Suriel v. Comm'r
| Decision Date | 04 December 2013 |
| Docket Number | No. 367–12.,367–12. |
| Citation | 141 T.C. No. 16,141 T.C. 507 |
| Parties | Vidal SURIEL, Petitioner v. COMMISSIONER of INTERNAL REVENUE, Respondent. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Decision for IRS.
P's wholly owned S corporation, V, claimed deductions for unpaid obligations, both principal and interest, owed into the Tobacco Master Settlement Agreement (MSA) fund, which is a qualified settlement fund under I.R.C. sec. 468B. R disallowed the deductions on the basis that economic performance did not occur until payment was actually made into the MSA fund, pursuant to sec. 1.468B–3(c)(1), Income Tax Regs. Under I.R.C. sec. 1366 R made adjustments to P's individual income tax returns and determined deficiencies in P's income tax.
Held: V is not entitled to deductions for unpaid MSA obligations, because economic performance does not occur until the obligations are actually paid. See sec. 1.468B–3(c)(1), Income Tax Regs.
Held, further, because the special rules governing qualified settlement funds do not differentiate between interest and principal, we afford them equal treatment.
Held, further, we sustain R's deficiency determinations.
Edward T. Yevoli, Paul D. Turner, and Joey M. Lampert, for petitioner.
Robert M. Ratchford and Jeffrey B. Fienberg, for respondent.
Respondent determined deficiencies in petitioner's Federal income tax as follows:
| Year |
Deficiency
2004
$33,912,933
2006
Respondent's determinations of tax deficiencies result from adjustments made following respondent's examination of returns of Vibo Corp., d.b.a. General Tobacco, Inc. (Vibo),1 an S corporation, because pursuant to section 1366 2 all of the deductions and losses of Vibo properly passed through to petitioner as the sole shareholder during each of the tax years in issue.
The issues in dispute concern Vibo's accrual of unpaid obligations incurred when it settled with 46 States, the District of Columbia, the Commonwealth of Puerto Rico, and 4 U.S. territories (collectively, settling States) by entering into the Tobacco Master Settlement Agreement (MSA). After respondent's concession,3 the issues for decision are:
(1) whether Vibo properly deducted its MSA payment obligations under section 461(h) before those obligations were actually paid into the MSA escrow account established at Citibank. We hold that it did not;
(2) whether accrued interest owed into a qualified settlement fund is deductible in the tax year before actual payment is made. We hold that it is not; and
(3) whether adjustments to income or tax should be made with respect to petitioner's 2004 and 2006 Forms 1040, U.S. Individual Income Tax Return, as a result of the adjustments made to Vibo's 2004–06 Forms 1120S, U.S. Income Tax Return for an S Corporation. We hold that they should be made.
Some of the facts have been stipulated for trial under Rule 91. The stipulation of facts and the attached exhibits are incorporated by this reference and are found accordingly.
I. Background
Respondent mailed a notice of deficiency to petitioner on October 6, 2011. Petitioner timely filed his petition with this Court on January 4, 2012. At the time the petition was filed, petitioner was a resident of Miami, Florida. The parties have stipulated that venue for purposes of an appeal is in the Court of Appeals for the Eleventh Circuit.
Vibo, a Florida corporation, began to sell cigarettes in the United States in 1999. During 2000–2006, Vibo was taxed under subchapter S and wholly owned by petitioner. Vibo was an accrual method taxpayer during the tax years 2004–06. For each of the tax years in issue, Vibo filed a Form 1120S. During the tax years at issue, Vibo did not own any cigarette manufacturing or packaging equipment.
Productora Tabacalera De Colombia S.A. (Protabaco), a Colombian company, is unrelated to petitioner by ownership. During the tax years in issue, Protabaco was in the business of manufacturing tobacco products. During the tax years in issue, Protabaco was the fabricator of Vibo's cigarettes. As part of its entry into the MSA, Vibo entered into an exclusive manufacturing and distribution agreement with Protabaco, whereby Vibo appointed Protabaco as its exclusive manufacturer and Protabaco appointed Vibo its exclusive importer.
II. Tobacco Master Settlement Agreement (MSA)A. Background
Before the MSA was executed various States either had commenced or were expected to commence litigation in order to assert claims for monetary, equitable, and injunctive relief against certain tobacco product manufacturers and other defendants for damages under State laws. Relief and damages were sought under State laws such as consumer protection or antitrust in order to further the States' policies regarding public health, including policies to reduce smoking by youth. The central purpose of the MSA was to reduce smoking—particularly youth smoking—in the United States.
