t c memo united_states tax_court united parcel service of america inc on behalf of itself and its consolidated subsidiaries petitioner v commissioner of internal revenue respondent docket no filed date joel v williamson j allen dougherty maurice m agresta joseph r goeke kim marie boylan roger j jones william a schmalzl daniel dumezich thomas l kittle-kamp clisson s rexford scott m stewart thomas c durham gayle l elsner michelle j kim richard t morrison mary ellen kiruit and wayne s kaplan for petitioner theodore j kletnick suzanne corbin curt m rubin william s garofalo maria t stabile elizabeth a maresca halvor adams ill stephen c best paul s manning anthony j kim and ron j mizrachi for respondent memorandum findings_of_fact and opinion ruwe judge respondent determined deficiencies in petitioner's federal income taxes and additions to tax as follows additions to tax_year deficiency sec_6653 sec_6653 a sec_6661 dollar_figure -- -- -- big_number dollar_figure of the dollar_figure interest due on dollar_figure respondent also determined that petitioner is liable for increased interest pursuant to sec_6621 on the portion of the deficiency attributable to respondent's determination that excess value charges are includable in petitioner's income after concessions ’ the issues for decision are ‘unless otherwise indicated all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure respondent concedes that dollar_figure of income earned on funds invested by overseas partners ltd opl is not income to petitioner pursuant to sec_482 respondent determined that if petitioner must include excess value charges in gross_income petitioner is entitled to a corresponding deduction of dollar_figure for shippers' claims respondent concedes that dollar_figure of the dollar_figure million paid liberty mutual insurance group liberty mutual for claims adjustment services is deductible respondent further concedes the deductibility of dollar_figure paid_by petitioner to liberty mutual for the retained layer of liability for losses above dollar_figure these concessions reduce the amount of the deduction at issue continued whether amounts collected by petitioner as excess value charges evc's from its customers must be included in gross_income in pursuant to sec_61 we hold that evc's must be included in petitioner's income whether petitioner is entitled to deductions under sec_162 for any amounts paid to national union fire insurance co of pittsburgh pennsylvania nuf we hold that petitioner is not entitled to those deductions whether respondent properly disallowed petitioner's deduction of dollar_figure paid to liberty mutual insurance group liberty mutual as california workers'_compensation premiums we hold that the deduction is allowable whether petitioner is liable for an addition_to_tax pursuant to sec_6653 and for negligence or continued with respect to the liberty mutual policy to dollar_figure in the notice_of_deficiency respondent disallowed sec_38 investment tax_credits of dollar_figure million and dollar_figure reported by petitioner in and respectively on date the parties filed a joint motion to sever requesting that the court sever the investment_tax_credit issue on date the motion to sever the sec_38 investment_tax_credit was granted the parties subsequently engaged in mediation and settled this issue -throughout the opinion evc represents excess value charge and evc's represents excess value charges as a result of our holding we need not consider respondent's alternative arguments under sec_482 and sec_845 intentional disregard of rules or regulations for the tax_year we hold that it is whether petitioner is liable for an addition_to_tax under sec_6661 for a substantial_understatement of tax for we hold that it is whether petitioner is liable for increased interest on substantial underpayments attributable to tax-motivated transactions under sec_6621 for we hold that it is some of the facts have been stipulated and are so found the stipulations of facts are incorporated herein by this reference at the time the petition was filed petitioner was a delaware corporation with its principal office in atlanta georgia findings_of_fact it general a united parcel service petitioner is the largest motor carrier in the united_states with a principal business consisting of the pickup and delivery of small packages and parcels during and petitioner conducted its business through wholly owned subsidiaries in the united_states canada and west germany petitioner united parcel service of america inc ups had several wholly owned subsidiaries including united parcel service inc --new york ups-new york united parcel service inc --ohio ups-ohio and united parcel service general services co ups-general services ups-general services provides management services to affiliates of ups ups-new york provides ground delivery services in the eastern region of the united_states ups-ohio provides ground delivery services in the central and western region of the united_states within the united_states petitioner generally provided statewide intrastate service’ and interstate service between all points in the states and the district of columbia another subsidiary ups-air provided air delivery service for packages traveling partially by air petitioner had operating districts in the united_states rach district had an operational and administrative staff anda manager who was responsible for all district operations the district manager reported to of regional managers who in turn reported to the corporate headquarters generally each package picked up by a ups driver is delivered to a package operating center at each center packages are unloaded from package cars and loaded onto trailers which haul the packages either directly to another center for delivery or to a ups sorting hub at the hub packages are petitioner did not provide intrastate service within texas ‘there were limited exceptions pertaining to texas hawaii and alaska in which petitioner did not provide full services sorted by destination loaded back onto trailers and hauled to the appropriate center where they are loaded onto package cars for delivery packages traveling by air are sorted at an air hub and transported to the center for delivery b shipping rates and tariffs as a domestic motor common carrier petitioner was regulated by the interstate commerce commission icc petitioner's intrastate service was regulated by state transportation agencies and public_utility commissions as an air carrier petitioner was regulated by the civil aeronautics board the icc issued certificates of public convenience and necessity as evidence of the carrier's authority to engage in transportation as a common carrier by motor_vehicle ups--new york and ups-ohio each filed tariffs’ and tariff supplements with the icc the icc tariffs and tariff supplements contained provisions which governed the rates and services offered by petitioner to its shippers the tariffs filed with the icc by a tariff is a public document setting forth services of common carrier being offered rates and charges with respect to services and governing rules regulations and practices relating to those services black's law dictionary 6th ed sgenerally a motor common carrier must publish and file with the icc tariffs containing the rates for transportation it may provide see trucking industry regulatory reform act of u s c sec a see also 664_fsupp_694 e d n y ups-new york and ups-ohio which were in effect during the years in issue contained among other things provisions relating to the scope of operations damaged and unclaimed property methods of determining rates and filing of claims with respect to the scope of operations the tariffs for both ups-new york and ups-- ohio provide rates and provisions named in this tariff or as amended are limited in their application to the extent of the operating rights set forth below the provisions of the tariffs governed the rates and services offered by petitioner to its shippers the icc tariffs filed by ups-ohio and ups-new york were similarly filed with the state transportation commissions of most of the states individual state filings were required in the the tariffs filed by ups-ohio were filed with the state transportation commissions of alabama arkansas colorado georgia idaho illinois indiana iowa kansas kentucky louisiana michigan minnesota mississippi missouri montana new mexico north carolina north dakota ohio oregon south carolina south dakota tennessee utah and washington the tariffs filed by ups-new york were similarly filed with the state transportation commissions of connecticut maryland massachusetts new hampshire new york pennsylvania rhode island vermont and west virginia in and the states of arizona delaware florida maine new jersey and wisconsin did not regulate intrastate motor common carriers in wyoming no regulatory filing was required in texas intrastate service was limited to the dallas-fort worth houston and san antonio metropolitan areas in hawaii an intraisland service was commenced between all islands of the state petitioner did not operate in alaska continued states of california hawaii nebraska oklahoma and virginia whenever ups-ohio or ups-new york made a change to its tariff a tariff supplement was filed with the icc pre-1984 a excess value charges petitioner refers to its customers as shippers petitioner charged its shippers a fee for the shipment of each package based on the weight of the package the distance that the package would travel the value of the package and various accessorial services offered by petitioner petitioner's rates were governed by the tariffs which it submitted to the icc and the various states the tariffs submitted to the icc provided among other things for rates in cents per package and per pound as follows item the rate for delivery of packages released to value not exceeding dollar_figure per package shall be per package plus the following rates per pound or fraction thereof continued outside the regulatory-free zones the provisions of the tariffs were similar except that the tariff provided by ups-ohio further included item which does not affect our decision and we will not reproduce it in the opinion zone rate zecc cece nnccccccccces i dice ccc e ener een ce ccene dew ww tw we ww ew ww eee cree eee n eee e eee nccece tew ww ww ew we wee eee sr the rates published in item applied to all the packages shipped by petitioner petitioner provided its shippers with a rate card that enabled shippers to determine what petitioner would charge for a particular shipment the distance a package was to travel determined the number of zones from the point of origin that the package would cross a package shipped to zone for example would travel approximately miles a package shipped to zone would travel up to miles zone was the furthest zone and distance a package would travel within the united_states zone sec_2 through were represented as column headings at the top of the rate card weight categories also determined how much petitioner charged shippers for transporting a particular package the rate card listed weights down the left side of the table in 1-pound increments from pound to pounds by cross-referencing the zone and the weight a shipper could determine the exact shipping charge for a particular package whose released value did not exceed dollar_figure there was an additional_charge under the tariff when a shipper declared the value of the package to be in excess of dollar_figure under the tariff shippers could also elect to purchase accessorial services that had additional charges accessorial services included among other things collection on delivery cod and acknowledgment of delivery aod with respect to damaged and unclaimed property the tariffs provided the following damaged and unclaimed property whenever property is damaged by the carrier in the course of transportation the carrier will tender the damaged property to the shipper and offer to pay for the damage not to exceed the actual or declared value of the property whichever is the lower if the shipper so elects the carrier will pay the full actual or declared value of the property whichever is lower and title of the property shall thereupon pass to the carrier thus petitioner was obligated to shippers under the tariffs to pay up to the actual or declared value for loss or damages caused by petitioner during the course of transporting the package petitioner applied for and received from the icc an order generally allowing petitioner and its shippers to agree in writing that petitioner's liability would be limited to a released value not exceeding dollar_figure per package with respect to the released rate and evc the tariff provided as follows to determine rates in this tariff refer to governing rate basis tariff to determine appropriate zone for use in determining the poundage rate refer to item or herein released value of shipment the rates published in item or are applicable only when the value of the property declared in writing by the shipper or agreed upon in writing as the released value thereof is as follows released to a value apply the rates as not exceeding dollar_figure published in item per package or or article not enclosed in a package released to a value apply the rates as exceeding dollar_figure per published in item package or article or as not enclosed ina base rates plus a package value charge of cents for each dollar_figure or fraction thereof of value in excess of the valuation in which the base rate applies under the provisions of the tariff petitioner received from its shipper sec_25 cents for each additional dollar_figure of declared value of a package shipped and petitioner referred to the additional_amount as an excess value charge evc if a shipper paid the evc of cents per dollar_figure of value part or all of the declared value of the package would be paid to the shipper in the event that the package was damaged lost or destroyed in the event that a shipper did not declare the value of the package to be in excess of dollar_figure petitioner was liable to the shipper for the value of the package up to dollar_figure in date petitioner filed supplements to its icc tariffs amending the provision related to the method of determining rates for shippers under the original tariff the supplements provided an additional clause with respect to the method of determining rates unless otherwise directed by the shipper the carrier may remit excess valuation charges to an insurance_company as a premium for excess valuation cargo insurance for the shipper's account and on its behalf if the carrier does so claims for loss of or damage to the shipper's property will be filed with and settled by the carrier on behalf of the insurance_company in the event that the insurance_company fails to pay any claim for loss of or damage to the shipper's property under the terms of its policy the carrier will remain liable for loss or damage within the limits declared and paid for although the supplements were filed date and became effective date petitioner did not remit evc's to an insurance_company before_1984 the declared value in excess of dollar_figure is indicated on petitioner's package pickup record ’ the package pickup record tdentical changes were made to petitioner's state tariffs ‘2petitioner's pickup record states unless a greater value is declared in writing on this receipt the shipper hereby declares and agrees that the released value of each package or article not enclosed in a package covered by this receipt is dollar_figure continued was used to enter billing information into petitioner's billing system billing information for regular customers and shippers who shipped parcels from petitioner's customer counters was entered into petitioner's computer system regularly by each district and petitioner billed its regular customers weekly the bills sent to petitioner's regular shippers reflected all amounts to be collected from those shippers included and itemized separately on those bills were the evc's and other miscellaneous charges all amounts collected from shippers by petitioner including amounts for evc's were deposited into petitioner's bank accounts for the taxable_year ended date evc's billed and or collected from shippers were included in petitioner's reported income for tax financial_accounting icc state regulatory and securities_and_exchange_commission sec reporting purposes b claims shippers' claims were governed by the tariffs submitted by petitioner to the icc and the various states petitioner' sec_12 continued which is a reasonable value under the circumstances surrounding the transportation the entry of a c o d amount is not a declaration of value in addition the maximum value for an air service package is dollar_figure and the maximum carrier liability is dollar_figure claims not made to carrier within months of shipment date are waived tariff 201-c effective date included provision relating to filing of claims which provided all claims for loss or damage to property transported or accepted for transportation in interstate or intrastate commerce must be in writing and must include reference to the pickup record number and date or copies of other documents sufficient to identify the shipment involved must assert liability of the carrier for alleged loss or damage must make claim for payment of a specified or determinable amount of money and must be accompanied with a copy of the original invoice or if no invoice was issued other proof certified to in writing as to the value of the property or extent of the damage under tariff provision a shipper was required to assert that petitioner was liable for the alleged loss or damages tariff 201-c also contained provision limiting the time for filing claims provision provided as a condition_precedent to recovery claims must be filed in writing with the carrier within nine months after delivery of the property or in case of failure to make delivery then within nine months after a reasonable_time for delivery