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endlinks, was allocated to the IRU agreement, and if any retained
conduit was installed, the incremental cost of adding such
conduit was allocated to Qwest’s retained assets. Finally, Qwest
allocated cable material, splicing, and testing costs between the
IRU agreement and its retained assets based on the ratio of
fibers sold to WorldCom to fibers retained by Qwest. As an
example, in the Dallas-Houston IRU project, Qwest installed a 72-
fiber fiberoptic cable, and WorldCom had an IRU in 24 of those.
Qwest allocated 24/72ths of the costs of cable material, splicing
and testing to the IRU agreement and 48/72ths to Qwest’s retained
assets.
V. Tax Returns for the Years in Issue
Petitioners timely filed consolidated Federal income tax
returns for the years in issue.
On February 4, 2003, respondent mailed a notice of
deficiency to petitioners for the years in issue. As reflected
in the notice of deficiency, respondent determined that an
average cost allocation approach should be used for all of
petitioners’ conduit installation and fiber pulling projects. In
the notice of deficiency, respondent explained:
certain incremental costs included in your cost of
sales claimed on your tax returns for taxable years
ending 7-31-94, 7-31-95 and 7-31-96 in the amounts of
$20,149,787, $10,977,427 and $14,602,442, respectively,
15(...continued)
conduit, and the right-of-way costs to Qwest’s retained assets.
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