## United States Court of Appeals for the Federal Circuit

2009-5025

CNG TRANSMISSION MANAGEMENT VEBA, Plaintiff-Appellant,

v. UNITED STATES, Defendant-Appellee.

Eric R. Fox , Ivins, Phillips & Barker, Charter ed, of Washington, DC, argued for plaintiff-appellant. With him on the brief were Kevin P. O’Brien and Patrick J. Smith

. Kenneth L. Greene , Attorney, Appellate Section, Tax Division, Un ited States Department of Justice, of Washington, DC, argued for def endant-appellee. With him on the brief were John A. DiCicco , Acting Assistant Attorney General, Gilbert S. Rothenberg , Acting Deputy Assistant Attorney General, and Arthur T. Catterall , Attorney. Appealed from: United States Court of Federal Claims Judge Lynn J. Bush

### UNITED STATES COURT OF APPEAL S FOR THE FEDERAL CIRCUIT

2009-5025

CNG TRANSMISSION MANAGEMENT VEBA, Plaintiff- Appellant,

v. UNITED STATES, Defendant-Appellee.

Appeal from the United States Court of Federal Claims in 06-CV-541, Judge Lynn J. Bush.

________________________ DECIDED: December 14, 2009

_________________________ Before MAYER, LINN, and PROST, Circuit Judges

. MAYER, Circuit Judge

. CNG Transmission Management VEBA (“ CNG”) appeals the judgment of the United States Court of Federal Claims holding that a vol untary employees’ beneficiary association (“VEBA”) may not avoid the limi tation on exempt function income in 26 U.S.C. § 512(a)(3)(E)(i) by allocating invest ment income to the payment of member benefits. See CNG Transmission Mgmt. VEBA v. United States , 84 Fed. Cl. 327 (2008). We affirm.BACKGROUND The relevant facts are not in dispute. CNG is a VEBA orga nized under section 501(c)(9) of the Internal Reve nue Code. It was established by Consolidated Natural Gas Company in 1994. As an employ er-funded VEBA, CNG “provid[es] for the payment of life, sick, acciden t, or other benefits to the mem bers of [the] association or their dependents or designated beneficiaries.” 26 U.S. C. § 501(c)(9). At the beginning of 2000, CNG had total fund balances of $44,804,622. Over the course of the year, CNG generated $2,798,002 in inve stment income, received employer contributions of $12,684,454 and spent $7,429,878 on member benefits. At the end of 2000, it had tota l fund balances of $42,592,818. 1 In November 2001, CNG filed Internal Revenue Service Form 990-T, reporting $2,693,592 2 in unrelated business taxable income for 2000 and paying $1,065,684 in tax on this income. In 2004, however, it filed an amended Form 990-T, reques ting a refund of the tax paid in 2000 on the ground that the amount it had reported as unrelated business taxable income was instead non-taxable exempt function income. Although CNG conceded that its year-end account balance exceeded the account limit spec ified in 26 U.S.C. § 512(a)(3)(E)(i), it contended that it was not obli gated to pay tax on its invest ment income because it had spent that income on member benefits during the year.

1 In addition to expending funds on me mber benefits, CNG also transferred assets to another VEBA during 2000 and its year-end account balance reflects this transfer.

2 CNG originally reported investment income of $2,693,592, but now asserts that its 2000 investment income was actually $2,798,002.

2009-5025 2The Internal Revenue Service denied CNG’s refund claim and the Court of Federal Claims affirmed. In granting the government’s motion for summary judgment, the court noted that pursuant to the formula provided in Temporary Treasury Regulation § 1.512(a)-5T, Q&A-3 (“Treasury Regulation § 1.512(a)-5T”), a VEBA will owe tax on the lesser of its investment income and the amount by which its year-end account balance exceeds the statutory account limit. 84 Fed. Cl. at 335. The court concluded, moreover, that a VEBA could no t “avoid the limitation on exem pt function income in 26 U.S.C. § 512(a)(3)(E)(i) merely by allocating investment income toward the payment of welfare benefits durin g the course of the tax year.” Id . at 338. CNG appeals. We have jurisdiction under 28 U.S.C. § 1295(a)(3). DISCUSSION We review a grant of summa ry judgment by the Court of Federal Claims without deference and conduct a de novo review of all questions of statutory interpretation. Consolidation Coal Co. v. United States , 528 F.3d 1344, 1347 (Fed. Cir. 2008); Old Stone Corp. v. United States , 450 F.3d 1360, 1367 (Fed. Cir . 2006). Here the only issue in dispute is the proper interpretation of 26 U.S.C. § 512(a)(3)(E)(i). Organizations otherwise exempt from feder al taxation pursuant to section 501(a) of the Internal Revenue Code are nonethele ss subject to tax on their “unrelated business taxable income.” 26 U. S.C. § 511(a). In the cont ext of organizations such as VEBAs, unrelated business taxabl e income generally consists of all income other than “exempt function income.” See id. § 512(a)(3)(B). Exempt f unction income is defined

as: the gross income from dues, fees, charges, or similar amounts paid by members of the organization as consi deration for providing such members