has elapsed and suits shall be instituted against the carrier only within two years and one day from the day when notice in writing is given by the carrier to the claimant that the carrier has disallowed the claim or any part or parts thereof specified in the notice where claims are not filed or suits are not instituted thereon in accordance with the foregoing provisions the carrier hereunder shall not be liable and such claims will not be paid under provision petitioner was required to promptly investigate each claim filed against petitioner with respect to disposition of claims tariff 201-c provides carrier after receiving a written claim for loss or damage to -- - property transported will pay decline or make a firm compromise settlement offer in writing to the claimant within days after receipt of the claim by the carrier ups-new york and ups-ohio through their respective district offices processed all claims for loss or damage to parcels including any excess value portion of a claim when a shipper was in need of a verification of the status of a shipment the shipper initiated an inguiry by either telephone or mail which was referred to the delivery information department of the district from which the shipment was made tracing requests were initiated as a result of shippers’ inquiries after the tracing request was completed it was transmitted to the destination district via computer if the record showed that the package was delivered and signed for the clerk made a copy of the delivery record if the tracing procedure was unsuccessful petitioner assigned a loss damage investigation number to identify the shipper claim petitioner remitted amounts for claims processed by ups-new york and ups-ohio from petitioner's central bank account generally a single check was issued to a shipper if the shipper had declared excess value and a claim for loss or damage was paid before_1984 petitioner reported claims paid in excess of dollar_figure as an expense for tax financial_accounting icc state regulatory and sec reporting purposes petitioner made efforts to reduce claims including excess value claims petitioner advised its drivers to pay extra attention to declared value packages petitioner also incurred added handling costs in connection with excess value packages in metro new york long island new jersey and metro chicago petitioner took special precautions to avoid loss or damage to high-value packages for instance in new york with respect to jewelry and similar items petitioner's driver would segregate them in his load and upon arrival at petitioner's facility a designated clerical person would meet the driver and take the packages containing the jewelry or other items under certain circumstances the packages would be specially bagged and tagged thereafter the appropriate contact person at the next destination of the package would be informed of the position of the package on the trailer when the trailer reached its destination a person would be present to retrieve the bag petitioner instituted and used special parcel handling procedures which involved segregating and protecting high-value parcels in other districts as well petitioner referred to the special handling procedure as controlled parcel handling ‘this procedure was not used in the metro new york long island new jersey and metro chicago districts controlled parcel handling procedures that were stricter than the controls set forth in the loss prevention manual were applied in metro new york long island new jersey and metro chicago petitioner maintained a loss prevention manual that contained written standards and procedures on prevention of loss associated with the shipment of packages controlled parcel handling was addressed in a specific section of the loss prevention manual as part of the controlled handling procedures petitioner performed audits in its hub transportation and delivery operations to ensure security of high-value packages petitioner considered these procedures to be expensive and time consuming cc negotiations to change petitioner's method of handling excess value charges mr kenneth johnson was the head of petitioner's insurance department after various discussions with mr walter danielewski petitioner's chief financial officer cfo regarding the manner in which petitioner collected evc's mr johnson contacted the brokerage firm of frank b hall hall hall hall was one of the largest insurance brokerage firms in the world mr johnson had first worked with representatives at hall in at that time mr george corde an experienced vice president of hall worked with mr johnson in connection with insurance for petitioner's aircraft and other matters mr thomas garrity was a hall vice president who worked for mr corde in mr johnson met with representatives of hall to discuss petitioner's evc's at their first meeting regarding petitioner's evc's mr corde advised mr johnson of potential alternatives that might be available to petitioner including the possibility of petitioner's forming its own insurance subsidiary thereafter mr corde and mr garrity attended meetings relating to the planning structuring and implementation of petitioner's subsidiary and petitioner's excess value activity in date at the request of petitioner hall prepared a document titled united parcel service--a preliminary analysis of an insurance subsidiary preliminary analysis the preliminary analysis indicated that hall understood that petitioner currently was liable to its shippers for the value of any parcels lost or damaged up to dollar_figure the preliminary analysis indicated that hall understood that those parcels with values in excess of dollar_figure could be declared by the shipper and the shipper could secure protection at a cost of cents per dollar_figure of value in excess of the first dollar_figure hall further understood that while the protection provided by the evc was not considered to be insurance insurance could be provided by a ups-owned insurance_company the preliminary analysis then proceeded to make the following assumptions and conclusions we have been advised that the revenues generated by this declared value protection for the year approximated dollar_figure and that the loss in excess of dollar_figure per claim approximated dollar_figure in exhibits ii-1a and ii-2a we have attempted to set forth the implications of this coverage to petitioner on a net after tax basis in this exhibit we have made the following assumptions revenues are in equal amounts payable at mid points of quarters expenses as percent of gross premium loss ratio duration in years to ultimate value of losses annual payout pattern -- plan reimburses gross paid losses for each month at the end of the following month applicable federal_income_tax rate as percentage and effective rate of interest per annum as percent based upon these assumptions review of exhibits ii-1a and ii-2a disclose that the contribution of this program to petitioner's after tax earnings is dollar_figure at the end of the second subsequent year when all losses are closed on date a meeting was held at hall's offices in briarcliff manor new york to discuss petitioner's excess value activity in attendance at this meeting were messrs danielewski johnson pat edmunds jerry stein and jack mcguinness representing petitioner mr allen dougherty as petitioner's attorney and messrs corde garrity and roger wade representing hall mr corde prepared a memorandum dated date that summarized the purpose and content of the february meeting at briarcliff manor the memorandum states the purpose of this meeting was to consider frank b hall's proposal presented to petitioner last date which dealt with the feasibility of creating a subsidiary insurance_company the subject reviewed in the report dealt with declared value insurance and the utilization of an insurance subsidiary to handle customer risk of loss on property in transit the topics discussed in our thursday meeting focused strictly on the declared value program and the viability of converting this into an insured plan that would produce in the final analysis an improved economic result for petitioner the report submitted by hall dealt with the organization of a united parcel insurance subsidiary company this new insurance entity would assume reinsurance from a licensed admitted us carrier who would underwrite the declared value program during the february meeting petitioner's tax counsel mr dougherty expressed concern with the specifics of the hall proposal and he believed that the proposal would not be viewed favorably by the internal_revenue_service irs mr dougherty suggested an alternative whereby petitioner would form an insurance_company in bermuda to be owned by petitioner's employees and in this manner such a company would be classified as a noncontrolled foreign_corporation mr dougherty believed that the bermuda insurance_company could accept reinsurance of a licensed u s underwriter directly and not have u s tax obligations on profits until risk funds were repatriated after all the alternatives were discussed it was agreed that petitioner would pursue the alternative to create an insurance subsidiary to act as a reinsurer further the insurance subsidiary would be owned by petitioner and ultimately petitioner might adopt a long-range strategy of transferring ownership in such a company to petitioner's shareholders finally it was agreed that mr danielewski and other members of the ups team would submit a proposal to senior management based on the following financial projections as stated in mr corde's date memorandum ups current position a projected declared value revenue dollar_figure estimated losses dollar_figure pretax profit dollar_figure net after tax profit dollar_figure b-alternative program insured declared value program u s front estimated annual premium dollar_figure estimated expenses dollar_figure net underwriting_income dollar_figure ups insurance subsidiary foreign reinsurance_premium income dollar_figure ceding commission -- dollar_figure net premium income dollar_figure expected losses dollar_figure underwriting profit dollar_figure c projected benefit to petitioner dollar_figure front fee premium tax federal excise_tax the dollar_figure projected benefit to petitioner is the amount of federal_income_tax petitioner would have otherwise paid and is based on the assumption that the underwriting profit which was referred to as the ups insurance subsidiary in bermuda would not be subject_to federal_income_tax aig nuf american international group inc aig was a holding_company and the parent of over subsidiary operating insurance and subsidiary companies aig risk management inc aigrm was a subsidiary of aig mr joseph smetana served as president and ceo of aigrm and senior vice president of nuf nuf was a wholly owned subsidiary of aig and operated as a domestic insurance_company on behalf of hall through a letter dated date mr corde contacted mr smetana in the letter mr corde apprised mr smetana of petitioner's plan regarding the evc's mr corde indicated in the letter that petitioner's plan contemplated that the shippers' property handled by petitioner would be insured under a master shippers interest policy further the letter indicated that the contract of insurance would be issued to petitioner and would cover the property of the owners shippers consignees or other interested parties with respect to the anticipated risk or exposure to aig the letter stated the shippers interest program is to be reinsured to union international hamilton bermuda union will then retrocede this risk to other insurers this therefore would leave the shippers interest issuing carrier ina fronting capacity with essentially no risk or exposure to loss under the program finally the letter requested that aig submit a proposal on petitioner's shippers interest program setting forth a the fronting administration fee it would require as the issuing carrier b estimated premium taxes applicable under this program cc its acceptance of union international as the program reinsurer d acceptance and confirmation of petitioner as the authorized program administrator with total claim settlement authority e the specific documentation required to be given to shippers electing coverage under this program on date mr corde sent a letter to mr robert sargent of travelers insurance co travelers discussing petitioner's excess value program and requested that travelers submit a proposal for the excess value program on date mr sargent sent a letter to mr corde outlining an alternative for petitioner in a letter dated date to mr corde mr smetana presented aigrm's proposal for an excess value program in the letter aigrm proposed that it would issue a single master insurance_contract that would cover the interests of petitioner's shippers the proposal indicated that the documentation of coverage under such a contract would be identified through a service instruction agreement and the declared value entry on the bill of lading aigrm's proposal was based upon insurance coverage for values in excess of dollar_figure at a premium charge of cents per dollar_figure of insured value in excess of dollar_figure among other things aigrm proposed that a premiums be remitted by petitioner to nuf on a monthly basis less any losses paid and loss expense incurred b petitioner administer all claims under the policy on behalf of nuf and c petitioner be responsible for bad_debts or uncollectible items since nuf had no control_over the payment of premiums by shippers hall found the aigrm proposal to be more reflective of petitioner's requirements than the traveler's proposal and submitted the aigrm proposal as its recommendation for review by petitioner's management nuf prepared a binder of insurance under which it described the insured as united parcel service of america inc on behalf of its customers shippers consignees or other interested parties as their interest may appear the binder described the insurance as shippers interest the rate or premium under the binder was set pincite cents per dollar_figure of declared value and the insurance would become effective as of date however on date mr corde sent a telex to mr smetana which stated petitioner has postponed finalization of shippers interest program pending their review and evaluation of new tax legislation currently on the floor of the house of representatives which wk understand camf sic of committee end of last week will keep you completely apprised of the developments as they occur petitioner and aig continued to work together in planning petitioner's shippers interest program on date mr corde of hall sent mr smetana of aig a letter which among other things proposed that changes be made to the wording of petitioner's service explanation petitioner's service explanation is a document regularly provided by petitioner to its customers as part of a kit containing other documents upon commencement of the relationship upon request by customers and upon other occasions service explanations were generally available to petitioner's walkup customers upon request as of date ' petitioner's service explanation stated unless a greater value is declared in writing on the pickup record the shipper declares the released value of each package or article not enclosed in a package to be dollar_figure for each dollar_figure or fraction thereof of value per package or article not enclosed in a package in excess of dollar_figure an additional_charge as stated on the current rate chart applies except if otherwise directed by the shipper the carrier will remit excess valuation charges to national union fire insurance_company of pittsburgh pa as a premium for excess valuation cargo insurance for the shipper's account and on its behalf when the carrier does so claims for loss of or damage to the shipper's property will be filed with and settled by the carrier on behalf of the insurance_company in the event that the insurance_company fails to pay any claim for loss of or damage to the shipper's property under the terms of its policy the carrier will remain liable for loss or damage within the limits declared and paid for shippers interest policy imb9310977 is available for inspection at the office of the carrier claims not made within nine months after receipt by the carrier of the merchandise shall be deemed waived in date petitioner circulated to its shippers an edition of its quarterly newsletter entitled roundups within the december roundups petitioner informed its shippers that this service explanation was used throughout petitioner's service explanations as revised in and contained similar wording these revisions both stated that petitioner remained liable for loss or damage however the and revised service explanations state that petitioner may remit evc's to nuf as opposed to the will remit language in the above excerpt we note that the may remit language of the and revisions is the same language used in petitioner's tariff we also note that the will remit language in the date service explanation could not have been effective in since the nuf contract itself does not purport to apply before date petitioner intended to make permanent the practice of allowing its drivers to leave packages at certain specified locations without a signature with respect to the delivery of packages without the normal signature petitioner stated the following in its newsletter petitioner also will continue to assume liability for lost and damaged packages up to dollar_figure or the declared value it might seem that leaving packages even in safe places risks theft weather damage denial of delivery or other types of losses actually claims for lost and damaged packages declined in indiana and towa where we've had the most experience with the program on date representatives of aig and nuf signed wis an insurance_policy entitled shippers insurance and numbered imb on behalf of nuf which listed the name and address of the insured as follows name and address of insured shippers consignees customers