Munford, Inc. v. Commissioner of Internal Revenue

CLARK, Circuit Judge,

dissenting:

Because I find the reasoning in the tax court and majority opinions to be internally inconsistent, I respectfully dissent.

First, both courts adjudicate that the Addition is not a building. Then, both conclude that the Addition is not tangible personal property. The facts, statute, regulations, case law and commonsense which require the first conclusion necessarily lead one to the deduction that the Addition is in fact and in law tangible personal property. Neither court tells us what the Addition is, when it is quite obviously a giant refrigerator. A refrigerator is tangible personal property by regulation. The taxpayer had constructed for his business a giant refrigerator instead of housing one or a number *1408 of large refrigerators inside a building. If he had done the latter, he would have received the investment tax credit for the refrigerators. He should not be penalized by the innovative approach used and should receive the investment tax credit intended by Congress.

I. Is it a building?

In holding that the Addition was not a “building”, the tax court in Munford, Inc. v. Commissioner, 87 T.C. 463 (1986), made the following various comments in its opinion:

We think that the refrigerated area of the Addition is not fairly distinguishable from those structures held not to be buildings in Catron, Central Citrus and, more particularly, Merchants Refrigerating. Thus, following our decisions in those cases, we hold that the refrigerated area of the Addition is not a building.

Id. at 485 (footnotes omitted).

In Rev.Rul. 74-452, 1974- 2 C.B. 11 , respondent has indicated that warehouses are generally “conventional buildings used for general storage purposes.” Although respondent concluded therein that certain refrigerated structures used for storing frozen foods were warehouses and not sec. 38 property, we do not think that a facility such as the Addition is a “conventional building used for general storage purposes.” First, the Addition is not a conventional building, since it contains numerous construction features which would not be found in a conventional or “dry” warehouse. Second, the Addition is not, in our view, used for “general storage purposes,” but rather, is both designed and used for the much more specific purpose of storing frozen foods at low temperatures. Thus, notwithstanding respondent’s contrary conclusion in Rev.Rul. 74-452, we do not think that a structure like the Addition can fairly be considered a “warehouse” as that term has been used by respondent in the cited ruling.

Id. at 485-86 n. 21.

In response to the Commissioner’s argument that the Addition could be used as a conventional warehouse, the court stated:

Furthermore, even if we considered adaptability to be a relevant factor in this context, we would still reject respondent’s position, since we think that the Addition is not reasonably adaptable to uses other than low temperature storage. Respondent contends that if the refrigeration system were simply switched off, the Addition could be economically used as a dry warehouse. However, petitioner provided credible testimony, supported by pro forma financial statements, to show that the Gateway Facility, of which the Addition was a part, could be operated profitably as a refrigerated facility, but would operate at a substantial loss if used as a dry warehouse. We find this evidence to be convincing.

Id. at 487.

To understand why the tax court reached this conclusion and to explain why I conclude that the Addition is a giant refrigerator, it is helpful to know the nature of the construction of the Addition as found by the tax court:

The foundation of the Addition consists of concrete footings which support the structure. In order not to be affected by the cold temperatures within the Addition, the footings are placed at a depth of 2 to 3 feet below the floor. Above the foundation, there is a system of under-floor ventilation pipes intended to prevent the earth below the structure from freezing; without this system, frost buildup in the fill beneath the Addition would eventually cause the concrete slab floor of the structure to heave and crack. Air is drawn through the ventilation system by fans, and the system can be enhanced if necessary, by forcing heated air through the pipes.

The under-floor ventilation system is covered by a bed of sand. Above the sand bed is a “vapor barrier” consisting of polyethylene laid out in large sheets. The vapor barrier, which extends from beneath the floor and continues vertically inside the walls of the Addition, is intended to prevent moisture from penetrating the Addition. The portion of the vapor *1409 barrier located beneath the floor is sealed at the joints to prevent any moisture penetration from the earth, and is covered by 6 inches of low temperature insulation. This insulation was placed directly upon the vapor barrier in two segments, or “boards,” which were staggered at the joints to reduce channels for temperature migration.

The floor of the Addition consists of a concrete slab which was poured over the low temperature insulation. Since contraction in the floor could occur as a result of the low temperatures within the Addition, a number of contraction joints were provided in the slab to minimize the possibility of cracking. Moreover, since the slab rests upon low temperature insulation, which is rather compressible relative to normal soil, the slab contains long steel rod dowels inserted in sleeves across the contraction joints in order to maintain proper alignment of the slab surface. Nothing protrudes from the floor surface but concrete curbs which line the base of the walls and act as bumper guards for the forklifts.

