96 T.C. 45 (1991), 33761-85, Harper Group & Includible Subsidiaries v. C.I.R.

Docket Nº:33761-85.
Citation:96 T.C. 45
Opinion Judge:JACOBS, JUDGE:
Attorney:Paul J. Sax, William L. Riley, and Andrew W. Stroud, for the petitioners. Eugene H. Ciranni and Cynthia K. Hustad, for the respondent.
Judge Panel:NIMS, KORNER, SHIELDS, HAMBLEN, COHEN, SWIFT, GERBER, WRIGHT, PARR, COLVIN, and HALPERN, JJ., agree with the majority. WELLS and RUWE, JJ., did not participate in the consideration of this opinion.
Case Date:January 24, 1991
Court:United States Tax Court

Page 45

96 T.C. 45 (1991)




No. 33761-85.

United States Tax Court

January 24, 1991

H, the common parent of an affiliated group of corporations filing consolidated income tax returns, is a holding company which engages, through certain of its domestic and foreign subsidiaries, in businesses related to the international shipment of cargo by air and sea. H organized R, an insurance company subsidiary, to provide liability insurance to H's subsidiaries. R also provided insurance coverage to customers using the shipping services of H's subsidiaries. Premium revenues from such customers accounted for 29%, 32%, and 33% of R's gross premium revenue in 1981, 1982 and 1983, respectively. Respondent disallowed deductions for insurance premiums which H's domestic subsidiaries paid to R during 1981, 1982, and 1983.

HELD, H's affiliated group is entitled to the claimed deductions for insurance premiums paid by its domestic subsidiaries to R.

HELD FURTHER, amounts paid by H's foreign subsidiaries to R are not taxable to H as constructive dividends.

Paul J. Sax, William L. Riley, and Andrew W. Stroud, for the petitioners.

Eugene H. Ciranni and Cynthia K. Hustad, for the respondent.


Respondent determined the following deficiencies in petitioners' Federal income taxes:

Year Deficiency
1981 $5,224,177
1982 2,114,098
1983 3,439,865
After concessions, the issues for decision are: (1) Whether insurance premiums paid by certain domestic subsidiaries of Page 46 The Harper Group (Harper) to Rampart Insurance Company Limited (Rampart), an indirectly wholly owned subsidiary of Harper, are deductible under section 162, [1] and if not (2) whether the premiums paid by certain foreign subsidiaries of Harper to Rampart constitute constructive dividends to Harper. Amounts paid for insurance are deductible business expenses. Section 162; Section 1.162-1(a), Income Tax Regs. Amounts set aside for the payment of anticipated losses through reserves or otherwise, as a plan of self-insurance, are not. [2] Spring Canyon Coal Co. v. Commissioner, 43 F.2d 78 (10th Cir. 1930); Pan-American Hide Co. v. Commissioner, 1 B.T.A. 1249 (1925); Humana v. Commissioner, 88 T.C. 197, 213 (1987), affd. in part and revd. in part 881 F.2d 247 (6th Cir. 1989). Captive insurance transactions, such as the one before us, straddle the fence between ordinary insurance and self-insurance. The deductibility of premiums paid to a captive insurer [3] has been before this and other courts on numerous occasions. See Amerco and Subsidiaries and Republic Western Insurance Company v. Commissioner, 96 T.C. ____ (1991); Gulf Oil Corp. v. Commissioner, 89 T.C. 1010 (1987), affd. on this issue, revd. on other issues 914 F.2d 396 (3d Cir. 1990); Humana, Inc. v. Commissioner, supra; Clougherty Packing Co. v. Commissioner, 84 T.C. 948 (1985), affd. 811 F.2d 1297 (9th Cir. 1987); Carnation Co. v. Commissioner, 71 T.C. 400 (1978), affd. 640 F.2d 1010 (9th Cir. 1981). See also Beech Aircraft Corp. v. United States, 797 F.2d 920 (10th Cir. 1986); Stearns-Roger Corp. v. United States, 774 F.2d 414 (10th Cir. 1985), affg. 577' F.Supp. 833 (D. Colo. 1984); Crawford Fitting Co. v. United States, 606 F.Supp. 136 (N.D. Ohio 1985); Mobil Oil Corp. v. United States, 8 Cl. Ct. 555 (1985). Except for Amerco and Subsidiaries and Republic Western Insurance Co. v. Commissioner, supra, Crawford Fitting Co., supra, and Humana, supra (in part), the arrangement involved in each of those cases, although styled as insurance, was found to be self- insurance. Page 47 The case law in the captive insurance arena draws a dichotomy between true insurance and arrangements which have been found to constitute, in substance, self-insurance. For the reasons hereinafter set forth, we find that Harper's captive insurance arrangement falls on the insurance side of the line; thus, we conclude that the premiums paid by the Harper domestic subsidiaries to Rampart are deductible business expenses. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and accompanying exhibits are incorporated herein. BACKGROUND Harper is a California corporation that had its principal office in San Francisco, California, at the time the petition was filed. It is tax holding company which directly and indirectly owns subsidiaries in the United States and throughout the world. The subsidiaries engage in a number of businesses related to the international shipment of cargo by air and sea, including freight forwarding. Each subsidiary handles an extensive variety of cargo and incurs liability in different capacities, such as an indirect air carrier, an airline agent, an ocean freight forwarder, a steamship agent, a breakbulk agent, a clearing agent, and a customshouse broker. Air freight operations are conducted principally through Harper's wholly owned subsidiary, Circle Airfreight Corporation (CAC), a California corporation, and CAC's foreign subsidiaries. Ocean freight operations are conducted principally through Harper's wholly owned subsidiary, Harper Robinson & Co. (Harper Robinson), a California corporation. During the years in issue (1981-1983), Harper Robinson owned 60 percent and CAC owned 40 percent of Western Navigation (Far East) Limited (WNFE), a Hong Kong company. WNFE was Harper's operating subsidiary in Hong Kong, engaging in both air and ocean freight forwarding. WNFE owned 100 percent of Rampart, a Hong Kong company. Page 48 In the course of their international air and ocean freight forwarding businesses, Harper's subsidiaries incur legal liability under bills of lading, forwarder receipts, air waybills, tariffs, contracts, etc., pursuant to applicable treaties, statutes, and international law for loss or damage to their customer's cargo. International freight forwarders customarily obtain marine liability insurance (for both ocean and air shipment) for protection against potential liability. Customers of freight forwarders and indirect air carriers customarily obtain shipper's interest cargo insurance to supplement the liability coverage provided by applicable treaties, statutes, and international law. Prior to 1969, Harper purchased marine legal liability insurance and its customers purchased shipper's interest insurance through various unrelated insurance companies. In 1969, CAC and Harper Robinson obtained marine cargo insurance through an open cargo policy with Commercial Union Insurance Company (Commercial Union), which is unrelated to Harper and its subsidiaries. [4] The Commercial Union open cargo policy not only insured the legal liability of CAC and Harper Robinson but also allowed them to provide shipper's interest cargo insurance to their customers. Harper and thirteen of its domestic subsidiaries (which included CAC, J.R. Michels, Inc., and Circle Airfreight Japan, Ltd. [5]) filed consolidated Federal income tax returns for the years in issue. In the consolidated returns, deductions were claimed for insurance premiums paid to Rampart by the three aforementioned domestic subsidiaries of Harper as follows:
Domestic subsidiaries 1981 1982 1983
CAC $894,935 $831,015 $879,313
J.R. Michels, Inc. 117,000 117,000 117,000
Circle Airfreight Japan, Ltd. 28,800 28,800 28,800
1,040,735 976,815 1,025,113
Respondent disallowed the deductions for the aforementioned insurance premiums and increased the consolidated Page 49 income of the Harper affiliated group by treating as constructive dividends to Harper, CAC, and Harper Robinson the amount of insurance premiums which Harper's foreign subsidiaries [6] paid to Rampart (on the theory that the foreign subsidiaries were " merely instruments in Harper's overall self-insurance scheme from which Harper [CAC and Harper Robinson] received the primary benefit" ), as follows:
1981 1982 1983
Harper $265,988 $146,727 $159,925
CAC 213,268 187,655 197,889
Harper Robinson 108,969 119,828 107,241
RAMPART In 1974, Harper's management decided to form an insurance subsidiary to provide substantially the same insurance coverage which Commercial Union had been supplying. To this end, Rampart was incorporated in March, 1974. Rampart's insurance policies were closely modeled after the Commercial Union policy although liability limits provided by Rampart were higher. The Commercial Union policy was terminated in 1975. Rampart complied with Hong Kong law governing the regulation of business corporations and insurance companies. It was duly authorized to carry on a marine insurance business in Hong Kong and was regulated by the Insurance Registry of Hong Kong.
Insurance premiums paid to Rampart
Foreign subsidiaries 1981 1982 1983
WNFE $97,015 $115,114 $94,135
CAC-Taiwan 23,760 23,760 23,760
CAC-Singapore 39,600 39,600 39,600
CAC-Thailand 1,800 1,800 1,800
CAC-U.K. 238,988 119,727 123,825
CAC-South Africa 15,000 1,500 15,000
CAC-Germany 18,000 1,800 18,000
CAC-N.Z. 5,613 7,150 5,298
CAC-Canada 27,000 27,000 27,000
CAC-Australia 102,009 97,319 88,097
CAC-Philippines 19,440 19,440 19,440
CAC-Spain 7,000
CAC-Portugal 2,100
Page 50 The initial paid-in capital of Rampart was HK $200,000 (U.S. $40,000). In January 1981, the share capital of Rampart was increased to HK $5,000,000 (U.S. $848,081) in compliance with a Hong Kong law requiring insurance companies to maintain minimum share capital in that amount. Rampart maintained its own books of account, business records, bank accounts, and investments. Rampart shared facilities and employees with WFNE, and reimbursed WFNE therefor; otherwise, Rampart conducted its business in a manner consistent with its status as a separate corporation. Each year, it filed a profits tax return with the Hong Kong Inland Revenue...

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