                       108 T.C. No. 19



                UNITED STATES TAX COURT



         SPRINT CORPORATION AND SUBSIDIARIES,
F.K.A. UNITED TELECOMMUNICATIONS, INC., Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 13159-94.                     Filed April 30, 1997.



     P, a telephone company, purchased certain
telecommunications equipment, digital switches, that
required computer software to operate. P claimed
investment tax credits (ITC) and depreciation
deductions under the accelerated cost recovery system
(ACRS) with respect to the total cost of each digital
switch, which included the cost of the software used in
each switch. R determined that P's expenditures
allocable to the software did not qualify for the ITC
or depreciation under the ACRS.
     P treated property known as “drop and block” as
5-year property, as defined in sec. 168(c)(2)(B),
I.R.C. R determined that the property was 15-year
public utility property. For the years in issue, the
property was depreciated under the ACRS.
     1. Held: P's expenditures allocable to the
software qualify for the ITC and depreciation under the
                                - 2 -

     ACRS. Norwest    Corp. & Subs. v. Commissioner, 108 T.C.
     ___ (1997), is   followed.
          2. Held,    further: Drop and block is 5-year
     property under   sec. 168(c)(2)(B), I.R.C.



     Jay H. Zimbler, Michael A. Clark, Michael R. Schlessinger,

and William J. McKenna, Jr., for petitioner.

     Alan M. Jacobson, John W. Duncan,and Patricia Pierce Davis,

for respondent.



     HALPERN, Judge:    Respondent determined deficiencies in

petitioner's Federal income taxes for the years and in the

amounts as follows:

                      Year              Deficiency

                      1982              $7,400,722
                      1983                  39,996
                      1984                 318,791
                      1985                 157,987

     Sprint Corporation (Sprint or petitioner) is a Kansas

corporation with its principal office in Westwood, Kansas.

Formerly known as United Telecommunications, Inc., petitioner

officially changed its name to Sprint Corporation as of February

26, 1992.   Unless otherwise noted, references herein to Sprint

and petitioner will include the period during which petitioner

was known as United Telecommunications, Inc.         Petitioner filed

consolidated Federal income tax returns for itself and its

eligible subsidiaries for the 1982, 1983, 1984, and 1985 taxable

years.
                                - 3 -

     After concessions by the parties, the issues remaining for

decision are (1) whether certain expenditures made by petitioner

during the years in issue that are allocable to the cost of

computer software used in central office equipment (COE or

digital switches) qualify for the investment tax credit (ITC) and

depreciation under the accelerated cost recovery system (ACRS)

and (2) the proper classification as recovery property of certain

telecommunications equipment known as “drop and block”.      Unless

otherwise noted, all section references are to the Internal

Revenue Code in effect for the years in issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure.



                           FINDINGS OF FACT1

     During the taxable years in issue, petitioner and its

subsidiaries were engaged in the business of providing local and

long-distance telephone service.     Petitioner generally operated

its business of providing telephone service through separately

incorporated, wholly owned subsidiaries.       The local companies are

generally known by names indicating the parent company and their

geographic location (e.g., United of Iowa or UT of Florida) and

will be so referred to herein where reference to a specific

subsidiary is necessary.    In all other instances, references to


1
     The stipulation of facts and accompanying exhibits are
incorporated herein by this reference. The trial Judge made the
following Findings of Fact, which we adopt.
                                - 4 -

Sprint and petitioner shall be deemed to include petitioner's

subsidiaries.

A.   The Digital Switch Issue

       The equipment that provides the switching function that

enables one telephone subscriber to connect to another has

undergone an evolution from its earliest form, when the switching

function was performed by human operators sitting at manual

switchboards.   Manual switching was automated with the advent of

electromagnetic relay switches.   Since 1980, switching in the

United States has increasingly been done by digital switches

consisting of a number of integrated circuits, clocks,

processors, and central processing units (hardware).    Digital

switches operate in accordance with programmed instructions

initially encoded on magnetic tape (software).   The central

processing units are specially designed computers that are used,

and can only be used, to control the switch function.

      During the years in issue, petitioner purchased from

different vendors several digital switches (hardware and

software) for use in its telephone business, generally to replace

existing electromechanical switches.    Investment tax credits and

depreciation deductions under the ACRS were claimed with respect

to the total cost of each switch.   In the notice of deficiency,

respondent disallowed that portion of the claimed investment tax

credits and accelerated depreciation deductions relating to the

costs of the software.
                                - 5 -

     General Background

     Broadly, the three basic components of a telecommunications

system are station equipment, transmission facilities, and

switches.   Station equipment is generally located on the

customer's premises and includes such items as the telephone at a

residential customer's house.   Transmission facilities provide

the paths over which information is transmitted between customers

(whether the medium is used for local network transmission or

transmission over trunks, which are lines between different

networks) and consist of transmission media such as copper and

fiber optic cable, as well as the equipment used to amplify and

regenerate the transmitted signals.     Switches connect

transmission facilities at key locations and route incoming and

outgoing calls.

     The basic objective of the telephone switch is to connect

any calling outlet with any wanted inlet, a process that can be

visualized by picturing an operator sitting at an old manual

switchboard.   As a call is made, the operator pulls a flexible

cord connected to the caller's line and physically plugs it into

a receptacle connected to another line in the same network or to

a trunk line if the recipient is in a different network.

     The process of switching actually involves four sequential

phases, each consisting of certain activities or functions.    The

first phase, preselection, encompasses activities related to

recognizing a new call request and determining how to route it.
                               - 6 -

The second phase of switching is call completion, which entails

the actual connection of the requesting outlet to the wanted

inlet utilizing the determined routing, and initiation of the

charging process.   The third phase of switching is conversation.

The fourth and final phase is release, which is the disconnection

of the call, completion of the charge record, and restoration of

the network to the normal (idle) state.

     In addition to switching activities, modern switching

equipment must also perform certain management functions (such as

automatically detecting and isolating system and component

malfunctions), as well as provide certain customer services (such

as call forwarding or coin return at a pay telephone when the

call is not completed).

     The implementation of the various activities and functions

of the switching process is complicated by certain system

requirements, including availability, reliability, privacy, and

economy, which at times may conflict with one another.    The first

requirement, availability, refers to the need to have sufficient

paths so that a connection can be made on demand.   The

reliability requirement refers to the need to assure that the

system as a whole, or a particular connection, does not go down

(fail).   The privacy requirement reflects the need to switch

correctly (to the desired customer exclusively) or not at all.

Intentional misconnections, such as those caused by attempts to

avoid proper charging, as well as accidental misconnections, must
                               - 7 -

be prevented.   The economy requirement refers to the need to

provide service at a competitive price.   To that end, it is

necessary to avoid overbuilding a system despite the desire for

availability, reliability, and privacy.   Availability and

privacy, which generally are presumed requirements, voice

quality, price, and reliability are the bases by which systems

compete, with reliability being the key differentiating basis.

The reliability standards for telephone switches are far more

stringent than for most modern computer systems.