The outer walls of the Addition consist of “tilt-up” concrete panels which were cast on site using conventional building materials and tilted into place. At the comers abutting the floor and walls of the structure, the continuity of the polyethylene vapor barrier is maintained. The sheets comprising the vapor barrier extend up along the inside of the walls of the structure and are hung from a point near the top of the walls. The joints of the vapor barrier are sealed.

The vapor barrier is covered within the walls of the Addition by 8 inches of low temperature insulation. This insulation was erected against the walls in two layers, with staggered joints to minimize temperature migration. To protect and provide continuity for the vapor barrier and the insulation, a high strength corner flashing (reinforcement material) is located at the joints where the wall insulation and the floor insulation overlap. Similarly, continuity of the vapor barrier and insulation is maintained by means of overlapped joints at the abutting wall corners of the structure. The insulation layers are covered on the interior of the structure by %-inch type “X” fire-resistant gypsum board. The gypsum board is intended to protect the insulation from damage. In addition, since it is highly flammable, the insulation is required by fire code guidelines to be enclosed in an air tight manner, and the gypsum board also performs this function. The insulation and the vapor barrier are not visible in the finished Addition, and cannot be removed without tearing out the existing wall and floor structures.

The roof of the Addition is constructed of steel decking. In order to maintain continuity of the vapor barrier and insulation at the juncture of the roof and the walls, the roof is not supported by the walls of the structure, but rather, rests upon columns of structural steel located within the Addition near the walls. The gap between the roof and walls is designed to allow the vapor barrier and insulation to “turn the corner” from the walls and continue along the roof without interruption.

The roof has 10 inches of low temperature insulation, comprised of two layers. A continuous wood blocking is bolted to the roof deck near the perimeter of the deck (near the upper portion of the walls) and the first layer of roofing insulation is located between the blocking and the wall insulation under compression, forming a tight seal. In addition to the low temperature insulation, the roof also contains two layers of noncombustible insulation board. The lower layer serves to separate the steel deck from the flammable low temperature insulation, and the upper layer was installed principally to allow hot bitumen (asphalt) to be mopped onto the built-up roof without damaging the low temperature insulation. Each layer of insulation board is attached to the low temperature insulation by means of adhesives. The joints of both the noncombustible and low temperature insulation are staggered to reduce channels for temperature migration. The built-up roofing of the Addition serves as a con *1410 tinuation of the vapor barrier and insulation as found within the walls and beneath the floor of the structure.

* * * * * *

The refrigerated area of the Addition covers 34,650 square feet. It contains multi-level storage racks with openings sized to accommodate products stacked on pallets and lifted into place by forklifts. The aisles of the refrigerated area are wide enough to accommodate the movement of the forklifts operated by petitioner’s employees. Lighting in this area is provided by special low temperature mercury vapor lamps, since normal commercial fluorescent lighting will not work in the low temperatures maintained therein.

Id. at 468-71.

The Addition has two special compartments, or vestibules, located between the refrigerated area and the truck loading platform. These vestibules function as “air locks” and help prevent the warmer outside air and moisture from entering the refrigerated area. The vestibules are constructed so as to maintain continuity of the vapor barrier and insulation. Each time the outer door of a vestibule opens, the interior of the vestibule receives an influx of warm, moist air. To prevent freezing of this moisture, heat lamps are used in the vestibules to maintain above-freezing temperatures for the inner floor, wall, and ceiling surfaces, as well as the door hinges. At night, the exterior of each vestibule is sealed off by heavy, metal-clad doors containing low temperature insulation. The perimeter of each door contains gaskets which form a seal with the wall insulation. These gaskets also contain heat cables to prevent freezing of condensation which could otherwise cause the doors to jam.

Id. at 473.

II. Is it tangible personal property?

The crucial issue becomes whether the Addition is “tangible personal property.” If so, the property qualifies for the investment tax credit. The definition is found in section 1.48-l(c), Income Tax Regs.:

(c) Definition of tangible personal property. — If property is tangible personal property it may qualify as section 38 property irrespective of whether it is used as an integral part of an activity (or constitutes a research or storage facility used in connection with such activity) specified in paragraph (a) of this section. Local law shall not be controlling for purposes of determining whether property is or is not “tangible” or “personal.” Thus, the fact that under local law property is held to be personal property or tangible property shall not be controlling. Conversely, property may be personal property for purposes of the investment credit even though under local law the property is considered to be a fixture and therefore real property. For purposes of this section, the term “tangible personal property” means any tangible property except land and improvements thereto, such as buildings or other inherently permanent structures (including items which are structural components of such buildings or structures). Thus, buildings, swimming pools, paved parking areas, wharves and docks, bridges, and fences are not tangible personal property. Tangible personal property includes all property (other than structural components) which is contained in or attached to a building. Thus, such property as production machinery, printing presses, transportation and office equipment, refrigerators, grocery counters, testing equipment, display racks and shelves, and neon and other signs, which is contained in or attached to a building constitutes tangible personal property for purposes of the credit allowed by section 38. Further, all property which is in the nature of machinery (other than structural components of a building or other inherently permanent structure) shall be considered tangible personal property even though located outside a building. Thus, for example, a gasoline pump, hydraulic car lift, or automatic vending machine, although annexed to the ground, shall be considered tangible personal property.

