United States Court of Appeals
for the Federal Circuit
01-5137
THE TRAVELERS INSURANCE COMPANY,
Plaintiff-Appellee,
v.
UNITED STATES,
Defendant-Appellant.
Peter H. Winslow, Scribner,
Hall & Thompson, LLP, of Washington, DC, argued for plaintiff-appellee.
Edward T. Perelmuter,
Attorney, Tax Division, Department of Justice, of Washington, DC, argued for
defendant-appellant. With him on the
brief were Eileen J. O’Connor, Assistant Attorney General; David
English Carmack, and David I. Pincus, Attorneys.
Appealed from: United
States Court of Federal Claims
Senior Judge Loren A. Smith
United States Court of Appeals
for the Federal Circuit
01-5137
THE TRAVELERS INSURANCE COMPANY,
Plaintiff-Appellee,
v.
Defendant-Appellant.
___________________________
DECIDED: September 16, 2002
___________________________
Before
SCHALL, DYK, and PROST, Circuit Judges.
DYK,
Circuit Judge.
This federal income tax refund case has been pending in the
Court of Federal Claims for over a decade.
It presents two issues, each of which relates to special rules for the
taxation of life insurance companies, such as the Travelers Insurance Co.
(“Travelers” or “taxpayer”), the appellee in this case. The first issue is whether the
policyholders’ share of income should have been excluded from “taxable income”
for purposes of computing the limitation on the foreign tax credit in section
904 of the Internal Revenue Code, 26 U.S.C. § 904 (1976). For life insurance companies, “taxable
income” is defined in terms of taxpayer’s “life insurance company taxable
income” (“LICTI”). Id.
§ 802. We hold that Congress
explicitly provided for the exclusion of the policyholders’ share from LICTI in
26 U.S.C. §§ 804(a)(1) and 809(a)(1) (1976), and accordingly reverse the
decision of the Court of Federal Claims to the contrary.
The second issue is whether, under 26
U.S.C. § 446 (1976), the Internal Revenue Service (“IRS” or “Service”) properly
determined that the taxpayer’s method of translating foreign currency profits
and losses from Canadian branch operations into United States dollars failed to
“clearly reflect income.” We hold that
the Court of Federal Claims erred in declining to defer to the IRS
determination, and that the taxpayer has not shown that the IRS abused its
discretion. Accordingly, we reverse the
decision of the Court of Federal Claims to the contrary.
BACKGROUND
Taxpayer is a stock life insurance company, which writes
various forms of life and accident insurance.
This case presents two issues concerning the taxpayer’s income tax
liability—one relating to the foreign tax credit and the other concerning the
taxation of income from taxpayer’s Canadian branch operations.
I The Foreign Tax
Credit Issue
In 1970, taxpayer entered into an
agreement with an offshore drilling company under which taxpayer received a 3%
interest in an Indonesian oil exploration and drilling joint venture. Every year between 1975 and 1980, taxpayer received
net income from its participation in the joint venture. During those years, taxpayer paid taxes to
Indonesia on the income it earned from the joint venture and claimed foreign
tax credits under sections 841 and 901 of the Internal Revenue Code, 26 U.S.C.
§§ 841, 901 (1976). In all relevant
respects, the pertinent sections of the Tax Code were unchanged between 1975
and 1980. For ease of reference, this
opinion refers to the 1976 version of the Tax Code. Many of the statutory provisions involved in this case have been
revised or repealed since 1980.
Computation of LICTI
In order to understand the foreign tax credit issue, it is
necessary to understand the method by which the income tax of life insurance
companies was computed. Instead of
using the familiar concept of “taxable income,” 26 U.S.C. § 11 (1976), as
the base, the Code provided that in the case of life insurance companies the
base was to be “life insurance company taxable income” (“LICTI”), id. §
802. During the relevant taxable years,
taxpayer computed its LICTI under provisions enacted in the Life Insurance
Company Tax Act of 1959, Pub. L. No. 86-89, 73 Stat, 112 (1959), which were codified in former sections 801
to 820 of the Code, 26 U.S.C. §§ 801-820.
Under those provisions, taxpayer initially was required to compute both
its “taxable investment income” and its “gain from operations.” Id. § 802(b). To compute its taxable investment income,
the company began with its gross investment income, an item that included
traditional investment income such as interest, dividends, rents, and
royalties, as well as income from non-insurance business enterprises, such as
oil-related income. Id.
