Pacific Far East Line, Inc. v. United States

• Decision Date: 20 October 1976
• Docket Number: No. 214-70.,214-70.
• Citation: 544 F.2d 478
• Parties: PACIFIC FAR EAST LINE, INC. v. The UNITED STATES.
• Court: U.S. Claims Court

544 F.2d 478

PACIFIC FAR EAST LINE, INC. v. The UNITED STATES.

No. 214-70.

United States Court of Claims.

October 20, 1976.

Mark P. Schlefer, Washington, D.C., attorney of record, for plaintiff. T.S.L. Perlman, Leonard Egan, Stephen T. Owen, Kominers, Fort, Schlefer & Boyer, Washington, D.C., of counsel.

Fenton P. Wilkinson, Washington, D.C., with whom was Asst. Atty. Gen. Scott P. Crampton, Washington, D.C., for defendant. Theodore D. Peyser and Robert S. Watkins, Washington, D.C., of counsel.

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

ON PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT AND DEFENDANT'S CROSS MOTION FOR SUMMARY JUDGMENT

KASHIWA, Judge:

This tax refund action concerning the investment tax credit provisions of the Internal Revenue Code of 1954, §§ 38, 46-48,¹ has previously been before this court. On March 19, 1975, this court granted plaintiff's motion for partial summary judgment, holding that plaintiff's credit should have been computed upon its entire bases in the ships, rather than upon only a ratable portion attributable to construction work done in 1962 as defendant contended. Pacific Far East Line, Inc. v. United States, 513 F.2d 1355, 206 Ct.Cl. 378 (1975).² We shall hereinafter refer to said March 19, 1975, opinion as the first opinion.

The case is again on cross motions for summary judgment and raises the following two questions reserved by the first opinion:

1. Whether from plaintiff's cost of the ships should be deducted that portion derived from tax deferred earnings deposited in plaintiff's reserve funds to arrive at plaintiff's qualified investment for the investment credit?

2. Whether from plaintiff's qualified investment should be deducted the amount of subsequent mortgage payments made by plaintiff from tax deferred earnings?

Affidavits have been filed by plaintiff in support of its motion for summary judgment. The pleadings and the affidavits filed show that there is no genuine issue of material fact. For the reasons stated below, we grant plaintiff's motion for summary judgment and deny defendant's cross motion.

Plaintiff has been, continuously since 1953, a contractor under operating-differential subsidy agreements with the federal Maritime Board and the Maritime Administration (hereinafter either will be referred to as Maritime).³ "To insure * * * the replacement of the contractor's subsidized vessels as may be required," § 607 of the Merchant Marine Act of 1936 (MMA) required contractors, including plaintiff, to create and maintain a "capital reserve fund." 46 U.S.C. § 1177 (1964). In this fund plaintiff was required to deposit amounts equal to (1) the annual depreciation charges on its subsidized ships, (2) insurance proceeds from losses of subsidized ships, (3) the proceeds of sales of such ships, and (4) certain portions of its net profits, viz. (a) half of all profits in excess of 10 per cent per annum, (b) such further portion as Maritime might deem necessary to build up a vessel replacement fund and (c) such further portion as the contractor might elect with Maritime's approval. From the "capital reserve fund" the statute permitted the contractor to "make disbursements for the purchase of replacement vessels" and to "pay the principal, when due, on all notes secured by mortgage on the subsidized vessels." 46 U.S.C. § 1177(b) (1964).

Also, "to insure the continued maintenance and successful operation of the subsidized vessels" the contractor must create a "special reserve fund" into which he shall deposit certain excess profits. 46 U.S.C. § 1177(c)(1964). The statute went on to provide (46 U.S.C. §§ 1177(f), (h) (1964)) that upon the termination of the subsidy contract "the reserve funds * * * shall be the property of the contractor * * *." and that "the earnings * * * deposited in the contractor's reserve funds as provided in this section * * * shall be exempt from all Federal taxes." (Hereinafter, capital reserve fund and special reserve fund will be referred to collectively as reserve funds.)

In 1947, several years before plaintiff became subsidized, shipowners then subsidized entered into tax closing agreements with the Commissioner of Internal Revenue (Commissioner). Those closing agreements provided that all earnings after 1946 deposited in the lines' reserve funds should be "tax-deferred income."⁴ The closing agreements defined tax deferred as meaning the income is not taxed but is not recognized in "cost basis" or "invested capital." This provision contained the following proviso: "provided, however, that the taxpayer shall not be bound by this commitment beginning with the calendar year in which a decision of any court, sustaining the contention that Section 607(h) of the Act MMA gives a tax exemption, instead of a Tax-deferment as herein provided, shall become final." The closing agreements contained other provisions concerning the time of accrual of deposits, investment income of the reserve funds, the useful life of vessels for depreciation, and the allocation of funds between income and capital items.

