Copyright 2000 eMediaMillWorks, Inc.
(f/k/a Federal
Document Clearing House, Inc.)
Federal Document Clearing House
Congressional Testimony
September 26, 2000, Tuesday
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 7280 words
COMMITTEE:
HOUSE WAYS AND MEANS
HEADLINE:
TESTIMONY TAX CODE AND THE HIGH-TECH ECONOMY
TESTIMONY-BY: MOLLY FELDMAN , TESTIMONY OF MOLLY
FELDMAN
BODY:
SEPTEMMER 26,2000 TESTIMONY OF MOLLY
FELDMAN, VICE PRESIDENT - TAX VERIZON WIRELESS BEFORE THE HOUSE COMMITTEE ON
WAYS AND MEANS SUBCOMMITTEE ON OVERSIGHT Chairman Houghton and Members of the
Oversight Subcommittee, thank you for holding these hearings on the tax code and
the new economy. My name is Molly Feldman and I am Vice President of Tax at
Verizon Wireless. I am appearing before you today on behalf of a coalition of
national and regional wireless telecommunications companies which have banded
together to seek greater clarity in the depreciation rules
governing our industry. We support the premise in the press release announcing
the Subcommittee's hearing that the Internal Revenue Code's
depreciation system is outdated and fails to adequately address
the cost recovery needs of the nation's new high technology-based economy. The
wireless telecommunications industry provides a textbook example of the
shortcomings of the current tax depreciation system for
emerging high technology -industries. Like so many other high technology
industries, the wireless telecommunications industry depends on
computer-based technology to facilitate the digitization of
voice, video and data over the industry's new digital networks. The first steps
in the development of the current wireless system started with the creation of a
computer-controlled network of "cells," which contained
low-powered computer- based switching equipment. It was the
introduction of a computer to the system of cell sites that
enabled the wireless system to provide call hand- offs as a mobile user passed
through its designated geographic area, allowing the wireless system to reuse
its limited frequency for another wireless user. Computers are
used to provide all the required functions and are present in all parts of the
system. Without the use of computers, it is not practical or
economical to implement a wireless system. The wireless PCS license auctions in
1993 and 1994 created heightened competition and led to an accelerated
change-out of technology, particularly the conversion from analog to digital
equipment. Wireless companies are continuously replacing equipment due to
functional or technical obsolescence. For example, much of the upgraded digital
wireless equipment that only recently replaced analog equipment beginning in the
mid- 1990s is itself expected to be replaced within the next three to four years
due to the emergence of the next generation of equipment. The increasing speed
with which this phenomenon is occurring has rendered many billions of dollars
worth of equipment obsolete, as well as shortened both service and economic
lives. The Treasury Department's recently released "Report to the Congress on
Depreciation Recovery Periods and Methods" makes the point that
the rapid pace of innovation in the information age has created many new
industries like the wireless industry that are not clearly addressed by current
depreciation rules. The report points out that the wireless
industry did not exist when the current assets classes were defined and that its
digital technology does not fit well into the existing definitions for wired
telephony-related classes. The Importance and Growth of the Wireless
Telecommunications Industry The wireless telephone industry has been one of the
fastest growing industries in the United States since the mid-1980s. The growth
in the industry, in terms of subscribership and capital investment, has taken
place at a much faster rate than predicted in even the most optimistic
forecasts. According to the most recent Cellular Telephone Industry Association
(CTIA) Semiannual Wireless Survey, 86 million American Subcribed to wireless
service in 1999, and analysts project 175 million subscribers by 2007. The
growth in wireless subscribers has had a dramatic effect on the U.S. economy in
terms of job creation. The wireless industry directly supplied 4,334 American
jobs in 1986. By 1999, the wireless industry directly supplied over 155,000 jobs
and was responsible for creating another million jobs in industries that support
wireless telecommunications. The wireless industry is part of the high
technology community that is the engine of our economic prosperity, creating new
jobs and new opportunities for all Americans. The rapid pace of technological
innovation that has characterized the wireless industry in the past will
continue and even increase in the future. The wireless industry is evolving from
an industry that provided primarily voice communications services to one that
increasingly works as a network providing computer
functionality, such as Internet access. New third-generation ("3G") products