     An automated telephone switch comprises (1) the switching

network, (2) various interfaces, and (3) control mechanisms.     The

heart of the switch is the network, which consists of individual

devices designed to connect (and disconnect) communication paths.

Before integrated circuit switching, automated switching was

accomplished through a series of electromagnetic relays.     When a

call was placed, a physical connection path would be formed by

closing the appropriate relays.   In its most simplified form,

i.e., a network system consisting of only two telephone

customers, the operation of the switch would involve nothing more

than closing and opening the relay switch on the line running

between the two customers.   When the relay was closed, the lines

of the two customers would be connected and the switch would have

functioned, enabling conversation.

     A local telephone system may consist of hundreds of

thousands of customers.   It would be cost prohibitive either to
                                - 8 -

connect each subscriber directly to every other subscriber or to

have a centralized switch within a network with the same number

of direct lines as there are combinations of customers.   Rather,

to satisfy the economic considerations of a telephone system, the

switch function in a given area is centralized at an office (the

central office), which receives calls placed by customers and

then routes those calls through one of a number of outlets to

other subscribers within the local network or to other local

networks via long-distance trunks.

     The earliest automated switching systems used direct

progressive control to operate the switch, whereby relay switches

along the path connecting the calling and the called parties

would be closed as each digit in a telephone number was dialed

until a complete connection was made.

     To address certain disadvantages of progressive control

systems, telephone designers in the 1940s began incorporating

registers, devices which store and release dialed telephone

numbers into telephone switches.   Using registers, systems could

be devised for looking ahead to ascertain the best possible

routing.   Moreover, with such use, common control, or control of

various telephone functions by a centralized mechanism shared by

separate lines, was possible.   By the 1950s, switches used

electromechanical switches and relays to accomplish the key

control functions of a switch on a common basis, including

determining routing, seizing trunk lines, and ringing the call
                               - 9 -

user.   Even identifying, measuring, and recording a long-distance

toll call was accomplished through common control mechanical

devices.

     With the advent of solid-state electronics, some or all of

the common control functions were accomplished by utilizing

integrated circuits on which processing (control) instructions

were encoded.   Instead of electromechanical devices opening and

shutting in a predetermined (programmed) fashion to respond to

various alternative situations, electronic circuits would be

opened or closed in accordance with the embedded logic.

     In the mid-1960s, new telephone switches began to use

specially designed processors called stored program control

(SPC), which execute programs encoded on magnetic tape or other

media, rather than wired-logic, to control certain switch

functions.   At first, the tendency in digitalized switch design

was to centralize most switch control functions in one central

processing unit.   By the end of 1985, it was deemed more

beneficial if certain control functions were performed by

decentralized processors controlled by the central processing

unit.

     The advantages of SPC were that, because its program was

loaded by tape, rather than in electromechanical devices or

hard-wired integrated circuits, the program could be more easily

maintained (or changed), and the speed of electronics could be
                             - 10 -

more easily harnessed to allow a large network to be controlled

by a single high-speed processor.

     Design and Architecture of the Modern Digital Switch

     Modern digital switches are designed from the ground up by a

handful of manufacturers around the world.   In the 1980s, the

major North American manufacturers were ITT Corp., Northern

Telecom, Inc. (NTI), American Telephone & Telegraph Co., GTE

Corp., TRW Vidar, Inc., and Stromberg Carlson, Inc.

     Beginning in the late 1970s, engineers designing a

particular model of a switch did not merely arrange standard

electronic components into a standard structure.   Rather, a

particular overall structure was conceived, and then the

components of each of the interfaces, the network devices, and

the control mechanisms (including the encoded program) were

specially engineered in the context of that concept.    As a result

of design choices and the proprietary nature of certain custom

designed components (many of which are patented), the

architecture of a modern digital switch produced by one

manufacturer differed (and still differs) significantly from the

architecture of a switch produced by another.

     Because each switch was designed for the particular

parameters (number of subscribers, usage patterns, potential for

growth) of a given central office location, there could be

differences in architecture between switches produced by the same

manufacturer but installed in two different locations.
                               - 11 -

     In addition to choices between the actual logic, engineers

designing the encoded programs for the control mechanisms of a

modern digital switch also had the option to place various parts

of the encoded logic in software (i.e., the encoded medium that

will be loaded into the central processing unit) or firmware

(permanently encoded chips located in the central processing unit

or in microprocessors located throughout the switch).   The

choices made were determined to a large extent by the switch's

architecture.    A switch manufacturer writes the programs and

decides how they would be incorporated into the processors in the

context of the design requirements of a particular model.     Just

as the architecture of the switch affects the programming, the

programming limitations and requirements affect the architecture

of the switch.   The programming is also affected by the given

location.   Due to the unique parameters of a given location,

programs are invariably location specific.

     Because of the interrelationship of the architecture and

programming and the unwillingness of manufacturers to sell the

switch hardware without the switch software, programming for a

digital switch is written by the manufacturer of the switch and

is not available from third parties.    Absent the manufacturer's

programming, the manufacturer's hardware cannot operate.    Because

the design of the programming is specific to the architecture and

even the location of the digital switch, not only can the

programming of one manufacturer not be used on the equipment of
                               - 12 -

another, but the programming of a switch in one location

generally cannot be used on a switch of the same type in another

location.

     Digital Switch Acquisitions (1982-85)--Generally

     The particular design of the digital switches acquired by

Sprint during the years in issue varied from manufacturer to

manufacturer and from model to model.    However, the facts

relating to the DMS-100, manufactured by NTI, including its

acquisition and software, are representative of the purchases in

issue.

     Although there were many design configurations and

software/firmware combinations, none of that concerned

petitioner, which was interested in a turnkey switch; that is,

Sprint desired that the vendor would engineer, furnish, install,

and prepare a complete switch for service.    Sprint's primary

purpose in the procurement process was to determine which

manufacturer could satisfy petitioner's requirements for the

lowest price.    Based on those criteria, Sprint selected a

manufacturer and negotiated a final price.

     Once an agreement was reached, a software load for the

switch was developed by the manufacturer, NTI in this instance.

First, NTI technicians reviewed Sprint's order to ascertain the

number of lines and trunks and the types of desired features and

prepared a written plan or blueprint to be used in compiling the

software load.    The software load was then made by downloading a
                              - 13 -

base load module from a software library onto a blank magnetic

tape, pulling down other existing modules from the software

library to meet design specifications, and manually installing

various “data information” and translation codes onto the tape.

Three copies of the software load were made, two being sent to

Sprint and one being retained solely for safety reasons by NTI.

NTI technicians then installed the custom software load on the

particular switch for which it was designed.    Once installed, the

custom software load was tested and validated by NTI technicians.

An invoice from NTI indicates that, on a particular switch, of

532 total hours to develop the software load, 500 hours were

spent writing the software blueprint and testing and validating

the installed software.   There was little or no time actually

spent writing new software for the digital switch, and there was

no evidence as to how many preexisting modules were used.