§ 804(b). The company then
subtracted from its gross investment income its investment expenses. The balance was referred to as “investment
yield.” Id. § 804(c).
The next computation involved the division of “investment
yield” into a “policyholders’ share” and the “company’s share.” Id. § 804(a). The first step in this computation was the
development of a fraction, which was the amount of investment income needed for
policyholder and other contract liability requirements (i.e., the amount
that must be added to reserves), divided by the total investment yield. This fraction was then multiplied by “each
and every item of investment yield,” id. § 804(a)(1), to obtain the
policyholders’ share of that item. The
policyholders’ share of each item was then excluded from income. Id. § 804(c)(1). The company’s taxable investment income was
the sum of the company’s share of each item and the net capital gain. Id. § 804(a)(2).
“Gain from operations,” in contrast to taxable investment
income, consisted of all of the company’s income—investment income and
underwriting income. See id.
§§ 809(b), (c) & (d); United States v. Atlas Life Ins. Corp.,
381 U.S. 233, 235 n.2 (1965). Like the
computation of taxable investment income, the investment income portion of gain
from operations was only “the life insurance company’s share of each and every
item of investment yield[.]” 26 U.S.C.
§ 809(b)(1)(A). The policyholders’
share of each and every item of investment yield was again excluded. Id. § 809(a)(1).
After computing its “taxable investment income” and “gain
from operations,” the company compared the two figures. If the company’s gain from operations was
less than its taxable investment income (because, for example, the company had
underwriting losses), its tax base (LICTI) was gain from operations. Id. § 802(b)(1). On the other hand, if the company’s gain
from operations was greater than its taxable investment income, its tax base
(LICTI) was taxable investment income plus one half of the excess of gain from
operations over taxable investment income.
Id. § 802(b)(2).
Although the method of
computing taxable income was complex, the central fact for present purposes is
that the policyholders’ share of “taxable investment income” and “gain from
operations” reduced taxable income (LICTI).
The Foreign Tax Credit Provisions
For insurance companies, the foreign tax credit was
authorized by 26 U.S.C. § 841 (1976), which incorporated the general
foreign-tax-credit provision of 26 U.S.C. § 901 (1976). Section 841 provided
that:
The taxes imposed by foreign countries or possessions of the
United States shall be allowed as a credit against the tax of a domestic
insurance company subject to the tax imposed by section 802 [on
LICTI] . . . to the extent provided in the case of a domestic
corporation in section 901 (relating to foreign tax credit).
26 U.S.C. § 841 (1976). Section 901 authorized a taxpayer to claim the credit “subject to
the limitation of section 904 . . . .” Id. § 901(a).
Section 904(a), in turn, provided:
The total amount of the credit taken under section 901(a) shall not exceed the same proportion of the tax against which such credit is taken which the taxpayer’s taxable income from sources without the United States (but not in excess of the taxpayer’s entire taxable income) bears to his entire taxable income for the same taxable year.
Id.
§ 904(a). As applied to life
insurance companies, section 841 provided that “life insurance company taxable
income” was to be used as “taxable income” for purposes of the foreign tax
credit. Id. § 841. The section 904 “limitation” may be
expressed by the following formula, in which the right-hand side of the formula
is referred to hereafter as the “section 904 fraction”:
United States Income Tax Foreign
Source LICTI
Liability before Application x ----------------------------------
of Foreign Tax Credit Worldwide
LICTI
In cases involving oil-related income, section 907(b)
provided that the section 904 limitation was to be applied separately for
“foreign oil related income” and “other taxable income.” Id. § 907(b)(1).[1]
The central dispute in the Court of Federal Claims[2]
was whether the policyholders’ share of both foreign source LICTI and worldwide
LICTI, which respectively comprise the numerator and denominator of the section
904 fraction, should be treated as an exclusion or a deduction. If the policyholders’ were an exclusion,
both the taxpayer and government agreed that the policyholders’ share should be
excluded from the numerator and denominator of the section 904 fraction, and
that no refund was due. On the other
hand, if the policyholders’ share were a deduction, the taxpayer argued that it
should be ignored in calculating the numerator – foreign source LICTI – because
the deduction was properly attributable to United States operations under the
sourcing rules of 26 C.F.R. §§ 861-863 (1977).[3] But the policyholders’ share, in the
taxpayer’s view, was still properly deducted from the denominator to compute
worldwide LICTI.[4]
On April 30, 1993, the Court of Federal Claims issued its
first opinion, granting partial summary judgment to taxpayer on the foreign tax
credit issue. Travelers Ins. Corp.
v. United States, 28 Fed. Cl. 602 (1993).
