Ocean Drilling & Exploration Co. v. U.S.

• Decision Date: 09 March 1993
• Docket Number: No. 92-5127,92-5127
• Citation: 988 F.2d 1135
• Parties: -1184, 93-1 USTC P 50,160 OCEAN DRILLING & EXPLORATION COMPANY, (on behalf of itself and its consolidated subsidiaries), Plaintiff-Appellee, v. The UNITED STATES, Defendant-Appellant.
• Court: U.S. Court of Appeals — Federal Circuit

Page 1135

988 F.2d 1135

71 A.F.T.R.2d 93-1184, 93-1 USTC P 50,160

OCEAN DRILLING & EXPLORATION COMPANY, (on behalf of itself and its consolidated subsidiaries), Plaintiff-Appellee, v. The UNITED STATES, Defendant-Appellant.

No. 92-5127.

United States Court of Appeals, Federal Circuit.

March 9, 1993.

James E. Milliman, Middleton & Reutlinger, Louisville, KY, argued, for plaintiff-appellee. With him on the brief were Charles J. Lavelle and Margaret E. Keane, Greenebaum, Doll & McDonald.

David I. Pincus, Dept. of Justice, Washington, DC, argued, for defendant-appellant. With him on the brief were James A. Bruton, Acting Asst. Atty. Gen., Gary R. Allen and John A. Dudeck, Jr., Attys.

Before NIES, Chief Judge, ARCHER and CLEVENGER, Circuit Judges.

PER CURIAM.

The United States appeals the judgment of the United States Claims Court ¹ in Ocean Drilling & Exploration Co. v. United States, 24 Cl.Ct. 714 (1991). The issues appealed by the government are: (1) whether the Claims Court erred in holding that payments made by Ocean Drilling & Exploration Company (ODECO) (on behalf of its operating subsidiaries) to Mentor Insurance Limited (Mentor), a wholly-owned subsidiary of ODECO, constituted true insurance premiums that are deductible as business expenses under section 162 of the Internal Revenue Code of 1954, as amended (IRC), ² and (2) if properly classified as insurance premiums, whether Mentor's income from insuring the drilling rigs of ODECO's subsidiaries located in waters of the outer continental shelf of the United States constituted income from the insurance of United States risks within the meaning of sections 951-953 of the IRC.

We adopt the analysis and holding on these issues as set forth in the Claims Court's opinion, which is attached as an appendix. Accordingly, the judgment of the Claims Court is

AFFIRMED.

APPENDIX

OPINION OF THE UNITED STATES CLAIMS COURT

OPINION

NETTESHEIM, Judge.

This tax refund case, before the court after trial, calls for resolution of two questions first, whether payments by a parent company to its wholly-owned Bermuda insurer during tax years 1974 and 1975 constitute a reserve for losses as opposed to insurance premiums that qualify as a business deduction for federal income tax purposes; second, if the payments constitute insurance, whether the premiums were for insurance of property located in the United States and therefore taxable income.

FACTS

The following facts were developed at trial. Plaintiff Ocean Drilling and Exploration Company ("ODECO" or "plaintiff") was incorporated in 1953 to take advantage of business opportunities that resulted from the opening up of the Gulf of Mexico to oil and gas exploration. ¹ Murphy Oil Corporation ("Murphy") and private investors provided the funds to establish plaintiff. The objectives of plaintiff were to build offshore drilling rigs and to invest the profits earned from this undertaking to establish an oil and gas reserve base. Plaintiff achieved these objectives and during the years at issue in this case, 1974 and 1975, operated as a holding company, with subsidiaries conducting its business. Plaintiff's principal lines of business during that period were offshore contract drilling, exploration for and production of oil and gas, underwater diving services, and insurance.

Richard E. Roberson, Jr., testified as to the development and business operations of plaintiff and its insurance subsidiary, Mentor Insurance Limited ("Mentor"). Mr. Roberson's knowledge derives from his experience as an internal auditor at Murphy from 1962 to 1965; controller for plaintiff from 1965 to 1977; vice-president for plaintiff from 1974 to 1977; and controller for Mentor from 1968 through the years at issue in this case. Currently, Mr. Roberson is employed by plaintiff as vice-president of finance. He returned to ODECO in 1986 after serving in executive positions with two other oil companies between 1977 and 1983 and as a financial consultant between 1983 and 1986.

Mr. Roberson described at length the type of drilling rigs owned by plaintiff and its subsidiaries and insured by Mentor. Plaintiff designed the first rig capable of operating as a mobile drilling rig in the Gulf of Mexico. ² Prior to the advent of mobile rigs, exploration companies had to construct artificial islands, also known as platforms, and use conventional land rigs on these sites. If oil was not discovered, the platform had to be torn down. Mobile drilling rigs reduced the cost of exploration; they could be moved from one location to another, thereby avoiding the cost of constructing and tearing down platforms. The mobile drilling rigs at issue in this case were operating in the Outer Continental Shelf area of the Gulf of Mexico.