     Once the equipment became operational, software load updates

were periodically provided by the manufacturers.     If there was a

new feature to be added, it was done at the time of the periodic

update.   The time required to effect those modifications varied

between 100 and 160 man-hours.   If the hardware of the switch was

moved to a different geographic location, a new custom software

load would be prepared utilizing the same steps.

     Nature of Sprint's Possession of the Software

     The direct sales agreement between petitioner and NTI

provided a warranty as to the software loads.   Provided that
                               - 14 -

Sprint adequately maintained the equipment, NTI warranted that

the software would function in accordance with the specifications

applicable on the shipment date, and, upon its failure to do so,

NTI would correct the failure and act to ensure that the software

was operating as specified.

     Section 8 of the sales agreement, labeled “Software

License”, provided that Sprint was granted a nonexclusive paid-up

license to use the software for its intended purpose, as long as

the switch was in use.    Software is defined as computer programs

contained on a magnetic tape, disk, semiconductor device, or

other memory device or system memory.    Sprint agreed that the

software provided by NTI was to be treated as the exclusive

property of NTI.    To that end, Sprint promised to hold the

software in confidence for the benefit of NTI; not provide or

make the software available to any person except to its employees

on a “need to know” basis; not modify the software; not reproduce

or copy the software in whole or in part; and return to NTI any

magnetic tape, disk, semiconductor device or other memory device

or system, and documentation or other material, which had been

replaced, modified, or updated.    Sprint was not required to

protect NTI's interest in any data or information that became

available to the general public, commonly known as “public

domain” software.    In the event that NTI modified or changed the

software to permit additional features or services, the updated
                              - 15 -

software was to be made available to Sprint at NTI's then-current

price for those features or services.

     Although there were significant limitations on Sprint's

rights in the software, under section 8.6 of the sales agreement,

Sprint was given the right, upon transfer of title to the digital

switch, to assign the license for the software or, upon a lease

or other nonpermanent transfer, sublicense the software, provided

the assignee or sublicensee agreed in writing to the above terms.

     Around 1988 or 1989, Sprint effected a trade of title of

approximately 30 DMS-100 type digital switches with ConTel Co.,

another telephone company.   None of the switches were actually

moved, and service to the customers was not interrupted.

Although neither party specifically notified NTI, the trade

received sufficient attention in the industry to give NTI at

least constructive notice of the trade.   NTI did not object to

the trade.

     Respondent determined in the notice of deficiency that the

costs of the software are not eligible for either the ITC or

accelerated depreciation under the ACRS because (1) Sprint

received a license to use the software rather than owning the

software and (2) in any event, the software is not tangible

property.

     Sprint acknowledges that the substantial value of encoded

programming on software, in general, relates to the programming's

conceptual or intangible value, but nonetheless contends that
                              - 16 -

(1) Sprint owned the software in issue and (2) the software

qualifies as tangible personal property.

      Respondent concedes that if Sprint in fact owned the

software and the software constitutes tangible property, Sprint

is entitled to the ITC and accelerated depreciation, as claimed.

If Sprint did not own the software in issue, or if the software

is not tangible personal property, respondent contends that

Sprint is entitled to amortize the cost of the software on a

straight-line basis over an 18-year period, while Sprint contends

that the costs should be amortized in accordance with Rev. Proc.

69-21, sec. 4.01(2), 1969-2 C.B. 303.   The 18-year period is the

class life asset depreciation range (CLADR) midpoint life of the

switch hardware with which the software is associated.     Rev.

Proc. 69-21, sec. 4.01(2), supra, is the procedure pursuant to

which, during 1982 through 1985, Sprint capitalized and amortized

the cost of purchased software, other than the software purchased

in connection with the digital switches (rather than claiming the

ITC and accelerated depreciation under the ACRS).

B.   Drop and Block Issue

      A telephone network includes transmission facilities and

station equipment (or station apparatus).   Transmission

facilities consist of the wiring and ancillary equipment used to

transmit telephone signals between the telephone company's

central office and the customer's (whether caller or callee)

station apparatus (i.e., telephone, modem, or other device).
                              - 17 -

Transmission facilities consist of three distinct segments:

(1) the main cable, either buried or aerial, (2) the wire (drop

wire) running from the distribution network to and including the

station protector (also known as the block) located on the

outside wall of the customer's premises (together the “drop and

block”), and (3) the wire running from the station protector to

and around the inside of the customer's premises (the inside

wiring).

     As a public utility, the telephone industry is regulated by

the Federal Communications Commission (FCC).   As part of its

regulatory function, the FCC prescribes the accounting treatment

of revenues earned and expenses incurred in the operation of a

telephone business.   The relevant rules are set forth in 47

C.F.R. part 31 (part 31), Uniform System of Accounts for Class A

and Class B Telephone Companies.   During the years in issue, all

of petitioner's subsidiaries were telephone companies subject to

part 31 rules.

     As of January 1, 1981, part 31 specified that the investment

in drop and block be accounted for in FCC account No. 232

(station connections).   As of January 1, 1981, and in accordance

with part 31, petitioner so accounted for its investment in drop

and block.   Beginning January 1, 1984, part 31 was changed and

specified that investment in drop and block be accumulated in FCC

account No. 242 (aerial and buried cable).   For income tax

purposes, petitioner treated property in FCC account No. 232 as
                                  - 18 -

depreciable over 5 years and property in FCC account No. 242 as

depreciable over 15 years.    In petitioner's 1984 and 1985 Federal

income tax returns, the following subsidiaries of petitioner

continued to account for drop and block in FCC account No. 232,

treating it as 5-year property for depreciation purposes:

                                  Company

        UT of PA & Saltillo                 Carolina T&T
        UT of New Jersey                    UT of Florida
        New Jersey Tel. Co.                 United Intermountain
        West Jersey Tel. Co.                UT of Carolinas
        Hillsborough-Montgomery             UT of Indiana
        Sussex Tel. Co. (D)                 UT of the Northwest
        UT of Ohio                          UT Texas & Palo Pinto

     In petitioner's 1984 and 1985 Federal income tax returns,

the following subsidiaries of petitioner accounted for drop and

block in FCC account No. 242, treating it as 15-year public

utility property for depreciation purposes:

                                  Company

                             UT   Arkansas
                             UT   Iowa
                             UT   Kansas
                             UT   Minnesota
                             UT   Missouri
                             UT   West

     Respondent concedes that, if the drop and block property

placed in service during the years in issue is properly

classified by reference to its pre-January 1, 1984, inclusion in

FCC account No. 232 and CLADR Asset Guideline Class 48.13, then,

with the exception of the depreciation described in the preceding

paragraph, the depreciation claimed with respect to that drop and
                                - 19 -

block per return as filed was correct; petitioner is then

entitled to adjustments increasing depreciation for the companies

listed in the preceding paragraph for which drop and block was

treated as 15-year public utility property on petitioner's

Federal income tax returns as filed for 1984 and 1985.

