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Court Finds Excise Tax On First Sale Inapplicable to Reconstructed Big Rigs

Greek philosopher Plutarch is famous for posing the Ship of Theseus Paradox.  The mythical hero Theseus, upon sailing back to Athens after an epic battle, replaces, one-by-one, the old, decayed planks of his mighty ship with new and stronger timbers.  The thought experiment is whether the ship which has been restored by replacing each and every one of its wooden planks is still the same ship.  If not, when did it become a new ship?  When half of the planks were replaced?  When the last plank was replaced? 

In a recently issued appellate court decision, Schneider National Leasing, Inc. v. United States, the IRS posed a similar paradox to the Seventh Circuit.  But it wasn’t a mere mental exercise in metaphysics.  It struck at the core of a safe-harbor to Section 4051 of the Internal Revenue Code which imposes a 12% excise tax on the “first sale” of semi-tractors and truck chassis.  The tax applies to manufacturers and producers of trucks when they first sell, lease or use the vehicle. 

At issue in the case was the tax’s safe-harbor at Section 4052(f) which provides that a taxpayer will not be treated as having manufactured or produced a new truck, and thus will not trigger the excise tax upon sale, lease or use of the truck, “solely by reason of repairs or modifications to the article (including any modification which changes the transportation function of the article or restores a wrecked article to a functional condition) if the cost of such repairs and modifications does not exceed 75 percent of the retail price of a comparable new article.”

The taxpayer in Schneider National Leasing overhauled 982 of its existing tractors using new and refurbished parts packaged together in so-called glider kits.  These kits were bundled assemblies of new and remanufactured tractor components.  The Seventh Circuit explained: “At a minimum, each glider kit came with a cab, chassis, radiator, front axle, front suspension, front wheels, front tires, front brakes, brake system, and trailer connections.  912 of these kits were so-called powered glider kits because they included a remanufactured engine. . . The refurbishing process generally involved dismantling the old tractors, stripping non-usable parts, reassembling the reusable components of the old tractor with the glider kit parts, and giving the rebuilt tractor a new vehicle identification number matching the serial number on the glider kit.”

The IRS argued that there is a point at which the refurbishment of a truck is so extensive that it essentially becomes a new truck that when sold, leased or used triggers the “first sale” rule, and that the taxpayer in Schneider National Leasing had crossed the line.  This was essentially the Ship of Theseus Paradox: whether an object that has had its components replaced remains the same object.  By the way, English philosopher Thomas Hobbes extended the thought experiment to another ship built alongside Theseus’ using only the planks Theseus had replaced.  Mind bending stuff.  The Seventh Circuit, after criticizing the IRS for its lack of clarity in how to determine whether the line is crossed and emphasizing the need for clarity in any safe-harbor, smartly avoided the metaphysical question entirely. 

The Court held that under principles of statutory interpretation, the dividing line was based not on the extent of modifications made to the trucks but by reference to the 75% rule stated in the statutory safe-harbor: “Congress's establishment of the 75% limit as a condition for qualifying for the safe harbor means that the question whether a repair or a manufacture occurred is not answered by looking at what replacement parts—which ones or how many—were used as part of refurbishing. What marks the line between “repairs or modifications” and “manufacture” is the 75% cost measurement.”  The Court therefore did not need to delve into an analysis that would have been akin to whether Theseus has built a new ship, and at what point – with the addition of which plank -- it became a new ship.

By sidestepping the Ship of Theseus Paradox, the Seventh Circuit has brought a measure of clarity and certainty to the application of the repair and modification safe-harbor in Section 4052(f), which should assist taxpayers in evaluating the safe-harbor’s application and potential refund opportunities.

  • Peter A. Lowy

    Peter A. Lowy, a shareholder in Chamberlain Hrdlicka’s Houston office, is best known for his tax controversy work and deep experience in the energy sector. He also advises corporations and other taxpayers in a broad spectrum of ...