will provide similar, much improved, services to remote users. Anticipated uses
for new technologies include enhanced voice and high-speed data links to office
computers, the ability to send and receive faxes, high- speed
Internet connectivity, video transmission and video conferencing. Wireless
companies plan to expand wireless networks into new markets and rural areas with
the goal of uninterrupted service throughout North America. The current
expansion in networks has distributed the job growth from metropolitan areas to
some of the most rural parts of the country. Continued investment in network
upgrades and expansion will continue to have a positive effect on local
economies throughout the country. Mobile data services available over the new
wireless digital networks will permit increased expansion of Internet access
into urban, rural and suburban communities, Not only has the increase in
wireless subscribership driven job growth, but it has also produced a
commensurate increase in capital spending to deploy new technology and expand
wireless networks. In 1985, total capital spending on wireless assets amounted
to $526 million. Annual capital expenditures on wireless assets exceeded $15
billion in 1999. Capital spending at the current levels make clear
depreciation rules a priority, but such clarity is exactly what
is lacking under our current depreciation system. History of
the Wireless Telecommunications Industry Cellular telecommunications technology
was first created in AT&T's laboratories in the 1940s. The technological
precursor of cellular telecommunications was called Mobile Telephone Service
("MTS") and consisted of one large broadcasting tower and a high- powered
transmitter which had a range of approximately 50 miles. In addition to this
range restriction, the system was further limited by the size of the
transmitter, bandwidth constraints and a small user capacity. Another key
limitation was that the MTS could only be used within the specific geographic
location of the tower. The MTS could not hand off calls to other towers as the
user moved outside the "home" area. These limitations doomed this technology
from ever becoming commercially feasible. The first modern cellular system -
which the industry now refers to as wireless -- was called Advanced Mobile Phone
Service ( AMP ). This system was designed to address the technological
limitations posed by MTS. The single base station in the MTS system was replaced
with a computer-controlled network of cells, which contained
low- powered computer-based switching equipment. It was the
introduction of a computer to the system of cell sites that
enabled the wireless system to provide call hand- offs as a mobile user passed
through its designated geographic area, allowing the system to reuse its limited
frequency for another wireless user. It should be clear that
computers are used to provide all the required function, and
that these computers are present in all parts of the system.
Without the use of computers, it is not practical or economical
to implement a wireless system. As a result of Federal Communications Commission
(FCC) action in 1981 that created a duopoly in 48 Metropolitan Statistical Areas
(MSAs), the first commercially viable AMPS system was launched in October 1983
in Chicago. Since then, the wireless industry has grown into a major industry
that has played a significant role in the economic growth in the 1990s. The FCC
auction of 30 MHz Personal Communications Systems (PCS) licenses during 1993 and
1994, as well as the passage of the Telecommunications Act of 1996, has
significantly increased investment and competition within the telecommunications
industry. The growth in the wireless industry is due to the technological
advances that have allowed wireless companies to meet consumer demand and still
offer affordable wireless service to a growing consumer base. Technological
Advances and the Speed of Change Consumer demand for wireless service has
increased at a phenomenal rate. Although the wireless industry has benefited
greatly from the strong demand for its products, the industry has also been
forced to aggressively pursue technological solutions to address bandwidth
limitations in order to keep up with increased competition from new entrants
into the wireless market using the latest digital technologies. The PCS license
auctions in 1993 and 1994 created heightened competition in the wireless
industry. This led to an accelerated change-out of technology, particularly the
conversion from analog to digital equipment. The increasing speed with which
this phenomenon is occurring has rendered many billions of dollars worth of
equipment obsolete, as well as shortened both service and economic lives.
Telecommunications technology is progressing at a rate that has previously only
been seen in the personal computer (PC) industry. Gordon Moore,
co-founder and Chairman Emeritus of Intel Corporation, stated in a speech in
1965, that the pace of technology change is such that the amount of data storage
that a microchip can hold doubles every year or at least every 18 months.
