Seventh Circuit Reverses $9 Million Excise Tax Judgment Against Trucking Company

(Parker Tax Publishing September 2021)

The Seventh Circuit, in a case involving two issues of first impression, reversed a district court's ruling and held that a trucking company was not subject to the excise tax under Code Sec. 4051(a)(1) when it leased refurbished highway tractors because the company qualified for the safe harbor in Code Sec. 4052(f)(1) for repairs and modifications the cost of which do not exceed 75 percent of the retail price of a comparable new vehicle. The court thus reversed a $9 million judgment that had been assessed against the trucking company and held that (1) the safe harbor test contemplates only whether the cost of the repairs exceeds 75 percent of the retail price of a comparable new article, not the extent of the repairs, and (2) the "retail price" of a comparable new article means the market price in ordinary, arm's length transactions, rather than the price the taxpayer actually paid for comparable tractors. Schneider National Leasing, Inc. v. U.S., 2021 PTC 271 (7th Cir. 2021).

Background

Schneider National Leasing purchases truck tractors and trailers and leases them to its parent company, Schneider National, Inc., one of the nation's largest trucking companies. At any one time, Schneider National Leasing owns several thousand tractors and tens of thousands of trailers and containers. To keep up with demand from drivers for updated rigs and to maintain the health of its fleet, the company purchases more than 3,000 semi-tractors each year.

From 2011 through 2013, rather than retiring a large set of older tractors and purchasing all new replacements, Schneider decided to overhaul 982 of its existing tractors using new and refurbished parts packaged together in so-called glider kits. This decision made strategic business sense for two reasons: (1) Schneider's older tractors were lighter and realized better fuel economy than newer models subject to more stringent environmental regulations, and (2) Schneider's tax advisors counseled that the company would have to pay a 12 excise tax under Code Sec. 4051 if it bought new tractors and then leased them to its parent company, but could avoid the tax by refurbishing tractors in the existing fleet.

Code Sec. 4051(a)(1) imposes a 12 percent excise tax on the "first retail sale" of certain "articles," including highway tractors. The "first retail sale" is generally defined in Code Sec. 4052(a) as the first sale or lease after production, manufacture, or importation. Under a safe harbor provided in Code Sec. 4052(f)(1), an article described in Code Sec. 4051(a)(1) is not treated as manufactured or produced, and therefore not subject to the 12 percent excise tax, "by reason of repairs or modifications to the article (including any modification which changes the transportation function of the article or restores a wrecked article to a functional condition) if the cost of such repairs and modifications does not exceed 75 percent of the retail price of a comparable new article."

Schneider purchased 982 glider kits - bundled assemblies of new and remanufactured tractor components - from Daimler Trucks North America LLC. At a minimum, each glider kit came with a cab, chassis, radiator, front axle, front suspension, front wheels, front tires, front brakes, brake system, and trailer connections. Nine hundred and twelve of these kits were so-called powered glider kits because they included a remanufactured engine. Schneider contracted with third-party outfitters to perform the refurbishments. The outfitters matched Schneider's old tractors with a glider kit and combined the parts to create overhauled tractors. The refurbishing process generally involved dismantling the old tractors, stripping non-usable parts, reassembling the reusable components of the old tractor with the glider kit parts, and giving the rebuilt tractor a new vehicle identification number matching the serial number on the glider kit. The precise parts from the old tractors that were combined with each glider kit varied, but in many instances the outfitter reused the transmission, driveline, rear axle, rear suspension, and rear wheel hubs, among other parts, in the refurbished tractors. Schneider sent the old engines to Daimler in exchange for a rebate on the refurbished engines included in the glider kits. Whatever components of the old tractors that remained were either kept as replacement parts for future repairs or sold for salvage value.

Schneider did not pay the Code Sec. 4051(a)(1) excise tax on any of the 982 refurbished tractors. Rather, it invoked the safe harbor in Code Sec. 4052(f)(1) for repairs or modifications. The IRS determined that the safe harbor did not apply to 912 of the overhauled tractors -- those that received new engines -- because the refurbishment process using powered glider kits resulted in the manufacture of new tractors. The IRS further found that, even if the refurbished tractors qualified as having been repaired or modified, the cost of repairs exceeded 75 percent of the retail value of a comparable new tractor. The IRS therefore assessed the company $9,387,403 plus interest in unpaid excise tax. Schneider paid the excise tax on 12 tractors and then filed a claim for a refund of that amount, which the IRS denied. In May 2017, Schneider sued in a district court for a refund and an abatement of the full amount of the IRS's tax assessment.

