Continental Insurance Company v. United States

• Citation: 474 F.2d 661,200 Ct. Cl. 552
• Decision Date: 16 February 1973
• Docket Number: No. 459-69.,459-69.
• Parties: The CONTINENTAL INSURANCE COMPANY v. The UNITED STATES.
• Court: U.S. Claims Court

200 Ct. Cl. 552, 474 F.2d 661 (1973)

The CONTINENTAL INSURANCE COMPANY v. The UNITED STATES.

No. 459-69.

United States Court of Claims.

February 16, 1973.

Walter J. Rockler, Washington, D. C., attorney of record, for plaintiff; Richard L. Hubbard, Washington, D. C., of counsel.

Roger A. Schwarz, Washington, D. C., with whom was Asst. Atty. Gen. Scott P. Crampton, for defendant; Philip R. Miller, and Joseph Kovner, Washington, D. C., of counsel.

Before COWEN, Chief Judge, and DAVIS, SKELTON, NICHOLS, KASHIWA, KUNZIG, and BENNETT, Judges.

ON PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT

SKELTON, Judge:

In this case plaintiff seeks to recover income taxes and interest, which it asserts were erroneously and illegally assessed and collected, in the amounts of $2,413.71 for the calendar year 1954 and $475,003.80 for the calendar year 1955. The case is before the court on plaintiff's motion for summary judgment and has been briefed and argued orally by both sides. The parties are in basic agreement as to the facts essential to our decision of this motion and these facts are set out below.

Plaintiff, The Continental Insurance Company, is a corporation organized under the laws of the State of New York. It is, and at all relevant times has been, engaged in business as a stock fire and casualty insurance company, transacting its business in each of the states of the United States and in the District of Columbia. Consequently, plaintiff is an insurance company subject to the tax imposed by Section 831 of the Internal Revenue Code of 1954 and computes its taxable income under Section 832 of the Code.

Plaintiff duly filed its federal income tax returns for the calendar years 1954, 1955, 1956, and 1957 and paid the taxes shown to be due thereon. The District Director of Internal Revenue later assessed deficiencies in tax and interest thereon against it for the years 1954 and 1955. Plaintiff paid these assessed tax deficiencies and interest in full and then filed claims for refund with respect to the portions of the deficiencies for 1954 and 1955 which resulted from the adjustment of its deductions for losses paid for the years 1955, 1956, and 1957.

In computing its federal income tax for the years 1954 through 1957, plaintiff included as income the amount of its earned premiums less losses paid and unpaid losses. In making such computation, it reduced losses paid by salvage which had been reduced to cash or its equivalent during the year. It did not, however, reduce losses paid by estimates of salvage that might be recovered on such losses in future years. Salvage consists basically of (1) amounts recouped by the insurer through the sale of damaged property to which it has taken title, and (2) amounts that the insurer recovers from third parties who are found to be ultimately responsible for the damage sustained by the insured (subrogation). During the years at issue the rules of some states barred the use of estimates of salvage, and barred salvage adjustments for property which had not been reduced to cash or cash equivalents.

The District Director determined that plaintiff's losses paid for the years 1955, 1956, and 1957 should be reduced by salvage recoverable, i. e., by an estimate of the salvage on losses paid in each year that might be recovered in subsequent years, as well as by salvage actually reduced to cash or cash equivalents during each year. He made this adjustment with regard to all plaintiff's business, and not merely with regard to that portion of the business done in states which did not expressly bar such an adjustment. The result of this determination was to increase plaintiff's taxable income for 1955 and 1956 and to decrease its taxable income for 1957. The effect of these income adjustments for the year 1954 was to decrease plaintiff's loss carryback from 1956 and consequently, to increase its income taxes for 1954. The effect for 1955 was to increase plaintiff's taxable income for that year and to increase its loss carryback from 1957, though in a much lesser amount, the net effect of which was to increase its income taxes for 1955. The plaintiff's claims for refund were denied and this suit followed.

