in order to relocate Maid-Rite's plant, entered into an Installment Sales Agreement with the Lackawanna County Industrial Development Authority for the acquisition and improvement of a facility in the Keystone Industrial Park, Dunmore, Pennsylvania. Included among the improvements made to the facility was the installation of an ammonia refrigeration system. By lease agreement dated January 13, 1978, as amended on October 1, 1978, the Bernsteins leased the facility, together with the ammonia refrigeration system, to Maid-Rite. The lease agreement was for a term of twenty-one years
and was executed by Donald Bernstein as lessor and as President of Maid-Rite as lessee.
In 1979 and 1980, the Bernsteins claimed an investment tax credit on their joint income tax returns for the refrigeration system leased to Maid-Rite. The total cost of the system was $1,398,896.00. The Bernsteins relied upon William E. Acornley, a Certified Public Accountant, who advised them that, as owners, they were entitled to claim the investment tax credit. In fact, they were not entitled to claim this credit as non-corporate lessors under 26 U.S.C. § 46(a)(3)(B), Internal Revenue Code of 1954 and Treasury Regulations, 26 C.F.R. § 1.46-4(d) because the lease was for twenty-one years on a property with a useful life of twelve years. Eligibility for non-corporate lessors under the statute requires that the lease term be less than 50% of the property's claimed useful life.
In the fall of 1981, a tax examination of the Bernsteins' and Maid-Rite's tax returns by Agent Richard Whiteford of the Internal Revenue Service disclosed that the Bernsteins were not entitled to the investment tax credit because they did not meet the requirements of the aforementioned test for non-corporate lessors. Subsequently, Mr. Acornley requested that the Bernsteins be allowed to pass through the investment tax credit of $139,890.00 to Maid-Rite. The request was denied on the ground that the pass-through election had not been made before the deadline established by Treas. Reg. § 1.48-4(f)(2). The Bernsteins, on March 23, 1982, applied to the Internal Revenue Service for an extension of time in which to file a pass-through election. In this letter, the Bernsteins stated that while they had previously claimed the tax credit on their individual returns for 1979 and 1980, they had relied on their accountant's advice and were totally unaware of their ineligibility. In addition, on or about May 25, 1982, approximately one year after the due date for filing its corporate tax return, Maid-Rite filed an amended 1980 corporate income tax return claiming the disallowed investment tax credit. The Bernsteins were subsequently advised by letter that their request for an extension of time to pass through the investment tax credit to Maid-Rite had been denied and that Maid-Rite's claim for a refund, based on a pass-through of the credit, had also been disallowed. Thereafter, plaintiffs paid the full amount assessed and filed this refund action.
Section 38 of the Internal Revenue Code of 1966, as amended in 1971, provides: "There shall be allowed, as a credit against tax imposed, the amount determined under" sections 46 through 48 of the Code. 26 U.S.C. § 38(a). To carry out the purpose of § 38, the Secretary is authorized to prescribe such regulations as are necessary. 26 U.S.C. § 38(b). Sections 46-48 provide rules to be utilized in computing credit for investment in § 38 depreciable property and define those investments which qualify for the investment credit. Specifically, § 46(e)(3) provides, with respect to non-corporate lessors, that a credit shall be allowed for § 38 property only if, inter alia, the term of the lease is less than 50% of the useful life of the property. Further, § 48 (d)(1) allows the parties to a lease of new § 38 property to treat the lessee as having acquired the property so that the lessee then may claim the investment tax credit.
The Treasury Department has promulgated a number of regulations pursuant to § 48. Treasury Regulation § 1.48-4(f)(1) states that if the lessor elects to pass through the investment tax credit to the lessee, the election shall be made by filing a statement with the lessee, signed by the lessor and including the written consent of the lessee, containing certain specified information. Pursuant to Treas. Reg. 1.48-4(f)(2), the statement shall be filed with the lessee on or before the due date of the lessee's return for the lessee's taxable year during which possession of the property is transferred. Additionally, the Parties are required to keep a copy of the statement for their records and a statement must be attached to the lessor's federal income tax return summarizing all property leased during the lessor's taxable year with respect to which an election is made. See e.g., Treas. Reg. 1.48-4(j). Further, the regulations provide that an election made pursuant to § 48 shall be irrevocable as of the time the statement is filed with the lessee. Treas. Reg. 1.48-4(f)(3). Finally, pursuant to Treasury Regulation § 1.9100-1, the Commissioner has discretionary authority to grant extensions of time. The discretionary authority under § 1.9100-1 is applicable to extensions of time in which to file an election to pass through an investment credit.Revenue Ruling 79-415; See infra at 16.