*1411 In applying this definition it is necessary to reconsider the nature and use of the property involved. The tax court assists us in recounting the determination made by the Commissioner. The respondent in this case

has allowed the credit for certain refrigeration system components of the Addition, including refrigeration pipes and pipe insulation, valves, and motors, having a cost of $103,470.12. Thus, the remaining costs for which petitioner is seeking the investment tax credit relate, in essence, to the structural elements of the refrigerated area of the Addition, including its foundation footings, walls, floor, roofing and supports, vapor barrier, insulation, and electrical components allocable thereto, having a cost of $404,-585.

87 T.C. at 488 (footnote omitted).

The use of the property is conceded to be for refrigeration only. In note 21 of his opinion in discounting the Commissioner’s argument that the Addition was a warehouse, the court said: “the Addition is not, in our view, used for ‘general storage purposes,’ but rather, is both designed and used for the much more specific purpose of storing frozen foods at low temperatures.”

In finding that the Addition was not personal property, the tax court returned to the definition of a building which states “ ‘tangible personal property’ means any tangible property except land and improvements thereto, such as buildings or other inherently permanent structures (including items which are structural components of such buildings or structures)”. The tax court then proceeded to reject the rationale used in finding the Addition not to be a building and finds it not to be tangible personal property. There is no question that “refrigerators” are specifically listed as tangible personal property in the definition of that term. The tax court found that the Addition had no use but that of a refrigerator, but then on page 492 says: “our inquiry must focus, not upon the refrigerated area of the Addition as a whole, but rather, upon the structural elements thereof for which petitioner is seeking an investment tax credit”.

The tax court’s focus went awry when it decided that the walls, roof, foundations, etc. were “structural components” and ignoring Sec. 1.48-1(e), Definition of building and structural components. 1 While true in most cases, those components were not principally structural in this case. The under-floor ventilation pipes to prevent the earth from freezing, the vapor barrier, the insulation to prevent temperature migration, the contraction joints to prevent the floor from buckling, the “tilt-up” panels, et al. were not structural components within the meaning of Sec. 1.48-1(e). See emphasized portions of regulation in footnote. There is no logic in allowing the tax credit for an oil and gas storage tank used in the distribution of those products and disallowing the credit for a giant refrigerator used in the distribution of foodstuffs.

In enacting the investment tax credit Congress wished to stimulate commerce by encouraging investment in properties that would assist in expanding the economy. It *1412 is elementary that the production of foodstuffs largely goes to naught without a system of distributing those foodstuffs to consumers. The taxpayer’s giant refrigerator is a link in that distribution chain and it is nonsense to penalize him for choosing to construct one large refrigerator rather than build a warehouse and then construct a series of large refrigerators inside the warehouse. Taxpayer started in the ice business in 1909 and owned and operated 12 refrigerated facilities in the southeastern United States when the Addition was constructed. One can assume from such experience that taxpayer concluded that the giant refrigerator was the best competitive investment rather than choosing the large individual refrigerators within a warehouse. Presumably his decision would lead to more competitive pricing of foodstuffs which is what the system is all about.

Thus, I respectfully dissent from the majority opinion which affirms the tax court.

. Sec. 1.48-1(e). Definition of building and structural components.

(1) Buildings and structural components thereof do not qualify as section 38 property. The term "building” generally means any structure or edifice enclosing a space within its walls, and usually covered by a roof, the purpose of which is, for example, to provide shelter or housing, or to provide working, office, parking, display, or sales space. The term includes, for example, structures such as apartment houses, factory and office buildings, warehouses, barns, garages, railway or bus stations, and stores. * * * Such term does not include (i) a structure which is essentially an item of machinery or equipment, or (ii) a structure which houses property used as an integral part of an activity specified in section 48(a)(1)(B)(i) if the use of the structure is so closely related to the use of such property that the structure clearly can be expected to be replaced when the property it initially houses is replaced. Factors which indicate that a structure is closely related to the use of the property it houses include the fact that the structure is specifically designed to provide for the stress and other demands of such property and the fact that the structure could not be economically used for other purposes. Thus, the term "building" does not include such structures as oil and gas storage tanks, grain storage bins, silos, fractionating towers, blast furnaces, basic oxygen furnaces, coke ovens, brick kilns, and coal tipples.