Albertson's, Inc., Petitioner-Appellant-Cross-Appellee v. Commissioner of Internal Revenue, Respondent-Appellee-Cross-Appellant
Docket: 91-70380, 91-70381
Court: Court of Appeals for the Ninth Circuit; December 30, 1993; Federal Appellate Court
Petitioner Albertson's, Inc. appeals two decisions from the United States Tax Court. The first decision denied Albertson's the ability to claim work incentive tax credits (WIN credits) retroactively for hiring certain welfare recipients. The second decision ruled against Albertson's claim for current deductions related to interest-like obligations accrued under deferred compensation agreements (DCAs) with top executives. The Commissioner of Internal Revenue cross-appeals a third Tax Court decision that granted Albertson's investment tax credits for its HVAC systems.
The Ninth Circuit affirms the Tax Court's ruling regarding WIN credits, agreeing that retroactive certification was not allowed due to congressional amendments in 1981. Conversely, the Circuit reverses the Tax Court's decisions on the DCA deductions and HVAC credits, indicating that further discussion on these issues will follow.
The WIN credits were established by Congress in 1971 to incentivize employers to hire individuals who were receiving public assistance. Albertson's had hired several qualifying employees but failed to certify them in time for tax credits. After discovering eligible employees during an IRS audit, Albertson's sought retroactive certification, which was initially permitted but later retracted, leading to the tax deficiency assessment that the Tax Court upheld.
Albertson's contends that the Tax Court incorrectly denied its request to submit certifications for WIN credits after its employees commenced work. However, Congress eliminated retroactive certification for WIN credits through the Economic Recovery Tax Act of 1981 (ERTA). Under I.R.C. Sec. 51(d)(16), employees must have state-agency certification prior to starting work to qualify for these credits. The contemporaneous certification rule was established to better motivate employers to hire WIN-qualified workers and mitigate revenue losses.
Albertson's further argues that an exception exists for employees hired by January 1, 1982, based on ERTA Sec. 261(g)(1)(B), which treats these employees as if they were part of a targeted group for tax years before January 1, 1982. However, this reading is rejected as it was merely intended to ensure former WIN employees were not disadvantaged under the new targeted jobs program, without altering the qualifications for WIN credits. The language of ERTA clearly states that the contemporaneous certification requirement applies to all individuals regardless of their hire dates.
In conclusion, since Albertson's did not claim the WIN credits until after September 26, 1981, and failed to obtain the necessary certifications before the employees' start dates, it is ineligible for the WIN credits. Additionally, deferred compensation agreements (DCAs) involve agreements where employees defer receiving bonuses or salaries for a specified period, allowing employers to use the funds as working capital until payment is made at the end of the deferral period, along with an additional amount reflecting the time value of the deferred compensation.
Prior to 1982, Albertson's established Deferred Compensation Agreements (DCAs) with eight executives and one outside director, stipulating that participants would receive deferred compensation along with an additional amount calculated via a predetermined formula upon retirement or termination. Participants could defer payment for up to fifteen years, during which additional amounts would continue to accrue annually. In 1982, Albertson's sought IRS approval to deduct these additional amounts immediately, which the IRS granted in 1983. However, in 1987, the IRS reversed its position and sought a deficiency for these amounts, prompting Albertson's to petition the Tax Court, asserting that the additional amounts were "interest" and thus deductible as they accrued. The Tax Court, in a divided opinion, ruled that the additional amounts constituted compensation, not interest, and under section 404 of the Internal Revenue Code, such compensation could only be deducted at the end of the deferral period. The current judgment reverses the Tax Court's ruling, concluding that the additional amounts should be classified as interest under I.R.C. Sec. 163, which permits deductions for interest paid or accrued within the taxable year. The ruling aligns with the Supreme Court's definition of interest as the value of the use of money over time, determining that the additional amounts reflect what Albertson's would have paid to borrow the funds, thus qualifying as interest under the Code.
The Commissioner contends that the additional amounts received by DCA participants were not classified as interest because Albertson's did not properly "borrow" the deferred compensation, arguing that participants lacked a legal right to possess it until the end of the deferral period. This view is deemed outdated by the Tax Court, which asserts that possession is not necessary for earnings to be deemed interest, citing the case of Starker v. United States, where interest was recognized despite the payee's lack of legal possession until a later date.
The Commissioner also claims that the additional amounts constituted deferred compensation rather than interest. However, the predetermined rate for these amounts was unrelated to the services performed by the participants; it was solely based on elapsed time since signing the DCAs. Participants received the same salary as their non-participating colleagues, with the only distinction being the delayed payment and additional amount at the end of the deferral period, indicating that the additional amounts were not additional compensation.