In its opinion, the Court of Federal Claims acknowledged that “[b]oth
parties present coherent arguments for their positions on the nature of the
policyholders’ share.” Id. at
612. The Court of Federal Claims
recognized that under sections 804(a)(1) and 809(a)(1) of the Code the
policyholders’ share of income is “exclud[ed]” from both the numerator and
denominator of the section 904 fraction.
Id. at 607. However,
relying almost entirely on section 810(b) of the Code, which relates to
adjustment of life insurance company reserves, the court found that the
statutory exclusion was in fact more “accurately viewed as a deduction.” Id. at 613. This was so because the excluded amounts (the policyholders’
share) reduced the amount of the reserves and hence the deduction allowed for
addition to reserves. The overall
effect was to increase LICTI after accounting for the deduction. The court reasoned, “[i]n reality, the
policyholders’ share exclusion is the required interest portion of the reserve
deduction which is fully recouped by the corresponding decrease in the year-end
reserves under [s]ection 810.” Id.
at 613. The court then concluded that
this “deduction” was “properly allocated to Travelers’ gross income from its
domestic insurance business and not to its Indonesian oil investment
activities.” Id. at 614. Therefore, the policyholders’ share was
improperly excluded from foreign source LICTI, which is the numerator of the section
904 fraction, but properly deducted from worldwide income to compute worldwide
LICTI. Id. at 615.[5]
II The Foreign
Currency Translation Issue
The second issue concerns foreign currency translation. During the years 1977 through 1980, taxpayer
derived income from insurance underwriting and investment operations in
Canada. On its United States tax
returns for those years, taxpayer calculated its taxable gain and income from
its Canadian operations in Canadian dollars.
Taxpayer combined those amounts with United States dollar amounts
attributable to its other operations.[6] Taxpayer then made a “Canadian Exchange
Adjustment” to the combined figure and reported that figure in United States
dollars as part of the process of computing both its taxable investment income
and its gain from operations for purposes of determining its LICTI for the
relevant taxable years. In making this
exchange adjustment, taxpayer used the current, end-of-the-year exchange
rate.
On audit, the IRS recomputed taxpayer’s LICTI by converting
each line amount attributable to Canadian operations into United States
dollars, combining that amount with the United States dollar amounts
attributable to taxpayer’s other operations, and reporting the total amount in
United States dollars. In making this
adjustment, the IRS concluded that taxpayer’s method failed to clearly reflect
its LICTI.
There is another significant difference between the IRS and
the taxpayer concerning the treatment of the historical basis of certain
taxpayer assets. The IRS converted the
adjusted basis of Canadian bonds, mortgages, and joint ventures from Canadian
dollars to United States dollars using historical exchange rates (i.e.,
the rates in effect at the time of the original acquisition of the asset). The government urges that this historical
exchange rate was required by section 805(b)(4), which provides that “the
amount attributable to— . . . (B) any other asset shall be the adjusted basis,
of such asset for purposes of determining gain on sale or other disposition.” 26 U.S.C. § 805(b)(4)(B) (1976).
Taxpayer paid the additional tax resulting from the
Commissioner’s determinations and filed a refund claim with the IRS. After the IRS denied the refund claim,
taxpayer filed this refund suit claiming that the IRS had erred in substituting
its own accounting method for the method employed by taxpayer.
On March 21, 1996, the Court of
Federal Claims issued another opinion.
In again granting partial summary judgment for the taxpayer, the Court
of Federal Claims noted that “[i]t is not the intention of this court to modify
or limit the amount of latitude that has been consistently accorded the
Secretary in determining what method of accounting will accurately reflect a
taxpayer’s income.” Travelers Ins.