The legislative history surrounding passage of the investment tax credit reveals that Congress intended to stimulate economic growth by providing an incentive to initiate capital investment projects. See Comdisco, Inc. v. United States, 756 F.2d 569, 572 (7th Cir. 1985). In Comdisco, the court examined extensively the legislative history behind the tax credit. "It is believed that the investment credit . . . will provide a strong and lasting stimulus to a high rate of economic growth and will provide an incentive to invest comparable to those available elsewhere in the rapidly growing industrial nations of the free world." Comdisco, supra at 572 (citing H.R.Rep.No. 1477, 87th Cong. 2d Sess. (1962)). In discussing the election provided for under § 48(d), the House Report stated that such a provision was desirable since, as a result of [the election], it is possible for the lessor to pass the benefit of the investment credit on to the party actually generating the demand for the investment." Comdisco, supra at 572 (citing H.R.Rep.No. 1477, 87th Cong. 2d Sess. (1962)).
As the Comdisco court noted, the Senate Report reflected a similar ideology: "The objective of the investment credit is to encourage modernization and expansion of the nation's productive facilities and thereby improve the economic potential of the country, with a betterment in our competitive position in the world economy." Comdisco, supra at 572 (citing S.Rep.No. 1881, 87th Cong., 2d Sess. (1962)).
The Committee is concerned, however, as was the House, that the restoration of the credit could once again make leasing arrangements motivated largely by tax reasons quite attractive. The committee agrees with the House that it is appropriate to impose limitations on the availability credit to individual lessors [and non-corporate lessors].
The bill provides that the credit is to be available to an individual [or other non-corporate] lessor in only two situations . . . In these situations, the lease arrangement is an integral part of the taxpayer's business and is not likely to have been entered into for the purpose of reducing tax liabilities.
[Additionally,] the bill provides, in general for the allowance of the credit in the case of short-term leases since in these cases the leasing activity constitutes a business activity of the taxpayer, rather than a mere investment, i.e., a financing arrangement.
S.Rep.No. 92-437, 92d Cong. 1st Sess. at 43-44 (1972-1 Cum. Bull. 559, 583).
Thus, while enactment of the credit was motivated by concerns regarding the depressed state of the economy, the credit was limited as to non-corporate lessors so that individuals would utilize the tax credit in business activities rather than enter into such lease arrangements only for the purpose of reducing tax liabilities.
Having set forth the relevant statutory framework, the court turns to the issues raised by the parties. For the purposes of this summary judgment motion only, neither party questions the amount of the claim, nor that the ammonia refrigeration system is properly classified as § 38 property. Further, it is undisputed that Maid-Rite, as a lessee, would have been able to claim the investment tax credit. Rather, the dispute centers around the Bernsteins having claimed the credit for themselves personally and when having been informed that they did not qualify under the regulations, the defendant's refusal to allow the Bernsteins to pass through the tax credit to Maid-Rite.
In support of their action, the Bernsteins advance three major arguments. First, they contend they may revoke their "election" to claim the tax credit personally because it was an impermissible choice. The Bernsteins maintain that it is only when the original election is a permissible one can it be held to be irrevocable. In other words, they argue that before a taxpayer's election can be held to be binding upon him, he must have two legal and allowable alternatives from which to choose. Inasmuch as the Bernsteins did not qualify as non-corporate lessors (because the lease term was more than 50% of the useful life of the property), the only choice available was to pass through the credit to Maid-Rite. According to plaintiffs, then, there was no election made and Maid-Rite, the lessee, should be free now to file an amended return claiming the tax credit. Secondly, the Bernsteins argue that compliance with Treasury Regulation § 1.9100-1 specifically allows for extensions of time fixed by the regulations. Thus, § 1.9100-1 grants the Commissioner discretionary authority to permit an extension ...