FedEx v. Commissioner: the continuing debate over cyclical maintenance costs

Tax Executive, The,  Nov-Dec, 2003  by James L. Atkinson

Tags: Federal Express

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Rev. Rul. 2001-4 demonstrates the inherently factual inquiry required in any repair situation. All of the costs in Scenario One are deductible because they were routine maintenance costs that neither increased the life or value of the aircraft nor adapted it to a new or different use. Some of the costs are required to be capitalized in Scenario Two, because those particular costs did in fact increase the value or life of the aircraft; the remaining costs were unrelated to the costs of the improvements and may be deducted, even though all the costs were incurred at the same time. Finally, at the far end of the spectrum, the airline was required capitalize all the costs incurred to restore the nearly exhausted aircraft to a state-of-the-art operating condition, even though many of those costs would have been deductible had they not been "incidental" to the overall plan to rehabilitate the aircraft.

Although Rev. Rul. 2001-4 was designed as a benchmark for analyzing a wide array of repair issues, the IRS examination function has tended to interpret it narrowly as applying only to the maintenance of aircraft airframes. The field has not applied the principles of the ruling even to aircraft engines, much less to other industries with similar maintenance programs. The national office has not issued a TAM on these issues since TAM 9618004, probably because it has not been asked to do so. (29) The result is an unsatisfying and disappointing use of a document that otherwise could have provided tremendous value in resolving the many controversies pending in this area.

4. Ingrain Industries

A few months after the issuance of Rev. Rul. 2001-4, the Tax Court took the next significant step in addressing the tax treatment of cyclical maintenance costs. Ingram Industries v. Commissioner (30) dealt with cyclical maintenance costs in the context of towboats. Towboats are similar to tugboats, but are used to push barges along commercial river routes. The engine of a towboat is such an integral component of the overall vessel that towboats are valued as single assets, and separate values are not assigned to the various components.

As with aircraft, towboats require recurring inspection and maintenance to attain their expected useful lives. With proper maintenance, towboat engines have an expected useful life of 40 years, the same useful life as the remainder of the towboat. Also similar to aircraft, towboat engine maintenance is based on the number of hours of use, such that with respect to the procedures at issue in Ingram, the engines were maintained on a three-to-four year cycle. Unlike aircraft engines, however, the engines are not required to be and were not removed from the boat during maintenance. Instead, the critical components can be removed from the engine block, inspected to determine whether each part remains within acceptable tolerances, and then either returned to the engine as is, repaired, or replaced. Conducting such maintenance (31) requires the towboat to be taken out of service for approximately 10 to 12 days, whereas either replacing or rebuilding the engines requires dry-docking the boat and removing it from service for approximately three to five months. Unlike aircraft maintenance, federal regulations do not govern the towboats' maintenance intervals or procedures.