      Petitioner concedes that, if the drop and block placed in

service during the years in issue is properly classified by

reference to its post-December 31, 1983, inclusion in FCC account

No. 242 and CLADR Asset Guideline Class 48.14, then the

depreciation claimed by petitioner in its Federal income tax

returns for 1984 and 1985 with respect to such drop and block

would be reduced, with the result that taxable income would be

increased with respect to the companies which treated the drop

and block as 5-year property.



                                OPINION

I.   Digital Switches

      A.   Introduction

      Petitioner purchased central office equipment (COE or

digital switches) for use in its business of providing telephone

service.    Petitioner claimed investment tax credits (ITC) and

depreciation deductions under the accelerated cost recovery

system (ACRS) with respect to the total cost of each digital

switch, which included the cost of the custom computer software

load (software load) necessary to make each switch operable.      In
                              - 20 -

the notice of deficiency, respondent disallowed that portion of

the claimed investment tax credits and accelerated depreciation

deductions relating to the costs of the software loads.

     The parties agree that, if this Court determines that

petitioner owned the software loads in issue and that those

software loads constitute tangible personal property, petitioner

is entitled to the claimed investment tax credits and accelerated

depreciation deductions.   We conclude that petitioner owned the

software loads in issue and that those software loads constitute

tangible personal property.   Therefore, we hold that petitioner

is entitled to the claimed credits and deductions.

     B.   Analysis

     Today, in Norwest Corp. & Subs. v. Commissioner, 108 T.C.

___, ___ (1997) (slip op. at 27), we decided that operating and

applications software that was subject to license agreements

entitling the taxpayer to use the software on a nonexclusive,

nontransferable basis for an indefinite or perpetual term

qualifies for the ITC as tangible personal property.   In holding

that the taxpayer's acquisition of the software without any

associated, exclusive, intangible intellectual property rights

was precisely the type of investment Congress intended to

encourage in enacting the ITC, we noted that “[i]ntangible

intellectual property rights and the tangible or physical

manifestations or embodiments of those rights are distinct

property interests.”   Id. at ___-___ (slip op. at 26-27) (citing
                              - 21 -

17 U.S.C. sec. 202 (1994)).   We see no material distinction

between the software in the Norwest case and the software loads

in issue here.   In this case, however, respondent has raised the

question of whether petitioner acquired sufficient benefits and

burdens of ownership with respect to the software loads to be

considered the owner of those loads for purposes of the ITC and

the ACRS.

     The parties agree that the issue of ownership of the

software loads is governed by the substance of the sales

agreements between petitioner and the various digital switch

manufacturers, not the labels used in those agreements.    See,

e.g., Tomerlin Trust v. Commissioner, 87 T.C. 876, 881-883

(1986); see also Leahy v. Commissioner, 87 T.C. 56, 66 (1986)

(transfer of the benefits and burdens of ownership govern for

Federal tax purposes, rather than the technical requirements of

passage of title under State law).     The parties also agree that

the direct sales agreement between petitioner and Northern

Telecom, Inc. (NTI), in effect from January 1, 1983, to

December 31, 1985 (the Sprint/NTI agreement), is representative

of all of the agreements pursuant to which petitioner acquired

the digital switches in issue.   Therefore, we must determine

whether petitioner owned the software load transferred by NTI to

petitioner (the NTI software load).    Whether petitioner became

the owner of the NTI software load is a question of fact to be

ascertained by reference to the Sprint/NTI agreement, read in
                                - 22 -

light of the attending facts and circumstances.     See, e.g., Grodt

& McKay Realty, Inc. v. Commissioner, 77 T.C. 1221, 1237 (1981).

     Petitioner acquired from NTI magnetic tapes containing

copies of the computer software necessary to make the digital

switch operable, i.e., the NTI software load, and did not acquire

any of the underlying, exclusive, intangible intellectual

property rights.   See, e.g., 17 U.S.C. sec. 101 (1994) (a

nonexclusive license is not within the definition of the term

“transfer of copyright ownership”).      Petitioner possessed all of

the significant benefits and burdens of ownership with respect to

those magnetic tapes.   NTI simply did not retain a residuary

interest in the NTI software load commensurate with an interest

typically retained by a lessor of property.     See Crooks v.

Commissioner, 92 T.C. 816, 819 (1989) (“interest retained by the

transferor is the primary distinction between a sale and a

lease”).

     First, petitioner paid a fixed amount for the digital

switch, which included the cost allocable to the NTI software

load, and did not incur any obligation to make further payments

for that load, contingent or otherwise.     More importantly,

petitioner acquired the exclusive right to use the NTI software

load for the useful life of the digital switch, which was

tantamount to acquiring the perpetual right to use that

particular load because of the interrelationship between the

switch hardware and software.    In addition, petitioner had the
                              - 23 -

right to transfer the software load in conjunction with a

transfer of the digital switch without NTI's consent.    Respondent

attempts to characterize that right as a “right without

substance” because any new owner of the digital switch would have

to acquire a new software load, unless the switch was used in the

same location.   That condition, however, appears relatively

unrestrictive in light of Sprint's trade of approximately 30

similar digital switches with ConTel Co., in the late 1980s,

which resulted in none of the switches actually changing

location.   Lastly, the Sprint/NTI agreement provided that the

risk of loss with respect to the digital switch, including the

NTI software load, would pass to petitioner upon delivery.

     Respondent points to certain provisions in the Sprint/NTI

agreement as evidence that the benefits and burdens of ownership

did not pass from NTI to petitioner.   In particular, respondent

focuses on certain provisions in the Sprint/NTI agreement that

provide that the software transferred with the digital switch

manufactured by NTI was to be treated as the exclusive property

and trade secret of NTI and that petitioner was under certain

obligations to protect NTI’s interest in the software.    The

provisions of the Sprint/NTI agreement cited by respondent all

relate to NTI’s interest in the intellectual property underlying

the NTI software load.   Those provisions protect, reinforce, and

extend NTI’s intellectual property rights in that software.

NTI’s retention of those rights is consistent with the conclusion
                              - 24 -

that petitioner owned the NTI software load.    Cf. Conde Nast

Publications, Inc. v. United States, 575 F.2d 400, 407 (2d Cir.

1978) (limitations on transferee's rights in subject property

that serve only to protect transferor's interest in other

property do not divest transferee of ownership).    Although those

provisions created certain obligations with respect to

petitioner's ownership of the NTI software load, such as holding

that load in confidence and only making that load available to

employees on a “need to know” basis, petitioner’s ownership

interest in that particular load remained intact.   Moreover, many

of the restrictions imposed on petitioner's use of that load were

also imposed on the technical and proprietary information

relating to the digital switch hardware; apparently, however,

respondent does not question petitioner's ownership of that

hardware.

     In sum, petitioner acquired from NTI all of the significant

benefits and burdens of ownership with respect to the NTI

software load.   The limitations on petitioner's use of that load

served only to protect NTI's underlying intellectual property

rights and did not divest petitioner of ownership in that

particular load.   We find that petitioner owned the NTI software

load and did not purchase any exclusive, intangible intellectual

property rights underlying that load.   In accordance with the

parties' agreement and our holding in Norwest Corp. & Subs. v.

