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A. The Reasonableness Standard of Section 1.263A-1(f)(4),
Income Tax Regs.
As found above, the reasonableness standard of section
1.263A-1(f)(4), Income Tax Regs., only applies to second level
allocations. The issue in the instant case is whether Qwest’s
first level allocations, i.e., those between property produced
under its customer contracts and its retained assets, were
reasonable. Therefore, the reasonableness standard of section
1.263A-1(f)(4), Income Tax Regs., is irrelevant in determining
whether Qwest’s incremental cost allocation method is reasonable.
B. Distortion in the Organization of Economic Activity
Respondent contends that Qwest’s incremental cost allocation
method fails to match Qwest’s income and expenses, resulting in
dramatic tax deferral, and is thus unreasonable because it
violates congressional intent. Respondent’s argument is based on
hindsight, not on the facts as they were at the time Qwest made
its allocations, and is thus unpersuasive.
The Senate report accompanying the Tax Reform Act of 1986
states:
The committee believes that present-law rules
regarding the capitalization of costs incurred in
producing property are deficient in two respects. * * *
Second, different capitalization rules may apply under
the present law depending on the nature of the property
and its intended use. These differences may create
distortions in the allocation of economic resources and
the manner in which certain economic activity is
organized.
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