The district court held that the Code Sec. 4052(f)(1) safe harbor did not apply to Schneider's refurbishments using powered glider kits because the refurbishment process resembled the creation of new tractors rather than repairs or modifications to existing tractors. The district court also held that the term "retail price" in Code Sec. 4052(f)(1) referred to the price paid at the first retail sale, meaning the price Schneider actually paid (net of any discounts) for comparable new tractors, rather than the industry retail price on the open market. Schneider appealed to the Seventh Circuit.

On appeal, the government argued that in practical terms, Schneider's refurbishment process resembled the production of a new tractor, and calling it a repair or modification was to read absurdity into the statute. Alternatively, the government argued that Congress's use of the term "the article" in Code Sec. 4051 demanded that the same identifiable article exist before and after the repairs or modifications. The government further argued that the term "retail price" in Code Sec. 4052(f)(1) refers to the price paid at the "first retail sale" as that term is defined in Code Sec. 4052(a)(1), and thus means the price the taxpayer actually paid for comparable tractors, including any discount off the market price.

Analysis

The Seventh Circuit reversed the district court and held that (1) the safe harbor in Code Sec. 4052(f)(1) does not contemplate a measurement for "repairs or modifications" apart from the 75 percent test, and (2) the appropriate measurement for the "retail price of a comparable new article" is the market price in ordinary, arm's length transactions. The Seventh Circuit noted that both issues were questions of first impression.

The court reasoned that under Code Sec. 4052(f)(1), something that otherwise constitutes an act of manufacturing "shall not be treated as" manufacturing for the purpose of assessing excise tax liability. Although the statute does not explicitly define "repairs or modifications," the court found that the parenthetical "(including any modification which changes the transportation function of the article or restores a wrecked article to a functional condition)" indicates a broad sweep to the meaning of the terms. The court observed that under the statute, a wrecked tractor can be restored to working condition without the refurbishing constituting the manufacture of a new tractor, so long as the cost falls below the 75 percent threshold. Likewise, a company could "change the transportation function" of a working tractor by, for example, converting it into a wrecker vehicle with a crane and still qualify for the safe harbor if the modifications meet the 75 percent condition. Thus, the court concluded that "repairs or modifications" can be extensive and substantial and yet still qualify for the safe harbor.

The court rejected the government's argument that it would be absurd to call Schneider's process a repair or modification, finding that under Code Sec. 4052(f)(2), some - but not all - repairs may be so extensive that they result in new "manufacture." The court said that the statute provides a quantitative test based on cost, which is precisely the type of definitive and mechanical assessment emblematic of a tax safe harbor. The court also found that, while Code Sec. 4052(f)(1) speaks in terms of a single article as the government contended, it does not contemplate an assessment separate and apart from the 75 percent test of whether the refurbishments are so fundamental that the core identity of the original article is lost and a new article comes into existence.

Regarding the meaning of the phrase "retail price of a comparable new article," the court found that the ordinary meaning of "retail price" is the amount at which an article is sold in individual, arm's length transactions to end consumers on the open market. The court noted that Code Sec. 4051(a)(1), which imposes the excise tax, is written in terms of single transactions on individual articles and the safe harbor in Code Sec. 4052(f)(1) likewise concerns repairs made to discrete articles. According to the court, the relevant comparator is therefore the price of a single comparable tractor in the open market, rather than bulk purchases. The court also rejected the contention that, because the word "retail" appears in both the safe harbor and the provision imposing the tax, the "retail price of a comparable new article" in the safe harbor refers to what the taxpayer would pay if the taxpayer bought the comparable tractor in a "first retail sale." The court said that, because the statute offers no definition, it had to presume that the ordinary meaning of the statutory language expresses Congress's intent. In this case, that meant that the "retail price" referred to in Code Sec. 4052(f)(1) is the price at which a comparable tractor could be acquired in the open market.

For a discussion of the excise tax on heavy trucks, see Parker Tax ¶235,101.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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