Upon termination, participants could still defer the additional amount for up to fifteen years without providing services, and the calculation of the additional amount continued at the same interest rate as before termination, further supporting the classification of these amounts as interest rather than compensation.
Lastly, the Commissioner argues that the additional amounts did not represent payments for true "indebtedness." However, the Tax Court defines indebtedness as an unconditional, legally enforceable obligation for payment. The DCAs were valid contracts obligating Albertson's to pay the participants for deferring their compensation, confirming that the additional amounts were indeed payments for indebtedness.
Having established that the additional amounts qualify as interest under section 163, the discussion shifts to whether section 404's timing restrictions apply to interest expenses. It concludes that these restrictions do not apply, allowing Albertson's to deduct the accrued interest expenses. Consequently, the Tax Court's judgment is reversed.
Prior to 1942, corporations could deduct Deferred Compensation Arrangement (DCA) expenses as they were incurred, despite employees not recognizing income until a later taxable year. In 1942, Congress eliminated this preferential treatment for specific "unqualified" DCAs, requiring employers to defer deductions until the end of the deferral period, as mandated by I.R.C. Secs. 404(a)(5) and 404(d). Section 404 restricts deductions for certain expenses until they are includible in the income of DCA participants, typically at the end of the deferral period. In the relevant taxable year, section 404 applied to section 162 (ordinary and necessary business expenses) and section 212 (expenses for producing or collecting income). However, the interest accrued on the DCAs did not fit these categories, as interest deductions are governed by section 163, which is not subject to the restrictions of sections 162 or 212. The interpretation emphasizes that the timing restrictions of section 404 do not apply to interest deductions, supported by legislative history that does not indicate an intention for section 404 to encompass interest. Congress was aware of the distinctions among sections 162, 163, and 212 when codifying section 404 in 1954, and its legislative history primarily discusses "compensation," without referencing interest deductions.
The Commissioner contends that a 1986 amendment to section 404, which removed references to sections 162 and 212, indicates Congressional intent to include interest as compensation under the statute. This argument is rejected, as legislative history shows that the amendment aimed to clarify the inclusion of compensation for services rendered, without suggesting that interest was to be included. The distinction between "compensation" and "interest" is emphasized, leading to the conclusion that the amendment does not support the inclusion of interest expenses under section 404's timing restrictions.
The Commissioner also argues that since Congress established timing restrictions for compensation expenses, it must have intended to apply similar treatment to interest expenses. This assertion is dismissed, highlighting that Congressional decisions regarding tax policy can be inconsistent and influenced by various factors. Although the Commissioner raises valid policy considerations about potential legislative intent, any necessary changes to the Code must originate from Congress, not the courts.
Ultimately, the ruling states that section 404's timing restrictions do not apply to interest expenses related to a Deferred Compensation Agreement (DCA), allowing Albertson's to deduct these expenses as they accrue, reversing the Tax Court's decision on this matter.
Regarding HVAC system credits, prior to 1986, tax credits for investments in specific property types excluded structural components of buildings unless their sole purpose was to meet operational temperature and humidity requirements for machinery. Albertson's claimed investment credits for HVAC systems installed in its supermarkets, arguing that these systems solely served to meet such requirements. The Tax Court agreed, but this ruling is reversed. The analysis identifies a clear error by the Tax Court in failing to recognize that the HVAC systems also served significant functions related to customer comfort and ventilation, beyond merely meeting machinery requirements.
Albertson's HVAC systems are essential for ventilating its supermarkets, providing a continuous supply of fresh air, and removing airborne contaminants. This function is crucial for maintaining cleanliness and customer satisfaction in a competitive market. Furthermore, these systems ensure a comfortable shopping environment, maintaining a consistent temperature of 72°F, which falls within the optimal comfort range. The historical context shows that Albertson's implemented these systems as early as the 1950s, prior to recognizing their impact on other machinery.
The Tax Court's assertion that the sole justification for the HVAC systems was to meet temperature and humidity requirements for equipment was deemed a clear error. Albertson's contended that customer comfort should also qualify as a justification under the regulatory exception for employee comfort. However, the court rejected this argument, emphasizing that the regulations specifically refer to employee comfort without mention of customers, indicating a narrow application intended by the IRS.
Ultimately, the court concluded that while maintaining equipment conditions is a significant reason for the HVAC systems, it is not the only one. Therefore, the systems do not meet the "sole justification" standard required for tax credit eligibility. The Tax Court's judgment was affirmed in part and reversed in part, with specific instructions for addressing the deferred compensation issue in future briefs.
