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July 19, 1977

AMERICAN TELEPHONE AND TELEGRAPH COMPANY et al., Defendants and Third-Party Plaintiffs, v. UNITED STATES of America, Third-Party Defendant

Edward Weinfeld, District Judge.

The opinion of the court was delivered by: WEINFELD


EDWARD WEINFELD, District Judge.

 In this class action, plaintiffs seek to recover from the American Telephone and Telegraph Company ("AT&T") and twenty-three companies affiliated with it (the "operating companies") a portion of the federal communications excise taxes which defendants collected from plaintiffs and paid over to the United States Government. Plaintiffs claim that those taxes were collected by reason of a contract, combination or conspiracy among the defendants in restraint of interstate commerce, in violation of Section 1 of the Sherman Act, *fn1" and seek treble damages. Alternatively, plaintiffs contend that the defendants violated an alleged statutory duty under the Excise Tax Reduction Act of 1965 *fn2" ("the Act"), and seek recovery of taxes paid as a proximate result of the defendants' alleged breach of duty. *fn3"

 The case arises out of a provision of the Act which exempted from the excise tax generally imposed on local telephone service, "private communication service," such as intercommunication between different telephones in the subscriber's office, if a separate charge is made for such intercommunication. *fn4" The plaintiffs are users of Centrex systems, a form of business telephone service which permits both intercommunication and calls to and from the outside telephone network. The gist of their complaint is that the defendants failed to establish a separate charge for the intercommunication portion of Centrex between 1965 and 1971 or 1972, and that, as a result, the plaintiffs paid a greater amount of excise tax than they would have paid had such a separation of charges been made. *fn5"


 a. The Parties

 The plaintiff class consists of all persons who were taxable *fn6" Centrex subscribers of one or more of the defendant operating companies at any time between January 1, 1966, the effective date of the Act, and the effective date in 1971 or 1972 of the operating companies' tariffs establishing a separate Centrex charge for intercommunication, and who did not request exclusion from the class. This includes over a thousand subscribers with over 1,400 Centrex locations.

 Collectively the defendants, along with certain other subsidiaries of AT&T, *fn7" are sometimes referred to as the Bell System. The relationship among the various companies of the Bell System was described by one witness as a "federal system." Each of the operating companies is an independently organized, autonomous corporation managed by its own board of directors, providing local telephone service, *fn8" including Centrex service, in one or more states. Each operating company also connects with the facilities of other telephone companies, including non-Bell System companies and the Long Lines Department of AT&T, to provide long-distance calls to and from its service area. The local telephone service, including Centrex service, of each of the operating companies is subject to regulation under state laws intended to protect the public against excessive or unduly discriminatory rates. *fn9" Within its service area each operating company is the only company authorized under these laws to render Centrex service. These laws further require that the types of telephone service and the rates charged by each operating company be set forth in tariffs filed with the public utility commission in each state. *fn10" In general, no changes can be made in rates or service until an amendment to the tariff is filed with, and allowed to become effective by, the public utility commission. *fn11" Thus each of the operating companies, within its service areas, is a regulated monopolist.

 Although the operating companies are independently organized, they are closely affiliated with each other and with AT&T. AT&T owns all of the capital stock of sixteen of the operating companies, at least 70% of the capital stock of five, and a substantial minority interest in the other two. *fn12" An AT&T officer sits on the board of directors of each of the operating companies except one, and transfers of personnel between the operating companies and AT&T are common. The president of each of the operating companies is chosen with the concurrence of the chairman of the board of AT&T.

 The operating companies are also affiliated with AT&T by virtue of license agreements. Under these agreements each operating company uses AT&T's patented telephone equipment within its service area. The license agreements obligate AT&T to engage in research and development and to provide technical advice and assistance to the operating companies in a wide range of matters. This assistance is rendered, for example, by responses to specific inquiries from the operating companies, by conferences involving personnel from all the operating companies and AT&T, and by memoranda and newsletters prepared by persons at AT&T and distributed throughout the Bell System. Through system-wide task forces and committees the operating companies often participate in preparing materials on which AT&T's recommendations are based. As a result, AT&T's advice is usually followed by the operating companies, with variations to account for local situations. Of particular relevance to this case is the fact that most of the operating companies generally relied on AT&T for information and advice relating to the federal excise tax.

 b. Characteristics of Telephone Service

 The nature of this case requires a fairly detailed description of some of the technical aspects of telephone service. Ordinary telephone service consists of the privilege of making calls within a local exchange area and, upon payment of an additional amount (message units or a toll charge), outside that area, plus the privilege of receiving telephone calls from any telephone within or outside the local exchange area. A subscriber receives access to the telephone network through a "line" or "loop" (usually consisting of a pair of wires) which is run from the telephone company central office to the subscriber's premises. At the subscriber's end, the line terminates in a "station," a broad term to describe the telephone instrument or other equipment used by the subscriber. When the subscriber makes a telephone call, switching equipment at the telephone company central office (or, in the case of long distance calls, at several telephone company offices) connects his line to the line of the called telephone, thereby completing the call. This ability to place calls through the telephone network is known as "exchange access."

