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WorldCom Debtors Not Entitled to IRS Refund, Says 2nd Cir

By Gabriella Khorasanee, JD on July 24, 2013 | Last updated on March 21, 2019

On Monday, the Second Circuit reversed a district court’s decision, affirming a bankruptcy’s court decision, granting WorldCom Debtors’ objections to an IRS proof of claim, and a motion for taxes that WorldCom previously paid.

The decision centered on how “local telephone service” was interpreted, because the federal tax code requires the addition of a three-percent tax to the purchase of a local telephone service. At issue was WorldCom’s purchase of “central-office-based remote access” (COBRA), a service that gave customers the ability to connect to the Internet and WorldCom’s network through a regular phone line.

The bankruptcy court and district court concluded that COBRA was not a local telephone service, and therefore not subject to the three-percent tax. The Second Circuit disagreed.

The tax code defines "local telephone service" as "the access to a local telephone system, and the privilege of telephonic quality communication with substantially all persons having telephone or radio telephone stations constituting a part of such local telephone system."

First, the court had to determine what constituted "access" and "telephonic quality communication" for purposes of interpreting the tax code. The court held that "access" simply means connectivity and "telephonic quality communication" is "the technological capacity of the channel to transmit voice signals, regardless of whether or not the channel is used for voice communication." Based on these definitions, the court concluded that "data communication transmitted by a modem" falls under the definition of the tax code.

Now that everything was properly defined, the court next considered whether COBRA services fell within those areas. The court found that it did. Because the modems that connected to the internet required telephonic quality communication to connect to the Internet, the Second Circuit found that the COBRA purchase was subject to the three-percent excise tax levied for the purchase of a local telephone service.

Finally, it should be noted, in determining how much weight to give to a previous IRS revenue ruling, the Second Circuit joined the Fifth, Sixth, Ninth and D.C. Circuits presented with the issue, and agreed "that revenue rulings are not entitled to Chevron deference."

This case may seem a bit dry, but when you look at the dollar amounts in question, you realize how important it is. At issue was $38,297,513 WorldCom already paid, and another $16,276,440.81 that the IRS was requesting. Furthermore, with the speed that technology is changing, it's always a good idea to see how courts are defining technical terms in statutory interpretation.

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