2009-5025 3or their dependents or guests goods, faci lities, or services in furtherance of the purposes constituting the basis for the exemption of the organization to which such income is paid. Such term also means all income . . . which is set aside . . . to provide for the payment of life, sick, accident, or other benefits . . . . Id. Under this provision, there are two cla sses of exempt function income: (1) member contributions to the VEBA, and (2) income whic h is “set aside” for the payment of life, sick, accident or other mem ber benefits. In 1984, Congre ss restricted the amount of income that a VEBA could exclude as exempt function income, providing that a “setaside” for purposes of section 512(a)(3)(B) can be considered exempt function income “only to the extent that such set-aside does not result in an amount of assets set aside . . . in excess of the account limit determi ned under section 419A . . . for the taxable year.” See 26 U.S.C. § 512(a)(3)(E)(i). 3 Pursuant to 26 U. S.C. § 419A, a VEBA’s account limit is generally the amount nece ssary to pay for incurred but unpaid benefit claims as of the end of the year as well as certain related administrative costs. Accordingly, a VEBA’s income is exempt from tax only to the extent that it does not result in a year-end account balance in excess of the amount necessary to satisfy incurred but unpaid member claims.

3 In relevant part, section 512(a)(3)(E) provides: Limitation on amount of set asi de. . . . In the case of any organization described in paragraph (9), (17), or (20) of section 501(c), a set-aside for any purpose specified in [26 U.S.C. § 512(a )(3)(B)(ii)] may be taken into account under subparagraph (B) only to the extent that such set-aside does not result in an am ount of assets set aside for such purpose in excess of the account limit determined under section 419A . . . for the taxable year.

2009-5025 4The crux of the present dispute is whet her CNG’s investment income “result[ed] in an amount of assets set aside” in excess of the statutory account limit. See 26 U.S.C. §§ 419A(c), 512(a)(3)(E)(i). CNG argues that its investment income did not result in any account overage because it spent that income during the year on member benefits. The government, however, contends that because CNG’s investment income caused its total fund balances to exceed the statutory acco unt limit, that investment income cannot be classified as exempt function income. We agree with the government. The la nguage of section 512(a)(3)(E) is clear and unambiguous: it provides that income does not qualify as exempt function income if it “result[s] in” an account balanc e that is “in excess” of the statutory account limit. The plain meaning of the term “results in” is “causes.” See Brown v. Gardner , 513 U.S. 115, 119 (1994) (concluding that the term “as a resu lt of” can be “natura lly read simply to impose the requirement of a causal connection” ); Murakami v. United States , 398 F.3d 1342, 1352 (Fed. Cir. 2005) (construing the term “as a result of” to mean “as a consequence of”); Black Hills Aviation, Inc. v. United States , 34 F.3d 968, 975 (10th Cir. 1994) (concluding that the term “as a result of ” is “logically interpreted to mean ‘caused by’”). Here, CNG’s account overage was c aused by, or occurred as a consequence of, the investment income it m ade in 2000. Thus, under t he plain meaning of section 512(a)(3)(E)(i) that investment in come was not tax-exempt. We reject CNG’s argument t hat its investment income could not have resulted in any account overage because it “spent” all of its investment income on member benefits during the course of the tax year. Money is fungible, and CNG ca nnot avoid taxation by claiming that it spent money from invest ment income, rather than money from some

