United Dominion Indus. v. USA., 98-2380

• Decision Date: 02 December 1999
• Docket Number: No. 98-2380,CA-95-341-MU,98-2380
• Citation: 208 F.3d 452
• Parties: (4th Cir. 2000) UNITED DOMINION INDUSTRIES, INCORPORATED, Plaintiff-Appellee, v. UNITED STATES OF AMERICA, Defendant-Appellant. (). . Argued:
• Court: U.S. Court of Appeals — Fourth Circuit

Page 452

208 F.3d 452 (4th Cir. 2000)

UNITED DOMINION INDUSTRIES, INCORPORATED, Plaintiff-Appellee, v. UNITED STATES OF AMERICA, Defendant-Appellant.

No. 98-2380 (CA-95-341-MU).

UNITED STATES COURT OF APPEALS, FOR THE FOURTH CIRCUIT.

Argued: December 2, 1999.

Decided: March 24, 2000.

Appeal from the United States District Court for the Western District of North Carolina, at Charlotte.

Graham C. Mullen, Chief District Judge.

COUNSEL ARGUED: Richard Farber, United States Department of Justice, Washington, D.C. for Appellant. Eric R. Fox, IVINS, PHILLIPS & BARKER, Washington, D.C. for Appellee. ON BRIEF: Edward T. Perelmuter, U. S. Department of Justice, Washington, D.C. for Appellant. Dirk J. J. Suringa, IVINS, PHILLIPS & BARKER, Washington, D.C. for Appellee.

Before TRAXLER and KING, Circuit Judges, and Margaret B. SEYMOUR, United States District Judge for the District of South Carolina, sitting by designation.

Reversed and remanded by published opinion. Judge King wrote the opinion, in which Judge Traxler and Judge Seymour joined.

OPINION

KING, Circuit Judge:

The question in this case arises from the filing of consolidated tax returns by the predecessor of plaintiff United Dominion Industries, Incorporated (the "taxpayer" or "AMCA" ¹). The taxpayer and the Government (the "IRS") disagree on how to determine the amount of the taxpayer's product liability expenses that may be characterized as "product liability loss."

The IRS appeals from the district court's judgment ordering tax refunds and statutory interest payments to the taxpayer. This dispute involves AMCA's consolidated tax returns for tax years 1983, 1984, 1985, and 1986. On those returns, AMCA characterized the product liability expenses incurred by five of AMCA's twenty-six group members as "product liability loss," which permitted a ten-year carryback of those losses. The five group members, however, each had positive "separate taxable income," as defined by the consolidated return regulations, in each of the relevant tax return years. The issue on appeal is whether, under these circumstances, these five group members' product liability expenses are properly characterized as "product liability loss" on AMCA's consolidated returns.

The district court entered summary judgment in favor of the taxpayer after the IRS and the taxpayer filed cross-motions for summary judgment. We possess jurisdiction pursuant to 28 U.S.C. § 1291. For the reasons explained below, we reverse and remand.

I.

AMCA was the parent of an affiliated group of corporations that properly elected to file consolidated tax returns for tax years 1983 through 1986. In those consolidated tax returns, relying on 26 U.S.C. § 172 (defining "product liability loss" and relevant carryback period, for individual tax returns), AMCA claimed "product liability loss" deductions arising from its group members' product liability expenses.² The product liability expenses of five of AMCA's twenty-six group members are at issue in this case. Those members are: Jesco, Inc.; the Cherry-Burrell Corp.; Amtel, Inc.; and Amtel's two subsidiaries, Litwin Corp. and Litwin Panamerican Corp.

The parties agree that the product liability expenses incurred by the five group members in the relevant years total $1,618,306. The parties also agree that during each of the relevant tax years, AMCA's "consolidated net operating loss" was much larger than the product liability expenses that are in dispute. However, with respect to the challenged refunds, the five group members also had positive "separate taxable income" in each of the relevant tax years.³

The taxpayer seeks to apply product liability expenses deductions to AMCA's consolidated tax returns for four years (1983, 1984, 1985, and 1986) for each of these five group members, except in two cases -Amtel in 1983, and Litwin in 1984.⁴ The taxpayer sought to characterize all of the five group members' product liability expenses deductions as "product liability loss." Further, the taxpayer seeks to carryback these deductions ten years, pursuant to§ 172(b), to AMCA's corresponding consolidated tax returns for tax years 1973 through 1976.⁵ The IRS contends that this position is erroneous, asserting that because the group members each had positive "separate taxable incomes," their product liability expenses are not "product liability loss." Consequently, according to the IRS, these expenses may not be carried back more than three years.