or other interested parties as their interest may appear with regard to parcels shipped via united parcel service of america inc and or its subsidiaries as now or hereafter constituted herein after referred to as ups west 43rd street new york new york the address listed under the name and address of the insured served as petitioner's world headquarters the contract was for a term from date until canceled nuf issued the ‘for reasons explained in our opinion we will refer to the agreement between petitioner and nuf as the shippers interest contract contract in the state of new york with the understanding that it was pursuant to the free trade zone legislation article of the new york insurance law clause of the shippers interest contract states petitioner will provide space on its pick-up record which will be labeled declared value if in excess of dollar_figure a declared value indicated by the named insured in the space provided shall evidence the existence and the amount of this insurance subject_to limits of liability provided herein this insurance shall not apply unless a declared value is indicated by the named insured in the space provided in petitioner's pick-up record clause of the shippers interest contract generally provided that nuf was not liable for the first dollar_figure of the value of the property and in no event did nuf's liability exceed the declared value for surface shipments and a maximum of dollar_figure per package for air shipments the cancellation provision of the contract stated this policy may be cancelled sic by the named insured or petitioner on behalf of the named insured by mailing to the company written notice stating when thereafter such cancellation shall be effective this policy may be cancelled sic by the company by mailing to the named insured or petitioner at the address shown in this policy or last_known_address notice stating when not less than thirty days thereafter such cancellation shall be effective under this provision petitioner had the power to cancel the shippers interest contract clause of the shippers interest contract addressed other insurance and stated - - if there is any other insurance covering the property insured hereunder or petitioner's liability if any whether prior subsequent to or simultaneous with this policy which in the absence of this insurance would cover the loss damage or liability hereby covered then this company shall not be liable hereunder for more than the excess over and above such other insurance this clause however shall not apply to insurance effected by a named insured and the existence of such insurance or payment of a loss thereunder shall not constitute a defense of any claim otherwise payable under this policy nor shall such insurance be called on to contribute to any loss payable hereunder under clause nuf was not liable in the event that petitioner's liability for loss or damage to a shipper's package was covered by another insurance_policy unless the other policy was effected by a shipper affiliated fm insurance_policy petitioner maintained an insurance_policy with affiliated fm insurance co afm policy the afm policy was issued on date and provided coverage from date to the afm policy insured petitioner's property and liability for among other things petitioner's interest in the real and personal_property of others including parcels held for delivery and in transit for which petitioner may be liable or for which the petitioner may assume liability or agree to insure prior to loss affected thereby the afm policy contained a dollar_figure million liability limitation with sublimits the afm policy had a dollar_figure million limit on personal_property while in the course of transportation as respects loss or damage arising out of any one occurrence and a deductible clause that excluded the first dollar_figure of claims arising out of any one occurrence from coverage on date an endorsement was added to the afm policy which became effective date the endorsement stated permission is hereby granted to insure the deductible amount big_number applicable to coverage 1b personal_property while in the course of transportation if such property is also insured under policy imb--9310977 issued by the national union fire insurance_company of pittsburgh pa and any renewals or rewrites thereof it is agreed that any such insurance shall be ignored in determining the amount of loss to which such deductible amount applies it is also agreed that thirty days advance notice of cancellation shall be given to national union fire insurance_company of pittsburgh pa any claims presented that exceeds dollar_figure national union agrees to abide with our settlement of such claims petitioner paid annual installment premiums of dollar_figure for coverage of all petitioner's real and personal_property including parcels held for delivery and in transit the annual premium was based on property values and stated rates the afm policy provided a calculation for the annual premium which operated to apportion dollar_figure of the total annual installment premium to property value related to parcels in transit the dollar_figure premium attributable to parcels was computed by multiplying the average daily value of parcels of dollar_figure continued upsinco ltd opl on date pursuant to petitioner's plan hall through parker co -interocean ltd parker co ’ prepared a summary of a proposal to organize an insurance subsidiary domiciled in bermuda under the name upsinco ltd upsinco by a memorandum dated date mr corde provided to mr johnson copies of the forms filed with the registrar of companies in bermuda relating to the incorporation of upsinco on date a meeting was held which the following persons attended messrs danielewski johnson and jerome stein representing petitioner messrs garrity corde and john iacono representing hall messrs robin spencer arscott and geoffrey hunt of hall-bermuda and messrs chet butterfield and john ellison of the bermuda law firm of conyers dill pearman among other things the purpose of the meeting was to discuss various aspects of the shippers interest program including the contract form documentation certification service instruction agreement monthly bordereaux ’ and premium loss reports 16’ continued times the rate of percent the average daily value equaled the average parcel value of dollar_figure times the annual total parcels of big_number divided by parker co is a wholly owned subsidiary of hall ‘spetitioner's bordereau is a statement which summarizes by state the units of excess value purchased by shippers and the continued upsinco was incorporated in bermuda as a wholly owned subsidiary of petitioner on date upsinco was registered as an exempted company pursuant to the provisions of section of the companies act of under the laws of bermuda on date the first meeting of the provisional board_of directors of upsinco was held the provisional directors of upsinco were listed as messrs john a ellison director c f a cooper and n b dill jr upsinco was incorporated with initial capital of dollar_figure million and had million shares of capital stock initial ownership of the stock of upsinco was as follows name no of shares united parcel service of america inc big_number walter e danielewski kenneth l johnson jerome d stein john ellison h c butterfield r s l pearman prpprppre on date the shareholders of upsinco held their first general meeting in which they elected a board_of directors the elected board_of directors consisted of five people three of the five directors elected messrs danielewski johnson and stein were also employees of petitioner the remaining two elected directors messrs ellison and butterfield were scontinued claims in excess of dollar_figure paid to petitioner's shippers representatives of the bermuda law firm of conyers dill pearman the minutes of the first meeting indicate that messrs danielewski and johnson were respectively elected to the positions of president and vice president of upsinco the minutes further indicate that mr stein was appointed as secretary and treasurer and that mr danielewski was appointed as assistant treasurer ’ thus the majority of upsinco's board_of directors and officers were all employees of petitioner during the date meeting the board_of directors of upsinco appointed parker co as manager of the company and passed bylaws which it then submitted to the shareholders for confirmation also on date the shareholders of upsinco confirmed and adopted the bylaws and approved all actions taken by upsinco's provisional directors on date and its directors on date on date upsinco was certified as an insurer in bermuda by the minister of finance by resolution dated date the executive committee of the board_of directors of petitioner authorized a capital_contribution in the amount of dollar_figure in cash to upsinco in addition the executive committee of the board_of the minutes also indicate that mr a l vincent ingham was appointed assistant secretary a s of date subject_to the directions and instructions of opl the administrative functions of opl were provided by parker co a bermuda corporation directors of petitioner resolved to take all actions necessary to effect a change_of the name upsinco to overseas partners ltd opl by resolution on date the board members of upsinco increased the authorized share capital of the company by dollar_figure from dollar_figure million to dollar_figure through the creation of an additional big_number shares of capital stock pincite cents par_value the members of upsinco further resolved that the sum of dollar_figure be accepted as contributed surplus resulting in an increase of dollar_figure in upsinco's capital to dollar_figure on date petitioner made a capital_contribution of cash in the amount of dollar_figure to upsinco on november and petitioner's board_of directors declared a dividend of share of opl then known as upsinco capital stock on each outstanding share of petitioner's stock excluding petitioner's shares held in treasury payable on date to shareholders of record on date on date the board members of upsinco resolved that the name of the company be changed to opl by resolution dated date petitioner's board_of directors changed the name of upsinco to opl on date nuf and opl entered into a facultative reinsurance agreement agreement under which nuf agreed to cede its liability under the shippers interest contract to opl as reinsurer under the terms of the agreement nuf was required to remit to opl percent of the gross amounts received from petitioner under the shippers interest contract less a a commission to nuf of dollar_figure percent of the gross premiums not to exceed dollar_figure million b an allowance of percent of the gross premiums written to cover nuf's premium tax and board and bureau charges and c percent of the gross premiums for the purpose of paying federal excise_taxes in addition under article ix of the agreement nuf held as security an amount equal to the first months of gross premiums written less commission taxes board and bureau charges losses paid loss expenses paid and federal excise_taxes if any the agreement became effective on date and remained in effect until canceled or terminated the termination provision of the agreement stated neither the company nor reinsurer may terminate this agreement while the policy listed in article i item b is in force however if the policy listed in article i item b ' is in fact terminated then in that event and that event only this agreement shall be terminated simultaneously therewith under this provision neither nuf nor opl could cancel the agreement while the shippers interest contract remained in force article i item b lists only the shippers interest contract between petitioner and nuf - - on date petitioner made a distribution which it treated as a taxable dividend to its shareholders of share of opl stock for each share of petitioner's stock then outstanding petitioner distributed big_number shares of opl stock with a net asset value of cents per share the total dividend was dollar_figure the fair_market_value of the opl capital stock received by each of petitioner's shareholders was considered by petitioner to be ordinary_income to each of petitioner's shareholders in petitioner was owned by its active employees and former employees as well as the families estates and trusts of former employees in there were approximately big_number shareholders on date as of the moment of distribution of the opl stock the shareholders of opl were essentially the same as petitioner's shareholders the only difference between the shareholders of opl and petitioner's shareholders was that petitioner's shareholders did not receive the same proportionate interest in opl that they owned in petitioner because petitioner itself was a shareholder of opl on date there were big_number shareholders in opl holding an aggregate of big_number shares of common_stock not including the big_number treasury shares of opl owned by petitioner the total shares in opl equaled big_number on date there were big_number shareholders in petitioner -- - holding an aggregate of big_number shares of common_stock the big_number shares of opl owned by petitioner represented percent of the big_number shares in opl on date during the years in issue restrictions applied in the event an opl shareholder wanted to sell shares of opl no outstanding shares of opl capital stock were transferable except by gift or inheritance unless the shares were first offered for sale to petitioner at the lower_of the net_book_value of the opl stock or at the price and terms at which the opl stock was offered to the proposed transferee opl shareholders were required to notify petitioner's treasurer of the number of shares proposed to be sold the proposed price per share the name and address of the proposed transferee and the terms of the proposed sale and provide a statement of the proposed transferee that the information contained in the notice was true and correct opl shareholders had the right to pledge opl stock but were not allowed to transfer the stock upon foreclosure without petitioner's having first been offered the option to purchase the stock and years following a general for the taxable_year ending date excess value amounts billed to regular shippers and collected from other shippers were not included in petitioner's reported taxable_income petitioner did not include excess value amounts billed to regular shippers in its filings with the sec and the icc for the year ended date otherwise petitioner's activities with respect to the excess value activity basically remained the same as in prior years petitioner continued to bill customers for shipping charges on the basis of information recorded by shippers on the package pickup records the bills reflected all amounts to be collected from shippers including evc's all amounts collected including evc's from the shippers were deposited in petitioner's bank accounts petitioner continued to process all claims for loss or damage to parcels including any excess value portions of the claims if a claim for loss or damage was paid petitioner continued to remit the amount for the claim by check to the shipper petitioner did not apply for and did not hold an insurance license of any type during petitioner's employees who processed shippers' claims were not licensed as claims adjusters in the states in which they processed claims nuf did not participate in the resolution of specific claims in challenge the amounts of specific loss claims paid_by petitioner or challenge the amounts of loss and damage claims that petitioner subtracted from the amounts that it remitted to nuf during in connection with nuf contract imb b accounting for the taxable years ended date and ups- new york and ups-ohio were required to file annual reports with the icc and were required to follow the rules of accounting and use the accounts established by the icc in connection with icc accounting and reporting requirements petitioner was also required to follow generally_accepted_accounting_principles for financial_accounting and managerial reporting purposes petitioner used a system of accounts that was generally the same as the icc system of account numbers however petitioner's expense accounts are much more detailed than icc expense accounts used for icc accounting purposes with respect to a shipment made by a regular customer there was no change in the method in which journal entries were made in and petitioner generally debited accounts_receivable and credited an intercompany account when petitioner received the evc amounts from its shippers the amounts were deposited in petitioner's bank accounts petitioner paid shippers' claims out of corporate bank accounts petitioner did make changes to its internal accounting worksheets at its district level in the worksheets detailed the evc's differently in than in however petitioner's accounting journal entries were the same in as they were in at the district level -- - cc transactions between petitioner and nuf beginning in date petitioner transferred excess value amounts billed to its regular shippers and collected from other shippers net of claims paid in excess of dollar_figure to nuf ona monthly basis petitioner did not receive reimbursement or compensation from nuf for generating billing and collecting evc's or for processing the excess value claims in petitioner began preparing a bordereau statement which summarizes by state the units of excess value purchased by shippers and the claims in excess of dollar_figure paid to petitioner's shippers the bordereau statement reflects total_amounts transferred by petitioner to nuf during as follows month gross premium claims paid net premium jan sdollar_figure sdollar_figure sdollar_figure feb dollar_figure dollar_figure dollar_figure mar dollar_figure dollar_figure dollar_figure apr dollar_figure dollar_figure dollar_figure may dollar_figure dollar_figure dollar_figure june dollar_figure dollar_figure dollar_figure july