Western Nat. Mut. Ins. Co. v. C.I.R., 94-2961
| Decision Date | 01 September 1995 |
| Docket Number | No. 94-2961,94-2961 |
| Citation | 65 F.3d 90 |
| Parties | -6124, 95-2 USTC P 50,478 WESTERN NATIONAL MUTUAL INSURANCE COMPANY, Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Appellant. |
| Court | U.S. Court of Appeals — Eighth Circuit |
David Pincus, Washington, DC, argued (Gary R. Allen and Edward T. Perelmuter, on the brief), for appellant.
E.P. Baker, Washington, DC, argued (Jay B. Kelly, St. Paul, MN, and Peter H. Winslow, Washington, DC, on the brief), for appellee.
Before BOWMAN, BEAM, and MURPHY, Circuit Judges.
The Commissioner of Internal Revenue (Commissioner) appeals the Tax Court's determination that there was no deficiency in Western National Mutual Insurance Company's income tax for 1987. We affirm.
The taxpayer, Western National Mutual Insurance Company (Western), is a property and casualty insurance company engaged in the business of writing a wide variety of insurance policies. Western, like other property and casualty insurance companies, maintains reserves to cover unpaid losses; that is, losses that have been reported but not yet paid, or losses that have been incurred but not yet reported. Prior to enactment of the Tax Reform Act of 1986, Pub.L. No. 99-514, 100 Stat. 2085 (TRA of 1986), the unpaid losses covered by these reserves were "losses incurred" for which Western was entitled to a full deduction under I.R.C. Sec. 832(b)(5) (1982). In effect, Western could obtain a current deduction for a loss that it might not actually pay until some later year. To eliminate this advantage to the taxpayer, the TRA of 1986 provides that for taxable years beginning after December 31, 1986, only part of total reserves for unpaid losses may be deducted. I.R.C. Sec. 846 (1988 & Supp. V 1993) and Treas.Regs. Sec. 1.846-1 (1992) provide the mechanism by which unpaid losses are discounted to account for the time value of money, and the taxpayer may deduct only the discounted value of the reserves.
The impact of the new discounting rules was to be mitigated by use of a transitional rule supplied by the TRA of 1986. Under this "fresh start" provision, applicable only to the 1986 taxable year, a property and casualty company is entitled to forgiveness of income in an amount equal to the difference between discounted and undiscounted unpaid losses at the end of that year. Nevertheless, because a property and casualty company anticipating application of the transitional rule could substantially increase the amount of income forgiven by artificially inflating its loss reserves for the 1986 taxable year, Sec. 1023(e)(3)(B) of the TRA of 1986 provides that the fresh start rule "shall not apply to any reserve strengthening in a taxable year beginning in 1986." 100 Stat. at 2404 (emphasis added). What Congress meant by "reserve strengthening" as the term is used in Sec. 1023(e)(3)(B) is the central issue in this case.
The Commissioner argues that under Treas.Reg. Sec. 1.846-3, reserve strengthening means any increase in a property and casualty company's reserves. Under the Commissioner's approach, the increase in Western's 1986 reserves over its 1985 reserves constituted reserve strengthening, which disqualified Western from obtaining a deduction under the fresh start provision. Western, on the other hand, contends that in the insurance industry reserve strengthening is understood to occur only if a property and casualty company's reserves are increased as a result of a change in the assumptions or methodologies used by the company for computing reserves. Western argues that it was this industry meaning of reserve strengthening that Congress had in mind when it used the phrase in Sec. 1023(e)(3)(B). Under this approach, Western's adjustments to its reserves would not have constituted reserve strengthening and Western would have been entitled to the fresh start deduction.
