In re Harvard Industries, Inc., 02-50586.

• Citation: 352 B.R. 613
• Decision Date: 20 October 2006
• Docket Number: No. 02-50586.,02-50586.
• Parties: In re HARVARD INDUSTRIES, INC., et al., Debtors.
• Court: U.S. Bankruptcy Court — District of New Jersey

352 B.R. 613

In re HARVARD INDUSTRIES, INC., et al., Debtors.

No. 02-50586.

United States Bankruptcy Court, D. New Jersey.

October 20, 2006.

James N. Lawlor, Esquire, Wollmuth, Maher & Deutsch, LLP, Newark, NJ, Attorney for Harvard Secured Creditors Liquidation Trust.

Lawrence P. Blaskopf, Esquire, U.S. Department of Justice, Washington, D.C., Attorney for United States.

OPINION

KATHRYN C. FERGUSON, Bankruptcy Judge.

Procedural History

The Debtors Harvard Industries, et al. ("Harvard") filed a motion styled "Notice of Motion Requesting a Determination as to Harvard's Right to a Tax Refund Pursuant to 11 U.S.C. § 505" ("Tax Refund Motion") on June 24, 2003. In September of that year, the Debtors amended the Tax Refund Motion to clarify certain statements made in the original motion. Prior to the resolution of the Tax Refund Motion, Harvard confirmed its Chapter 11 plan. Pursuant to the Plan, certain assets and causes of action were assigned to various trusts that were to be established under the Plan. As a result, the Harvard Secured Creditors Liquidation Trust ("Trust") became the party in interest in this matter.

The court determined that the Tax Refund Motion should proceed as a contested matter under Fed. R. Bankr.Pro. 9014. On February 22, 2005, the court took oral argument on motions for summary judgment brought by the Internal Revenue Service ("IRS") and the Trust. At the conclusion of oral argument, the court denied summary judgment on the issue of deduction for workers' compensation expenses pending additional discovery by the parties. The remaining issues were addressed in an opinion dated February 28, 2005, and incorporated into an order dated March 24, 2005 ("summary judgment order"). The IRS appealed the summary judgment order to the District Court, which disallowed the partial refund this court had ordered and remanded the proceeding to this court.

Discovery on the workers' compensation issue concluded on June 23, 2006, and this court took evidence on July 6, 2006. After presenting closing statements, the parties requested an opportunity to submit post-trial briefs. The final post-trial brief was filed on August 11, 2006.

Discussion

The Trust seeks to carry back $2,076,066.55 in workers' compensation and products liability related expenses¹ to the 1985 tax year, a year in which the Debtor and its subsidiaries had more than $6 million in net income.² The IRS contends that Harvard is not entitled to its claimed deductions because: 1) Harvard did not pay the claimed expenses in the 1995 tax year; 2) Harvard cannot carry back amounts it paid Wausau to administer the insurance claims; and 3) the IRS already allowed an excessive refund because it did not allocate part of the losses carried back to Doehler-Jarvis.

At the evidentiary hearing, the Trust presented the testimony of David A. White. Mr. White had been associated with Harvard in various capacities since 1995. His positions with Harvard have included president, chief financial officer, secretary, assistant general counsel, and general counsel. In addition, Mr. White serves as a consultant to the Trust. Mr. White was responsible for risk management issues, including workers' compensation and other insurance issues, for Harvard and some of its subsidiaries. The IRS cross-examined Mr. White, but did not present any witnesses.

A. Timing and nature of the premium payments

From 1988 to 1992, Harvard and its subsidiaries had workers' compensation and general liability policies with Wausau Insurance Company. Mr. White testified that the Wausau policies were "retrospective insurance plans." Tr. 7/6/06 at 19. Under such plans, yearly premiums are based on the insured's actual loss experienced during the policy term. Harvard was required to pay an initial premium at the beginning of the policy year, which functioned as both a standard insurance payment and as a prepayment designed to cover anticipated claims under the policies. Tr. 7/6/06 at 19-21. Harvard was sometimes required to pay additional premiums based on the number of claims Wausau paid during the policy year. Wausau routinely made these retrospective adjustments approximately six months after the end of policy years. Mr. White testified that Harvard's records indicated that the retrospective adjustments relevant to the refund request at issue were sent to Harvard around October 1995. Wausau and Harvard then commenced negotiations and ultimately came to an agreement as to the appropriate adjustments in early 1996. Tr. 7/6/06 at 59-62.

