Texas Instruments Inc. v. U.S.

• Decision Date: 27 April 1977
• Docket Number: No. 76-2365,76-2365
• Parties: 77-1 USTC P 9384, 1 Employee Benefits Ca 1752 TEXAS INSTRUMENTS INCORPORATED, Plaintiff-Appellee, Cross-Appellant, v. UNITED STATES of America, Defendant-Appellant, Cross-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 599

551 F.2d 599

77-1 USTC P 9384, 1 Employee Benefits Ca 1752

TEXAS INSTRUMENTS INCORPORATED, Plaintiff-Appellee, Cross-Appellant, v. UNITED STATES of America, Defendant-Appellant, Cross-Appellee.

No. 76-2365.

United States Court of Appeals Fifth Circuit.

April 27, 1977.

Michael P. Carnes, U. S. Atty., Fort Worth, Tex., Martha Joe Stroud, Asst. U. S. Atty., Dallas, Tex., Scott P. Crampton, Asst. Atty. Gen., Leonard J. Henzke, Jr., Ann Belanger Durney, Gilbert E. Andrews, Acting Chief, Appellate Sec., Tax Div., Dept. of Justice, Washington, D. C., for defendant-appellant cross-appellee.

William E. Collins, Buford P. Berry, Emily A. Parker, Dallas, Tex., for plaintiff-appellee cross-appellant.

Appeals from United States District Court for the Northern District of Texas.

Before MORGAN and FAY, Circuit Judges, and HUNTER, ^* District Judge.

EDWIN J. HUNTER, Jr., District Judge:

This case involves claims for refund of federal income taxes in excess of $10,000,000. The tax years involved are 1968 and 1969. Following payment of the deficiencies under protest and the disallowance of its claims for refund, plaintiff filed this suit in the District Court. There are three separate and important issues involving interpretations of Internal Revenue Code sections dealing with: (1) employer deductions to qualified employee pension trusts; (2) credit for foreign taxes paid by a Western Hemisphere Trade Corporation; and (3) the distinction between "tangible" and "intangible" property as applied to investment tax credit and the double declining balance method of depreciation. The District Court concluded that Texas Instruments was entitled to the deductions made to its employee pension trust and that it was entitled to carry over the foreign tax credits under Section 1503(b) of the Code, but that it was not entitled to a tax credit and accelerated depreciation for certain tapes and films. ¹ We affirm as to the first two issues and reverse as to the latter.

CONTRIBUTIONS TO PENSION TRUST

The TI Employee's Pension Trust ("Pension Trust") is a qualified pension trust organized for the exclusive benefit of the employees of TI and certain of its subsidiaries. Under Section 404(a) of the Internal Revenue Code, employer contributions to the trust are deductible when paid if they are computed pursuant to one of several well-established actuarial methods, and also meet the "ordinary and necessary" business expense test incorporated by reference from Code section 162(a). ²

On this appeal the Government does not challenge the fact that taxpayer's payments were in accord with an appropriate During 1968 and 1969, approximately 23,000 employees of TI were covered by the Pension Trust. The primary investment and management responsibility rests with a retirement committee composed of not less than five (5) participants. All necessary actuarial computations are made by or under the supervision of an actuary. Significant uncertainties concerning future events are of necessity constructed into the basic assumptions used to value the contributions. Once the various significant variables are identified and reduced to statistically probable values, the present value of future benefits can be computed. There are several acceptable actuarial methods. This case involves two of the most commonly used the aggregate method and the entry age normal method. The sub-paragraphs of IRC section 404(a)(1) permit their utilization. Sub-paragraphs (A) and (B) together allow use of the aggregate method; sub-paragraph (C) allows use of the entry age normal.

Code actuarial method, but insists that in the years of payment, the contributions did not satisfy the "ordinary and necessary" business expense standard. They argue that they were not "ordinary" expenses because they were nondeductible capital outlays and alternatively that they were not "ordinary" or "necessary" within the more general meaning of those terms. These contentions will be considered separately. The "ordinary and necessary" business expense test is conjunctive and must be applied with regard to the facts of each case. Welch v. Helvering, 290 U.S. 111, 54 S.Ct. 8, 78 L.Ed. 212 (1933).