The Tax Court held that Treas.Reg. Sec. 1.846-3 was invalid because the regulation's use of the term reserve strengthening did not comport with the statutory use and purpose of the term. Based on a thorough review of the statute's legislative history, the Court held that Congress intended that the statute incorporate the insurance industry's well-understood definition of reserve strengthening. That holding resolved the case, the parties having agreed that under the industry's accepted definition of reserve strengthening, Western had not engaged in reserve strengthening with respect to its 1986 loss reserve. Accordingly, the court entered its decision sustaining Western's position. On appeal, the Commissioner challenges the Tax Court's invalidation of Treas.Reg. Sec. 1.846-3. We exercise plenary review over the question of the validity of a treasury regulation. See Armstrong World Indus., Inc. v. Commissioner, 974 F.2d 422, 429-30 (3d Cir.1992).
The Commissioner contends that the Tax Court was required to defer to the construction of reserve strengthening set forth in Treas.Reg. Sec. 1.846-3 because the regulation is reasonable and is not plainly inconsistent with the statute it purports to implement. See Commissioner v. South Texas Lumber Co., 333 U.S. 496, 501, 68 S.Ct. 695, 698, 92 L.Ed. 831 (1948). However, the Commissioner's argument begs the question whether a regulatory definition of reserve strengthening is even necessary. We discern three possibilities with respect to the definition of reserve strengthening: (1) the term is defined by the statute; or (2) Congress intended the term to be defined by industry usage; or (3) the term is ambiguous. Only in the last case, i.e., only if the term is ambiguous, may we properly shift our attention to the definition set forth in Treas.Reg. Sec. 1.846-3. Accordingly, we begin our analysis with an examination of the statute itself. See Consumer Product Safety Comm'n v. GTE Sylvania, Inc., 447 U.S. 102, 108, 100 S.Ct. 2051, 2056, 64 L.Ed.2d 766 (1980).
Section 1023(e)(3)(B) provides in relevant part as follows:
(B) Reserve strengthening in years after 1985.--
Subparagraph (A) [the fresh start provision] shall not apply to any reserve strengthening in a taxable year beginning in 1986, and such strengthening shall be treated as occurring in the taxpayer's 1st taxable year beginning after December 31, 1986.
The meaning of reserve strengthening is not immediately apparent from the face of this provision. The statute does not provide a definition of the term elsewhere, and we search Sec. 1023(e)(3)(B) in vain for any clarification of the activity Congress intended to proscribe. Thus, absent a statutory definition, reserve strengthening must be either a term readily understood within the industry or one that is plainly ambiguous and that requires regulatory definition.
In light of the context in which the provision at issue appears, it seems fair to conclude that it was not drafted with the lay reader in mind. See Penn Sec. Life Ins. Co. v. United States, 524 F.2d 1155, 1156 (Ct.Cl.1975), aff'd, 430 U.S. 725, 97 S.Ct. 1440, 52 L.Ed.2d 4 (1977). Like the rest of subchapter L of the Internal Revenue Code, Section 1023(e)(3)(B) is devoted to taxation of the insurance industry and, unsurprisingly, makes substantial use of language peculiar to that industry. See Continental Ins. Co. v. United States, 474 F.2d 661, 666 (Ct.Cl.1973) (). We believe that reserve strengthening is an example of congressional employment of industry language and that Congress used the term reserve strengthening with full knowledge of its etymology and with the intent that its industry meaning be controlling. See McDermott Int'l, Inc. v. Wilander, 498 U.S. 337, 342, 111 S.Ct. 807, 811, 112 L.Ed.2d 866 (1991) (). Our conclusion is supported both by the Internal Revenue Service's use of the term in Treas.Reg. Secs. 1.806-4(b), Ex. (1) (1960), 1.809-5(a)(5)(iii) (as amended 1969), and 1.810-3(a) (1961) (), and by case law recognizing a well-understood industry meaning for reserve strengthening, see, e.g., Jefferson Standard Life Ins. Co. v. United States, 408 F.2d 842, 850 (4th Cir.), cert. denied, 396 U.S. 828, 90 S.Ct. 77, 24...
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