The Trust argues that the IRS improperly characterizes Harvard's insurance premium payments as the equivalent of an escrow or annuity, and attributes payments not to the date when Harvard ultimately paid the billed premiums, but to a date when the insurer paid the underlying claim. The IRS contends that apart from some expenses incurred through self-insuring its Trim Trends subsidiary and a payment of $651.45, there is no evidence that Harvard made any payment in its 1995 tax year to Wausau on account of workers' compensation.

The taxpayer has the burden of proving that it is entitled to a refund. United States v. General Dynamics corp., 481 U.S. 239, 107 S.Ct. 1732, 95 L.Ed.2d 226 (1987). The proper timing for a deduction is generally determined based on the method of accounting used by the taxpayer. 26 U.S.C. § 461(a). Harvard used the accrual method of accounting and is thus not considered to incur an expense "any earlier than when economic performance with respect to such item occurs." 26 U.S.C. § 461(h)(1). The Internal Revenue Code defines "economic performance" based on the nature of the payment. For workers' compensation payments, "[i]f the liability of the taxpayer requires a payment to another person and-arises under any workers compensation act ... economic performance occurs as the payments to such person are made." 25 U.S.C. § 461(h)(2)©. The accompanying regulations further elucidate that definition and provide examples. The examples accompanying 26 C.F.R. § 1.451-4(g)(5) make clear that for workers' compensation liabilities covered by insurance, economic performance occurs when the insurance premium is paid. 28 C.F.R. § 1.461(g)(8)(examples 5-7).

Application of those principles to these facts is not as clear as the Court would hope. As the IRS correctly points out, Harvard paid Wausau insurance premiums at the inception of each policy year and the policy years ran from April 1988 through April 1992. Accordingly, the IRS argues that Harvard cannot claim a deduction for its 1995 tax year. The IRS maintains that as Wausau received premiums from Harvard, it used them to "establish reserves for each of Harvard's subsidiaries", and it used these "reserves" to cover the worker's compensation claims it paid to Harvard's employees. United States' Post-Trial Brief at 9. The court disagrees with the IRS's interpretation of the facts of record, which do not clarify how Wausau treated the premiums Harvard paid. The IRS did not present testimony to support its "reserve" theory; instead, it relied on the records Wausau sent to Harvard in the Fall of 1995 [Ex. T-2; T-1953, T-2031] to show that Wausau applied previously paid premiums to pay claims that arose between October 15, 1994 and October 15, 1995. Those records are ambiguous as they could merely reflect the historical course of conduct between the parties rather than the establishment of a reserve. Mr. White testified that the books reflect that Wausau did not issue refunds and then require Harvard to pay new premiums, rather the amounts were offset and only an excess payment or refund actually issued. Mr. White testified that was the course of conduct established between Harvard and Wausau. The IRS's only attempt to refute Mr. White's testimony was to argue that it was "telling" that Harvard did not consider any such "refunds" as income to be reported on its tax returns. Mr. White acknowledged that he did not know whether Harvard reported any of the "hypothetical refunds" from Wausau as income on its 1995 tax return Tr. at 104. But even if the IRS had definitively established that Harvard did not report theses hypothetical refunds there are other possible ways the "refunds" could have been reported for tax purposes. Overall, the court finds Mr. White's testimony about the previous practices between Harvard and Wausau not only convincing, but also consistent with standard practices in the insurance industry. It would be a significant departure to interpret an insurance policy as the equivalent of an escrow agreement. The evidence presented does not warrant such a departure.

The Trust's argument is also consistent with the regulations regarding economic performance. As previously noted, for an accrual based taxpayer such as Harvard, a liability is only incurred "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." 26 C.F.R. § 1.461-1(a)(2) For Harvard, the earliest those requirements could have been met was October 1995 when Wausau sent Harvard the retrospective plan adjustments. Therefore, the court will overrule the IRS's objection to the refund claim on the ground that Harvard did not pay the workers' compensation expenses in its 1995 tax year.

B. Nature of payments to Wausau

Wausau charged Harvard a premium expense for the administration of the plan. Tr. 7/6/06 at 19-20. Wausau would apply a loss conversion factor to the paid losses and bill Harvard to cover claims adjusting expenses and the insurer's claim service. According to the testimony of Mr. White, the loss conversion factor was a charge included by all insurance companies in retrospective policies and was nonnegotiable. Tr. at 20-21. Mr. White further testified that the application of a tax multiplier was standard in retrospective...