dollar_figure dollar_figure dollar_figure aug dollar_figure dollar_figure dollar_figure sept dollar_figure dollar_figure dollar_figure oct dollar_figure dollar_figure dollar_figure nov dollar_figure dollar_figure dollar_figure dec dollar_figure big_number dollar_figure total dollar_figure dollar_figure dollar_figure the category net premium represents evc's billed to petitioner's regular customers and collected from other shippers from each of the states and the district of columbia less claims over dollar_figure remitted to petitioner's shippers during the month generally around the middle of the month following billing to regular shippers or collection from walk-in shippers the net amounts were remitted by wire transfers from petitioner's account to an nuf account no interest on excess value amounts that had been collected before the excess value amounts were transferred to nuf was paid to nuf during if a shipper did not pay a bill that included declared excess value amounts petitioner did not reduce the amount transferred to nuf if collection activities occurred petitioner attempted to collect the entire amount due from the shipper including any evc's included in the bill petitioner did not reduce the amount transferred to nuf by any amount uncollected or any cost it incurred in collecting delinquent evc's d transactions between nuf and opl beginning in date after receiving the amounts remitted to nuf by petitioner nuf prepared a bordereau and remitted the net amounts shown on nuf's bordereau to opl by wire transfer the following table summarizes the amounts and dates of transfers made by nuf to opl relating to excess value amounts during -the amounts shown in the table were rounded resulting in minor discrepancies of a few dollars under- taxes interest on month prenftns tepenses bureaus withheid withheld neto oflt jan dollar_figure dollar_figure dollar_figure dollar_figure -0- -0- feb big_number big_number big_number big_number dollar_figure dollar_figure mar big_number big_number big_number -o- big_number big_number apr big_number big_number big_number -o- big_number big_number may big_number big_number big_number -o- big_number big_number june big_number big_number big_number -o- big_number big_number july big_number big_number big_number -o- big_number big_number aug big_number big_number big_number -o- big_number big_number sept big_number big_number big_number -o- big_number big_number oct big_number big_number big_number -0- big_number big_number nov big_number big_number -o- big_number big_number dec big_number big_number big_number big_number total big_number big_number big_number big_number big_number big_number ‘this column was arrived at by netting gross_income and losses paid this column contains the total_amounts included on the bordereau for taxes board and bureau charges and federal excise_taxes in the net amounts to be remitted by nuf to opl for january and february were withheld in escrow by nuf ‘the net payment to opl is calculated by reducing the net_premiums shown in column one by expenses taxes board and bureau charges and funds withheld and by increasing that amount by interest on funds withheld nuf paid hall dollar_figure from the dollar_figure million it received from petitioner as fees opl ultimately recorded the funds received in its general ledger c ffic pip fireman's fund insurance co ffic through a policy sold by parcel insurance plan inc pip since offered excess value protection for shipments sent via petitioner the u s postal service and other carriers most of ffic pip's business came from petitioner's shippers pip tried to solicit business from petitioner's shippers who spent at least dollar_figure annually for -- - evc's generally pip charged percent of the rate charged for the excess value coverage offered by petitioner to its shippers this amounted to a price of dollar_figure5 per dollar_figure of coverage pip declined to provide coverage to certain high-risk shippers and also declined to provide coverage on certain types of packages however pip's marketing materials indicate that shippers in industries with serious theft problems could still participate but they were charged more than dollar_figure5 per dollar_figure of coverage if such a shipper were accepted by pip pip would charge between dollar_figure and dollar_figure5 per dollar_figure of coverage ffic was responsible for payment of losses and reimbursed pip weekly for loss claims paid for the years and pip's profit margins equaled percent and percent respectively pip paid approximately percent and percent for and respectively of the amounts collected to ffic for the parcel protection for ffic's gross_profit margin equaled percent of the premium written il liberty mutual insurance_policy a insurance_policy between petitioner and liberty mutual liberty mutual is a group of mutual insurance_companies liberty mutual are multiline property and casualty insurers based in boston massachusetts which operate in all states and the the profit margin is equal to premiums minus claims paid minus commissions district of columbia canada and the u s virgin islands liberty mutual fire insurance co liberty mutual fire is a member of liberty mutual liberty mutual wrote workers'_compensation insurance in all states except those that were monopolistic in the eight monopolistic states only one state-affiliated company was permitted to write workers'_compensation policies in workers'_compensation policies accounted for percent of liberty mutual fire's net_premiums in liberty mutual fire wrote workers'_compensation policies in california california law prohibited insurance policies for california workers'_compensation risks from also insuring workers'_compensation risks for other states thus a california workers'_compensation policy was always a stand-alone policy the initial premium for a workers'_compensation policy in california was determined by a statutory formula which took account of the estimated payroll for each job classification however an employer's loss experience could also affect the premium if the employer received an experience modification from the state of california generally california law permits the payment of dividends by a mutual_insurance_company but prohibits any individual or insurance_company from promising the future payment of dividends under an unexpired workers'_compensation policy or misrepresenting the conditions for dividend payment see cal code regs tit sec_2504 from through petitioner self-insured its workers'_compensation risks in california r l kautz a company unrelated to petitioner or liberty mutual administered this program liberty mutual wrote the workers'_compensation insurance for petitioner in all other states that were not monopolistic during this period any employer in california seeking to be self-insured for workers'_compensation must submit an application to the state and obtain state approval any employer seeking to change from a self-insured to an insured program for workers'_compensation must also submit an application to california and obtain state approval on date mr eugene schoenleber of petitioner's insurance department requested that mr al sharlun submit a proposal for taking over the administration of petitioner's california workers'_compensation program from r l kautz mr sharlun worked in liberty mutual's national sales department which handles large national accounts subsequently petitioner and liberty mutual agreed that liberty mutual would write an insurance_policy for petitioner's california workers'_compensation liability on date the state of california sent a letter to petitioner reflecting its understanding that it was the intention of petitioner to withdraw from workers'_compensation self-insurance status in california on date petitioner sent a letter to the state of california confirming that liberty mutual fire was taking over the management of all open and closed self-insurance claims from through the state of california granted petitioner's application to terminate its self-insurance plan as of date petitioner and liberty mutual entered into an insurance_policy with respect to petitioner's california workers'_compensation liability petitioner was listed as the insured the policy was issued by liberty mutual fire and was a permissible workers'_compensation policy in the state of california as part of the agreement liberty mutual fire was required to investigate and adjust all claims made under the policy the policy provides coverage for compensation and other_benefits required of petitioner by the workers'_compensation laws of california and provides coverage for all sums which petitioner is legally obligated to pay as damages because of bodily injury or accident or disease including death arising out of the course of employment under the participating provision endorsement of the insurance_policy petitioner was designated a member of liberty mutual with a right to participate in the distribution of dividends dividends were determined by the board_of directors of liberty mutual this endorsement provided that the policy was nonassessable as a nonassessable policyholder petitioner could not be assessed for liberty mutual's losses_and_expenses in excess of the premiums_paid for the california workers'_compensation policy the participating provision endorsement also reiterated the statutory provision in california which made it unlawful for liberty mutual to promise the future payment of dividends before the expiration of the policy period and the endorsement noted that dividends are payable only as determined by the board_of directors of liberty mutual following the expiration the policy also contained a redetermination agreement endorsement which provided that an initial apportionment of dividends may be made from a surplus accumulated from the california workers'_compensation insurance following termination of the policy further the policy provided that if a subsequent dividend is greater than the dividend previously paid to petitioner liberty mutual shall pay to petitioner the additional dividend shown to be due however if the subsequent dividend is less than the dividend previously paid to petitioner petitioner shall refund the amount by which the previous dividend exceeds the current dividend the audited premium for the policy is based upon actual payroll amounts during the policy period for various job classifications multiplied by a standard rate set by the state for each classification and further multiplied by an experience modification factor the estimated modified annual premium is the amount initially paid to liberty mutual fire which is determined based upon estimates of payroll amounts for the year after the end of the year the audited modified premium is determined based upon the final payroll figures for the year under the policy helmsman management a subsidiary within the liberty mutual group would administer the runoff of the through workers'_compensation self-insurance plan for petitioner beginning in for a flat fee of dollar_figure liberty mutual charged petitioner percent of its workers'_compensation losses subject_to a maximum of dollar_figure million for the cost of handling the workers'_compensation claims liberty mutual charged petitioner percent of its audited premium for excise_tax and percent for management fees dividends were to be declared and paid in accordance with california law and the determinations of the board_of directors of liberty mutual in petitioner made premium payments to liberty mutual in connection with the california workers'_compensation policy and received a dividend payment in during petitioner also continued to insure its workers'_compensation liability for most other states with liberty mutual in date the estimated premium for petitioner in california was calculated to --- - be dollar_figure the dollar_figure estimated premium was paid to liberty mutual by petitioner in monthly installments in by date liberty mutual completed its audit of the hours worked by various classes of petitioner's employees in california and determined the audited premium after the audit the standard premium for petitioner was increased by dollar_figure to reflect the actual amounts of petitioner's california payroll for the year in date liberty mutual fire sent petitioner a statement showing the first dividend adjustment to the liberty mutual policy every year thereafter through an annual dividend statement was sent to petitioner reflecting further dividend readjustments to the policy b liberty mutual-opl reinsurance treaty effective date liberty mutual and opl entered into a reinsurance treaty for petitioner's california workers'_compensation liability which was the subject of the liberty mutual policy pursuant to the agreement in liberty mutual paid opl dollar_figure in premiums in monthly installments retained a ceding commission of dollar_figure million withheld and created an escrow of dollar_figure to cover opl's liability for losses paid_by liberty mutual paid a federal excise_tax of dollar_figure and retained a management fee of dollar_figure the agreement with respect to opl's reinsurance of liberty mutual includes but is not limited to the following terms opl reinsured liberty mutual's ups california workers'_compensation exposure for losses not exceeding dollar_figure from any one accident liberty mutual retained the exposure for losses exceeding dollar_figure from any one accident liberty mutual also retained the risk of multiple accidents with losses in excess of dollar_figure liberty mutual fire agreed to pay over to opl an amount equal to the premiums received on the california workers compensation policy less dollar_figure for the retained layer of liability for losses above dollar_figure a management fee equal to percent of the premium percent of the premium for excise_tax and a ceding commission equal to percent of the losses_incurred the ceding commission was capped at dollar_figure million liberty mutual retained the obligation to investigate and adjust all claims for the ups workers'_compensation program in california liberty mutual paid a percent excise_tax on reinsurance by a foreign insurer pursuant to sec_4371 cc amount in dispute on its federal_income_tax return petitioner deducted the estimated premium of dollar_figure it paid to liberty mutual for california workers'_compensation coverage by date petitioner had incurred workers'_compensation losses in california that had been paid_by liberty mutual in the amount of dollar_figure respondent disallowed dollar_figure deducted on petitioner's return after concessions the amount in dispute with respect to the liberty mutual policy has been reduced to dollar_figure opinion rt excess value charges respondent determined that evc's in the amount of dollar_figure must be included in petitioner's income pursuant to sec_61 sec_61 provides in part that gross_income means all income from whatever source derived it is fundamental to our system of taxation that income must be taxed to the one who earns it see commissioner v culbertson this amount represents the difference between the total of dollar_figure of deductions and the dollar_figure actually paid out by liberty mutual fire in claims respondent conceded a total of dollar_figure see supra note thus respondent's initial disallowance of dollar_figure has been reduced by dollar_figure to dollar_figure the dollar_figure conceded by respondent is made up of dollar_figure representing a 12-percent claim adjustment expense for losses paid in plus dollar_figure in premiums_paid to liberty mutual for risk associated with claims over dollar_figure the dollar_figure conceded amount was calculated by respondent to be an allocation of a portion of the total dollar_figure million retained by liberty mutual based on the ratio of claim payments to total claims paid between and - - u s the incidents of taxation cannot be avoided through an anticipatory_assignment_of_income see 410_us_441 281_us_111 this has been described as the first principle of taxation commissioner v culbertson supra pincite the question of who should be taxed depends on which person or entity in fact controls the earning of the income rather than who ultimately receives the income see 333_us_591 281_us_376 73_tc_1246 see also 62_tc_27 56_tc_828 42_tc_601 a taxpayer realizes income if he controls the disposition of that which he could have received himself but diverts to another as a means of procuring the satisfaction of his goals the receipt of income by the other party under such circumstances is merely the fruition of the taxpayer's economic gain see commissioner v sunnen supra pincite 311_us_112 respondent does not and need not challenge opl's separate existence as a valid corporate entity the classic assignment_of_income cases involve persons and entities whose separate existence was unguestioned see united_states v basye supra -- - lucas v barl supra 104_tc_140 the supreme court's articulation of the assignment_of_income_doctrine requires no challenge to the separate existence of the persons or entities to which the doctrine applies as the court stated the entity earning the income--whether a partnership or an individual taxpayer--cannot avoid taxation by entering into a contractual arrangement whereby that income is diverted to some other person or entity such arrangements known to the tax law as anticipatory assignments of income have frequently been held ineffective as means of avoiding tax_liability united_states v basye supra pincite therefore the issue we must decide is whether petitioner rather than nuf and opl earned the evc's during the years prior to petitioner properly reported revenues from evc's as income for federal_income_tax purposes during those years petitioner performed the following evc functions and activities maintained and advertised the shipping activity which provided a customer base for petitioner's excess value activity printed shipping forms with an excess value election published excess value rates in tariffs