In 1952, after plaintiff had applied for a subsidy, Maritime offered it a subsidy contract providing in part that "No subsidy accrued hereunder shall be paid * * * unless the Operator is * * * a party to * * * a Closing Agreement similar in scope and effect, so far as applicable, to the Closing Agreements with the then subsidized Operators approved July 21, 1947 * * *." Although it had no dispute with the Internal Revenue Service (IRS), plaintiff had no choice but to apply for and execute a closing agreement, in order to obtain the subsidy accruing to it. The Commissioner approved the agreement on April 13, 1954.

Like its predecessors, plaintiff's closing agreement provided that all earnings deposited in the reserve funds would be "tax-deferred income" but that plaintiff would be relieved of the commitment when a court decided that § 607(h) of the MMA exempted the income from taxes. Pertinent provisions of plaintiff's closing agreement read as follows:

"Tax-deferred" or "Tax-deferment" referring to ordinary income and capital gains deposited in Reserve Funds means that such items are not to be recognized as taxable income, except as provided in paragraph VI(c) hereof, and likewise are not to be recognized in the determination of cost basis or invested capital.

* * * * * *

All earnings including capital gains, (not tax exempt under the Internal Revenue Code), which are deposited in the taxpayer's Reserve Funds, shall be tax-deferred income; provided, however, that the taxpayer shall not be bound by this commitment beginning with the calendar year in which a decision of any court, sustaining the contention that Section 607(h) of the Act MMA gives a tax exemption, instead of a Tax-deferment as herein provided, shall become final.

Plaintiff's agreement also tracked the 1947 agreements in its provisions for useful life, accrual of deposits, investment income, and allocation of the reserves. In 1964 plaintiff entered into a new closing agreement merely changing the useful life of ships from 20 years to 25 years. We shall hereafter refer to plaintiff's closing agreements as the 1947 agreement because in substance they are the identical agreements that the other shipowners entered into in 1947.

From the beginning of its subsidized operations, in accordance with § 607 of the MMA, plaintiff made periodic deposits in its reserve funds. These included amounts equal to its depreciation expense on the subsidized ships and portions of its earnings.

In 1959, pursuant to the replacement provisions of its subsidy contract, plaintiff and Maritime contracted with Bethlehem Steel Company for the construction of the ships Philippine Bear and China Bear. While they were under construction the Revenue Act of 1962 providing for the investment credit was enacted. Bethlehem delivered the ships in 1962 and they then entered the plaintiff's subsidized service. Plaintiff used them in its business of carrying cargo for hire between United States ports on the West Coast and the Far East.

Plaintiff paid $14,558,925 for the ships.⁵ It financed these payments with $10,274,557 borrowed on the security of mortgages on the ships and $4,284,368 cash down payment from its own funds. The down payment included $1,406,416 of reserve funds moneys attributed to plaintiff's deposits of earnings treated as "tax-deferred" and $2,877,952 of plaintiff's general moneys and reserve funds moneys attributed to deposits of funded depreciation or other forms of capital.

Since delivery of the ships plaintiff has made periodic payments of principal and interest on the mortgages. These payments were in part drawn from the reserve funds. The source of the reserve funds moneys included $1,912,332 allocated to plaintiff's earlier deposits of tax deferred earnings.

In filing its federal income tax returns for 1962, 1963, and 1964,⁶ plaintiff claimed an investment credit of $999,479, seven per cent of $14,278,270, which it then computed as its qualified investment eligible for the investment tax credit.⁷ On audit the IRS reduced the credit to $146,410, then "recaptured" $20,795 of that sum. The reduction reflected (i) the elimination of the portion (84.7 per cent) of plaintiff's cost that the IRS attributed to construction work before January 1, 1962, and (ii) the elimination of a further part of the cost on account of the $1,406,416 that had been part of plaintiff's down payment for the ships, that was drawn from the reserve funds, and that in accounting for those funds was allocated to tax deferred earnings. The "recapture" reflected (iii) the elimination of a still further part of the cost on account of $1,912,332 of plaintiff's mortgage payments in 1962, 1963, and 1964 that had been drawn from its reserve funds and had been allocated to tax deferred earnings. The IRS issued a deficiency notice accordingly. Having paid the deficiency and...