After the parties agreed there was no genuine issue of material fact, the district court granted summary judgment to the taxpayer on the question of law presented by the cross-motions for summary judgment. In doing so, the court determined that the taxpayer may properly characterize all of its group members' product liability expenses as "product liability loss," because the five group members' aggregated product liability expenses were less than AMCA's consolidated net operating loss. The court accordingly ordered the IRS to refund the taxpayer the sum of $1,618,306 in disputed tax payments, plus statutory interest. We find this decision to be in error, for the reasons explained below.

II.

A.

In the case of a taxpayer who files a separate individual tax return, the tax code establishes a basic framework for determining the amount of product liability expenses that may be characterized as "product liability loss." The difference between the taxpayer's gross income and its allowable deductions reflects either the taxpayer's taxable income, or -if the allowable deductions exceed the gross income -its net operating loss. See, e.g., 26 U.S.C. §§ 63(a) (defining taxable income), 172(c) (defining net operating loss). If a net operating loss results, the taxpayer may characterize its product liability expenses as "product liability loss," to the extent that such expenses do not exceed the taxpayer's net operating loss. See 26 U.S.C. § 172(j) (defining "product liability loss" on an individual tax return).⁶ Under § 172(j), any "product liability loss" cannot exceed the taxpayer's "net operating loss."

For example, a taxpayer with a net operating loss of fifty dollars and product liability expenses of seventy-five dollars may characterize no more than fifty dollars of its product liability expenses as "product liability loss." The advantage of such a characterization to the taxpayer is that a deduction for "product liability loss" may be carried backward or forward for up to ten years, rather than the threeyear period that is generally available for loss deductions. See 26 U.S.C. § 172(b)(1)(A), (I) (defining carryover and carryback time periods).⁷ Because on an individual tax return, a taxpayer with positive taxable income has no "net operating loss," a corollary is that a taxpayer with positive taxable income must have zero"product liability loss," notwithstanding the amount of its product liability expenses. This is true because the taxpayer must have a net operating loss before any of its product liability expenses may be classified as "product liability loss."

B.

An affiliated group of corporations may properly elect to file a consolidated tax return through the parent corporation, rather than filing individual tax returns for each of the group members. See 26 U.S.C. §§ 1501-1505 (authorizing consolidated tax returns). Consolidated tax return calculations have both similarities to, and certain distinctions from, those applicable to individual tax returns.

The consolidated tax return regulations require that some information be calculated separately for each group member, similar to calculations that would be necessary had that member filed its own individual tax return. The "separate taxable income" for a group member is calculated in accordance with the tax code provisions covering the determinations of taxable income of separate corporations, subject to modifications. See Treas. Reg. § 1.1502-12 (defining "separate taxable income").⁸ One such modification, for example, is that no net operating loss deduction may be taken into account when computing a group member's "separate taxable income." See id.

Thus, pursuant to the consolidated returns regulations, some important and relevant tax return information from the group members is not included in these per-group-member calculations. Instead, that tax return information is separately designated and utilized in consolidated form. These consolidated amounts and the per-group-member amounts are then combined into the parent corporation's "consolidated taxable income," which accumulates all the relevant information by taking into account: (i) the "separate taxable income of each member of the group;" and (ii) deductions attributable to seven different consolidated amounts, e.g., any "consolidated net operating loss" deduction, and any consolidated charitable contributions deduction. See Treas. Reg. § 1.1502-11(a) (generally defining "consolidated taxable income").⁹

C.

The question in this case -how to properly determine the amount of product liability expenses that may be characterized as "product liability loss" on a consolidated tax return-arises because, before such expenses may be characterized as "product liability loss," a preliminary determination must be made that a net operating loss has occurred. Cf. 26 U.S.C. § 172(j) (defining "product liability loss" on an individual tax return); see discussion supra Part II.A. Both the tax code and the regulations are silent as to whether this "product liability loss" characterization should be determined on a per-group-member basis or on a consolidated basis. The regulations, however, lay the groundwork for this determination by defining several relevant terms: the group members' "separate taxable income" (see Treas. Reg. § 1.1502-12) and "separate net operating loss" (see Treas. Reg. § 1.1502-79(a)); and the parent corporation's"consolidated taxable income" (see Treas. Reg. § 1.1502-11) and "consolidated net operating...