Corp. v. United States, 35 Fed. Cl. 138, 141 (1996). Nonetheless, the court concluded that no
deference was due the IRS determination for two reasons. First, the court found that the IRS abused
its discretion by imposing its own accounting method without making the
necessary formal and explicit determination that the taxpayer’s method did not
clearly reflect income. Id. at
145-46. Second, the court found:
De novo
review of the taxpayer’s method of accounting may, at first blush, seem to
contradict the express language of section 446(b) because implicit in the
phrase “in the opinion of the Secretary” is the concept of Secretarial
discretion. Upon further examination of
the placement of that language within the section, however, it is clear that
section 446(b) contemplates two different levels of judicial review. The first determination to be made by the
Secretary—whether the taxpayer’s regularly used method of accounting clearly
reflects income—is not subject to the Secretary’s opinion and therefore is to
be reviewed de novo. The second
determination—what alternative method does clearly reflect income—is subject to
the “opinion of the Secretary” and therefore must be accorded the significant
degree of deference normally accorded to an administrative agency by a
court.
Id. at 141
(citations omitted) (emphasis added).
The court then examined the two methods of conversion
generally recognized by the IRS: the
“profit and loss” and the “net worth” methods.
Id. at 142. The “profit
and loss” method involves computing net income attributable to foreign branch
operations in foreign currency and then using end-of-the-tax-year exchange
rates to translate the income into United States dollars. Id.
The “net worth” method translates the balance sheet net worth, not just
the income of the foreign branch. The
increase in net worth is treated as taxable income. Id. As an example
of a profit and loss method, the court identified Revenue Ruling 75-107, which
provides in pertinent part that “[t]he balance of the net profits, expressed in
[foreign] Country Y’s units should be converted into United States money at the
rate of exchange as of the end of the taxable year, regardless of the fact that
the profits may not have been remitted to M [a domestic corporation].” Id.; Rev. Rul. 75-107, 1975-1 C.B.
32. The court then concluded that
“[t]he Travelers’ Method, which computes net gain or loss in Canadian currency
and then converts this amount to U.S. dollars by the end-of-the-year exchange
rate,” Travelers, 35 Fed. Cl. at 142, was “essentially the same as the
profit and loss method described in Revenue Ruling 75-107,” 33 Fed. Cl. at
143. The court accepted this revenue
ruling as evidence that Travelers’ Method clearly reflected income. Id.
The court further concluded that the government had “not
offered any conclusive evidence in support of the Service’s determination that
the Travelers’ Method does not clearly reflect income,” id. at 144, and
more specifically, that “the government has failed to show any basis for its
position that the Travelers’ Method of accounting did not accurately reflect
plaintiff’s income for taxable years 1977 through 1980,” id. at
145. In light of taxpayer’s consistent
use of this accounting method in addition to the IRS’s previous acceptance of
the method, the court held that the IRS exceeded the scope of section 446(b) by
requiring taxpayer to use the Service Method.
Id. at 145. In addressing
the foreign currency translation issue, the Court of Federal Claims did not
discuss section 805.
When the Court of Federal Claims entered a final judgment on
June 22, 2001, the United States appealed.
We have jurisdiction pursuant to 28 U.S.C. § 1295(a)(3).
DISCUSSION
The issues in this case are issues of
law, which we review without deference to the Court of Federal Claims. Conti v. United States, 291 F.3d
1334, 1338 (Fed. Cir. 2002).
I The Foreign Tax
Credit Issue
The clear language of the Code governs the foreign tax
credit issue. Those provisions excluded
the policyholders’ share from LICTI.
As noted above, the “section 904 fraction” for purposes of
the foreign tax credit is calculated in terms of taxpayer’s “life insurance
company taxable income” (“LICTI”), which is, in turn, calculated from the
company’s “taxable investment income” and “gain from operations.” 26 U.S.C. §§ 841, 802(b) (1976). Section 804(a)(1) provides in pertinent part
that “[t]he policyholders’ share of each and every item of investment yield
(including tax-exempt interest and dividends received) of any life insurance
company shall not be included in taxable investment income.” Id. § 804(a)(1) (emphasis
added). Section 809(a)(1) similarly
provides that “[t]he share of each and every item of investment yield
(including tax-exempt interest and dividends received) of any life insurance
company set aside for policyholders shall not be included in gain or
loss from operations.” Id.
§ 809(a)(1) (emphasis added).
Thus, both provisions require that the policyholders’ share be excluded
from any computation of LICTI. Indeed,
the Supreme Court recognized that the policyholders’ share should be treated as
an exclusion in United States v. Atlas Insurance Corp., 381 U.S. 233
(1965), stating: “Each item of
investment income, including tax-exempt interest, is divided into a policyholders’
share and a company’s share. The
policyholders’ share is added to the reserve, is excluded for tax purposes from
the gross income of the company and is not taxed to either the company or the
policyholders.” Id. at 239
(emphasis added).
