Gerling Int'l Ins. Co. v. Comm'r of Internal Revenue, Docket No. 26765-83.

• Decision Date: 24 September 1986
• Docket Number: Docket No. 26765-83.
• Citation: 87 T.C. No. 41,87 T.C. 679
• Parties: GERLING INTERNATIONAL INSURANCE COMPANY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

87 T.C. 679

87 T.C. No. 41

GERLING INTERNATIONAL INSURANCE COMPANY, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 26765-83.

United States Tax Court

Filed September 24, 1986.

In implementation of its prior opinion, see 86 T.C. 468 (1986), the Court determined that petitioner should be precluded from introducing into evidence the books and records of a deemed related Swiss corporation or any information derived therefrom. HELD, no change should be made in the two orders of the Court, dated March 12, 1986 and April 9, 1986, and accordingly petitioner's motion for summary judgment is denied. HELD FURTHER, respondent's motion for summary judgment is granted. Lawrence Gerzog, for the petitioner.

David Brodsky, for the respondent.

OPINION

TANNENWALD, JUDGE:

This case is again before us on cross motions for summary judgment. The parties agree (and we concur) that, in the present posture of the case, there are no genuine issues of material fact involved; consequently, we may dispose of the case by decision as a matter of law. Rule 121, Tax Court Rules of Practice and Procedure.

The factual background, which provides the foundation for the motions herein, is largely set forth in our prior opinion, 86 T.C. 468 (1986), and will not be repeated herein. Rather, we will set forth what has occurred since the memorandum sur order, which subsequently became the aforementioned published opinion, was issued on March 12, 1986.

Simultaneously with the issuance of the memorandum sur order, an order was entered. A copy of that order is set forth as Exhibit A to this opinion. Thereafter, the parties attempted to arrive at a mutually acceptable procedure pursuant to which respondent would be afforded the opportunity to examine the books and records of Universale Reinsurance Company, Ltd. (‘Universale‘). Their attempt failed for the reasons hereinafter set forth. As a consequence, the Court issued a further order, dated April 9, 1986, copy of which is set forth as Exhibit B to this opinion.

Upon the basis of the two above-mentioned orders of the Court and other material of record herein, respondent moved for summary judgment contending that, because of the preclusion of evidence provision of the Court's April 9, 1986 order, petitioner would, as a matter of law, be unable to meet its burden of proof and that consequently a decision should be entered for respondent. ¹

Petitioner countered respondent's motion for summary judgment with a cross motion for summary judgment. In support of its cross motion, petitioner argues that: (1) respondent has ignored the economic reality of its relationship with Universale; (2) while the Court (incorrectly according to petitioner) rejected that argument in its prior opinion, the argument nevertheless supports the contention that respondent has acted arbitrarily and unreasonably in issuing the deficiency notice herein, particularly in light of respondent's prior acceptance of petitioner's method of reporting, for United States tax purposes, only the net income or loss revealed by the annual statements furnished it by Universale; (3) petitioner has made every effort to permit respondent to audit the books and records of Universale and the condition, insisted upon by respondent, that the audit first be approved by the Swiss Federal Government, see p. 6, infra, is unreasonable and was properly rejected by Universale and consequently by petitioner.

Petitioner's first two arguments have essentially been disposed of by our prior opinion. See 86 T.C. at 473-474. Petitioner's ‘economic reality‘ argument ignores the nature of the relationship between petitioner and Universale, namely agent (Universale) and principal (petitioner). See Colonial Surety Co. v. United States, 147 Ct. Cl. 643, 178 F. Supp. 600, 602 (1959). If, in fact, Universale has ascribed to petitioner more than its proper share of losses and expenses, petitioner has not received the share of the net income due it. It is well established that income received by an agent is taxable to a principal at the time of receipt by the agent, rather than at the time of payment by the agent to the principal. Maryland Casualty Co. v. United States, 251 U.S. 342, 347 (1920); Alsop v. Commissioner, 290 F.2d 726, 728 (2d Cir. 1961), affg. 34 T.C. 606 (1960). See also McGahen v. Commissioner, 76 T.C. 468, 478 (1981), affd. without published opinion 720 F.2d 664 (3d Cir. 1983).