Moore's observation, now known as Moore's Law, described a trend that has
continued and is still remarkably accurate. It is the basis for many planners
performance forecasts. Moore's law is easily applied to changes that have
occur-red with wireless telecommunications equipment. The cost of equipment has
remained fairly constant while equipment capabilities have continued to increase
exponentially. The striking similarity between the PC industry and the wireless
equipment industry is due in large part to the fact that the major components of
a cell site are in fact computers or peripheral equipment
controlled by computers. Wireless companies are continuously
replacing equipment due to functional or technical obsolescence. For example,
much of the upgraded digital wireless equipment that only recently replaced
analog equipment beginning in the mid-1990s is itself expected to be replaced
within the next three to four years due to the emergence of the next generation
of equipment. The Future of Wireless Technology The rapid pace of technological
innovation that has characterized the wireless industry in the past will
continue and even increase in the future. The wireless industry will evolve from
an industry that provides primarily voice communications services to one that
increasingly works as a network providing computer
functionality, such as Internet access. New third-generation products will
provide similar, much improved, services to remote users. Anticipated uses for
new technologies include enhanced voice and high- speed data links to office
computers, the ability to send and receive faxes, high-speed
Internet connectivity, video transmission and video conferencing. In addition,
governmental actions may necessitate wireless carriers to purchase new equipment
to meet government mandates. Currently, the wireless telephone is in the process
of complying with FCC requirements to implement enhanced 911 service. Enhanced
91 1 ("E91 1 ") service provides emergency service personnel with the telephone
number and location of a caller reporting the need for emergency services. This
information is used to more rapidly dispatch help and to enable the emergency
personnel to call the user back at the same number should the call become
disconnected. Both the technological changes taking place in the wireless
industry and new government regulations will require wireless companies to make
substantial. capital investments implementing new technology. These rapidly
approaching events serve to highlight the critical importance of
depreciation rules that accurately reflect the future state of
the industry. The Components of Wireless Telecommunications Systems The three
primary components of a wireless telecommunications system -- cell sites, mobile
switching centers and handsets -- work together as an integrated network to
provide wireless telecommunications services. Each cell site consists of
computer- based assets, which operate as a coordinated unit
that is directly connected to a mobile switching center via a microwave
transmitter or other dedicated transmission facility. A cell site's
computer-based assets are driven by advanced software programs
that encode and decode analog and digital data through complex algorithms; that
monitor and adjust the power transmission levels of wireless handsets allowing
customers to receive and deliver calls within a particular cell radius (ensuring
quality reception); and that enable call hand-off as subscribers pass from one
cell to the next. Compared to traditional landline telephone systems, the
functions of wireless telecommunications systems are highly decentralized - -
being allocated among the mobile stitching centers and cell sites which comprise
these systems. Without the complex, - software-driven functionality of the
equipment at both the cell sites and the mobile switching centers, the
successful coordination of these decentralized functions would be impossible, as
would be wireless telecommunications itself. Description of a Cell Site The
equipment at a cell site includes computers as well as
equipment that is under the control of computers located at the
cell site itself or at the MSC. A typical cell site is made up of the following
computer base station equipment, which is integrated to form a
single functioning component of the overall wireless network: -A cell site
controller (CSQ, which is a specialized computer that connects
calls and maintains call quality. The CSC controls the
computer-based functions of the cell site. Specifically, the
software in the CSC allows the CSC to communicate with both the cell phone and
the MSC, and to, relay and construct the messages that are required to connect
and disconnect calls. Further, the CSC is responsible for monitoring hand- offs
and for relaying signal strength measurements to the MSC. In addition, the CSC
operates together with the transmitters, receivers and transceivers that
modulate the voice signal into a radio frequency, and vice versa. For example,
when a cell phone makes or receives a call, the CSC will instruct one of the
transceivers to begin transmitting and will send a digital transmission to the
cell phone with instructions as to the frequency on which the transceiver is
communicating. Because the CSC is a functional extension of the MSC, any upgrade
or change to the MSC will require an upgrade of the CSC. Transmitters,
receivers, transceivers, antennas and moderns that enable the cell site
controller to communicate with both the MSC and the wireless telephone. The
transmitting and receiving equipment is controlled and operated by software
programs that execute on cell site computers, and these
transform signaling and speech information between the formats used in the
land-line communications facilities and those used in over the air transmissions
between the cell site and the mobile units. -Power equipment. A variety of power
equipment exists to provide the electrical power necessary to keep the cell site
switching equipment operational under all circumstances. For example, this
equipment is necessary to convert the external power supply for' AC to
"controllable" DC; to operate the cell site equipment; to monitor and filter the
power level; and, as a secondary function, to ensure that there is a back-up
power supply in the case of a complete commercial power failure. This power
equipment is peripheral equipment that is essential to the operation of all the
cell site computer-based switching equipment. -An enclosure to
protect the electronic equipment and climate control equipment that enables the
equipment to operate within a controlled temperature and humidity range In order
for a cell site to operate, each component listed above must be present and in
working order. Changes over Time: Smaller, More Integrated, Similar to Personal
Computers The cell site has experienced the same technological
advancements in terms of size and integration as most other technology-based
industries. Cell sites are analogous to early mainframe
computers, which often occupied large amounts of space,
sometimes entire rooms within office buildings. Each successive mainframe
required less space, and eventually the personal computer (PC)
was developed. Today's laptop and palmtop PCs weigh as little as a few pounds,
but have exponentially greater computing capacity than the first room-sized
mainframes. Early cell sites, while always an integral component of wireless
communications, included an antenna, an enclosure and computer
based switching equipment that required leasing a separate sizable piece of real
estate to assemble the finished product. As wireless equipment continues to
evolve, the size of cell site equipment is integrated into a smaller package.