Taxpayer’s primary argument, adopted by the Court of Federal
Claims, is that any exclusion is only a temporary exclusion because the amount
of the exclusion is later included in income by an adjustment to the reserves
of the company. Thus, according to the
taxpayer, this “exclusion” is in reality a “deduction” and that “deduction . .
. is fully recouped by the corresponding decrease in the year-end reserves
under [s]ection 810.” Travelers,
28 Fed. Cl. at 613.[7]
The taxpayer misunderstands the function of section 810.
“Life insurance reserves may be defined simply as that fund which, together
with future premiums and interest, will be sufficient to pay future
claims.” Atlas, 381 U.S. at 236
n.3; accord 26 U.S.C. § 801(b)(1) (1976). Section 810 provides the method of computing its decreases or
increases in annual reserves. A net
decrease produces a corresponding increase in income, and a net increase
produces a reserve deduction (and a decrease in income). 26 U.S.C. §§ 810(a), (b), 809(d)(2)
(1976). Sections 810(a) and (b) provide
parenthetically that prior to computation of any net decrease or increase in
reserves, the items taken into account in calculating the adjustment in
reserves[8]
must first be “reduced by the amount of investment yield not included in gain
or loss from operations for the taxable year by reason of section
809(a)(1).” Id. § 810(a)
and (b) (parentheses omitted). In other
words, the policyholders’ share is not taken into account in computing the
increase or decrease in reserves. While
the net effect of section 810 may be that the reserve deduction is decreased
(and the taxpayer’s income increased) in some circumstances by the
policyholders’ share, nothing in section 810 alters the provisions of sections
804 or 809 or converts an exclusion into a deduction.
As the Supreme Court has repeatedly recognized, “[c]ourts are not authorized to rewrite a statute because they might deem its effects susceptible of improvement.” Badaracco v. Comm’r, 464 U.S. 386, 398 (1984); see also TVA v. Hill, 437 U.S. 153, 194-95 (1978). Here the taxpayer effectively requests that this court rewrite the Tax Code and treat a clearly labeled statutory exclusion as a deduction. Although the parties urge us to consider legislative history[9] and policy considerations to determine the appropriate treatment of the policyholders’ share, that is quite unnecessary. The Code is clear on its face, and we are not charged with rewriting it to convert an exclusion into a deduction based on the theory proposed by the taxpayer and adopted by the Court of Federal Claims. See Marsh Corp., Inc. v. United States, No. 02-5002, slip op. at 20 (Fed. Cir. Sept. 6, 2002); Phila. & Reading Corp. v. United States, 944 F.2d 1063, 1074 (3d Cir. 1991).[10]
Taxpayer relies on our decision in American Mutual Life Insurance Corp. v. United States, 267 F.3d 1344 (Fed. Cir. 2001), to urge that the policyholders’ share is more analogous to a deduction than an exclusion. In American Mutual, the taxpayer argued that it received only a partial tax benefit from the deductions it took for increases in reserves. American Mutual, 267 F.3d at 1349. Consequently, the taxpayer urged that the corresponding reserve releases (i.e., reductions in reserves) in later tax years should not have been taxed as income, relying on the tax benefit rule codified at section 111.[11] Id. at 1349-50. The tax benefit rule ensures that “if a taxpayer takes a deduction attributable to a specific event, and the amount is recovered in a subsequent year, income tax consequences of the later event depend in some degree on the prior related tax treatment.” Id. at 1346 (citation omitted). Affirming the Court of Federal Claims, we held that “because American Mutual received a benefit from the reserve deductions taken, it cannot resort to the tax benefit rule to exclude from income amounts corresponding to release of those reserves.” Id. at 1354. Nothing in American Mutual remotely suggests that the policyholders’ share is a deduction from reserves rather than an exclusion.[12]
Therefore, we conclude that the Code requires that the policyholders’ share be treated as an exclusion from both the numerator and the denominator of the section 904 fraction, and we reverse the Court of Federal Claims’ decision to the contrary.