Petitioner seeks to avoid the principal-agent characterization by contending that its arrangement with Universale was one of indemnity, as distinguished from assumption, reinsurance. See section 1.809-4(a)(l)(iii) and 1.809-5(a)(7)(ii), Income Tax Regs. Aside from the fact that we have serious doubts as to the validity of petitioner's position in light of the terms of the treaty between petitioner and Universale, and particularly article 4 thereof (see 86 T.C. at 469-470), we think any such distinction is irrelevant under the facts and circumstances herein. Cf. International Life Insurance Co. v. Commissioner, 51 T.C. 765, 772 (1969), affd. per curiam 427 F.2d 137 (6th Cir. 1970). To permit any such distinction, in the context of the instant case, would preclude respondent from questioning the underpinnings of any indemnity arrangement in order to determine the proper tax consequences flowing therefrom and to obtain the information necessary to make such questioning effective.

We are unable to perceive why, having refused to accept petitioner's ‘economic reality‘ argument as a matter of substantive law, we should nevertheless apply that argument in order to hold that respondent's determinations in the notice of deficiency were arbitrary. Nor are we persuaded that we should do so because respondent did not question petitioner's method of reporting its transactions with Universale over a period of 18 years and, in fact, accepted such method after examining petitioner's returns for the taxable years 1959, 1960, and 1961. It is well established that a taxpayer is not entitled to continue the treatment of an item of income or deduction simply because respondent either has not objected in the past or has approved like treatment of the item in an earlier year. Coors v. Commissioner 60 T.C. 368 406 (1973), affd. 519 F.2d 1280 (10th Cir. 1975); Union Equity Cooperative Exchange v. Commissioner, 58 T.C. 397, 408 (1972), affd. 481 F.2d 812 (10th Cir. 1973).

We now turn to the third prong of petitioner's argument. See pp. 3-4, supra. Both prior and subsequent to the Court's order of March 12, 1986 (Exhibit A), discussions took place between petitioner (who consulted Universale) and respondent. As a result of those discussions, Universale, through petitioner, offered to have an American C.P.A. firm, with an office in Switzerland, selected and paid by respondent, audit the relevant books and records of Universale at Universale's office in Zurich, Switzerland and transmit the results of that audit to respondent. Respondent, however, was concerned about the effect of article 271 of the Swiss Penal Code, ² and insisted that the Swiss Federal Government be informed of, and approve, the audit. Universale refused to accede to that condition because it did not want ‘to engender Swiss governmental intrusion into a matter in which neither Universale nor the Swiss government are parties‘ and asked that the auditors ‘do the audit on an invitation-type basis.‘ See Petitioner's Memorandum in Support of its Cross-Motion for Summary Judgment, pp. 9-10. As a consequence of that refusal, respondent returned to his original position that Universale's books and records be produced in the United States for examination by respondent's agents, a situation described by petitioner as an ‘impractical and inequitable demand.‘ Supra at p. 10.

Petitioner vigorously asserts that respondent's insistence on approval of the audit in Switzerland by the Swiss Federal Government is unreasonable. We disagree.

In the first place, article 271 of the Swiss Penal Law clearly prohibits an examination in Switzerland by respondent's agents. See note 2, supra; United States v. Vetco, Inc., 691 F.2d 1281, 1290 (9th Cir. 1981). Clearly, we should not countenance action by agents of the United States Government which would cause a violation of the laws of a nation with whom we have friendly relations. See Application of Chase Manhattan Bank, 297 F.2d 611, 613 (2d Cir. 1962).³ Nothing in article 271 suggests that an ‘invitation-type‘ audit, i.e., an audit with Universale's consent, would remove respondent's agents from the sanctions of article 271. In the second place, even if the use of an ‘invitation-type‘ audit might arguably avoid the need for the approval of the Swiss Federal Government, we do not think it is within our province to second-guess respondent on this issue. It is common knowledge that the efforts of the United States to obtain the cooperation of the Swiss Federal Government in facilitating the enforcement of our tax laws have involved delicate and sometimes difficult negotiations. ‘»T†he courts must take care not to impinge upon the prerogatives and responsibilities of the political branches of the government in the extremely sensitive and delicate area of foreign affairs.‘ See United States v. First National City Bank, 396 F.2d 897, 901 (2d Cir. 1968). See also United States v. Davis, 767 F.2d 1025, 1035 (2d Cir. 1985). The fact that the alternative of producing the books and records of Universale in the United States may be expensive or cumbersome and therefore impose some hardship on petitioner and Universale does not make respondent's position unreasonable. See United States v. Vetco, Inc., supra at 1289 and 1291. We hold that respondent's condition that the approval of the audit by the Swiss Federal Government should be obtained is not unreasonable.

At one point in these proceedings, petitioner suggested that disclosure of its books and records by Universale to respondent's agents...