Commissioner, 108 T.C. ___ (1997), we hold that petitioner owned
                                 - 25 -

all of the software loads used in all of the digital switches in

issue and that those software loads constitute tangible personal

property for purposes of the ITC and the ACRS.2   Therefore,

petitioner is entitled to the claimed investment tax credits and

accelerated depreciation deductions.

II.   The Drop and Block Issue

      A.   Introduction

      The drop and block portion of petitioner's telephone network

consists of the wire running from petitioner's transmission

network to a station protector located on the outside of a

customer's premises.   We must determine the depreciation class of

the drop and block for purposes of the ACRS.

2
     In accordance with Norwest Corp. & Subs. v. Commissioner,
108 T.C. ___ (1997), we hold today that the software loads in
issue constitute tangible personal property for purposes of the
investment tax credit (ITC) and tangible property for purposes of
the accelerated cost recovery system (ACRS). Although respondent
does not assert that there exists a distinction in the meaning of
the term “tangible” as it is used in the term “tangible personal
property” for purposes of the ITC and the term “tangible
property” for purposes of the ACRS, we believe that our reliance
on the legislative history of the ITC in Norwest requires at
least a brief discussion of that issue.
     As a preliminary matter, sec. 168 and the regulations
thereunder do not define the term “tangible property” for
purposes of the ACRS. Sec. 168, which implements the ACRS, was
enacted by the Economic Recovery Tax Act of 1981 (ERTA), Pub. L.
97-34, sec. 201, 95 Stat. 203. The relevant committee reports
accompanying the enactment of ERTA indicate that Congress, in
substantial part, considered the ITC and the ACRS to be in pari
materia. See H. Rept. 97-201, at 73-74 (1981); S. Rept. 97-144,
at 47 (1981), 1981-2 C.B. 412, 425; H. Conf. Rept. 97-215, at
206, 213 (1981), 1981-2 C.B. 481, 487, 490. This Court will not
create a distinction unintended by Congress, and, thus, we
conclude that the software loads in issue constitute tangible
property for purposes of the ACRS.
                              - 26 -

     B.   Discussion

          Taxpayers have long been allowed asset
     depreciation deductions in order to allow them to
     allocate their expense of using an income-producing
     asset to the periods that are benefited by that asset.
     * * * an allocation of depreciation to a given year
     represents that year’s reduction of the underlying
     asset through wear and tear. * * *

Simon v. Commissioner, 103 T.C. 247, 253 (1994), affd. 68 F.3d 41

(2d Cir. 1995).   Such wear and tear, or “using up”, can be

thought of as being a gradual sale of the capital asset.      United

States v. Ludey, 274 U.S. 295, 300-301 (1927).   The estimation of

the wear and tear of the capital asset for a given period is

based on the historical cost and does not take into consideration

later fluctuations in valuation through market appreciation.

Fribourg Navigation Co. v. Commissioner, 383 U.S. 272, 277

(1966).   Originally, depreciation was calculated by apportioning

the historical cost of the asset, less its salvage value, to the

period the taxpayer expected to use the asset in his business.

Massey Motors, Inc. v. United States, 364 U.S. 92, 107 (1960).

     At one time, taxpayers were required to establish the useful

life of the asset, which was the period the taxpayer expected to

use the asset in his trade or business, and which did not

necessarily coincide with the economic life of the asset.     Id. at

104; sec. 1.167(a)-1(b), Income Tax Regs.   For assets placed in

service after December 31, 1970 (and before 1981), the asset

depreciation range system (ADR) was the primary means of

determining useful lives.   Sec. 1.167(a)-11, Income Tax Regs.
                                - 27 -

The ADR was meant to objectify and standardize the useful lives

of assets by grouping assets into nearly 125 different asset

guideline classes, each with its own guideline period.      See sec.

1.167(a)-11(b)(4)(i)(b), Income Tax Regs; Rev. Proc. 77-10, 1977-

1 C.B. 548.   Taxpayers had to elect an asset depreciation period

from the ADR assigned to each guideline class, which was 80 to

120 percent of the asset guideline period.      Sec. 1.167(a)-

11(b)(4)(i), Income Tax Regs.    If no ADR was in effect, or if the

taxpayer did not elect to use the ADR system, the useful life was

determined with reference to the facts and circumstances

surrounding the asset.   Simon v. Commissioner, supra.

     In 1981, Congress enacted the ACRS by the Economic Recovery

Tax Act of 1981, Pub. L. 97-34, sec. 201, 95 Stat. 203.      The ACRS

was meant to stimulate the economy by allowing greater

depreciation by taxpayers through shortened depreciation periods,

as well as simplifying depreciation calculations by reducing the

number of property classes from around 125 under the ADR system

to 5.   It was expected that the reduction in the number of

property classes would help alleviate problems associated with

the complexity of the ADR depreciation system.      S. Rept. 97-144,

at 47 (1981), 1981-2 C.B. 412, 425.      The ACRS is mandatory and

must be used for most depreciable property placed in service

after 1980.   Sec. 168(e)(1).   Section 168, in relevant part,

provides:
                               - 28 -

     SEC. 168.   ACCELERATED COST RECOVERY SYSTEM.

          (a) Allowance of Deduction.--There shall be
     allowed as a deduction for any taxable year the amount
     determined under this section with respect to recovery
     property.

                 *    *    *    *    *    *    *

          (c) Recovery Property.--For purposes of this
     title--

               (1) Recovery property defined.--* * *
          the term “recovery property” means tangible
          property of a character subject to the
          allowance for depreciation--

                      (A) used in a trade or
                 business, or

                      (B) held for the production of
                 income.

               (2) Classes of recovery property.--Each
          item of recovery property shall be assigned
          to one of the following classes of property:

                 *    *    *    *    *    *    *

                      (B) 5-year property.--The term
                 “5-year property” means recovery
                 property which is section 1245
                 class property and which is not 3-
                 year property, 10-year property, or
                 15-year public utility property.

                 *    *    *    *    *    *    *

                      (E) 15-year public utility
                 property.--The term “15-year public
                 utility property” means public
                 utility property * * * with a
                 present class life of more than 25
                 years.

The parties agree that drop and block is recovery property.   To

ascertain which class of property includes the drop and block, it
                                              - 29 -

      is necessary to determine the present class life, defined in

      section 168(g)(2):

                    (g) Definitions.--For purposes of this section--

                            *     *       *     *       *    *     *

                         (2) Present class life.--The term
                    “present class life” means the class life (if
                    any) which would be applicable with respect
                    to any property as of January 1, 1981, under
                    subsection (m) of section 167 (determined
                    without regard to paragraph (4) thereof and
                    as if the taxpayer had made an election under
                    such subsection).