incurred liability for damage or loss to packages in excess of dollar_figure when the shipper declared such excess value and paid an evc ’ billed shippers for evc's collected evc's deposited evc's into petitioner's bank accounts retained_interest paid on evc income held in petitioner's accounts processed excess value claims investigated excess value claims traced lost parcels inspected damaged parcels paid excess value claims maintained a loss prevention manual and personnel to audit and implement it defended against lawsuits brought by shippers whose excess value claims had been denied incurred all costs associated with the administration of its excess value activity obtained and paid for catastrophic insurance to cover its liability for lost or damaged shipments petitioner accepted liability for damage or loss to packages up to dollar_figure and made payment for such loss or damages after date petitioner continued to perform all these functions and activities this continuity in petitioner's evc activity after date was consistent with a plan petitioner had formulated during during petitioner asked aig to submit a proposal for restructuring petitioner's excess value program aig's proposal contemplated that nuf would perform ina fronting capacity a capacity in which nuf would receive excess value income under the shippers interest contract and reinsure its liability under the shippers interest contract with opl in his letter dated date mr corde of hall stated that nuf would exist ina fronting capacity with essentially no risk or exposure to loss under the program nuf retained an even dollar_figure million in as a fronting service fee for agreeing to reinsure the shippers interest contract with opl ’ mr smetana of aig proposed that petitioner would continue to collect evc's from shippers administer and pay all valid claims and remit excess value amounts to nuf net of claims mr smetana also proposed that petitioner be responsible for uncollectible evc's mr smetana reasoned that since 7a front has been generally described as an arrangement whereby an insurance_company allows another company to use its name for a fee see 740_f2d_1384 n 7th cir see also 817_fsupp_1424 e d wis -- - aig nuf would have no control_over the payment of premium by shippers atg nuf would not take on the responsibility for any bad_debt or uncollectables under the program these proposals all became part of petitioner's method of operation on date under the facultative reinsurance agreement between nuf and opl article i item b lists the shippers interest contract as the policy to be reinsured under article xviii subparagraph a neither nuf nor opl could terminate the reinsurance agreement while the shippers interest policy remained in force article xviii further requires that only in the event that the shippers interest contract is in fact terminated will the reinsurance agreement between nuf and opl be terminated simultaneously therewith either petitioner or the named insured could cancel the shipper's interest contract under the terms of that agreement beginning in date petitioner transferred excess value amounts billed to its regular shippers and collected from other shippers net of claims paid in excess of dollar_figure to nuf ona monthly basis petitioner did not reduce the amounts transferred to nuf in order to compensate itself for sales and marketing 8we note that it is unrealistic to conceive of a situation in which a single shipper could cancel the whole shipper's interest contract or that all the unrelated shippers in unison could cancel the contract expenses that it incurred regarding the evc's petitioner did not charge either nuf or opl for providing the point_of_contact with shippers who declared excess value and paid evc's no interest on excess value amounts that had been collected before the excess value amounts were transferred to nuf was paid to nuf during if a shipper did not pay a bill that included excess value amounts petitioner attempted to collect the entire amount due from the shipper including any evc's included in the bill petitioner did not reduce the amount transferred to nuf by any amount uncollected or any cost it incurred in collecting delinquent evc's petitioner also adjusted and paid all claims with respect to lost or damaged shipments petitioner also defended against shippers' claims that had been denied petitioner did not reduce the amounts it transferred to nuf in order to compensate itself for performing these activities and did not otherwise charge nuf or opl for performing any of these activities petitioner also continued to provide other services related to evc's petitioner provided controlled parcel handling procedures which were expensive and time consuming those procedures included bagging tagging and tracking high value packages that had declared values in excess of dollar_figure petitioner maintained a loss prevention department in which it employed personnel to audit controlled parcel handling procedures such audits took place at petitioner's hub and delivery center operations petitioner's special controlled parcel handling procedure with respect to high-value packages constituted extra services for shipments whose declared value exceeded dollar_figure petitioner did not reduce the amount transferred to nuf in return for performing the controlled parcel handling procedures and did not otherwise charge nuf or opl for performing these activities before date petitioner performed all the functions and activities related to the evc's and was liable for the damage or loss of packages up to their declared value after date petitioner continued to perform all the functions and activities related to evc's including billing for and receiving evc's and remained liable to shippers whose shipments were damaged or lost while in petitioner's possession petitioner continued to receive shippers' claims for lost or damaged goods investigate and adjust such claims and pay such claims out of the evc revenue that it had collected from shippers the difference between petitioner's evc activity before and after date was that after that date it remitted the excess of evc revenues over claims paid i1 gross_profit to nuf which after subtracting relatively small fronting fees and expenses paid the remainder to opl which was essentially owned by petitioner's shareholders the only potentially relevant change that occurred on date was the introduction of the shippers interest contract between petitioner and nuf and the facultative reinsurance agreement between nuf and opl petitioner attempts to justify this arrangement on the ground that it was based on bona_fide business considerations and that the arrangement had economic_substance if on the other hand the arrangement with nuf and opl had neither business_purpose nor economic_substance other than tax_avoidance the entire arrangement has all the earmarks of a classic assignment_of_income wherein petitioner was attempting to assign evc income that had been earned through its own services and activities to opl for the benefit of petitioner's and opl's common shareholders on brief petitioner relies on 319_us_436 for the proposition that it may rearrange change and divide business activities among business entities we agree that normally a choice to transact business in corporate form will be recognized for tax purposes as long as there is a business_purpose or the corporation engages in business activity see 105_tc_341 citing moline properties inc v commissioner supra pincite affd 115_f3d_506 7th cir as previously noted opl's separate corporate existence is not being questioned the issue then is -- - whether the restructuring of petitioner's evc activity in by inserting nuf and opl as part of the evc transactions had substance if these transactions lack substance then petitioner engaged in an anticipatory_assignment_of_income and cannot avoid taxation no matter how clever or subtle the arrangement united_states v basye u s pincite while a taxpayer may structure a transaction to minimize tax_liability that transaction must have economic_substance if it is to be respected for tax purposes see 862_f2d_1486 llth cir affg 87_tc_1087 the inquiry into whether transactions have sufficient substance to be respected for tax purposes turns on both the objective economic_substance of the transactions and the subjective business motivation behind them see kirchman v commissioner supra pincite2 see also acm partnership v tn 862_f2d_1486 11th cir affg 87_tc_1087 the court observed courts have recognized two basic types of sham transactions shams in fact are transactions that never occur in such shams taxpayers claim deductions for transactions that have been created on paper but which never took place shams in substance are transactions that actually occurred but which lack the substance their form represents because all the transactions at issue in this case actually continued -- - commissioner 157_f3d_231 3d cir affg in part and revg in part on another ground tcmemo_1997_115 939_f2d_44 3d cir affg fox v commissioner tcmemo_1988_570 909_f2d_1360 9th cir affg in part and revg in part on another ground 89_tc_1229 the objective and subjective prongs of the inguiry are related factors both of which form the analysis of whether the transaction had sufficient substance apart from its tax consequences see acm partnership v commissioner supra pincite casebeer v commissioner supra pincite in making our determination as to whether a transaction has substance we will first look to whether the taxpayer had a business_purpose for engaging in the transaction other than tax_avoidance see 435_us_561 kirchman v commissioner supra pincite 820_f2d_1543 9th cir affg tcmemo_1986_23 the determination of whether the taxpayer had a legitimate business_purpose in entering into the transaction involves a subjective analysis of 29’ continued occurred we limit our inquiry to the guestion of whether their substance corresponds to their form -- - the taxpayer's intent see kirchman v commissioner supra pincite petitioner argues that it had legitimate business purposes for entering into the arrangement with nuf and opl other than tax_avoidance petitioner specifically alleges that during it was seriously concerned that its continued receipt of the excess value income was potentially illegal under various state insurance laws and that it was this concern that motivated it to rearrange its method of handling its evc activity therefore petitioner argues the evc income cannot properly be considered to belong to petitioner petitioner cites 650_f2d_75 5th cir as authority in bank of coushatta v united_states supra the taxpayer bank was contesting the imposition of federal_income_tax on credit life_insurance commissions which the bank contended were actually earned by one of its executives see id pincite the bank had transferred the credit life_insurance business to the executive because the bank believed that it would have been illegal for it to continue to earn and receive insurance commissions the district_court reasoned that because there was no showing of any kind that the bank ever received the commissions as income under sec_61 the bank had not earned the income see id pincite the court_of_appeals for the fifth circuit affirmed on the basis of the district court's opinion however the court_of_appeals limited its holding to the situation where the bank's decision to transfer the insurance_business to the executive was motivated by the good_faith belief that it would be illegal for the bank to continue to earn and receive insurance commission income see id pincite therefore petitioner's ability to rely on bank of coushatta depends on whether petitioner's decision to transfer the excess value income to opl through nuf was motivated by a good_faith concern that it was illegal for petitioner to continue to receive the excess value income we do not believe that this was petitioner's purpose mr kenneth johnson head of petitioner's insurance department testified that in the early 1980's he learned that the collision damage waivers offered by the hertz and avis rental car companies were being challenged by state insurance regulators as an illegal insurance_business and that this caused him to become concerned that petitioner's excess value activity could be viewed by state insurance regulators as engaging in an unlicensed insurance activity no state insurance regulators had ever guestioned the legality of petitioner's evc activity and mr johnson was not aware that any such questions had ever been raised with other carriers mr johnson testified that because of his concerns he had a casual conversation with an - -- acquaintance ms yudain who was an insurance broker who told him that his concerns might have substance both mr johnson and mr corde testified that they met in and had some discussion regarding the possibility that petitioner's evc activities might run afoul of state insurance regulations after mr johnson met with mr corde in mr corde sent mr johnson a report on date discussing the feasibility of creating a subsidiary to reinsure declared value risks the report stated it is our understanding that petitioner currently provides its customers with coverage for any parcels lost or damaged up to dollar_figure those parcels with values in excess of dollar_figure can be declared by the shipper and protection secured at a cost of dollar_figure per dollar_figure of value while this protection is not considered to be insurance it could be converted to insurance and that insurance could be provided by a petitioner owned insurance_company the report contains figures regarding petitioner's evc revenues claims and gross_profits and discusses the potential for increasing profits the report does not discuss problems with state insurance laws mr johnson's conversation with mr corde in appears to be his and petitioner's last inquiry regarding problems with state insurance regulation neither mr johnson nor petitioner sought legal advice regarding these alleged concerns in addition neither mr johnson nor anyone else on petitioner's staff appears to have made an inquiry as to whether the evc program as proposed to be restructured might violate state insurance regulations no contemporaneously prepared documentary_evidence was presented to indicate that petitioner had such concerns or to indicate that petitioner analyzed the alleged problem and considered the steps necessary to deal with its alleged concerns mr johnson's testimony on cross-examination is revealing q your concern about possible state regulation you never discussed this with the sic anybody at the icc did you a i did not no q and you're not aware of anybody at ups ever discussing it with anybody at the icc a i'm not aware of it during mr corde of frank b hall inguired about how other hall clients handled cargo coverage in connection with analyzing the proposed ups declared value program mr doug brown of hall prepared an internal memorandum to mr corde dated date outlining the arrangements of other companies which were hall clients the concluding paragraph of mr brown's memorandum states in my discussions with frank b hall people and underwriters the opinion with regard to the legality of selling shippers interest when in fact neither client is a licensed insurance agent was that provided the carrier is simply requesting an acceptance or declination from the shipper for the insurance does not put them in a brokerage or agency position i find this questionable especially since both clients that i reviewed are doing very little domestic shippers interest coverage consequently the problem may not have arisen -- - q you're not aware --- you did not discuss it with any state regulators a no i didn't q rither insurance or transportation a that's correct q and you're not aware of anybody at ups discussing it with any state regulators insurance or transportation a no i'm not q throughout the entire time that ups was considering revising the excess value program it never obtained a legal -- a written legal opinion relating to whether the excess value activity could be construed as insurance a i did not q and you're not aware of ups doing it a no i'm not q and you never -- ups never prepared an opinion of even in-house counsel relating to whether the activity -- its excess value activity could be construed as insurance a not that i'm aware of q pardon me i didn't hear you a i said -- i'm sorry -- not that i'm aware of i did not request one q even after you became concerned and started with the negotiations you didn't ask for an opinion a legal opinion a no q okay you indicated yesterday you were concerned about the avis and hertz collision damage waiver cases a and liability insurance -- - q and liability insurance cases did you ever request a legal opinion as to whether ups's activity was similar or distinguishable a no q during the negotiations did you ever request an opinion regarding whether federal transportation law preempted state regulation a no i didn't q okay at some point in late ups decided to go forward with the transaction correct a q i'm sorry a yes q and it -- a i don't know if it was late in q tt's not my intention to quibble about the date sometime in ups decided to go forward a yes q and at some point the structure was fairly known to you national union would be involved and opl would be the reinsurer is that correct a yes q at that point in time did you request a legal opinion as to whether that satisfactorily alleviated your concerns about state regulation a no qo did ups a not that i'm aware of q now was -- the court mr johnson could you speak up just a little bit the witness i'm sorry sir by mr kletnick q was one of the aspects of your concern that ups employees were selling excess value units in a that was one of my -- my concerns were that it was offered to our customers and they were accepting it in q and who was it offered by a it was in -- i guess in our explanation of service and i assume the customer service people were talking to