Chrysler Corp. v. C.I.R.

• Decision Date: 08 February 2006
• Docket Number: No. 03-1214.,03-1214.
• Citation: 436 F.3d 644
• Parties: CHRYSLER CORPORATION, fka Chrysler Holding Corporation, as Successor by Merger to Chrysler Motors Corporation and its Consolidated Subsidiaries, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

436 F.3d 644

CHRYSLER CORPORATION, fka Chrysler Holding Corporation, as Successor by Merger to Chrysler Motors Corporation and its Consolidated Subsidiaries, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 03-1214.

United States Court of Appeals, Sixth Circuit.

Argued: September 14, 2005.

Decided and Filed: February 8, 2006.

COPYRIGHT MATERIAL OMITTED

ARGUED: Jennifer L. Fuller, Kenneth B. Clark, Fenwick & West, Mountain View, California, for Appellant. Joan I. Oppenheimer, Bridget M. Rowan, United States Department of Justice, Washington, D.C., for Appellee. ON BRIEF: Jennifer L. Fuller, Kenneth B. Clark, William F. Colgin, Barton W.S. Bassett, James P. Fuller, Ronald B. Schrotenboer, Fenwick & West, Mountain View, California, for Appellant. Joan I. Oppenheimer, Gilbert S. Rothenberg, Charles Bricken, United States Department of Justice, Washington, D.C., for Appellee.

Before: BOGGS, Chief Judge; NORRIS and COOK, Circuit Judges.

OPINION

ALAN E. NORRIS, Circuit Judge.

Chrysler Corporation appeals from three adverse Tax Court rulings that granted partial summary judgment to the Commissioner of Internal Revenue. The disputed tax computations stem from the early to mid-1980s and involve substantial sums of potential tax liability. These rulings present the following questions: 1) Under the accrual accounting method used by Chrysler, was the company permitted to deduct anticipated warranty expenses in the year that it sold warranted motor vehicles to its dealers even though warranty claims had not necessarily been made? 2) Was Chrysler barred by the ten-year statutory limitations period from altering certain foreign tax credit elections? 3) Did costs associated with the redemption of Chrysler's Employee Stock Option Plan ("ESOP") constitute deductible capital expenditures?

This case essentially involves three discrete appeals. For that reason, we will abandon our usual practice of beginning our opinion with a generalized background section in favor of treating each issue individually, providing the necessary factual context in conjunction with our legal analysis.

I. Deduction for Anticipated Warranty Expenses

In its opinion, the Tax Court framed the issue in these terms:

We must decide whether for Federal income tax purposes all events necessary to determine petitioner's liability for its warranty expenses have occurred when it sells its vehicles to its dealers; in other words, has petitioner satisfied the first prong of the all events test entitling it to deduct its estimated future warranty costs on the sale of such vehicles?

Chrysler Corp. v. Comm'r, No. 22148-97, 2000 WL 1231528, 80 T.C.M. (CCH) 334, T.C.M. (RIA) 2000-283 (Aug. 31, 2000). Although discussed in more detail shortly, the "all events test" alluded to by the Tax Court provides as follows:

Under an accrual method of accounting, a liability ... is incurred, and generally is taken into account for Federal income tax purposes, in the taxable year in which all the events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability.

Treas. Reg. § 1.461-1(a)(2)(i) (2001). In this appeal, only the first prong of the test — whether the "fact of the liability" has been established — is at issue.

The parties agree that this court reviews de novo a grant of summary judgment by the Tax Court.¹ Roberts v. Comm'r, 329 F.3d 1224, 1227 (11th Cir.2003).

In tax years 1984 and 1985, Chrysler included deductions of $567,943,243 and $297,292,155 on its federal income tax returns on the basis that it incurred those amounts as warranty expenses for motor vehicles sold in those years to its dealers. A sale generally occurred when a vehicle was delivered to the carrier for shipment to the dealer.

New vehicle warranties, which are at issue here, cover defects in material and manufacture. As Chrysler points out, state and federal laws regulate the entire warranty regime. Specifically, the Uniform Commercial Code, as adopted by virtually every state, state "lemon" laws, and the Magnuson-Moss Warranty-Federal Trade Commission Improvement Act, 15 U.S.C. §§ 2301-12 ("Magnuson-Moss"), impose warranty obligations on the seller. During the period at issue, every new vehicle sold by Chrysler was covered by a warranty. When selling a new vehicle dealers would provide buyers with a warranty manual that explained its terms and limitations.