               Section 167(m), as it applies to section 168(g)(2), provides

      that the Secretary shall prescribe the class lives for each class

      of property, which will reasonably reflect the anticipated useful

      life of the property class to the industry or group.                      Sec.

      167(m)(1).      The Commissioner issued numerous revenue procedures,

      pursuant to section 167(m), prescribing or modifying class lives.

      See Rev. Proc. 77-10, 1977-1 C.B. 548; Rev. Proc. 72-10, 1972-1

      C.B. 721.      As of January 1, 1981, the following pertinent asset

      guideline classes in Rev. Proc. 77-10, supra, were in effect:

                                                                        Asset Depreciation Range
                                                                              (in Years)

                                                                                 Asset
Asset Guide-                                                            Lower   Guideline   Upper
line Class             Description of Assets Included                   Limit    Period     Limit

  48.13   Telephone Station Equipment:

          Includes such station apparatus and connections as
          teletypewriters, telephones, booths, private exchanges,
          and comparable equipment as defined in Federal
          Communications Commission Part 31 Account Nos.
          231, 232, and 234 . . . . . . . . . . . . . . . . . . . . .     8        10         12

  48.14   Telephone Distribution Plant:
                                      - 30 -
    Includes such assets as pole lines, cable, aerial wire,
    underground conduits and comparable equipment, and
    related land improvements as defined in Federal
    Communications Commission Part 31 Account Nos. 241,
    242.1, 242.2, 242.3, 242.4, 243, and 244 . . . . . . . . . 28     35        42


See also Rev. Proc. 83-35, 1983-1 C.B. 745.3              Under the

regulations promulgated by the FCC for class A and class B

telephone companies,4 as of January 1, 1981, FCC account No. 232

included the original cost of drop and block wires.                 47 C.F.R.

sec. 31.232 (1980).        Pursuant to Rev. Proc. 77-10, supra, FCC

account No. 232 has an asset guideline period of 10 years, making

it 5-year property under section 168(c)(2)(B), while property in

FCC account No. 242 has an asset guideline period of 35 years,

making it 15-year public utility property under section

168(c)(2)(E).      The parties agree that prior to 1984, drop and

block was properly included in FCC account No. 232 and, thus, was

5-year property.       In 1984, the FCC regulations were amended so




3
     Rev. Proc. 83-35, 1983-1 C.B. 745, was meant to replace,
with certain modifications, preceding revenue procedures,
including Rev. Proc. 77-10, 1977-1 C.B. 548, that prescribed
asset guideline classes, asset guideline depreciation periods,
and ranges for the class life asset depreciation range system.
This revenue procedure leaves intact the assets included and the
depreciation range for asset guideline classes 48.13 and 48.14.
4
     Companies having annual operating revenues exceeding
$250,000 are class A telephone companies; Sprint is a class A
company.
                              - 31 -

that drop and block was included in FCC account No. 242.5    47

C.F.R. secs. 31.242:1, 3 (1984).

     Respondent argues that drop and block was FCC account No.

242 property when it was placed in service in 1984 and 1985, and

that FCC account No. 242 property, on January 1, 1981, was

15-year public utility property.   Respondent contends that she is

still using the class lives that were in place on January 1,

1981; the FCC, by changing the accounting treatment of drop and

block, has caused the property to be classified as 15-year

property for the years after January 1, 1984.    Respondent also

cites various reports of the FCC which tend to support its

accounting change.

     Petitioner argues that the plain language of section

168(g)(2) requires that we apply to the property the class lives

that were in effect as of January 1, 1981, thus making drop and

block 5-year property.   Finally, petitioner argues that Congress

has twice amended section 168(g)(2), and those amendments should

be read as requiring specific authorization from Congress for any

departure from the January 1, 1981, class lives.

     Public utilities, whose rates are often mandated by

expenses, are routinely required to utilize uniform systems of

accounting promulgated by regulatory agencies.    See Pacific



5
     Drop and block is actually segregated into Federal
Communications Commission (FCC) account No. 242.1, aerial cable,
or 242.3, buried cable. For our purposes, because both accounts
are treated in the same fashion, we need not make the distinction
and will refer simply to FCC account No. 242.
                              - 32 -

Enters. & Subs. v. Commissioner, 101 T.C. 1 (1993) (gas company);

Kansas City S. Indus., Inc. v. Commissioner, 98 T.C. 242 (1992)

(railroad); Oglethorpe Power Corp. v. Commissioner, T.C. Memo.

1990-505 (electric company); American Tel. & Tel. Co. v.

Commissioner, T.C. Memo. 1988-35 (telephone company).    For

Federal tax purposes, if the generally accepted method of

accounting of a taxpayer is made compulsory by a regulatory

agency, and the method clearly reflects income, it is virtually

presumed to be valid for Federal tax purposes.   Commissioner v.

Idaho Power Co., 418 U.S. 1, 15 (1974).   The FCC accounted for

drop and block in account No. 232 until 1984, when it was

accounted for in account No. 242.1 or 242.3.   Respondent looks to

the administrative justifications for such changes.    Although

there may have been legitimate and persuasive reasons for the

administrative change in accounting by the FCC, as well as some

industry support, we do not need to reach that issue.    It is not

for us today to decide whether the action of the FCC was valid,

justified, or authorized.

     Instead the analysis begins with the plain meaning of the

statute, and for reasons which follow, ends there.    Respondent

contends that the class lives have never changed; that is,

account No. 242 has always been 15-year public utility property.

That is only one-half of the analysis, for we must also apply

those class lives to property as they would have been applied on

January 1, 1981.   The statute, in relevant part, provides that

“`present class life’ means the class life (if any) which would
                                - 33 -

be applicable with respect to any property as of January 1,

1981”.    Sec. 168(g)(2) (emphasis added).    We agree with

petitioner; the language is not ambiguous, and accordingly we

need not peer into the legislative history.      Nevertheless, such

an inquiry would support our analysis.      The intent of the ACRS

was to eliminate disagreement between taxpayers and the

Commissioner and to stimulate economic activity.      One essential

theme of the ACRS was predictable depreciation periods; that was

accomplished by freezing in time the property classifications as

they were on January 1, 1981.    Until further amendment by

Congress, there were to be no changes.

     C.     Conclusion

     Drop and block, as of January 1, 1981, was included in FCC

account No. 232.    That account had an asset guideline period of

10 years, making it 5-year property under section 168(c)(2)(B).

We conclude that drop and block placed in service in the years in

question is 5-year property for purposes of the ACRS.


                                             Decision will be entered

                                         under Rule 155.


     Reviewed by the Court.

     SWIFT, PARR, WELLS, RUWE, WHALEN, BEGHE, FOLEY, VASQUEZ, and
GALE, JJ., agree with this majority opinion.

     CHIECHI, J., did not participate in the consideration of
this opinion.

     COLVIN, J., dissents.
                               - 34 -

     KÖRNER, J., dissenting:   The majority, relying on Norwest

Corp. & Subs. v. Commissioner, 108 T.C. ___ (1997), filed this

date, concludes that the computer software in issue is tangible

for purposes of the investment tax credit and for purposes of the

accelerated cost recovery system (ACRS).    I disagree with the

conclusion reached in Norwest, and respectfully dissent from its

application to this case.