our customers about it q so they would in effect be selling excess value units wouldn't they a i think it would certainly look like that yes q and so was that part of your concern a yes it was q and they're not licensed as brokers a no they're not q they're not licensed as agents a no they're not q and then if there's a claim ups customer service personnel would on occasion settle the claim a we had a claims department -- q right a -- yes in the company that would settle claims yes -- - q all right and those people weren't licensed in various states a no q okay so was that part of your concern a yes q okay so now after nuf comes into the picture the same ups employees are still meeting with the customers correct the shippers a yes q they're still selling the excess value units right a i wouldn't characterize it as -- well call it selling if you want but i don't -- q well what would you call it a i don't know i don't know what i would call it i don't really know how they did it is my problem q they were going out and meeting with the customers telling them about ups's excess value --- the excess value charges a yes i'm sure they were q so -- and ---- but you did not take the next step and obtain an opinion as to whether that would be permissible under state insurance laws a no i did not with nothing more than the sketchy testimony about vague concerns by mr johnson petitioner would have us conclude that it divested itself of a very profitable dollar_figure million per year revenue source that was based on a decades-old system for setting shipping rates that had consistently received approval of the -- jo - federal and state governments we do not believe that petitioner would have restructured a significant portion of its business in order to avoid a potential state law problem without having thoroughly analyzed and considered the matter and the ramifications that any proposed change might have had petitioner been seriously concerned with state insurance regulation a logical question would have been whether petitioner's evc activity regarding interstate transportation was preempted by federal_law the liability of an interstate carrier for damage to a shipment is a matter of federal_law controlled by federal statutes and decisions see 377_us_134 a t clayton co v missouri-k901_f2d_833 10th cir the carmack amendment codifies an initial carrier's liability for goods lost or damaged in shipment generally carriers are liable for loss or damage caused by them to property they transport see id see also 712_f2d_740 2d cir during the years in issue pursuant to the carmack amendment to the interstate commerce act a motor common carrier could although the substance of the carmack amendment originally u s c sec was recodified into u s c secs and these sections were commonly termed the carmack amendment see 829_f2d_1407 n 7th cir effective continued establish rates for the transportation of property under which the liability of the carrier was limited to a value established sec_1 continued date the carmack amendment was again recodified pincite u s c secs and see 98_f3d_874 n 5th cir u s c sec provides in pertinent part a a common carrier providing transportation or service subject_to the jurisdiction of the interstate commerce commission shall issue a receipt or bill of lading for property it receives for transportation that carrier or freight forwarder and any other common carrier that delivers the property and is providing transportation or service x are liable to the person entitled to recover under the receipt or bill of lading the liability imposed under this paragraph is for the actual loss or injury to the property caused by the carrier c a common carrier may limit its liability for loss or injury of property transported under section of this title u s c sec b provides a motor common carrier may establish rates for the transportation of property other than household goods under which the liability of the carrier for such property is limited to a value established by written declaration of the shipper or by written_agreement between the carrier and shipper if that value would be reasonable under the circumstances surrounding the transportation u s c sec provides except as otherwise provided in this subtitle the remedies provided under this subtitle are in addition to remedies existing under another law or at common_law by written declaration of the shipper or by written_agreement between the carrier and the shipper if that value would be reasonable under the circumstances surrounding the transportation see u s c sec a see also 664_fsupp_694 ef d n y art masters associates ltd v united parcel serv n be 2d n y a motor common carrier must publish and file with the icc tariffs containing the rates for transportation it may provide see u s c sec a fabulous fur corp v united parcel serv supra pincite petitioner offered its interstate shippers released rates authorized by a series of icc released rate orders rro petitioner filed tariffs and tariff supplements during the years in issue which determined released value rates authorized by the icc by released rates decision mc-978 under the damaged and unclaimed property provision of the tariffs if the package was damaged by petitioner petitioner was liable to the shipper to pay the full actual or declared value of the property whichever was lower under the method of determining rates provision of the tariffs if a shipper did not declare value in excess of dollar_figure petitioner collected its base rate and its similar orders were issued by each state relating to intrastate orders -- - liability was limited to dollar_figure if a shipper declared value in excess of dollar_figure petitioner collected its base rate plus an evc of cents per dollar_figure of additional declared value and its liability equaled the amount of value declared thus the evc was part of the rate charged by petitioner and the rates including the evc were determined under the tariff under both federal_law and the provisions of the tariff petitioner was liable for damage to shippers' packages up to the declared value or dollar_figure if no value was declared even if petitioner's excess value activity could be characterized as some form of insurance under the various state laws federal_law appears to preempt state law with regard to the liabilities of interstate carriers the supreme court addressed the preemptive scope of the carmack amendment relating to state regulation of carrier liability in 226_us_491 there the court held almost every detail of the subject is covered so completely that there can be no rational doubt but that congress intended to take possession of the subject and supersede all state regulation with reference to it id pincite later in 6_f3d_305 5th cir the court_of_appeals for the fifth circuit addressed the carmack amendment and stated a purpose of the carmack amendment was to substitute a paramount and national law as to the rights and liabilities of interstate carriers subject_to the amendment this court furthermore adopted the supreme court's language in adams express co that the legislation supersedes all the regulations and policies of a particular state upon the same subject results from its general character it embraces the subject of the liability of the carrier under a bill of lading which he must issue and limits his power to exempt himself by rule regulation or contract to hold that the liability therein declared may be increased or diminished by local regulation or local views of public policy will either make the provision less than supreme or indicate that congress has not shown a purpose to take possession of the subject the first would be unthinkable and the latter would be to revert to the uncertainties and diversities of rulings which led to the amendment id pincite citing 721_f2d_483 5th cir quoting adams express co v croninger supra pincite petitioner has successfully asserted that the carmack amendment preempted state law which might otherwise govern a shipper's claim for damage to packages see plaid giraffe inc v united parcel serv inc no 94-1002-pfk d kan date art masters associates ltd v united parcel serv supra pincite petitioner similarly defended itself in other actions by shippers for recovery_of lost or damaged shipments 335tn united parcel serv inc v smith n e 2d ind ct app petitioner appealed from an action in which glenn smith the shipper filed suit against petitioner regarding an allegedly lost shipment mr smith sought to recover dollar_figure the continued while we need not specifically decide whether federal_law preempts state insurance laws with respect to petitioner's excess value activity we believe that petitioner was well aware of the preemption position and had good reason to believe that it continued value of the lost package from petitioner on appeal petitioner advanced the position that congress clearly intended the carmack amendment to preempt all state regulation of claims against common carriers for interstate ground shipments and the supreme court has specifically so held appellant's opening brief pincite united parcel serv inc v smith supra the indiana court_of_appeals concluded that u s c et segq the interstate commerce act and specifically those portions known as the carmack amendment preempt all state regulation of interstate ground shipments id pincite fn ref omitted in 924_fsupp_65 w d tex mr james w simmons filed suit in the state district_court of bexar county texas against petitioner regarding two excess value shipments mr simmons sought to recover dollar_figure in damages on motion by mr simmons to remand to the state court petitioner alleged that the carmack amendment completely preempted all state law claims the court stated under the complete pre-emption doctrine once an area of state law has been completely pre-empted any claim purportedly based on that pre-empted state law is considered from its inception a federal claim and therefore arises under federal_law both the supreme court and the fifth circuit have held that the carmack amendment preempts all state law claims against a common carrier id pincite citing 226_us_491 6_f3d_305 5th cir the court held that the complete pre-emption doctrine applied and that removal from state court was proper see id applied nevertheless petitioner made no attempt to analyze the issue or obtain legal advice before deciding to restructure the evc part of its business this leads us to believe that petitioner's interjection of nuf and opl into its excess value activities in was not done in order to avoid running afoul of state insurance laws and regulations petitioner has not attempted to draw a distinction between concerns about interstate versus intrastate matters according to the testimony of petitioner's former chairman and c e 0o in excess of percent of petitioner's volume in consisted of interstate shipments and percent of petitioner's volume in consisted of ground transportation as previously indicated petitioner obtained authorization for its pre-1984 evc activities from the required state transportation authorities and no state had asserted that petitioner was not in compliance with state insurance law as stated by dr shapiro in his expert report assuming the risk of state regulation was real abandoning a profitable business because of this risk is equivalent to burning down the barn to get rid of the rats even if you solved the problem the price was too high based on my business experience it is my strongly--held opinion that a company would not walk away from such a valuable business on a mere suspicion that it might be subject_to an added risk of regulation rather in such a situation the company would first meet with legal counsel to get an opinion as to the likelihood and business consequences of such regulation next it would analyze the financial impact of such regulation and explore how it might be able to legally avoid minimize or delay the impact of any potential regulation fn ref omitted assuming that petitioner's excess value activity might have been considered insurance subject_to regulation under various state laws petitioner's restructured method of handling evc's would also seem to violate state laws for example in some states the sale or solicitation of insurance without authorization is a violation of state statutes see eg cal ins code sec west n y ins law sec_109 ’cal ins code sec west provides dollar_figure admittance required penalties compliance hearings issuance of certificate a a person shall not transact any class of insurance_business in this state without first being admitted for that class admission is secured_by procuring a certificate of authority from the commissioner the certificate shall not be granted until the applicant conforms to the requirements of this code and of the laws of this state prerequisite to its issue ob the unlawful transaction of insurance_business in this state in willful violation of the requirement for a certificate of authority is a public offense punishable by imprisonment in the state prison or ina county jail not exceeding one year or by fine not exceeding one hundred thousand dollars dollar_figure or by both and shall be enjoined by a court of competent jurisdiction on petition of the commissioner cal ins code sec_35 west provides dollar_figure transact transact as applied to insurance includes any of the following a solicitation continued --- - mckinney ’ during petitioner provided its shipper sec_3 scontinued b negotiations preliminary to execution c execution of a contract of insurance d transaction of matters subsequent to execution of the contract and arising out of it s7n y ins law sec_1102 mckinney provides dollar_figure insurer's license required issuance a no person firm association corporation or joint-stock company shall do an insurance_business in this state unless authorized by a license in force pursuant to the provisions of this chapter or exempted by the provisions of this chapter from such requirement any person firm association corporation or joint-stock company which transacts any insurance_business in this state while not authorized to do so by a license issued and in force pursuant to this chapter or exempted by this chapter from the requirement of having such license shall in addition to any other penalty provided by law forfeit to the people of this state the sum of one thousand dollars for the first violation and two thousand five hundred dollars for each subsequent violation n y ins law sec_1101 mckinney provides sec_1101 definitions doing an insurance_business b except as provided in paragraph two hereof any of the following acts in this state effected by mail from outside this state or otherwise by any person firm association corporation or joint-stock company shall constitute doing an insurance_business in this state and shall constitute doing business in the state within the meaning of section three hundred two of the civil practice law and rules continued with the necessary forms upon which the shippers could declare excess value the package pickup record was used by petitioner to bill shippers for the evc's sold petitioner received and deposited evc income in itss corporate accounts thus assuming that the shippers interest program was insurance petitioner sold or solicited the putative insurance in petitioner also received reviewed defended and paid claims by selling the shippers interest policy collecting the premiums and adjusting claims without the appropriate licenses petitioner would seemingly have been in violation of state statutes prohibiting the sale collection of premium and adjustment of claims related to the nuf insurance_policy it strains credulity to believe that petitioner attempted to avoid the requirements of state statutes by restructuring its excess value activity in a manner that arguably caused petitioner to remain in violation of state statutes had such a restructuring occurred to avoid violating state law we believe that a large successful corporation such a sec_37 scontinued c collecting any premium membership fee assessment or other consideration for any policy or contract of insurance 8tindeed on the question of whether petitioner's evc activity constitutes insurance petitioner fails to make any meaningful distinction between the promise to insure the first dollar_figure of value in return for a shipping fee which petitioner continued after date and the excess value activity petitioner would have thoroughly analyzed the legal and business ramifications that was not done petitioner also argues that one of its business purposes for restructuring the evc activity was to leverage the excess value profits into the creation of a new reinsurance company which over time could become a full-line insurer we have no doubt that transferring the profits from the evc activity tax free could provide opl with the capital to become a full-line insurer of other risks but any investment of money into opl could accomplish this purpose the question here is whether petitioner earned and must pay tax on the funds ultimately transferred to opl or whether the evc profits were earned by nuf and opl the purpose for which the profits were ultimately used or intended to be used does not answer the question before us petitioner alleges that another business_purpose for restructuring its evc activity was to enable it to increase its rates petitioner argues that by removing the excess value revenue from its operating ratio computation it could obtain larger rate increases than would have otherwise been possible petitioner historically targeted a 90-percent operating ratio on its ground transportation business petitioner alleges that petitioner's operating ratio was computed as a ratio of operating_expenses to operating revenue an operating margin is the inverse of an operating ratio thus a 90-percent operating continued its operating ratios played an important role in obtaining rate increases we do not believe that petitioner shifted evc income to opl in order to justify