The statutory context of this case can be briefly summarized. Section 831 of the Internal Revenue Code of 1954 imposes corporate taxes (computed as provided in Section 11) on insurance companies such as plaintiff. Section 832 of the Code¹ describes how the "taxable income" of such insurance companies is to be determined. "Taxable income" is defined as "gross income" less certain specified deductions. The two major components of "gross income" are "underwriting income" and "investment income" which, according to Section 832(b)(1)(A), are to be "computed on the basis of the underwriting and investment exhibit of the annual statement approved by the National Convention of Insurance Commissioners."² The term "underwriting income" means the premiums earned on insurance contracts during the taxable year less "losses incurred" on such contracts and "expenses incurred." "Losses incurred" during the taxable year on insurance contracts consist of two elements, losses paid and unpaid losses. Section 832(b)(5) provides:

(5) LOSSES INCURRED. — The term "losses incurred" means losses incurred during the taxable year on insurance contracts, computed as follows:

(A) To losses paid during the taxable year, add salvage and reinsurance recoverable outstanding at the end of the preceding taxable year and deduct salvage and reinsurance recoverable outstanding at the end of the taxable year.

(B) To the result so obtained, add all unpaid losses outstanding at the end of the taxable year and deduct unpaid losses outstanding at the end of the preceding taxable year.

Thus, losses paid must be adjusted for the change during the year in salvage and reinsurance recoverable. Any increase in salvage and reinsurance recoverable during the year decreases the amount of losses paid, and any decrease in salvage and reinsurance recoverable during the year increases losses paid.

The statute, however, does not define the term "salvage * * * recoverable" or even describe what is meant by salvage. It is therefore necessary to look beyond the statute to the applicable regulations and to insurance law. As pointed out earlier, salvage includes all tangible property and subrogation claims acquired by an insurance company after indemnifying its insured under contracts of insurance. In Phoenix Insurance Co. v. Erie Transportation Co., 117 U.S. 312, 321, 6 S.Ct. 750, 753, 29 L.Ed. 873 (1886), a case involving the subrogation rights of an insurer, the Supreme Court defined salvage as follows:

From the very nature of the contract of insurance as a contract of indemnity, the insurer, when he has paid to the assured the amount of the indemnity agreed on between them, is entitled, by way of salvage, to the benefit of anything that may be received, either from the remnants of the goods, or from damages paid by third persons for the same loss.³

Section 1.832-1(c)⁴ of the Treasury Regulations, 26 C.F.R. 1.832-1(c), reads as follows:

(c) That part of the deduction for "losses incurred" which represents an adjustment to losses paid for salvage and reinsurance recoverable shall, except as hereinafter provided, include all salvage in course of liquidation, and all reinsurance in process of collection not otherwise taken into account as a reduction of losses paid, outstanding at the end of the taxable year. Salvage in course of liquidation includes all property (other than cash), real or personal, tangible or intangible, except that which may not be included by reason of express statutory provisions (or rules and regulations of an insurance department) of any State or Territory or the District of Columbia in which the company transacts business. Such salvage in course of liquidation shall be taken into account to the extent of the value thereof at the end of the taxable year as determined from a fair and reasonable estimate based upon either the facts in each case or the company\'s experience with similar cases. Cash received during the taxable year with respect to items of salvage or reinsurance shall be taken into account in computing losses paid during such taxable year.

With respect to salvage, the above-quoted paragraph of the regulations has four components, one stated in each sentence. First, salvage recoverable includes all salvage in course of liquidation. Second, salvage in course of liquidation includes all property (other than cash) except that which is excluded by an express statute, rule, or regulation of any state in which the insurer transacts business. Third, salvage in course of liquidation must be taken into account upon a fair and reasonable estimate based upon the facts in each case or experience in similar cases. Fourth, cash received during the year with respect to salvage is taken into account as a reduction in computing losses paid during the year, before this item is adjusted by estimates of future salvage recoveries.

The parties have stipulated that:

1. During each of the years 1953-1957, the insurance departments of some states in which plaintiff did business during such years had express rules or regulations (within the meaning of Treasury Regulations Section 1.832-1(c)) prohibiting plaintiff from reducing losses paid by, or otherwise, taking credit for, (a) any property, tangible or intangible, in the form of salvage or subrogation, before such property is reduced to cash or cash equivalents, and (b) estimates of the value of any property, tangible or intangible, in the form of salvage or subrogation, before such property is reduced to cash or cash equivalents.

The issue presented is whether, under Section 832(b)(5)(A) of the Code, plaintiff is required to adjust losses paid by estimates of future salvage recoveries on such losses, in light of (a) Section 1.832-1(c) of the Treasury Regulations which excludes from...