II
The Foreign Currency Translation Issue
A
We turn now to the second issue relating to foreign currency
translation. Taxpayer argues that
neither the Code nor the regulations required that a particular accounting
method be used to translate the foreign currency into United States
dollars. Taxpayer urges that its
accounting method, which reported its Canadian branch taxable investment income
and gain from operations in Canadian dollars and then applied year-end exchange
rates to convert those figures into United States dollars, clearly reflected
income because it was in essence the profit and loss method identified in
Revenue Ruling 75-107. Revenue Ruling
75-107 provides in pertinent part that “[t]he balance of the net profits,
expressed in [foreign] Country Y’s units should be converted into United States
money at the rate of exchange as of the end of the taxable year, regardless of
the fact that the profits may not have been remitted to M [a domestic
corporation].” Rev. Rul. 75-107, 1975-1
C.B. 32. The taxpayer acknowledges that
its accounting method differs from Revenue Ruling 75-107 in that it is applied
in two separate phases, which yield two exchange rate conversions, rather than
just one phase as the revenue ruling suggests.
However, the taxpayer argues that this difference is an immaterial
variation.
The government urges that taxpayer’s accounting method does
not clearly reflect income and that the IRS has broad discretion to set aside a
taxpayer’s accounting method if it does not clearly reflect income. The government contends that the profit and
loss method of accounting identified in Revenue Ruling 75-107 differs markedly
from taxpayer’s accounting method.
Specifically, the government urges that taxpayer combined its taxable
gain and income from its Canadian operations with the taxable gain and income
from other United States operations without first translating the Canadian
dollars to United States dollars. The
government then states that taxpayer applied an unspecified “Canadian Exchange
Adjustment” to the combined figure using the current, year-end exchange
rates. The government argues that
taxpayer’s method fails to clearly reflect income and contends that the Court
of Federal Claims erred by substituting its judgment for that of the IRS when
it concluded that taxpayer’s accounting method clearly reflected income.
A second foreign currency translation issue concerns the
calculation of the basis of certain assets.
The government urges that section 805(b)(4) dictates that the taxpayer
should have used historical rather than current year-end exchange rates for the
foreign currency translation of certain assets. The taxpayer urges that section 805(b)(4) does not govern this
case because “[t]he purpose of section 805(b)(4) is to quantify assets to
determine the current earnings rate,” App. Br. at 59, and it does not
address whether historical or current exchange rates should be used in
calculating the basis of those assets.
As noted above, the Court of Federal Claims failed to address this
issue.
B
Initially, we note that the decision of the Court of Federal
Claims on the foreign currency translation issue rests on two quite mistaken
premises concerning the authority of the IRS acting pursuant to section 446 of
the Code. Section 446 provides in
pertinent part:
(a)
General Rule
Taxable income shall be computed under the method of
accounting on the basis of which the taxpayer regularly computes his income in
keeping his books.
(b) Exceptions
If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary, does clearly reflect income.
26 U.S.C. § 446 (1976) (emphasis added).
First, the Court of Federal Claims erred when it concluded
that no deference was due the IRS determination because the IRS had not made an
explicit determination that the Service Method clearly reflected income. Travelers, 35 Fed. Cl. at 145. There is no requirement in section 446 that
the IRS make explicit findings identifying section 446 as the source of its
authority. Such a determination is
implicit when the IRS substitutes its method for the method of the taxpayer.
Second, the Court of Federal Claims, following its own
decision in Mulholland v. United States, 28 Fed. Cl. 320, 335 (1993),
erred in applying a de novo standard of review as to whether the
taxpayer’s accounting method clearly reflected income within the meaning of
section 446(b). See Travelers,
35 Fed. Cl. at 141. We find no support
for the Court of Federal Claims’ position in the language of the statute. Under section 446, the Commissioner has
broad discretion to set aside a taxpayer’s accounting method if he believes
that it does not clearly reflect income.
Over 70 years ago, in Lucas v. American Code Corp., 280 U.S. 445
(1930), the Supreme Court emphasized the broad discretion that the Service
should be given to interpret the Code, including provisions such as the
precursor to section 446:
And the direction that net income be computed according to the method of accounting regularly employed by the taxpayer is expressly limited to cases where the Commissioner believes that the accounts clearly reflect the net income. Much latitude for discretion is thus given to the administrative board charged with the duty of enforcing the Act. Its interpretation of the statute and the practice adopted by it should not be interfered with unless clearly unlawful.
Id. at 449. See also Thor Power Tool Corp. v.
Comm’r, 439 U.S. 522, 532 (1979) (indicating that section 446, inter
alia, “vest[s] the Commissioner with wide discretion in determining
whether a particular method of inventory accounting should be disallowed as not
clearly reflective of income.”).