raising its rates the 90-percent operating ratio was a standard set by petitioner rather than a federal or state regulatory mandate the motor carrier act of mca publaw_96_296 94_stat_793 provided for a zone of rate freedom zorf for motor common carriers and freight forwarders zorfe allowed for the filing of rate increases up to percent above the rate in effect year before the effective date of the proposed increase or a decrease of as much as percent below the lesser_of the rate in effect on date or the rate in effect year before the effective date of the proposed rate see mca sec_11 94_stat_801 petitioner did not offer any continued ratio is equal to a 10-percent operating margin the pertinent portion of the motor carrier act of publaw_96_296 94_stat_801 provided zone of rate freedom for motor carriers of property and freight forwarders sec_11 section of title united_states_code is amended by adding at the end thereof the following new subsection d notwithstanding any other provision of this title the commission may not investigate suspend revise or revoke any rate proposed by a motor common carrier of property or freight forwarder on the grounds continued credible_evidence that the various federal and state regulatory agencies would have denied a rate increase had it retained the evc income petitioner's primary consideration in setting rates was fairness and competition according to its former executives indeed the testimony of petitioner's former executives indicates that they could have sought greater rate increases under zorf than what was requested and that they were not concerned about maximizing rates in date petitioner sought and obtained from the icc and various state regulatory bodies a percent rate increase effective date petitioner's rate increase of dollar_figure percent was dollar_figure percent less than the maximum increase allowed by zorf continued that such rate is unreasonable on the basis that it is too high or too low if-- a the carrier notifies the commission that it wishes to have the rate considered pursuant to this subsection and b the aggregate of increases and decreases in any such rate is not more than percent above the rate in effect one year prior to the effective date of the proposed rate nor more than percent below the lesser_of the rate in effect on date or in the case of any rate which a carrier first establishes after date for a service not provided by such carrier on such date such rate on the date such rate first becomes effective or the rate in effect one year prior to the effective date of the proposed rate - - mr kent c nelson who during the years in issue was a member of petitioner's board_of directors and was petitioner's chief financial officer testified as follows q mr nelson i believe you mentioned earlier you were familiar with the rate increase in date a yes q was that rate increase higher or lower because of the spinoff of the excess value business a it's hard to tell because the projection process projects increased volume projected labor costs and the revenue that we had from growing businesses that are profitable and it all comes together the way it comes together i don't know if it would have had any effect on it at the time it would be conjecture on my part q assuming that all other factors were equal did the rate increase in increase or decrease because of the transfer of the excess value business a i don't think it made any difference like petitioner's other alleged business justifications for restructuring its evc activity there is no contemporaneous documentation that petitioner investigated or considered the impact that restructuring its evc activity would have on its shipping rates petitioner also argues that by restructuring the evc activity it enhanced protection of the assets of its core transportation activity from the risks associated with assuming - -- liability for declared value in excess of dollar_figure in order to evaluate this alleged business_purpose we will look to whether petitioner actually transferred or reduced its liability to shippers in any meaningful sense in other words did the rearranged evc activity have any real economic impact on petitioner in petitioner supplemented tariffs filed with the icc on behalf of ups-new york and ups-ohio supplement provision 540-a to the tariffs provided that petitioner may remit excess valuation charges to an insurance_company as a premium for excess valuation cargo insurance on the shipper's behalf however supplement provision 540-a also stated that in the event that the insurance_company failed to pay any claim for loss or damage to the shipper's property under the policy petitioner would remain liable for any loss or damage within the limits declared and paid for petitioner's service explanation also states that if nuf fails to pay any claim for loss of or damage to the shipper's property petitioner will remain liable for loss or damage within the declared limits of the shippers interest contract the shippers interest contract document specifically lists the shippers under the name and address of insured however the contract document also lists the address of the insured to be that of petitioner's world headquarters under the cancellation provision of the shippers interest contract either petitioner or the named insured could terminate the contract thus petitioner had the power to cancel the insurance_policy that petitioner alleges was between its shippers and nuf of course continued - - pursuant to tariff provision filing of claims shippers were required to allege in writing among other things that petitioner was liable for the loss or damage pursuant to tariff provision time limit for filing claims petitioner was relieved of liability under its tariff if the shipper did not file a claim with petitioner or institute a lawsuit against petitioner within years and day from when petitioner notified the shipper that the claim had been disallowed by petitioner under this provision shippers were required to bring an action against petitioner in order to pursue their claims for damage or loss of packages each of the above-mentioned provisions existed in petitioner's tariffs before and during on the basis of federal_law and the provisions that remained in petitioner's tariffs liability continued to arise under such tariffs in petitioner treated liability for loss or damages associated with evc's as arising from petitioner's tariffs in accordance with federal_law upon commencement of a relationship with its shippers petitioner provided most shippers with a copy of petitioner's service explanation while the service explanation referred to nuf and the shippers interest contract petitioner did not generally provide a copy of the shippers interest continued petitioner would in any event have remained liable to its shippers for damage claims -- - contract to each of its shippers as a result of tariff requirements and rather than filing claims with nuf under the shippers interest contract shippers were required to file a claim only against petitioner within a specific time in order to be compensated for loss or damage even at the point when petitioner adjusted shippers' claims petitioner does not appear to have informed the shippers that nuf was the insurer of the claim or that the shippers had any recourse against nuf thus shippers' claims were presented to and resolved by petitioner in accordance with the provisions of the tariff petitioner represented to its customers in its quarterly publications that petitioner was liable for lost or damaged packages in date petitioner's roundups newsletter informed its customers that petitioner's drivers would leave packages without signatures at certain delivery locations in the newsletter petitioner assured its shippers that ups would continue to assume liability for lost and damaged packages up to dollar_figure or the declared value on the basis of the foregoing facts we find that after date petitioner remained liable to shippers who had declared a value in excess of dollar_figure there still remains the guestion of whether the arrangement with nuf and opl sufficiently reduced petitioner's financial exposure to be recognized as having economic_substance the shippers interest contract provided that nuf was not liable for the first dollar_figure of value and in no event did nuf's liability exceed the declared value of a shipper's package the shippers interest contract also provided that if petitioner's liability for loss or damage to a shipper's package was covered by another insurance_policy then nuf would not be liable for the amount covered by petitioner's other insurance_policy other insurance did exist throughout petitioner maintained an insurance_policy with affiliated fm insurance co afm policy that covered petitioner's liability for loss or damage to shipper's packages petitioner paid annual installment premiums of dollar_figure of which dollar_figure was allocated to property value related to parcels in transit under the policy dollar_figure of annual premium provided coverage for an average daily parcel value of dollar_figure the afm policy provided for a dollar_figure deductible to all loss claims arising out of a loss occurrence to the extent that other insurance did not exist the shippers interest contract generally did not limit claims to any maximum amount per loss occurrence the afm policy covered petitioner's purchase of the afm policy and its operation effect of covering petitioner's liability for packages shipped during is inconsistent with petitioner's argument that it had no such liability to shippers after date with respect to packages sent up sec_2nd day air or ups next day air the shippers interest contract limited nuf's continued petitioner's liability for package losses related to any single occurrence to the extent the liabilities were greater than dollar_figure but did not exceed dollar_figure million thus there was a theoretical exposure for nuf and opl to the extent that one or more loss occurrences resulted in more than dollar_figure million in loss per occurrence for example if petitioner incurred liability to shippers as a result of a single occurrence of three times the dollar_figure million limit that petitioner was insured for under the afm policy in nuf opl would have been liable for approximately dollar_figure million twenty million dollars in additional claims would have reduced the gross_profit_percentage from evc's in from percent to percent even in this unlikely event excess value revenue in would have exceeded over two times the amount of claims paid considering the extreme magnitude of a catastrophe that would have to occur before claims exceeded excess value revenue in a given year we again find it unrealistic that petitioner or nuf opl would realize a loss in its excess value activity continued liability to dollar_figure per package disregarding the dollar_figure deductible petitioner would have coverage of dollar_figure million under the afm policy and nuf opl would be liable for claims in excess of that the only potential financial benefit that petitioner could realize from its arrangement with nuf and opl was if liabilities continued petitioner must have drawn the same conclusion through the afm policy petitioner was able to cover its liability for up to dollar_figure million for any single occurrence in return for premiums of dollar_figure this amount of premium is less than one-tenth the amount petitioner agreed to pay nuf to be a front in the restructuring of the excess value activity nuf and opl were not liable for losses attributable to a single occurrence to the extent such losses were between dollar_figure and dollar_figure million petitioner in turn was not dependent upon nuf and opl for single-occurrence catastrophic losses above the deductible of dollar_figure and under dollar_figure million but would have been able to procure coverage for such liability in excess of dollar_figure million for a relatively nominal premium petitioner had a conservative risk-averse insurance philosophy and sought to have sufficient coverage to protect its assets from a catastrophe in petitioner considered raising the dollar_figure million afm policy limit to dollar_figure million ina letter dated date sent by mr edmund mihich of hall to mr johnson and mr eugene schoenleber of petitioner's insurance department mr mihich wrote continued for lost and damaged shipments were to exceed evc revenue that it had given up this afm coverage excludes liabilities of up to dollar_figure per occurrence -- - please allow this letter to confirm our telephone discussion of date with regard to the afm policy with regard to your interest in increasing the unnamed location and transit sub-limits from dollar_figure to dollar_figure allendale has requested to be provided with the exposure data which creates this request gene as i indicated to you on the telephone it was allendale's understanding that the present dollar_figure limit provided was far more than sufficient with regard to the transit limit allendale was under the impression that there was no situation in which the exposure approached anywhere near the dollar_figure mark both allendale afm's parent and hall considered petitioner's afm policy limit of dollar_figure million to be substantially more coverage than necessary to insure against losses that petitioner's transit operation exposed petitioner to petitioner chose not to increase the limits on the afm policy to dollar_figure million further indicating to us that there was no realistic possibility that petitioner or nuf opl would realize a loss in its excess value activity because the afm policy was in effect before during and after the time when petitioner restructured its excess value activity we do not find any relationship between petitioner's goal of protecting against catastrophic loss and the restructuring of petitioner's excess value activity ’ an endorsement was added to the affiliated fm policy effective date which referred to the shippers interest contract however petitioner maintained the same level of coverage and deductible of the affiliated fm policy that existed continued the afm policy did not provide benefits for damage to packages below the dollar_figure single occurrence deductible such losses could also theoretically have exceeded evc revenue however petitioner's excess value losses were part of a very large universe of shipments and the ratio of losses to evc's remained consistent over many years and was therefore predictable the following schedule reveals the consistency of claims paid_by petitioner for damages in excess of dollar_figure continued before the execution of the shippers interest contract petitioner had been engaged in a declared value program since the 1950's claims over evc's less year evc's dollar_figure paid claims paid ratio dollar_figure dollar_figure dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number ‘amounts in this column for and are estimated amounts this column represents the ratio of excess value income less claims paid divided by total excess value income petitioner's excess value claims payments over years never exceeded percent of the total excess value income considering the consistency of the ratio of loss claims payments to evc revenue from year to year we find that the possibility that total cumulative annual payments for shipping losses from single occurrences involving less than dollar_figure might exceed evc revenue was so remote that for all practical purposes it was - - nonexistent as a result the level of risk if any that was shifted from petitioner to nuf and opl was insignificant the possibility that cumulative catastrophic losses in excess of the dollar_figure million per-occurrence limit on the afm policy would occur and that claims for occurrences involving less than dollar_figure would increase dramatically and that either individually or in combination they would exceed total evc's was improbable unrealistic and insignificant we find that these theoretical possibilities had nothing to do with petitioner's motivation for transferring the evc profits less fronting costs to opl and that the insertion of nuf and opl into petitioner's evc activity provided no significant nontax benefit to either petitioner or its shippers we agree with respondent's expert mr edward t kelley who concluded as follows as a general_rule the firm would prudently retain exposures which could be expected to generate reasonably predictable numbers of claims and relatively stable and consistent amounts of total loss and seek to transfer exposures with substantially lower predictability and greater volatility to an insurer willing to assume liability for such exposures at terms acceptable to the firm since petitioner by the nature of its operations generates a very large number of relatively homogeneous units of exposure the predictability of expected losses related to shippers' property in its custody is very high and year to year variability is relatively limited its self-insurance program for handling claims for loss of or damage to shippers' property produced consistently profitable results during the years through another factor in determining whether a particular transaction was a sham is the presence or absence of arm's--length price negotiations and the relationship between the price and fair_market_value see 87_tc_983 supplemented by tcmemo_1987_529 affd 860_f2d_1075 3d cir see also 73_tc_1163 affd 673_f2d_1062 9th cir in deciding such issues courts often look to expert opinions the court is not bound by the opinion of any expert and we may accept or reject in full or in part experts opinions proffered by the parties see 304_us_282 102_tc_149 86_tc_547 both petitioner and respondent offered the reports and testimony of various expert witnesses in an effort to establish an arm's-length price that petitioner could have obtained for the coverage provided by nuf and opl respondent offered the expert report of mr kelley for the purpose of proving that within