On November 23, 1998, the MSA execution date, four tobacco product manufacturers (TPMs) entered into the MSA with representatives (the NAAG) 4 from the settling States. The four manufacturers were Brown & Williamson Tobacco Corp., Lorillard Tobacco Co., Phillip Morris, Inc., and R.J. Reynolds Tobacco Co. The settling States included 46 States, the District of Columbia, the Commonwealth of Puerto Rico, and 4 U.S. territories.
(1) manufactures Cigarettes anywhere that such manufacturer intends to be sold in the States, including cigarettes intended to be sold in the States through an importer * * *;
(2) is the first purchaser anywhere for resale in the States of cigarettes manufactured anywhere that the manufacturer does not intend to be sold in the States; or
(3) becomes a successor of an entity described in subsection (1) or (2) above.
Amendment No. 24 (amendment 24) to the MSA provides:
In addition, and in consideration for the above, * * * [Vibo] shall be considered to be a * * * [TPM] and a Participating Manufacturer, and Protabaco shall not be considered to be a * * * [TPM].
A participating manufacturer as defined in the MSA is a TPM that is or becomes a signatory to the MSA, provided that: (1) in the case of a TPM that is not an original participating manufacturer (OPM) (i .e., in Vibo's case), that TPM is bound by the MSA in all settling States in which the MSA binds OPMs, and (2) in the case of a TPM that signs the MSA after the MSA execution date (i.e., also in Vibo's case), that TPM, within a reasonable time after signing the MSA, makes any payments that it would have been obligated to make in the intervening period had it been a signatory as of the MSA execution date.
Under the MSA, the settling States released a participating manufacturer from all past and future tobacco-related claims that the States might have against that company, when the participating manufacturer became a signatory to the MSA. The MSA specifies two types of participating manufacturers: an OPM and a subsequent participating manufacturer (SPM). The OPMs consisted of the four TPMs, discussed supra, that signed the MSA on the MSA execution date. An SPM is a TPM (other than an OPM) that: (1) is a participating manufacturer, and (2) is a signatory to the MSA, regardless of when that TPM became a signatory to the MSA.
In consideration for the released claims, the participating manufacturers were required to make MSA payments to the settling States in order to promote educational programs tailored to preventing smoking and to compensating the States for healthcare costs incurred from the effects of smoking and tobacco use. Both the released claims and the MSA payments will be discussed in turn.
Section XVIII(d) of the MSA provides: “All payments to be made by the Participating Manufacturers pursuant to this Agreement are in settlement of all of the settling States' antitrust, consumer protection, common law negligence, statutory, common law and equitable claims for monetary, restitutionary, equitable and injunctive relief alleged by the settling States with respect to the year of payment or earlier years”.
Section IX(a) of the MSA, titled “Payments”, provides that all payments made pursuant to the MSA (except those not at issue in this case) shall be made into escrow pursuant to the escrow agreement. The second and third sentences of section 6 of the escrow agreement provide:
The escrow established pursuant to this Escrow Agreement is intended to be treated as a Qualified Settlement Fund for Federal tax purposes pursuant to Treas. Reg. § 1.468B–1. The Escrow Agent shall comply with all applicable tax filing, payment and reporting requirements, including, without limitation, those imposed under Treas. Reg. § 1.468B * * *.
The OPMs and SPMs are required under the MSA to make their payments to the settling States into an escrow fund. The parties stipulate that the MSA escrow fund is a qualified settlement fund under section 1.468B–1, Income Tax Regs.
The escrow fund was established with Citibank, N.A., which served as the escrow agent.
III. Pre–MSA
Tobacco manufacturers that do not join the MSA are known as nonparticipating manufacturers (NPMs). The MSA directed each settling State to enact legislation that would require an NPM to make deposits into an escrow account to satisfy any judgments that a particular State might bring against the NPM in that particular State. These statutes required an NPM to make annual deposits into State escrow accounts for each State where the NPM sold its tobacco products. The escrow payment amounts were based on each company's sales in the respective State.
The exclusive manufacturing and distribution agreement states in its recitals:
WHEREAS, manufacturers of cigarettes sold in the United States are obligated under the laws of various U.S. states to either (i) join the * * * [MSA] or (ii) to...
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