 A business or other organization which has a large number of personnel at one location generally will have more than one exchange access line and more than one station. Such a subscriber often finds that there are many calls between its own stations and desires a specific service for such intercommunication. Equipment for intercommunication can be leased or purchased from a non-Bell System company or provided by an operating telephone company. However, prior to 1968, the defendants' tariffs provided that non-Bell System equipment could not be connected with the telephone network. *fn13" Thus, a subscriber who obtained his intercommunication equipment from a competitor of one of the defendants required two telephone systems -- one for exchange access and one for intercommunication.

 (i) PBX Service

 For many years prior to the introduction of Centrex service in 1961, the operating companies provided the capability of intercommunication among a subscriber's stations and exchange access through Private Branch Exchange ("PBX") service. The switching equipment for PBX service is generally located on the subscriber's premises. Each of the subscriber's stations is connected to this PBX switching equipment by a station line, and the switching equipment is connected in turn to the telephone company central office by a number of "trunks," or pairs of wires (physically similar to the lines used for ordinary telephone service) which provide exchange access. However, since not all of a PBX subscriber's stations are likely to be making outside calls at once, a PBX subscriber generally has many fewer trunks than stations. In addition, one or more attendant positions such as switchboards or consoles are connected to the PBX switching equipment. A PBX subscriber generally pays a separate monthly charge for the service provided by each PBX station, each PBX trunk, each attendant position and the PBX switching equipment, as well as charges for any supplemental services furnished.

 An incoming call to a PBX system arrives over one of the trunks connecting the PBX switching equipment to the telephone company central office, and rings at the attendant's position. After answering the phone and ascertaining which individual or extension the caller wishes, the attendant completes the call by establishing a connection between the trunk line on which the call is coming in and the desired station line. If a person wants to make an outgoing call from one of the PBX stations, his station line is connected through the PBX switching equipment -- either manually by the attendant (as with incoming calls) or automatically -- to one of the trunks connecting the PBX switching equipment to the telephone company central office. The call is then dialed and routed through the central office as with ordinary telephone service. If a person wants to call from one PBX station to another within the subscriber's system, the station lines are connected through the PBX switching equipment, either automatically or manually by the attendant.

 In 1961, message unit and toll calls could not ordinarily be identified to the individual PBX station which made the call; rather, they were billed to the subscriber's PBX system as a whole. However, at that time six of the defendant operating companies furnished PBX with identified outward dialing ("IOD"), which permits identification of the individual station making the outward toll call for the customer's administrative purposes. The only type of IOD available with PBX service in 1961 was Centralized Automatic Message Accounting ("CAMA"), in which outgoing calls are interrupted by an operator at a telephone company office, who asks the caller for the number he is calling from and records it for use in billing. However, certain more advanced types of switching equipment which did not become available for use with PBX until 1965 or thereafter are capable of identifying the calling station automatically, by a process known as automatic number identification ("ANI"). Both CAMA and ANI provided essentially the same service, that is, IOD.

 Another service feature provided by some of the operating companies with their PBX service prior to 1961 was direct inward dialing ("DID"). DID enables persons outside the subscriber's PBX system to dial any PBX station within the system directly, bypassing the attendant station. Prior to 1961 twelve operating companies offered PBX with DID, including the same six who offered PBX with IOD.

 (ii) Centrex Service

 In 1961 the operating companies began to offer Centrex service, which is the subject of this litigation. Centrex service, like PBX service, provides the capability of intercommunication among the telephone stations within the subscriber's Centrex System, as well as exchange access. *fn14" While the precise nature of Centrex service varied among the operating companies, in broad outline it was similar throughout the Bell System. Centrex service can be provided using two different physical arrangements, known as Centrex-CU (for "Customer") and Centrex-CO (for "Company" or "Central Office"), depending on the location of the switching equipment. These two types of Centrex service are functionally similar. Each permits intercommunication and exchange access. In addition, each allows incoming calls to be dialed directly to an individual Centrex station (DID) and permits identification of the particular station making a message unit or toll call (IOD).

 However, there are several differences between the equipment used in Centrex-CU and that used in Centrex-CO. Centrex-CU uses essentially the same equipment as PBX service with DID and IOD. Thus, the switching equipment is located on the customer's premises, and is connected to the central office by trunks. In Centrex-CO, on the other hand, all the switching equipment is located at the telephone company central office, and each Centrex station is connected to the central office by an individual line. Calls between Centrex stations, as well as outside calls, are routed through the central office. Second, ANI was initially available only with Centrex-CO, which used more advanced switching equipment; until ANI became available with the PBX switching equipment used in Centrex-CU after 1965, Centrex-CU could provide IOD only through an operator, by means of the CAMA system described above. However, despite these differences between Centrex-CU and Centrex-CO, the overall service provided by each was essentially similar.