Industry experts predict that future cell sites will fit into a small box and
will be placed on utility poles and existing interstate traffic signs. While
functionality and capacity have increased, Figure 5 shows how the size of the
enclosures has decreased. Figure 1: Rapid Miniaturization of Enclosures Found on
hard copy only Cell Site Equipment Although the next generation of cell site
equipment has been dubbed 3G (for "third- generation"), there have already been
several waves of wireless technology. Table 1 describes the major introductions
of new cell site equipment that have occurred since 1983. The first generation
of equipment used with ANTS was introduced for commercial use in 1983. This
analog system was designed to carry one voice channel per 30 kHz bandwidth. The
first digital alternative to AMPS was introduced in 1989. This system, called
TDMA ("Time Division Multiple Access"), allowed more than one user to share the
same voice channel, effectively tripling the number of calls per bandwidth area.
A different and still more efficient digital encoding system called CDMA ("Code
Division Multiple Access") was introduced in 1994. CDNfA doubled the carrying
capacity of TDMA, allowing six users to share the same voice channel that
formerly would have been assigned to one analog user. A third digital standard,
GSM, has also been developed. CDMA, TDMA, and GSM technologies are used for the
new all digital cell sites operating in the PCS bandwidth, which was assigned by
auction in 1993 and 1994. Continual technological advancements such as CDMA,
TDMA, and GSM allow more efficient utilization of spectrum and reduce the size
of cell site enclosures. Table 1: Major Technological Changes 1984-1998 Found on
hard copy only Overview of Federal Depreciation Rules and
Current Treatment of Wireless Telecommunications Equipment. The cost of most
tangible depreciable property placed in service after 1986 is recovered using
the modified accelerated cost recovery system (MACRS) enacted as part of the Tax
Reform Act of 1986. Under MACRS, assets are grouped into classes of personal
property and real property, and each class is assigned a recovery period and
depreciation method. The applicable class-life and method used
to compute the annual depreciation allowance varies depending
upon the particular asset being depreciated. An IRS table lists various Asset
Classes, along with their respective class lives and recovery periods. The
commercial wireless industry was in its infancy in 1986 and 1987 when the
depreciation system was last revised. As a result, the rules
which are currently being applied by the IRS and by the wireless industry were
originally developed without specifically considering the characteristics of
wireless telecommunications equipment. The IRS and the wireless industry have
taken different paths regarding wireless telecommunications equipment
depreciation issues since 1986. The IRS approach has been to
break down cell site equipment into their individual sub-components and
depreciate each based on the functional nature of the individual sub-component.
Wireless companies have taken the position that the functional nature of the
integrated components should dictate how the assets should be depreciated, and
that the parts of the cell site cannot operate independently and therefore
should be considered an integrated asset. The differences have resulted in ad
hoc, inconsistent, and costly case-by-case determinations as the issue has
arisen on audit. The IRS recently provided limited guidance on the application
of Rev. Proc. 87-56 to wireless assets in Technical Advice Memorandum 98-25-003
(Jan. 30, 1998) ("TAM"). The TAM asserted that the classes of assets used to
provide wireless telecommunications service are comparable to wireline
telecommunications assets and thus should be assigned to wireline asset classes.