So too, our prior decisions reject a de novo
standard of review. See LaCrosse
Footwear, Inc. v. United States, 191 F.3d 1372, 1379 (Fed. Cir. 1999)
(finding that the Commissioner did not abuse his discretion when he concluded
that taxpayer’s accounting method did not clearly reflect income); Morgan
Guar. Trust Corp. of N.Y. v. United States, 585 F.2d 988, 997 (Ct. Cl.
1978) (finding that the Commissioner abused his discretion when he rejected
taxpayer’s accounting method).
Accordingly, the Court of Federal Claims must accord substantial
deference to the IRS determination that the taxpayer’s method does not clearly
reflect income.
C
Applying the correct standard, we conclude that the IRS determination must be sustained. The taxpayer here made no showing that the IRS abused its discretion in determining (1) that the taxpayer’s method did not clearly reflect income and (2) substituting its own methodology. The IRS properly required the use of the established profit and loss method. The fact that the taxpayer’s methodology may have been “conceptually similar” to or “essentially the same as” the IRS-approved method is irrelevant. Contrary to the Court of Federal Claims’ decision, it is also of no moment that the IRS did not challenge the taxpayer’s methodology in each year. The IRS is not bound by its earlier position. See Dickman v. Comm’r, 465 U.S. 330, 343 (1984); Caldwell v. Comm’r, 202 F.2d 112, 115 (2d Cir. 1953). We have considered and reject the taxpayer’s other challenges to the IRS determination. However, one aspect of the IRS determination requires further comment.
The government contends that section 805 compels that the basis of bonds, mortgages, and joint venture assets be computed at historical rather than current, year-end exchange rates. We are unable to find any such requirement in section 805.
Section 805 provides in pertinent part:
(b) Adjusted reserves rate and earnings
rates.
. . . .
(4) Assets
For purposes of this part, the term “assets” means all
assets of the company (including nonadmitted assets), other than real and
personal property (excluding money) used by it in carrying on an insurance
trade or business. For purposes of this
paragraph, the amount attributable to—
(A) real property and stock shall be
the fair market value thereof, and
(B) any other
asset shall be the adjusted basis, of such asset for purposes of determining
gain on sale or other disposition.
26 U.S.C. § 805 (1976) (emphasis added). Section 805(b)(4) describes how to quantify
assets to determine the adjusted reserves rates and earnings rates for any
taxable year. Nothing in section 805
specifies whether, for income tax purposes, the basis of assets for computing
capital gain or loss should be computed using historical or current, year-end
exchange rates. Section 805 does not specifically
define “adjusted basis.” That section
evidently contemplates use of standard basis provisions. Section 1011(a), a generally applicable
section of the Code, simply provides that the “adjusted basis” shall be
determined under section 1012. Id.
§ 1011(a). Section 1012(a), in
turn, provides that “[t]he basis of property shall be the cost of such property
. . . .” Id. § 1012. Thus, section 805 does not specify the use
of a particular basis for foreign branch assets of life insurance companies purchased
with foreign currency. We hold that
section 805 does not require the result for which the government argues—namely,
determining the basis of bonds, mortgages, and joint venture assets for income
tax purposes by reference to historical exchange rates.[13] Nonetheless, we conclude that the IRS could
properly, as an exercise of discretion, require the use of historical exchange
rates in order to capture the gain attributable to the purchase of capital
assets in depreciated foreign currency, which have since increased in value.[14]
CONCLUSION
For the above reasons, we reverse the decision of the Court of Federal Claims on both the foreign tax credit and the foreign currency translation issues.
COSTS
No costs.
[1] There is also a separate section 907(a) limitation applicable to “foreign oil and gas extraction income,” 26 U.S.C. § 907(a) (1976), but the application of that limitation apparently has no effect here. As the Court of Federal Claims noted, “Under defendant’s computation, [s]ection 907(b) imposes the greatest restriction upon Travelers’ allowable foreign tax credit related to the Indonesian oil venture. Thus, [s]ection 907(b) provides the lesser foreign tax credit under [s]ection 901(a), and is the operative limitation in this case.” Travelers Ins. Corp. v. United States, 28 Fed. Cl. 602, 608 (1993).
[2] When the complaint was first filed on August 19, 1988, the
Court of Federal Claims was known as the United States Claims Court.
