Gulf Oil Corp.. v. Comm'r of Internal Revenue
| Citation | 89 T.C. No. 70,89 T.C. 1010 |
| Decision Date | 24 November 1987 |
| Docket Number | Docket No. 22499-82 |
| Parties | GULF OIL CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | United States Tax Court |
OPINION TEXT STARTS HERE
In 1971 Gulf incorporated Insco, a wholly owned foreign subsidiary, to conduct a general insurance business. During 19 74 and 1975 Gulf and its affiliates insured risks with unrelated insurance carriers who, by prearrangement, reinsured with Insco and ceded premiums on such reinsurance to Insco. Insco paid claims on the reinsured risks. In 1975 Insco began insuring risks of unrelated parties. Net premium income from unrelated parties represented 2 percent of its total net premium income in 1975.
The Commissioner determined that premium payments made by Gulf and its domestic affiliates were not deductible to the extent those payments were ceded to Insco. He also recharacterized as constructive dividends to Gulf the premiums paid by the foreign affiliates which were ceded to Insco. In addition, he recharacterised as constructive dividends to Gulf the payments of claims by Insco to Gulf and its domestic affiliates. HELD, the sums paid to Insco are not deductible as ordinary and necessary business expenses. Humana v. Commissioner, 88 T.C. 197 (1987); Clougherty Packing Co. v. Commissioner, 84 T.C. 948 (1985), affd. 811 F.2d 1297 (9th Cir . 1987); and Carnation Co. v. Commissioner, 71 T.C. 400 (1978), affd. 640 F.2d 1010 (9th Cir. 1981), followed. HELD FURTHER, the premiums paid by the foreign affiliates to Insco and the claims paid by Insco do not constitute constructive dividends to Gulf.See Mobil Oil Corp. v. United States, 8 Cl. Ct. 555 (1985). J. Waddy Bullion, Emily A. Parker, Sean T. Crimmins, Buford P. Berry, J. Y. Robb III, and Margaret S. Alford, for the petitioner.
Joel V. Williamson and Joseph R. Goeke, for the respondent.
*
The Commissioner determined deficiencies in petitioner's Federal income tax for the taxable year 1974 in the amount of $80,813,428 and for the taxable year 1975 in the amount of $166,316,320. Petitioner, respondent, and the Court agreed that certain issues would be severed and tried at a special trial session. 1 One of the issues tried was designated as the ‘Insco issue.‘ It involves the following two questions:
1. Whether petitioner may deduct as ordinary and necessary business expenses amounts paid as insurance premiums by Gulf Oil Corporation and its domestic affiliates to the extent that those payments were ceded to its wholly owned captive insurance company, Insco, Ltd.; and
2. Whether the payments designated as premiums made by the foreign affiliates of Gulf Oil Corp. which were ceded to Insco, Ltd., and the claims paid by Insco, Ltd., to Gulf Oil Corp. and its domestic affiliates represent constructive dividends to Gulf Oil Corp.
Some of the facts have been stipulated. The stipulation of facts and accompanying exhibits are so found and incorporated by this reference.
Gulf Oil Corporation (hereinafter referred to as petitioner or Gulf) is a corporation organised under the laws of the Commonwealth of Pennsylvania with its principal office in Pittsburgh, Pennsylvania. During the taxable years a issue, Gulf and certain of its subsidiary corporations constituted an ‘affiliated group‘ as that term is defined in section 1504. 2 Petitioner, directly and through its foreign subsidiaries and affiliates, is engaged in world-wide exploration, development, production, purchase, transportation, and marketing of petroleum products. Petitioner maintained its books of account for the taxable years in issue on the accrual method of accounting using the calendar year as its taxable year. Gulf, as the common parent of an affiliated group of corporations, timely filed consolidated Federal income tax returns for its taxable years 1974 and 1975 on behalf of itself, and certain of its subsidiary corporations, with the Office of the Internal Revenue Service at Pittsburgh, Pennsylvania.
When the law of large numbers operates, the risk of each policyholder is divided into small units and is transferred to and distributed among the policyholders. As the Supreme Court stated in Group Life & Health Ins. Co. v. Royal Drug Co., 440 U.S. 205, 211 (1979):
It is characteristic of insurance that a number of risks are accepted, some of which involve losses, and that such losses are spread over all the risks so as to enable the insurer to accept each risk at a slight fraction of the possible liability upon it. »Citations omitted.†
Thus, risk transfer and risk distribution occur upon the issuance of each policy. 11
One is compelled to conclude that Judge Goffe, Dr. Plotkin and Mr. Stewart can only reach their conclusion by adopting the economic family theory, an approach not based on insurance principles, but rather on the principle that the capital of the affiliates remains at risk, regardless of the
identity of the captive's insureds, because the affiliates and the captive are related. 3 As the majority points out we have rejected this theory in the past and we do not, despite Judge Goffe's view to the contrary, adopt that theory here simply because the experts rely on it.