I.   Majority Opinion

      The majority holds that based on Norwest, the software is

tangible, and further that Sprint was the owner of the software.

I did not have a vote in Norwest, and therefore was unable to

voice my opposition at the time of its adoption.    In Norwest, the

Court offers an expansive analysis that discredits the intrinsic

value test; unfortunately, its analysis of its own test is

nowhere near as thorough.   Indeed, one of the faults the Court

found in Ronnen v. Commissioner, 90 T.C. 74 (1988), was that it

lacked "rigorous analysis".    Norwest Corp. & Subs. v.

Commissioner, supra at __ (slip op. at 19).    One would expect

that the Norwest majority, in light of such murky reasoning as it

perceived in Ronnen, would take the opportunity to clear the air

with a definitive test, or at the very least offer some

compelling reasoning to abandon the established precedent of this

Court.   Instead, they summarily conclude, with virtually no

analysis, that the software was tangible.    This conclusion is

based on their interpretation of the legislative history of the

investment tax credit that the tangibility requirement should be
                               - 35 -

construed broadly.    Their conclusion may also be based (it is not

clear) on the fact that Norwest did not possess the right to

distribute, sell, lease, or license the software it purchased

(the "copyright rights").

     A.    Attack on the Intrinsic Value Test

     The Norwest majority attacks this Court's implicit

conclusion in Ronnen that computer programs were different from

the seismic data at issue in Texas Instruments, Inc. v. United

States, 551 F.2d 599 (5th Cir. 1977), and that the inextricable

connection which existed between the seismic data and tapes in

Texas Instruments was not present between the software and disks

in Ronnen.    Norwest Corp. v. Commissioner, supra at __ (slip op.

at 20).    I disagree with the Court's conclusion that there is no

fundamental difference between seismic data and a computer

program.

     The distinction made in Ronnen v. Commissioner, supra, was

appropriate and warranted by the facts.   The seismic data

consisted of the recording of a natural phenomenon.   Although a

recording of a natural phenomenon is the result of human

exertion, it is neither the expression of an idea nor an un-

obvious improvement of prior technology or art.   Accordingly,

copyright or patent protection is not available for it.1

Software, which is the result of human creativity (not mere



1
   Although a recording of music is a recording of a natural
phenomenon which can be copyrighted, it is the creative element
that is copyrightable. See infra.
                                 - 36 -

exertion), can exist as source code on tapes, disks, computer

memory, or written out on paper.      As the result of human

creativity and design, copyright or patent protection2 is

available for it.      I would therefore conclude that there exists a

material difference between the sound recordings in Texas

Instruments and the computer software purchased by Sprint, and at

issue in Ronnen, and Norwest.

        B.   Majority's "Traditional Approach"

     The Norwest result is based upon an interpretation of the

legislative history of the ITC that the term "tangible" should be

construed broadly and possibly in the absence of copyright

rights.      I agree with Judge Jacobs and the other dissenters in

Norwest that the majority's reading of the legislative history is

inappropriate for the reasons stated therein.      No purpose would

be served to repeat those arguments.      There is, however, an

additional factor in Sprint not present in Norwest.      Section 168

requires that property must be tangible to qualify for ACRS

treatment.      The majority points out that the ITC and ACRS were

considered by Congress to be in pari materia, and therefore they

extend their expansive construction of "tangible" property to

ACRS.     Because I disagree that the legislative history requires




2
   Traditionally, software, which is fundamentally a written set
of instructions, was protected under copyright law, and
infringement actions first were brought under copyright law.
Later came a trend to allow patent protection for the design
portion of computer applications. Petry, Taxation of
Intellectual Property, secs. 1.08, 3.04 (1980).
                              - 37 -

such a broad construction for purposes of the ITC, I similarly

disagree with its extension to ACRS.

     1.   Absence of Intellectual Property Rights

     The second basis of the Norwest majority's holding is that

no copyright rights were passed to Norwest (or Sprint).    In

Norwest the Court failed to offer any analysis or cite any cases

which indicate why the presence or absence of such rights should

control the character of the tangible medium which, as the

majority itself points out, is distinct and separate property

from the copyright rights.   Norwest Corp. v. Commissioner, supra

at __ (slip op. at 27).   The notion that copyright rights are

separate and independent from a tangible embodiment is well

supported.   In Rev. Rul. 80-327, 1980-2 C.B. 23, the rights to

manufacture and distribute books were acquired with the plates

used in the printing of the books.     The Service analyzed the two

types of property separately and ruled that the plates were

tangible, while the distribution rights were intangible.    There

simply is no rational basis to conclude that the presence or

absence of one separate and distinct property interest, the

intangible copyright right, should control the character of other

separate and independent property.

     Furthermore, this approach ignores the fact that the

computer source code, which is intellectual property, is property

separate and distinct from the copyright rights and the tangible

medium.   As the Court of Appeals for the Sixth Circuit indicated

in Comshare, Inc. v. United States, 27 F.3d 1142, 1145 (6th Cir.
                              - 38 -

1994), computer software can consist of three types of property:

The tangible computer tapes and disks, the intangible source code

found on the disks, and the intangible copyright rights.   Each of

these types of property must be analyzed separately, unless there

is some compelling reason to analyze them together.   A computer

program, which may be the creative expression of an idea, or an

unobvious improvement on existing technology or art, can be

protected by copyright and/or patent.   Part of this property is

the copyright rights.   This intellectual property can exist in

multiple forms, such as on disk, tape, computer memory, or

written out on paper.   An analysis must take place when a program

is purchased as to what exactly was purchased.   The components

must be identified, and it must be determined whether there is

any compelling reason to consider one or more of the components

together.

     The fallacy of the Norwest approach, and the majority here,

is illustrated by considering that if the same property had been

transferred to Norwest (or Sprint), coupled with a copyright

right, then the property would become intangible.   Further,

consider that if software was purchased in one year, and the next

year the right to reproduce and sell was acquired, where the

controlling factor for character determination is the presence of

that right, then the property would be tangible in year 1 and

intangible in year 2, despite the fact that it was the same

property.
                                - 39 -

      2.   Majority Opinion in Conflict With Case Law

      The majority's reliance on the presence or absence of one or

more intangible intellectual property rights to control character

is in direct conflict with the case law.    In Comshare, Inc. v.

United States, supra, the taxpayer received (by purchase) the

right to distribute the software.     Despite the presence of this

intangible property right, the court went on to conclude that the

software was tangible.     Thus, Norwest is in direct conflict with

Comshare.    The application of the rationale in Norwest to this

case likewise brings this case in conflict with Comshare.

II.   Conservative Approach

      Rather than dispose of a hazy test which this Court adopted

in Ronnen v. Commissioner, 90 T.C. 74 (1988), for another one

which is just as hazy and not supported by any case law, I think

we should clarify the test in Ronnen and attempt to distinguish

Comshare, Inc. v. United States, supra.     To do so would leave

intact our own precedent, as well as its progeny that relied upon

it.