[3] Specifically, taxpayer cited Treas. Reg. § 1.861-8(a),
which provides in pertinent part:
(1)
Scope. Sections 861(b) and 863(a) state
in general terms how to determine taxable income of a taxpayer from sources
within the United States after gross income from sources within the United
States has been determined. Sections
862(b) and 863(a) state in general terms how to determine taxable income of a
taxpayer from sources without the United States after gross income from sources
without the United States has been determined.
This section provides specific guidance for applying the cited Code
sections [which include section 904] by prescribing rules for the allocation
and apportionment of expenses, losses, and other deductions (referred to
collectively in this section as “deductions”) of the taxpayer.
26 C.F.R. § 1.861-8(a) (1977) (emphasis
added).
[4] Even if the policyholders’ share were a deduction, the
government argued that it should be deducted from foreign source LICTI in
computing the section 904 fraction.
[5] The government correctly points out that the Court’s
assumptions as to the operation of the reserve provisions were not
correct. In light of our disposition of
this issue, we need not address the Court of Federal Claims’ error in this
respect.
[6] The parties dispute whether taxpayer combined the amounts
before or after it translated the Canadian dollars to United States
dollars. This dispute is irrelevant to
the outcome of this appeal.
[7] An exclusion is defined as “[a]n item of income excluded
from gross income.” Black’s Law
Dictionary 585 (7th ed. 1999). On
the other hand, a deduction is defined as “[a]n amount subtracted from gross
income when calculating adjusted gross income, or from adjusted gross income
when calculating taxable income.” Id.
at 422.
[8] These items include life insurance reserves, unearned
premiums and unpaid losses included in total reserves, amounts necessary to
satisfy obligations under insurance or annuity contracts, premiums received in
advance, liabilities for premium deposit funds, and special contingency
reserves. 26 U.S.C. § 810(c)
(1976).
[9] If we were to
consider the legislative history, we would conclude that it favors the
government, not the taxpayer. All of
the pertinent legislative history indicates that the policyholders’ share was
to be treated as an exclusion, not a deduction. See, e.g., S. Rep. No. 291, at 22 (1959), reprinted in
1959 U.S.C.A.N. 1575, 1596 (“Under your committee’s amendments the required
interest is omitted here because it is represented by the exclusion of that
portion of the investment yield set aside for policyholders.”). Indeed, the Court of Federal Claims noted
that “the legislative history indicates that Congress specifically designated
the policyholders’ share as an exclusion after initially labeling it as a
deduction.” Travelers, 28 Fed.
Cl. at 612.
[10] There is no inconsistency in this respect with the Supreme
Court’s decision in Atlas, which characterized the tax consequences of
the Code for purposes of a constitutional issue, not for purposes of statutory
construction. Atlas, 381 U.S. at
250-51.
[11] The tax benefit rule codified in section 111(a)
provides: “Gross income does not
include income attributable to the recovery during the taxable year of any
amount deducted in any prior taxable year to the extent such amount did not
reduce the amount of tax imposed by this chapter.” 26 U.S.C. § 111(a) (2000).
[12] Taxpayer also urges that the government has taken a
different position on appeal to this court from the previous position that it
took in its brief to this court filed in American Mutual. Even if its two positions were inconsistent,
such an inconsistency is irrelevant, because our task is to determine the
correct interpretation of the statute.
In any event, the government did not say anything inconsistent in its
brief in that case with its current position in this court.
[13] We also note that the foreign currency cases on which the government relies do not involve capital assets held by foreign branch operations. See, e.g., KVP Sutherland Paper Corp. v. United States, 344 F.2d 377 (Ct. Cl. 1965); Bennett’s Travel Bureau, Inc. v. Comm’r, 29 T.C. 350 (1957); The Joyce-Koebel Corp. v. Comm’r of Internal Revenue, 6 B.T.A. 403 (1927); Appeal of Bernuth Lembcke Corp., 1 B.T.A. 1051 (1925).
[14] We note that these foreign currency issues are now governed
by legislation enacted in the Tax Reform Act of 1986, Pub. L. No. 99-514, 100
Stat. 2085 (1986). The Conference
Committee Report on that legislation noted that under the law existing before
the new statute for purposes of the net worth method, historical exchange rates
were to be used. H.R. Conf. Rep. No.
99-841, at II-674 (1986), reprinted in 1986 U.S.C.C.A.N. 4075, 4762.