Instead, the majority relies on principles of the insurance industry to distinguish between arrangements which are in essence self-insurance and arrangements which will be recognized as insurance for tax purposes. The majority recognizes that there are circumstances under which a captive should be treated as a separate corporation providing insurance to its affiliates and premiums paid by the affiliates should be deductible.
I also disagree with Judge Goffe that the theory of the majority is ‘new and novel‘ and is in direct conflict with case law holding that insurance requires risk shifting and risk distribution.
Gulf's principal arguments throughout its briefs are that Insco should be treated as a separate corporate entity and that the agreements entered into by Gulf, Gulf's affiliates and Insco are insurance, under the definition set forth in Helvering v. Le Gierse, for which premiums paid should be deductible. 4 Gulf argues that the agreements resulted in a transfer of risk because Insco was financially capable of meeting its obligations and that therefore Insco, rather than Gulf and its affiliates, bore the risk of loss. Gulf further
argues that risk distribution was achieved both by the types of risks Insco insured and the parties who were insured. Gulf maintains that this should be true regardless of whether the captive insured unrelated parties. Alternatively it contends that the insurance of unrelated third parties is relevant because
Set forth below is a schedule of Gulf and its foreign and domestic affiliates whose risks were reinsured with Insco during the taxable years 1974 and 1975 along with their respective country of incorporation:
+--------------------------------------------------+
¦ ¦Country of ¦
+------------------------------------+-------------¦
¦Name ¦incorporation¦
+------------------------------------+-------------¦
¦Gulf Oil Corp. ¦U.S. ¦
+------------------------------------+-------------¦
¦Mene Grande Oil Co. ¦U.S. ¦
+------------------------------------+-------------¦
¦Ecuadorian Gulf Oil Co. ¦U.S. ¦
+------------------------------------+-------------¦
¦Zaire Gulf Oil Co. ¦U.S. ¦
+------------------------------------+-------------¦
¦Key International Drilling Co., Ltd.¦Bermuda ¦
+------------------------------------+-------------¦
¦Britama Tankers, Ltd. ¦England ¦
+------------------------------------+-------------¦
¦Belgulf Tankers, NV ¦Belgium ¦
+------------------------------------+-------------¦
¦Nedgulf Tankers, NV ¦Belgium ¦
+------------------------------------+-------------¦
¦Fuel Transport Co., Ltd. ¦Liberia ¦
+------------------------------------+-------------¦
¦Compannia Maritima Rio Gulf Co., SA ¦Spain ¦
+------------------------------------+-------------¦
¦Gulf Oil Company (Nigeria), Ltd. ¦Nigeria ¦
+------------------------------------+-------------¦
¦Afran Transport Co. ¦Liberia ¦
+------------------------------------+-------------¦
¦Gulftankers, Inc. ¦Liberia ¦
+--------------------------------------------------+
Insco paid claims to primary carriers relative to all risks it reinsured totaling $1,001,444 and $3,107,212 for the years 1974 and 1975, respectively. No part of the claims paid in 1974 and only $48,018 of the claims paid in 1975 related to the risks of unrelated third parties.
Members of the American International Group, Inc. (AIG), served as primary insurers for a substantial amount of the risks of Gulf and its affiliates that were reinsured with Insco. On December 20, 1973, Gulf executed a guaranty in favor of AIG that obligated Gulf to indemnify AIG in the event Insco could not meet its obligations regarding the risks it reinsured. The AIG guaranty remained in effect throughout the relevant years. On December 20, 1973, Gulf also executed a similar guaranty relative to the risks reinsured by Oil Industry Association. The latter guaranty, or a substituted version thereof, was in effect throughout the relevant years. Gulf was never required to indemnify any primary insurers under these guaranties.
In 1975 several changes in the operation and structure of Insco were made. Among these changes, Gulf transferred ownership of Insco to Transocean Gulf Oil Company (Transocean), a wholly owned Gulf holding company. At this time Insco called its issued but non-paid-up shares and Transocean...
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