2009-5025 5other source, on member benefits. There is no requirement in se ction 512(a)(3)(E)(i) that a VEBA’s investment income can result in a year-end account overage only to the extent that the actual dollars in the account at year end ar e directly traceable to income made on investments. The legislative history of section 512(a)(3)(E)(i) supports this interpretation of the statutory language. The impetus for Congress’ enac tment of changes to the tax treatment of funded we lfare benefit plans was its c oncern about the “tax-shelter potential” of such plans. H. R. Rep. No. 98-432, pt. 2, at 1275 (1984). Specifically, Congress feared that “the comb ination of advance deductions for contributions and the availability of tax exempti on for certain employee benefit organizations (such as the voluntary employees’ beneficiary associati on or VEBA) provides tax treatment very similar to that provided to qualified pensio n plans, but with far fe wer restrictions.” Id. It therefore enacted sections 419 and 419A to limit the ext ent to which a VEBA could deduct employer contributions and enacted sect ion 512(a)(3)(E) to limit the extent to which a VEBA could set aside income on a tax-free basis. See id. at 1292 (“Present law does not specifically limit the amount of income that can be set aside” by a VEBA on a tax-exempt basis.); H.R. Rep. No. 98- 861, at 1163 (1984) (Congress intended to impose “more specific limits” on VEBAs in order to ensure t hat “the amount set aside for an exempt purpose is generally not to exceed the qualified asset account limit.”). Under CNG’s interpretation of section 512(a)(3)(E)(i ), however, a VEBA could avoid tax on its investment income simply by asserting t hat it had spent this income—rather than income from employee and employer cont ributions—on member benefits during the relevant tax year.

2009-5025 6I. Treasury Regulation § 1.512(a)-5T We find the language of sect ion 512(a)(3)(E)(i) to be unam biguous, but even if it were not, we would be compelled to acco rd deference to the Treasury’s reasonable interpretation of the statute. See Am. Express Co. v. United States , 262 F.3d 1376, 1383 (Fed. Cir. 2001) (“In the context of tax ca ses, the IRS’s reasonable interpretations of its own regulations and procedures are entitled to particular deference.”); LTV Steel Co. v. United States , 215 F.3d 1275, 1279 (Fed. Cir. 2000) (“When a term in the Internal Revenue Code is ambiguous, but is defined in a Treasury Regulation, we are instructed to defer to the Treasury Regulation as l ong as its interpretation of the Code is reasonable.”); see also Cottage Sav. Ass’n v. Comm’r , 499 U.S. 554, 560-61 (1991) ( “Because Congress has delegated to the Commissioner the power to promulgate all needful rules and regulations for the enforcem ent of [the Internal Revenue Code], we must defer to his regulatory interpretations of the Code so long as they are reasonable.” (citations and internal quotat ion marks omitted)). Soon a fter section 512(a)(3)(E)(i) was enacted, the agency issued Treas ury Regulation § 1.512(a)-5 T, which clarifies how much income a VEBA may set aside on a ta x-free basis. Under this provision, a VEBA’s unrelated busi ness taxable income will generally “equal the lesser” of “the income of the VEBA” and “the excess of the tota l amount set aside as of the close of the taxable year . . . over the qualified asset a ccount limit.” 26 C.F.R. § 1.512(a)-5T. In other words, a VEBA will pay tax on the lesser of: (1) its investment income, and (2) the amount by which its set aside exc eeds the statutor y account limit. 4 The formula

4 Since Treasury Regulation § 1.512(a)-5T imposes tax on the lesser of a VEBA’s investment income and its excess total set aside ov er the applicable account limit, CNG may have been able to shield its investment income fr om tax if it had

2009-5025 7contained in Treasury Regulation § 1.512(a)-5 T does not provide for the allocation of income from a particular source to a parti cular expense. Thus , under this formula, a VEBA may not avoid taxation on it s investment income by allocating that income to the payment of member benefit s during the tax year. On appeal, CNG argues that Treasury Regulation § 1.512(a)-5T is procedurally and substantively invalid under the Administrative Procedure Act (“APA”). See 5 U.S.C. §§ 553, 706. Because CNG did not properly raise this ar gument at the trial court, however, we decline to consider it here. See 84 Fed. Cl. at 335 n.5 (“For the first time at oral argument, [CNG] suggested that [Treasury Regulation § 1.512(a)-5T was] ‘clearly invalid.’ This argument is unt imely and waived.” (citations omitted)); see also Singleton v. Wulff , 428 U.S. 106, 120 (1976) (“It is the general rule, of course, that a federal appellate court does not consi der an issue not passed upon below.”); Rentrop v. Spectranetics Corp. , 550 F.3d 1112, 1117 (Fed. Cir. 2008) (noting that “appellate courts do not consider a party’s new theories, lod ged first on appeal” (citations and internal quotation marks omitted)). In deed, when it was before t he Court of Federal Claims,

established that the amount by which its total set aside ex ceeded the account limit was less than its investment income. CNG, however, failed to present any evidence regarding the amount by which it s set aside exceeded the statutory limit. As the Court of Federal Claims explained: [CNG] has conceded that it exceeded th e account limit for its qualified asset account at the end of 2000. Because there has been an excess over the account limit described in 26 U.S.C. § 419A(c), [CNG’s unrelated business taxable income] would be the lesser of CNG’s investment income, or CNG’s excess over the acc ount limit . . . . [CNG] has chosen, however, to not put in any evidence of the amount of it s excess over the account limit . . . fo r the 2000 tax year. 84 Fed. Cl. at 338 (citations omitted).