 Like the technical aspects of Centrex service, the Centrex rate structure varied somewhat from jurisdiction to jurisdiction, but there were broad areas of similarity among all the operating companies. Whereas PBX rates are based upon a separate monthly charge for the service provided by each individual piece of equipment, the operating companies' Centrex tariffs established a "package" rate, including the cost of all the facilities and equipment required. Thus during the period relevant to this litigation, from 1961 to 1971 or 1972, a Centrex subscriber paid a single monthly charge for each Centrex station and attendant position, which covered both exchange access and intercommunication, rather than separate monthly charges for the various pieces of equipment used. Moreover, although the costs of providing Centrex-CO and Centrex-CU differ because of the different equipment used, Centrex service had a single composite rate regardless of serving method, based on an average of the costs of Centrex-CO and Centrex-CU. The only difference was that the rates for Centrex-CO were slightly higher to reflect the floor space and power provided by the telephone company for the switching equipment which was located on its premises, rather than on the subscriber's as in the case of Centrex-CU. Finally, a Centrex subscriber did not generally have a choice of whether he would receive Centrex-CO or Centrex-CU because Centrex service was a single offering. The tariffs of most of the operating companies reserved to the company the right to determine which type of equipment would be used in each case. Even when the tariff did not explicitly so provide, the company generally made the decision itself based upon considerations of which type of service could be provided more economically.

 c. The Federal Communications Excise Tax

 From 1917 to 1924 *fn15" and from 1932 to date, *fn16" telephone and other communications services have been subject to a federal excise tax. This tax is imposed upon the person paying for the telephone service, but the company providing the service is required to collect the tax from its subscribers and remit it to the government. *fn17" In 1961, when the operating companies began to offer Centrex service, a tax of 10% was imposed on the amounts paid for "general telephone service." Essentially "general telephone service" included any kind of local telephone service which permitted exchange access, i.e., which permitted the subscriber to complete a call through a local exchange. *fn18" The statute specifically prescribed that PBX service was "general telephone service." *fn19" In addition, since Centrex service permitted local exchange access, it too was taxable as "general telephone service." However, since the defendants' tariffs at that time prohibited intercommunication equipment furnished by a non-Bell System company from being connected to the telephone network, *fn20" such equipment was not capable of providing exchange access and was not taxed, since it did not fall within the definition of "general telephone service." This created a competitive disadvantage for the defendants' PBX and Centrex services, since they were taxed while their competition was not.

 The Act substantially restructured the provisions of the communications excise tax, in part "to make it clear that it is the service as such which is being taxed and not merely the equipment being supplied." *fn21" To ameliorate the defendants' competitive disadvantage, the Act exempted from the tax, as of January 1, 1966, "private communication service," defined in relevant part as:

communication service furnished to a subscriber which entitles the subscriber . . . to the use of an intercommunication system for the subscriber's stations, regardless of whether such . .. intercommunication system may be connected through switching with [a local telephone exchange.]22

 The congressional committee reports noted that this provision was added to remove the defendants' "severe competitive handicap" in furnishing intercommunication systems. *fn23"

 However, the Act further provided that intercommunication service was not tax-exempt "unless a separate charge is made for such service." *fn24" Because the defendants' PBX rates were based upon a charge for each individual piece of equipment used, a "separate charge" could be identified for those portions of a PBX system devoted to intercommunication, such as the PBX switching equipment, and those devoted to exchange access, such as the trunks. Amounts paid by a PBX subscriber for the former items were therefore exempt from the tax. However, since Centrex was billed on a "package rate" basis, covering the entire cost of service in one charge, there was no separate charge for intercommunication distinct from that for exchange access, and thus the entire amount paid by a subscriber for Centrex service was taxable even after passage of the Act. *fn25" This was recognized in the congressional committee reports:

It is understood that . . . PBX systems generally will immediately qualify for this exemption. However, it is understood that Centrex systems -- where the switching equipment is generally on the premises of the local exchange rather than on that of the subscriber -- generally do not, as yet, provide for a charge which is separate and distinct from that for local telephone service. Until such a separation is made, this exemption, therefore, will not apply in the case of Centrex service. *fn26"

 In passing the Act, Congress contemplated a gradual reduction and eventual elimination of the telephone excise tax. Thus the tax was to be reduced from 10% to 3% on January 1, 1966, with subsequent annual reductions of 1% until it was eliminated entirely. However, shortly after the reduction to 3% took effect it was rescinded. Between 1966 and 1970 the reduction and elimination of the tax was postponed several times because of the government's need for revenue during the Vietnam War. *fn27" Finally, in 1970, Congress provided that the excise tax would remain at 10% through 1972, and then over a ten-year period would be reduced 1% each year until its ultimate elimination on January 1, 1982. *fn28" Until 1971 the tariffs of all the operating companies continued to contain a package rate for Centrex service. Thus during that period the members of the plaintiff class were taxed on the entire amount they paid for Centrex service at the rate of 10%, while PBX customers and persons who obtained intercommunication systems from non-Bell System companies were taxed only on the amounts they paid for exchange access, and not on the amounts they paid for intercommunication. It was not until 1971 or 1972 that the various operating companies filed revised tariffs establishing separate charges for exchange access and for intercommunication.

 Against this extensive factual background the Court considers the ...

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