For many years prior to 1967, the amount of the contribution made to the Pension Trust was actuarially determined under the entry age normal method. For 1967, the amount of the contribution was determined under the aggregate method. Likewise, the amounts contributed for 1968 and 1969 were determined under the aggregate. ³

The objective of the aggregate method is to fund the total estimated remaining liabilities over the remaining working life of the participants. The present value of benefits to be paid in the future is determined upon certain assumptions concerning interest rate, administration expenses and future benefits. The present value of future benefits is then reduced by the value of assets to determine the present value of the benefits which have not been funded. The contribution for the year is then equal to a level percentage of payroll which would completely fund the unfunded benefits, if paid over the remaining working life of the plan participants.

Under the entry age normal method, the "normal cost" for the particular year is first determined. These costs are computed on the assumption, (i) that every employee entered the plan (entry age) at the time of employment or at the earliest time he would have been eligible if the plan had been in existence, and (ii) that contributions of "normal cost" have been made from the entry age to the date of actual valuation. Theoretically, the contributions are then equal to the level percentage of payroll which, if contributed each year and accumulated at the rate of interest used in the actuarial valuation, would result in a fund equal to the present value of the pensions at retirement for the employees who survive to that time.

Since "normal cost" under the entry age normal method is determined on the assumption that there have been prior contributions of "normal cost," which may or may not be true, it is necessary to compute separately the past service costs on that group of employees who did not enter the program at its creation. Hence the annual contribution under the entry age normal method is comprised of two components: the normal cost and unfunded past services cost. The past services cost may be reduced by contributions equivalent to the interest on the unfunded balance of past services cost and an amount intended to reduce the principal amount of the unfunded balance.

During 1967 it was deemed advisable to change the interest rate assumption for the Pension Trust from 31/2% to 4%. This change was warranted by past investment experience and a forecast of investment probabilities in the future. The interest rate assumption is an important factor in determining the present value of future benefits, and the increase substantially decreased the present value of the benefits payable by the Pension Trust as of January 1, 1967.

At the time the decision was made to increase the interest rate assumption, the actuary for the Pension Trust advised that under the Internal Revenue Service's ("IRS") position, TI would have no deductible contribution to the Pension Trust for 1967 if the contribution were computed under the entry age normal method. Therefore, the actuary recommended that TI change to the aggregate method of computing its contribution to the Pension Trust for 1967. ⁴

Some companies which were not in good shape financially had changed their actuarial assumptions in order to reduce or avoid entirely contributions to their pension trusts. TI, as well as the financial community, felt this type of action by these companies did not satisfy established liabilities and, in effect, resulted in improper financial reporting to the public. TI recognized that such action had been received very poorly in the financial community and TI had no desire to be placed in a similar position, either with the financial community or with its own employees. In the words of George Livings, a member of the retirement committee, the Pension trust changed to the aggregate method to "avoid these wild swings where you go from eight million dollars' contribution in one year to zero in the next."

The entry age normal method lends itself to the concept of "overfunding." If the assets exceed accrued liability, the trust is said to be overfunded. ⁵ The concept of overfunding is alien to the aggregate method, because "accrued" costs of past service are spread, along with current costs, over the remaining work life of each employee. A pension trust under the aggregate method is not strictly "overfunded" until the value of the trust assets exceeds the total benefits payable.

In the light of what has been said, we turn to the precise contention that the contributions were not "ordinary," because "they were non-deductible capital outlays." Shorn of unnecessary actuarial embellishment, the bottom line of this contention is simple. The government puts it this way:

"The taxpayers' Pension Trust was substantially overfunded in 1968, its $7,000,000 contributions in 1968 and 1969 constitute payments for (or attributable to) its employees' pensions for their future years of service."

We do not regard as contrarily persuasive the numerous decisions adhering to the established rule that prepaid expenses are not deductible in the year of payment and must be capitalized because they create an asset having a longer life than a single tax year. E. g., Commissioner of Internal Generally, an expense is considered prepaid if it is paid in a taxable year prior to the taxable year in which the benefits therefrom are received. The non-deductibility of a prepaid expense is based on the assumption that an expense in a fixed amount can be directly associated with a benefit to be received in a future year. Paying a worker so many dollars per hour is a simple closed-end business...