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

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

Finally, the Tax Court also held that the maintenance procedures did not materially add to the value of the boat. The court rejected as factually unsupported the IRS's allegation that a buyer would pay a higher purchase price for a boat whose engines had recently been maintained, (32) Accordingly, because the towboat owner was doing what any reasonable owner would have done in order to maintain the value and operating efficiency of a critical asset, and because those actions neither increased the value or life of that asset nor adapted it to a new or different use, the towboat owner was entitled to currently deduct those costs as incidental repairs.

5. FedEx

As with the issuance of Rev. Rul. 2001-4, the IRS examination function read and applied Ingram narrowly, essentially limiting the case to its facts rather than applying the underlying legal principles. As such, the IRS pressed forward with litigation against taxpayers incurring cyclical maintenance costs outside the context of aircraft airframes and towboats. This narrow view has now resulted in the taxpayer's victory in FedEx.

In all material respects, FedEx is consistent with the national office's holding in Rev. Rul. 2001-4 and the Tax Court's decision in Ingram. FedEx involves the cyclical maintenance of aircraft engines. As part of its package delivery business, FedEx owns and operates a large fleet of sophisticated jet aircraft. Pursuant to the Federal Aviation Regulations (FARs), FedEx must conduct ongoing maintenance operations on both the airframes and the engines of its aircraft. Only the engines were at issue in the case. In purchasing the aircraft, FedEx bought airframes and engines as single units, although it also bought additional engines as part of the original purchase for use as rotable spares. FedEx typically did not purchase engines separately from airframes, and the company expected the engines to remain in service for the entire useful life of the aircraft that they powered (approximately 30 years).

The FARs required FedEx to perform certain maintenance procedures after specified intervals, measured in either hours of flight operations, elapsed time since the last visit, or in cycles (one take-off and one landing). The specific tasks required at particular intervals were developed in conjunction with the aircraft's manufacturer and were incorporated into a maintenance manual, which the FARs mandated be followed. At certain intervals, specified maintenance was required in order to permit FedEx to continue operating the plane. Failure to comply with the maintenance schedule would result in the FAA grounding the aircraft (i.e., rendering it "unserviceable"), regardless of its actual physical condition.

In almost all cases, FedEx contracted with third-party vendors to conduct the required maintenance. FedEx removed the engine from the aircraft and shipped it to the vendor for maintenance. The engine was immediately replaced with another, rotable engine, so that the plane could remain in service. The district court provides a thorough discussion of the maintenance procedures performed on the engine, but in general, the maintenance procedures at issue closely resembled those in TAM 9618004.