Eligibility for financial assistance under Part A of Title IV of the Social Security Act requires individuals to have continuously received such assistance for the 90 days prior to employment or to have been placed in a job through a work incentive program. Employers must employ individuals for over 30 consecutive days on a full-time basis, not displace others from their jobs, and ensure that they are not migrant workers. Certifications from designated local agencies are necessary for individuals to be recognized as part of a targeted group; these certifications must be obtained before the individual begins work. The term "eligible work incentive employee" refers to those certified as eligible for financial assistance or placed in jobs under specific work incentive programs. The WIN-type credits have been renamed "targeted jobs credits" following the 1981 merger of the WIN credit program with the targeted jobs credit program to reduce employer confusion. The basic eligibility criteria for these credits remain unchanged despite the rebranding. Amendments made by recent legislation apply to all individuals regardless of their start date with the employer, with specific provisions for those who commenced work prior to the 45th day before the enactment of the Act.
Individuals who began work for an employer prior to 45 days before the enactment of the relevant Act will be subject to I.R.C. Sec. 51(d)(16) with adjustments to the start date to July 23, 1981. Those starting work within 45 days before or after the enactment, during a 90-day period, will see the same section applied by adjusting the start date to the last day of that 90-day period. Transitional rules allowed retroactive certification for requests made by September 26, 1981, while requests made after that date were bound by the general rule of contemporaneous certification. A case cited, Honeywell, Inc. v. United States, determined that ERTA eliminated retroactive certifications for employers. Additionally, Albertson's contends that the Commissioner is bound by a stipulation regarding ERTA's effects, but it is established that legal stipulations do not bind courts.
The agreements for eight executives included provisions for deferring compensation until employment termination, with interest calculated on the total deferred amount using the company's long-term borrowing rate. The outside director was compensated based on rates published for large certificates of deposit. The tax implications suggest that early deductions are favorable for taxpayers, allowing investment of funds otherwise owed to the IRS.
A Tax Court ruling indicated a split decision regarding the characterization of an additional payment as either compensation or interest, with the majority rejecting the deduction on the grounds it was not considered interest. The dissent claimed it was interest and that timing restrictions applied only to compensation. The court noted the necessity for a reasonable approach in defining interest for tax obligations.
The interest component in this case is deemed reasonable due to the DCA participants utilizing the cash method of accounting, which defers income recognition until payment is received at the end of the deferral period. Recent Congressional efforts have targeted various forms of "hidden" interest, but the Commissioner’s argument distinguishing these provisions based on tax avoidance fails. The government cannot selectively recognize interest based on revenue outcomes. Denying the interest element would misrepresent historical tax treatment. The Commissioner claims the additional amounts were compensation for advisory services, but this is countered by the lack of specific service requirements and the identical calculation method to the pre-termination interest rate.
The Commissioner references Deputy v. du Pont to assert that obligations are not necessarily "indebtedness," but this case is not relevant as it did not involve the time value of money. Unqualified plans, which discriminate in favor of highly compensated employees, are acknowledged as not applicable in this instance. According to I.R.C. Sec. 404, compensation under deferred-payment plans is not deductible unless certain conditions are met, including that it is included in the gross income of employees in the relevant taxable year. Most individuals on the cash accounting system also recognize income from their DCAs upon full payment. Contributions must qualify as ordinary and necessary expenses for deductibility under Section 404(a) and relate to personal services rendered.
The bill establishes that deduction-timing rules for deferred compensation arrangements apply universally to any method of deferring compensation, irrespective of the section under which deductions are typically claimed. Specifically, it mandates that such amounts are deductible only under section 404(a)(5) and prohibits deductions under any other section. This clarification aims to prevent taxpayers from claiming deferred compensation as related to capitalizable expenses, which could allow for an accelerated deduction timeline.
Additionally, the excerpt discusses the treatment of machinery concerning tax credits, specifying that machinery necessary solely for maintaining temperature or humidity for other machinery or material processing does not qualify as "structural components." The IRS's position allows for incidental benefits to employee comfort without disqualifying the machinery. Albertson's contends that a strict interpretation of the "employee comfort" exception would invalidate it in environments with inspectors or auditors, but this is refuted, as the ruling is confined to customer-present environments.
The excerpt also references the case of Piggly Wiggly Southern, Inc. v. Commissioner, where the Eleventh Circuit ruled in favor of investment tax credits for HVAC systems. However, the current stance is to align with the Court of Claims' decision that HVAC systems do not qualify for such tax treatment, as seen in Publix Supermarkets, Inc. v. United States.