      A.    Identify the Subject Property

      The first step in applying the intrinsic value test is to

identify the subject property, or in other words, determine what

exactly the taxpayer has purchased or created.    In Texas

Instruments, Inc. v. United States, 551 F.2d 599 (5th Cir. 1977),

the court found that seismic data did not exist without the tapes

upon which the data was stored, and accordingly that the data and
                              - 40 -

tapes were inextricably connected.     The intangible information

could not exist without the tangible medium.     See Bank of Vermont

v. United States, 61 AFTR 2d 88-788, at 88-790, 88-1 USTC par.

9169, at 83,250 (D. Vt. 1988).   Thus, the subject property was

the tape that contained the seismic data.     In Comshare, the court

found that the source code was the subject property, but like the

seismic data in Texas Instruments, that it could not exist

without the disks upon which it was stored.     Thus, there the

subject property was the unit consisting of the tapes and disks

which contained the source code.     In Ronnen v. Commissioner,

supra, the subject property was the source code.     We did not find

the same "inextricable connection" that existed between the

seismic data and tapes in Texas Instruments.     We instead found

that the disks containing the source code were but one type of

conduit for the ideas contained on it.     In Rev. Rul. 80-327,

supra, plates to print books were purchased with the copyright

rights to reproduce and sell copies of the books.     The physical

plates containing the creative work product were the subject

property (while the copyright rights were analyzed separately).

     In this case, the subject property is the source code.

Sprint paid a fixed amount for the right to one working copy of

that software.   There was not simply one embodiment of the

software (as was the case in Comshare).     Rather, the intellectual

property existed in more than one locale, and Sprint purchased

the right to use, or possess, a working copy of that intellectual
                                - 41 -

property.    Sprint possessed two copies, while the manufacturer

possessed one.    The record indicates that if Sprint had lost one

of its copies, or if one had been destroyed, it would have been

provided with another by the manufacturer.    The copies were

interchangeable.    There was no significance as to which copy it

used, where it existed, or in what form it existed.    Sprint

purchased the right to use the intellectual property of the

manufacturer.    The nexus between the intangible information and

the tangible medium is far more attenuated here than in Texas

Instruments, and like the software in Ronnen, is independent of

the tapes upon which it was received.    See Bank of Vermont v.

United States, supra.

     B.     Characterize Property

     Once the subject property is identified, it must be

characterized.     This is a facts and circumstances analysis, the

focus of which is upon the relationship between the intangible

intellectual property and any tangible medium upon which it

exists.     In Texas Instruments, the subject property, consisting

of the intangible information (seismic data) and the tapes, was

permanently embodied and inextricably bound.    Therefore, the

property was tangible.     Although in Texas Instruments, the

subject property was not software, we nevertheless borrowed the

analysis and applied it to software in Ronnen.     Although our
                                - 42 -

analysis was less than thorough,3 we concluded that "the

intrinsic value of the [subject] software is attributable to its

intangible elements rather than to its tangible embodiments."

Ronnen v. Commissioner, supra.    Although this phrase is somewhat

ambiguous, because it appears immediately after the Texas

Instruments analysis, I would interpret it to mean that in

Ronnen, the integral connection between the intangible and

tangible present in Texas Instruments did not exist between the

software and the physical medium.    The taxpayer's investment was

not in an intangible which was inextricably bound to the specific

tangible medium upon which it existed, but rather was in the

intangible alone.

      Turning to the software purchased by Sprint, an examination

of what Sprint purchased, the right to a copy of source code that

would operate its switches, leads to the conclusion that the

property right is intangible.

II.   Conclusion

      Based on the foregoing, I cannot agree with the majority

that software is tangible.   Therefore, the software is not

eligible for the ITC or ACRS treatment.   I believe the following

analysis regarding depreciation of the software, in light of its



3
   This discussion illustrates the hazards of adopting a standard
that is less than clear. I cannot adequately emphasize how
improper it would be to abandon our own precedent on the grounds
that it is not fully developed only to replace it by an analysis
that is equally undeveloped.
                                 - 43 -

intangible character, is appropriate.         Petitioner contends that

its costs should be amortized over a period no shorter than 60

months pursuant to section 4.01(2) of Rev. Proc. 69-21, 1969-2,

C.B. 303.    Respondent contends that the software should be

depreciated over 18 years, the asset guideline period for central

office equipment (COE), for the software was an integral part of

the COE.

     Rev. Proc. 69-21, supra, provides in section 4.01:

          (.01) With respect to costs of purchased software, the
     Service will not disturb the taxpayer's treatment of such
     costs if the following practices are consistently followed:

                   *    *    *     *      *      *    *

                 2. Where such costs are separately stated, and
            the software is treated by the taxpayer as an
            intangible asset the cost of which is to be recovered
            by amortization deductions ratably over a period of
            five years or such shorter period as can be established
            by the taxpayer as appropriate in any particular case
            if the useful life of the software in his hands will be
            less than five years.

Under this revenue procedure, if the taxpayer uses a period

shorter than 5 years, he must establish that the useful life is

less than 5 years; otherwise, the Commissioner will let stand the

amortization period.

     The software was separately stated on petitioner's books and

in its purchase invoices from the assets from which it was

purchased.    The only issue is whether petitioner treated the

software as an intangible asset.       Petitioner did not originally

amortize the software pursuant to this revenue procedure but

rather treated the software and COE as one whole asset and
                              - 44 -

depreciated that whole asset pursuant to ACRS.     Sec.

168(c)(2)(B); Rev. Proc. 83-35, 1983-1 C.B. 745, 758.     Petitioner

amortized all other software as an intangible and amortized it

pursuant to Rev. Proc. 69-21, supra, over a 5-year period.

     Respondent argues that petitioner did not treat the software

as an intangible and amortize it on its income tax returns for

the years in issue, and that petitioner has not shown that a 5-

year amortization period is appropriate.   Petitioner does not

need to show that a 5-year period is appropriate, for it did not

claim an amortization period less than 5 years.4

     Respondent looks to the treatment of the COE into which the

software went.   COE's belong to asset guideline class 48.12,

which has an asset guideline period of 18 years for purposes of

the class life asset depreciation range system.     Rev. Proc. 83-

35, 1983-1 C.B. 745.   Under section 168(c)(2)(B), such property

is treated as 5-year property and depreciated over 5 years.

However, as we have held, the software is intangible and

therefore does not qualify for ACRS.   Accordingly, respondent has

determined that ACRS treatment is not available for the software,

but the software is still part of the COE, and therefore

depreciable over 18 years.

     COHEN, CHABOT, JACOBS, GERBER, and LARO, JJ., agree with
this dissent.



4
   If I had to decide whether a shorter period was appropriate, I
would take particular notice of the fact that the software loads
were updated as often as every 6 months, but at least every 2
years.