During the 1960's plaintiff faced difficulties insuring its drilling rigs. At that time the drilling rig business was written predominately by the Lloyd Syndicate ("Lloyd's"), with the London Market serving as an ancillary market to Lloyd's. As the technology of drilling rigs developed rapidly, Lloyd's adjusted its insurance rates in an attempt to cover itself against potential losses from the new drilling rigs. Because of the limited experience in insuring the new rigs and a number of substantial losses on these rigs, insurance rates increased sharply. By the end of the 1960's, rates were as high as 10 percent of the value of insured vessels, and plaintiff was unable to obtain full coverage of its rigs through the existing insurance market. In response to this dilemma, plaintiff analyzed its history of premiums and losses and determined that establishment of a captive insurer could alleviate the problems that plaintiff faced in the insurance market. In 1968 plaintiff established Mentor as a wholly-owned subsidiary incorporated in Bermuda.

The initial capitalization for Mentor was $12,000.00, the minimum amount of capitalization required to organize a company in Bermuda. Plaintiff increased the capital contribution to Mentor to $200,000.00 by the end of 1968. In a December 19, 1968 meeting of Mentor's board of directors, the chairman of the board stated that this increase in capital was necessary for the insurance business that Mentor was undertaking. In June 1969 plaintiff increased Mentor's capitalization to $950,000.00. At the time Mentor was increasing its insurance of plaintiff's risks and considering insuring the risks of companies unrelated to plaintiff. Mentor increased its capitalization because of its concern that it be adequately capitalized and able to attract unrelated entities to insure with Mentor.

The capitalization of Mentor remained at $950,000.00 through the years 1974 and 1975, despite Mentor's purchase of another insurance company in 1975. ³ Through 1975 Mentor was never asked by the Government of Bermuda to increase its capital, nor was it informed that it did not meet the capital requirements of Bermuda. For 1974 the capital surplus (share capital + retained earnings + minority interests) of Mentor amounted to $12,508,417.00; the net earned premiums (accounted for premiums net of commissions and reinsurance) were $5,335,617.00; the losses paid were $2,527,640.00; and the reserves for losses (liabilities) were $2,512,030.00. For 1975 the capital surplus was $15,943,790.00; the net earned premiums were $12,310,711.00; the losses paid were $7,946,191.00; and the reserves for losses were $6,427,834.00. Mentor's capitalization during 1974 and 1975 was adequate to cover any losses that might be presented to Mentor for payment. ⁴

Mentor maintained offices in Bermuda from the time of its inception in 1968. Initially, Mentor shared an office and employees with Universal Marine Insurance Co., Ltd. ("Universal Marine"), a company not affiliated with plaintiff. This share arrangement between Mentor and Universal Marine was a common practice among insurers in Bermuda. Mentor entered into the arrangement prior to underwriting any insurance and concluded the arrangement in 1973 due to the increased business of both companies.

When the arrangement between Mentor and Universal Marine was instituted, Mentor's books were transferred to Bermuda. A chartered accountant kept Mentor's books, and Anthony Robert Gwinnell, an employee of both Mentor and Universal Marine in Bermuda, underwrote insurance for Mentor. ⁵ Mr. Gwinnell was employed by Mentor and Universal Marine from December 1968 to February 1971. His position with Mentor required that Mr. Gwinnell establish an underwriting seat for Mentor in Bermuda. He was also responsible for the placement of investments for Mentor, but plaintiff determined how funds would be invested during Mr. Gwinnell's tenure with Mentor.

When plaintiff hired Mr. Gwinnell, plaintiff explained to him that Mentor initially would insure risks of plaintiff and that, if such endeavor proved successful, Mentor would begin underwriting risks for unrelated parties. Consequently, the first policies Mr. Gwinnell wrote for Mentor were those of plaintiff, followed by those of unrelated parties from 1970 onward. The reinsurance of Mentor's policies began in 1969 as a measure to protect the policies written by Mentor.

In his position with Mentor, Mr. Gwinnell rejected submissions for insurance that he deemed undesirable or bad for business. The rates charged by Mentor to plaintiff and third parties were not established or approved by plaintiff. Plaintiff negotiated through its brokerage house, Marsh & McLennan Inc. ("Marsh & McLennan"), the rates it would pay for insurance by Mentor. Plaintiff paid Marsh & McLennan for insurance obtained for itself and its subsidiaries with Mentor and other insurers. Marsh & McLennan then paid the insurers directly, and plaintiff charged its subsidiaries for their share of the insurance.

Subsequent to the conclusion of the arrangement with Universal Marine, Mentor retained its own accountant and underwriter in Bermuda. Mentor compensated them with funds from accounts in Bermuda....