Chrysler offered two kinds of express warranty: a basic warranty that applied to the first 12 months or 12,000 miles, and an extended warranty that covered certain types of repairs after the basic warranty had expired. In turn, Chrysler contracted with its dealers to repair vehicles under warranty. Typically, dealers would make repairs and then seek reimbursement from the company. However, dealers were required to comply with certain agreed upon procedures to substantiate their reimbursement requests that, if not followed, could result in non-payment. By 1984 Chrysler had installed a computer system known as the Dealer Information Access Link ("DIAL"), which an increasing number of dealers used to report warranty repairs that were subject to reimbursement. DIAL made it easier for Chrysler to track and respond to warranty claims.

Chrysler engaged consultant Arthur D. Little, Inc., to calculate the amount of warranty expenses the company incurred for tax years 1984 and 1985. Chrysler uses the accrual method of accounting and a tax year based upon the calendar year. It is undisputed that the expenses incurred by Chrysler to fix conditions covered by warranty constitute "ordinary and necessary" business expenses under 26 U.S.C. § 162. During the period at issue, Chrysler accrued the entire estimated cost of its warranties in the year that it sold the vehicles to the dealers. Chrysler included this liability on its balance sheet and took it into account in the calculation of net (BOOK) income.

The Commissioner reduced Chrysler's warranty cost deduction for 1984 by $287,939,317, which had the ripple effect of increasing the company's 1985 deduction for such costs by $62,767,885.

The Tax Court framed the legal question in these terms:

Whether a business expense has been "incurred" so as to entitle an accrual-basis taxpayer to deduct it under section 162(a) is governed by the "all events" test as set out in United States v. Anderson, 269 U.S. 422, 441, 46 S.Ct. 131, 70 L.Ed. 347 (1926). In Anderson, the Supreme Court held that a taxpayer was entitled to deduct from its 1916 income a tax on profits from munitions sales that took place in 1916. Although the tax would not be assessed and therefore would not formally be due until 1917, all the events had occurred in 1916 to fix the amount of the tax and to determine the taxpayer's liability to pay it....

[U]nder the regulations, the all events test has two prongs, each of which must be satisfied before accrual of an expense is proper. First, all the events must have occurred which establish the fact of the liability. Second, the amount must be capable of being determined "with reasonable accuracy." Sec. 1.461-1(a)(2), Income Tax Regs. (accrual of deductions); sec. 1.446-1(c)(1)(ii), Income Tax Regs. (accrual in general). For the purpose of deciding this motion, only the first prong of the test is relevant. For the purpose of the first prong of the test the Supreme Court has stated that the liability must be "final and definite in amount", Security Flour Mills Co. v. Commissioner, 321 U.S. 281, 287, 64 S.Ct. 596, 88 L.Ed. 725 (1944), "fixed and absolute", Brown v. Helvering, 291 U.S. 193, 201, 54 S.Ct. 356, 78 L.Ed. 725 (1934), in order to be deductible.

Chrysler, 2000 WL 1231528, 80 T.C.M. (CCH) 334, T.C.M. (RIA) 2000-283 (Aug. 31, 2000) (citations and footnote omitted).

Having set the legal stage, the court then examined and distinguished two Supreme Court opinions urged upon it by the parties: United States v. Hughes Prop. Inc., 476 U.S. 593, 106 S.Ct. 2092, 90 L.Ed.2d 569 (1986), and United States v. Gen. Dynamics Corp., 481 U.S. 239, 107 S.Ct. 1732, 95 L.Ed.2d 226 (1987). Because we agree that these cases are central to the resolution of this particular question, we find it useful to begin our discussion with reference to the construction given to them by the Tax Court:

[Chrysler] places reliance on United States v. Hughes Properties, Inc., 476 U.S. 593, 106 S.Ct. 2092, 90 L.Ed.2d 569 (1986), for the proposition that statutory liabilities satisfy the first prong of the all events test....

In Hughes Properties, the taxpayer was a Nevada casino that was required by State statute to pay as a jackpot a certain percentage of the amounts gambled in progressive slot machines. The taxpayer was required to keep a cash reserve sufficient to pay the guaranteed jackpots when won. Hughes Properties at the conclusion of each fiscal year entered the total of the progressive jackpot amounts (shown on the payoff indicators) as an accrued liability on its books. From that total, it subtracted the corresponding figure for the preceding year to produce the current tax year's increase in accrued liability. On its Federal income tax return this net figure was asserted to be an ordinary and necessary business expense and deductible under section 162(a). The Court found that the all events test had been satisfied and the taxpayer was entitled to the deduction. The Court reasoned that the State statute made the amount shown on the payout indicators incapable of being reduced. Therefore the event creating liability was the last play of the machine before the end of the fiscal year, and that event occurred during the taxable year.

We conclude that the cases cited by [Chrysler] do not strictly stand for the proposition that if a liability is fixed by statute, that fact alone meets the first prong of the all events test. Rather we are...