2009-5025 8CNG affirmatively relied on Treasury Regulat ion § 1.512(a)-5T to support its argument that its investment income was exempt from tax. See 84 Fed. Cl. at 335.
II. Section 419 and Sherwin-Williams In an effort to avoid the plain language of section 512(a)(3)(E)(i) and Treasury Regulation § 1.512(a)-5T, CNG argues that 26 U.S.C. § 419 contains an “ordering rule” which should be applied to section 512(a)(3)(E)(i). According to CNG, section 419 treats a VEBA’s investment inco me as the first source of funds to pay current member benefits and this same rule should be extended to section 512(a)(3)(E)(i). We find this argument unpersuasive. As a preliminary matter, section 419(c) is prefaced by the phrase “[f]or purposes of this section” and there is nothing to indicate that section 419’s alleged ordering rule shou ld be applied to section 512. Furthermore, sections 419 and 512 were enacted to deal wit h two fundamentally different problems. While the former addresses the problem of excessive employer deductions for contributions to a VEBA, the latter addre sses the problem of allowing a VEBA to generate excessive tax-free income. Section 419 limits the extent to which an employer can deduct contributions to a VEBA by limiting the deducti on to the VEBA’s “qualified cost” for the year. 5 See 26 U.S.C. § 419. Nowh ere, however, does it indicate that in determining the amount of tax-exempt set as ide available under se ction 512(a)(3)(E)(i), investment income must be the first sour ce used to pay mem ber benefits.

5 Pursuant to section 419, a VEBA’s “ qualified cost” genera lly equals amounts expended on benefits plus any “addition” to the VEBA fo r the year, to the extent that such addition does not result in an accoun t balance in excess of the account limit specified in section 419A. A VEBA’s qualified cost is t hen reduced by its after-tax income. See 26 U.S.C. § 419(c).

2009-5025 9We likewise reject CNG’s argument based on Sherwin-Williams Co. Employee Health Plan Trust v. Comm’r , 330 F.3d 449 (6th Cir. 2003). That case is clearly distinguishable on its facts, because the parties there stipul ated that the investment income at issue had been spent on administrative costs. See id. at 452 (“This case requires us to determine whether passive inco me that [a VEBA] set aside and actually spent on administrative costs during the year counts against § 512(a)(3)(E)’s limit.”); id. at 454 (“The parties agree that [the VEBA’s] inve stment income . . . was set aside and spent on administrative costs directly connect ed with the provision of benefits.”). Here, however, there has not been an equiva lent stipulation. To the contrary, the pivotal issue before us is whether a VEBA can avoid taxation by purpor ting to spend income from investments, rather than income from some other source, in providing member benefits. We disagree, moreover, with the Sixth Circuit’s conclusion that section 512(a)(3)(E)(i) imposes a limit on a VEBA’s “accumulated funds” rather than its setaside funds. See Sherwin-Williams , 330 F.3d at 454 (“The question presented here is whether the limit is meant to cap the tota l amount of income that a VEBA may set aside under § 512(a)(3)(B) over the cour se of a year, or whether it acts as a cap only on the amount of income that the VEBA may accumulate, by setting aside an amount in excess of the amount needed to cover the costs of administrat ion during the course of a year.”). As the Court of Federal Claim s correctly noted, “[t]he term ‘accumulated’ appears nowhere” in sect ion 512(a)(3)(E). 84 Fed. Cl. at 337. By its plain terms, section 512(a)(3)(E) applies to amounts “set aside” to pay fo r welfare benefits, not to amounts “accumulated” after expenses have been paid. See 26 U.S.C. § 512(a)(3)(B) (defining “exempt function income” as income wh ich is “set aside . . . for the payment of

2009-5025 102009-5025 11 life, sick, accident, or other benefits”); id. § 512(a)(3)(E)(i) (providing that a “set aside” will be tax exempt only “to the extent that such set-as ide does not result in an amount of assets set aside . . . in excess of the a ccount limit determined und er section 419A”). Furthermore, in analyzing section 512(a)(3)(E), the Sixth Circuit did not take account of the formula contained in Treasury Regulation § 1.512(a)-5T, which, as we have said, imposes tax on the lesser of a VEBA’s investment income and its excess over statutory account limits, regardless of whether income is spent on member benefits during the
year. CONCLUSION Accordingly, the judgment of the Court of Federal Claims is affirmed.

AFFIRMED