The IRS based this conclusion on the fact that wireless assets performed
switching, transmission, reception and coordination functions similar to the
wireline assets. The TAM did conclude that mobile switching centers should be
classified in asset class 48.121 (computer-based telephone
central office switching equipment), but it failed to take a definitive position
with respect to the classification of cell site equipment. Because the
conclusions in the TAM with respect to the classification of cell site equipment
were not definitive, the TAM provides little practical guidance for IRS auditors
or taxpayers as to the proper classification of cell site equipment. Because
cell site equipment is the backbone that makes wireless telecommunications
possible, the failure to have clear agreement between the IRS and the industry
on the rules for depreciating this equipment poses substantial difficulties for
the industry. Significant Increase in the Cost of Capital As previously noted,
the IRS's approach during audits has been to break cell site equipment down into
its sub-components and propose depreciating each sub-component on its alleged
functional nature, often using a 10-year recovery period (which equates to a 16
to 20 year class life). The assignment of assets that are properly five-year
property to improper depreciation classes, with longer recovery
periods has a large impact on the cost of investment borne by wireless
companies. Table 2 shows the effort on the hurdle rate of return and the
effective tax rate of improper assignment of five-year property to classes with
longer periods. The pre-tax hurdle rate of return when the assets are properly
assigned is 19.1%, while the effective tax rate on the assets is close to the
statutory rate of 35 %.5 Table 2: Hurdle Rates of Return and Effective Tax Rates
for Cell Site Equipment Found on hard copy When the five-year property is not
properly assigned, the hurdle rates of return increase. If the assets are
classified as 15-year property, the hurdle rate of return almost doubles, rising
to 36.2%, while effective tax rate rises to over 64%. The result of
misclassifications is to impose unfairly high taxes on wireless companies,
compared to other companies utilizing assets that have properly defined class
lives. The burden of these unfair taxes is borne by the users of wireless
service, who pay a hidden tax, and potential users of wireless systems who do
not receive service due to decreased investment and slower build-out. One of the
guiding principles of MACRS is that the depreciation tax life
of an asset should be shorter than the actual book life of the asset (i.e.,
"accelerated"). The median five-year recovery period used by companies filing
their tax returns is more consistent with the principles underlying MACRS as to
the rapid obsolescence of wireless equipment. Given the rapid technological
change and advances in the wireless industry, the median five- year recovery
period used by many companies on their tax returns is the maximum recovery
period that should be applied given the rapid obsolescence of wireless
equipment. Clearly, the appropriate class life of wireless telecommunication
assets does not even approach 10 years, let alone the 16 years to 20 years used
by the IRS. In addition to imposing higher capital costs, the lack of clarity in
the depreciation rules for cell site equipment places wireless
companies at a significant risk of incurring penalties and interest as a result
of depreciation audit adjustments. This is particularly
troublesome given the industry's merger and acquisition activity. Acquiring
companies are finding that some acquired companies may have significant exposure
on audit as a result of depreciation elections made in past
years. Solution - Include Wireless Equipment in Qualified Technological
Equipment. Rather than trying to shoehorn wireless telecommunications equipment
into wireline telephony "transmission" or "distribution" classes, a better
solution would be to include wireless telecommunications equipment within the
definition of "qualified technological equipment," which the Code currently
defines (in section 168(i)(2)) as any computer or peripheral
equipment, any high technology telephone station equipment installed on a
customer's premises, and any high technology medical equipment. The wireless
telecommunications industry believes that its equipment is properly
characterized as "qualified technological equipment" because of the fact that
the major components of wireless networks are in fact computers
or peripheral equipment controlled by computers. Representative
Phil Crane (R-IL) will be introducing legislation this week to make this
important clarification. We are grateful to Representative Crane for recognizing
the need to address this problem and provide certainty to the wireless
telecommunications industry and its customers. Summary
-Depreciation guidance for the wireless industry is needed to
provide certainty and avoid further controversy leading to unnecessary costs to
both the government and industry. -The current depreciation
system should be revised to clarify that all wireless telecommunications
equipment is included in the "qualified technological equipment" category.
Additionally, Congress should carefully consider the need for reducing the five-
year recovery period to provide proper recognition of the economic life and
resultant class-life for wireless equipment. To ensure
depreciation certainty in the future, Congress should recognize
the rapid technological change occurring in the information age and be prepared
to shorten depreciable lives for assets that increasingly have shorter economic
useful lives. Corrective action would assist the IRS in performing simplified,
accurate audits and would greatly reduce the high compliance costs and excessive
capital costs currently borne by wireless companies. Clarification of the
depreciation rules will allow wireless companies to continue to
pursue business objectives which translate into continued job growth,
productivity gains, and overall economic expansion.
LOAD-DATE: September 28, 2000, Thursday
