Transportation Law Update: Seventh Circuit Finds Safe Harbor Provision Applies to Federal Excise Tax
The United States Court of Appeals for the Seventh Circuit recently held that the determining factor for whether a repair or modification occurred under the safe harbor provision of the federal excise tax statute is whether the cost of the repairs or modifications exceeded 75 percent of the retail value of a comparable new tractor. Schneider Nat'l Leasing, Inc. v. United States, 11 Fed. 4th 548 (7th Cir. 2021). This decision is significant within the transportation industry as it clarified the method by which trucking companies can determine whether the 12 percent federal excise tax applies to certain transactions.
This case rises out of an appeal by Schneider National Leasing, Inc. (“Schneider”), based on the district court’s decision that Schneider’s refurbishing of its tractors did not constitute a repair or modification under 26 U.S.C. § 4052(f)(1), such that the company would be required to pay a 12 percent excise tax on each refurbished tractor pursuant to 26 U.S.C. § 4051(a)(1). The safe harbor provision of the federal excise tax statute allows a company to lease or sell tractors without paying an excise tax when certain conditions are met, as discussed in detail below.
Schneider purchases truck tractors and trailers, and leases them to its parent company. Rather than retiring a large set of older tractors, Schneider decided to overhaul 982 of the tractors using glider kits which consisted of new and refurbished parts. Nine-hundred-and-twelve of these kits included a remanufactured engine. Schneider did not pay the federal excise tax on any of the 982 refurbished tractors, but rather invoked the safe harbor provision for repairs or modiﬁcations. The IRS position was that Schneider triggered the 12 percent excise tax upon leasing the tractors to its parent company, and that the safe harbor was only applicable to six of the tractors.
Schneider paid the excise tax on 12 tractors, and ﬁled an administrative claim for a refund of that amount. The IRS denied the refund, and Schneider subsequently filed a tax refund action in federal court seeking the refund and an abatement of the full amount of the IRS’s tax assessment. The district court decided Schneider’s refurbishment to the 912 tractors using glider kit engines resembled the creation of new tractors and were not repairs or modiﬁcations to existing tractors. The district court applied a two-step process to determine whether the safe harbor applied: Schneider first had to prove it made “repairs or modifications” to its tractors, and only then did the safe harbor require an assessment of whether the cost of those repairs or modifications exceeded the 75 percent limit.
By the time the case went to trial, the government conceded that the safe harbor provision applied to 64 of Schneider’s refurbished tractors, provided the cost of repairs fell below the 75 percent limit in section 4052(f)(1), but not the 912 tractors using glider kit engines. The IRS argued that the refurbishment of 912 overhauled tractors exceeded permissible “repairs or modiﬁcations” which resulted in the manufacture of new “articles” under the statute. The government further argued that the 75 percent cost measurement should be applied to the price Schneider actually paid for comparable new tractors, rather than the industry retail price for new tractors in the open market. In turn, Schneider argued that the appropriate measurement for the “retail price of a comparable new article” should be the market price in ordinary, arms-length, transactions on the open market.
On appeal, the Circuit Court analyzed the language of the excise tax statute, which provides that a tax of 12 percent of the amount for which a tractor is so sold will be imposed on the ﬁrst retail sale of “[t]ractors of the kind chieﬂy used for highway transportation in combination with a trailer or semitrailer.” 26 U.S.C. § 4051(a)(1). The Court noted that leases are treated as a first retail sale. However, as the Court discussed, § 4052(f)(1) permits companies to repair or modify tractors they already own, and for which they have already been taxed, without triggering a second 12 percent excise tax. Under the safe harbor, a company can lease, sell, or use a tractor without the transaction constituting a “ﬁrst retail sale,” and therefore is not subject to the tax, provided it has not been produced, manufactured, or imported. The safe harbor provision provides that a repaired or modified tractor is not to be treated as manufactured or produced if, and only if, the cost of the repairs or modiﬁcations is less than or equal to 75 percent of the price of a comparable new tractor.
Given that the excise tax statute and the safe harbor provision do not deﬁne the terms “repairs,” “modiﬁcations,” or “retail price of a comparable new article,” the Circuit Court applied fundamental rules of statutory interpretation and construction in order to reach its holding. The Circuit Court noted that the record before it did not offer guidance for deciding when changes to a tractor are so extensive that they cross the line from repairs to the manufacture of a new tractor. The Circuit Court ultimately decided that the establishment of the 75 percent limit in the safe harbor means that whether a repair or modification occurred is determined by whether the cost of the repairs or modifications exceeds 75 percent of the price retail of a comparable new tractor, and not by analyzing the replacement parts used in the process of refurbishing the tractor.
Further, the Circuit Court concluded that the appropriate measurement for the retail price of a comparable new tractor is the market price in ordinary, arms-length transactions on the open market. In reaching this decision, the Circuit Court applied the fundamental rule that “unless otherwise deﬁned, words will be interpreted by their ordinary, contemporary, common meaning.” The Circuit Court further reasoned that Congress speciﬁcally directed that the excise tax be imposed on “the amount for which the article is so sold,” in other parts of the statute but not in the safe harbor provision. Consequently, the decision of the district court was reversed and remanded for the district court to proceed consistent with Circuit Court’s decision.