the insurance industry the arm's-length price that petitioner could have obtained for coverage associated with petitioner's excess value activity would have been substantially less than cents per dollar_figure of excess value mr kelley has in excess of years of experience buying and providing insurance and reinsurance products in his report mr kelley stated the dollar_figure per dollar_figure of declared value charges used on the nuf policy was apparently derived directly from petitioner's tariff filing and bore no reasonable relationship to the rate that would have been developed in a competitive marketplace for a comparable insurance arrangement transacted on an arm's length basis x for the period through total premium received and losses paid on the nuf policy amounted to approximately dollar_figure and dollar_figure respectively for an overall loss ratio of there was little or no potential for late reported claims or significant adverse reserve development on business of this kind so the numbers reflected on nuf's premium and loss bordereaux may be treated as final for the years involved in a competitive marketplace such results could never be achieved ait should be noted that the u s property-casualty insurance industry has achieved a combined ratio the sum of the loss ratio incurred losses earned premium plus the expense ratio expenses written premium of less than 1l1 e produced an underwriting profit in only three of the past twenty years it is also extremely unlikely that any insurance broker that permitted an insurer to generate such profits at the expense of its client could expect to retain that client for very long in this instance of course the profits were not retained by nuf but flowed as intended as ceded reinsurance premiums back to opl mr kelley logically concluded that the 25-cent price per dollar_figure of excess value set on the nuf policy was not an arm's-length price that would have been agreed upon in a competitive market - similarly respondent's expert mr michael cohen an insurance expert with extensive brokerage experience agreed that the cents per dollar_figure of excess value was too high referring to continued -- - this conclusion is also supported by comparing the 25-cent price paid to nuf with the price that was offered by ffic and pip for more than years before ffic through a policy sold by pip solicited and sold excess value coverage to petitioner's shippers generally pip sold the excess value coverage at a price of dollar_figure5 per dollar_figure of coverage pip retained approximately percent of the premium in and percent in thus of the dollar_figure5 per dollar_figure of coverage pip retained approximately dollar_figure5 and dollar_figure25 in and respectively ' on the other hand ffic underwrote the coverage for approximately cents per dollar_figure of coverage in and dollar_figure25 in ffic was able to realize a gross_profit margin of percent in based on an approximate price of cents per dollar_figure of excess value coverage the ffic pip program 59’ scontinued petitioner's loss ratios and declared revenues for through mr cohen stated in his expert report in my experience spanning more than thirty years i cannot recall one case where the broker would offer the insurer on behalf of his client a piece of business at such an advantageous rate -'the dollar_figure5 price time sec_36 percent and percent equals dollar_figure5 and dollar_figure25 respectively dollar_figure5 less dollar_figure5 equals dollar_figure dollar_figure5 less dollar_figure5 equals dollar_figure25 gross_profit margin in this instance is defined as continued did not offer coverage to certain high-risk shippers nevertheless the coverage underwritten by ffic was very similar to that which was purported to be provided by nuf and opl and is an indication that the price of the excess value coverage provided by nuf and opl was substantially more than the price petitioner could have obtained in arm's-length negotiations respondent's expert prof alan shapiro ph d professor of finance and business economics estimated that dollar_figure2 per dollar_figure of declared value in excess of dollar_figure would have been an arm's--length price for insurance covering petitioner's excess value activity professor shapiro based his analysis on the proposition that an arm's-length price for opl's excess value coverage would be one that over time provided opl with a fair return on its necessary equity_investment in coming to his conclusion professor shapiro compared what opl's return on eguity would have been had it been reinsuring the evc activity during the years through with that of -4 continued premiums minus claims paid minus commissions -had petitioner's customers paid dollar_figure5 per dollar_figure of declared value the same as pip charged evc revenues would have been cut in half but the gross_profit_percentage one-half of evc's less all claims paid divided by one-half of evc's for the years through would have been percent one-half of evc revenue for through is dollar_figure less actual claims paid of dollar_figure equals gross_profit of dollar_figure gross_profit of dollar_figure divided by dollar_figure equals a gross_profit_percentage of percent -- -- other members of the insurance sector opl would have operated in professor shapiro's report contained the following chart which includes value line’ statistics regarding return on equity in each year for property casualty insurers and diversified insurance_companies mean mean value line roe estimated value line k ' minimum value line o o roe maximum value line roe opl's estimated roe dollar_figure charge opl's estimated roe dollar_figure2 charge estimated opl k value line sample size tk is the estimated year-by-year cost of equity_capital professor shapiro concluded that had opl been in existence during the periods preceding and had it charged a fee of cents instead of dollar_figure2 per dollar_figure in excess value coverage it would have earned huge persistent returns and that opl's roe would value line is a publication widely used as a source of financial data have been over four times as large as the highest return earned by any of the value line companies in any year and its average roe of percent would have been almost times the average roe of percent earned by the value line companies respondent also offered the expert report of mr frederick kilbourne an actuary for his opinion regarding an arm's--length premium for the coverage associated with petitioner's excess value activity in computing the premium rate mr kilbourne analyzed the following premium elements losses payments to claimants claim expense sec_3 other expenses commissions taxes etc investment_income risk charge provision for profit and catastrophes mr kilbourne determined on an actuarial basis the following rates per premium element in cents per dollar_figure of coverage losses claims expenses other expenses risk charge investment_income - total additionally mr kilbourne concluded that if claim expenses were to be covered within the premium rate as is customary in the industry the needed rate would increase from cents to about cents respondent's expert dr blaine nye an insurance economist explained in his expert report that an insurance_company would price a policy by calculating the expected losses_and_expenses and adding an underwriting profit margin dr nye used the capital_asset pricing model to derive an underwriting profit for petitioner's excess value activity dr nye concluded that the arm's-length price of an insurance arrangement providing coverage on the liability to shippers declaring values in excess of dollar_figure to be percent of declared value revenues thus according to dr nye petitioner would have paid a price of approximately cents percent of cents per dollar_figure of coverage to insure its excess value activity liability one of the experts presented by petitioner at trial implicitly acknowledged that petitioner could have negotiated a lower arm's-length price for the coverage provided by nuf and opl petitioner presented dr neil doherty as an expert in the economics of insurance on cross-examination dr doherty responded as follows q from purely insurance pricing perspective would you agree that if overseas partners limited was entirely unrelated to ups had no common shareholders no common officers no common board_of directors that this transaction would have made little sense from ups's perspective a everything else in the transaction was the same except that the ownership of opl was different it was totally unrelated q and from an insurance pricing perspective the question is whether that -- the transaction would make sense from ups's perspective a that's a little difficult to answer it would be very strange to think if ups had the opportunity to sell insurance either directly or indirectly at the prices which were prevailing in that marketplace at that time it would be a rather strange business decision to basically give off that profit to an outsider as previously explained in the evc's billed by petitioner were dollar_figure and claims paid were dollar_figure thus claims paid in represented approximately percent of the total evc's billed ’ claims paid during the years through represented approximately percent of the total evc's billed during those years after carefully considering the entire record including the expert reports offered by both petitioner and respondent we are persuaded that the price of cents per dollar_figure of excess value liability paid to nuf pursuant to the shippers interest contract that petitioner and nuf agreed to was not a result of arm's- dollar_figure divided by dollar_figure equals approximately percent when claims are added to fronting expenses of dollar_figure and taxes and board and bureau charges of sbig_number for the claims and fees increase to dollar_figure and the ratio increases from percent to approximately percent dollar_figure plus dollar_figure plus dollar_figure equals dollar_figure length negotiations and that the price of cents per dollar_figure was far in excess of the price that could have been negotiated by petitioner this is another indication to us that petitioner's arrangement with nuf and opl was a sham finally unlike petitioner's purported business reasons for its arrangement with nuf and opl there is contemporaneous documentation to establish that petitioner seriously considered and was motivated by the reduction of federal_income_tax that would occur by transferring excess value income to opl in date petitioner's tax manager and another employee prepared a memorandum to mr danielewski concerning tax and other implications of the insurance_business the memorandum was prompted by a meeting at which petitioner's evc program was discussed in date hall prepared a memorandum regarding the feasibility of creating a united parcel service insurance subsidiary throughout the memorandum hall noted that there were a number of tax benefits if an offshore insurance_company were to be created the tax benefits were stated to be approximately dollar_figure million in summary the report states it has been the purpose of this brief preliminary report to consider in some detail the immediate potential available to petitioner in maximizing the profit potential in the declared value protection which you are currently providing shippers and also to acquaint you with some of the basic issues involved in a captive operating in either a traditional role or within the context of the declared value program as an insurance subsidiary it appears obvious to us that the conversion of the declared value program to an insured basis utilizing an offshore insurer and f i r s t will increase the profits generated by this program by approximately dollar_figure it is also obvious that there are many complex issues involved in this conversion which should be considered by counsel the potential increase in after-tax profits appears to be totally dependent on projected savings in federal_income_tax in date hall prepared a memorandum that contained a description of the tax benefits if petitioner used the alternative structure for the excess value program the memorandum indicated that the projected tax_benefit to petitioner was dollar_figure for the first year hall arrived at this amount by calculating the benefit to petitioner to be equal to the elimination of income_tax on petitioner's expected evc income less the fronting fees premium taxes federal excise_taxes and ceding commission thus the documents generated by hall portray the tax results of creating a bermuda insurance_company as the focus for improving the economic result of the transaction the memorandum stated that the projection of tax savings prepared by hall was to be submitted to petitioner's senior management by mr danielewski petitioner subsequently postponed its decision to go forward with the proposed evc activity structure because of tax considerations nuf had prepared a binder for the shippers interest contract to become effective as of date on the same day the contract was to become effective mr corde sent a telex to mr smetana indicating that petitioner postponed the finalization of the shippers interest program to allow for petitioner's review and evaluation of pending tax legislation in date after restructuring its evc activities petitioner released a report to shareholders in which petitioner indicated that because opl was organized as a bermuda corporation doing no business in the united_states opl'ss earnings were not expected to be subject_to u s federal or state taxes on income the contemporaneous documentation prepared by petitioner and hall regarding the plan to restructure the excess value activity emphasized the resulting tax benefits to petitioner petitioner produced no documentation such as corporate minutes that was prepared during the period in which petitioner was considering or executing its evc restructuring that indicates that petitioner had motives other than tax reduction petitioner has failed to prove that the restructuring of its evc activity was motivated by nontax business reasons or that the restructuring had economic_substance rather we find that the restructuring was done for the purpose of avoiding taxes and that the arrangement between petitioner nuf and opl had no economic_substance or business_purpose petitioner controlled and performed all activities and functions that resulted in evc revenue the evc profits that were transferred to opl for the benefit of petitioner's and opl's shareholders were the fruition of petitioner's evc activity opl provided nothing of value to petitioner the purpose of the arrangement with nuf and opl was to confer tax-free benefits on petitioner's and opl's shareholders obviously petitioner is not entitled to any deductions for profits transferred to opl as a result petitioner must include evc revenue in income for and is liable for tax on the resulting profits 8tn arriving at our finding we recognize that some of petitioner's witnesses testified that they considered state insurance regulation and other nontax considerations to be reasons for restructuring petitioner's evc program we have fully considered that testimony the demeanor of the witnesses and the statements they made before trial in both contemporaneous documents and interviews in addition to the aforementioned matters discussed in the text in the final analysis we do not believe that nontax business considerations were the reasons that motivated petitioner because we have held that petitioner's arrangement with nuf and opl was an assignment_of_income and a sham we do not reach the issue of whether an allocation must be made under sec_482 or sec_845 petitioner makes no argument that a sec_482 analysis should be preferred over an assignment_of_income analysis nevertheless we are aware that several court opinions appear to have expressed a general preference for application of a sec_482 analysis over the assignment_of_income analysis we believe those opinions are distinguishable because the facts in the instant case are both more extreme and heavily freighted with tax motives cf 621_f2d_865 7th cir revg and remanding tcmemo_1976_294 rubin continued il sec_162 deductions having held that petitioner's restructuring of its excess value activity constituted a sham_transaction that had no economic_effect we are presented with the question of whether petitioner is entitled to deduct the amounts retained by nuf the amounts retained consisted of nuf's commission of dollar_figure million plus allowances for various costs sec_162 allows as a deduction all ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying on any trade_or_business see sec_162 however expenses_incurred in furtherance of a sham_transaction are not deductible as stated by the court_of_appeals for the eleventh circuit in kirchman v commissioner f 2d pincite the sham_transaction doctrine requires courts and the commissioner to look beyond the form of a transaction and to determine whether its substance is of such a nature that expenses or losses_incurred in connection with it are deductible under an applicable_section of the internal_revenue_code if a transaction's form complies with the code's requirements for deductibility but the transaction lacks the factual or economic_substance that form represents then expenses or losses_incurred in connection with the transaction are not deductible the court_of_appeals for the second circuit recently addressed a similar issue with respect to interest deductions under sec_52 continued v commissioner 429_f2d_650 2d cir revg and remanding 51_tc_251 in 155_f3d_584 2d cir affg in part and remanding in part on another ground tcmemo_1997_ the taxpayers had entered into a sham investment transaction solely for the purpose of claiming tax deductions see id pincite the taxpayers argued that interest arising from economically empty transactions may still be deducted so long as the debt itself has economic_substance the court_of_appeals for the second circuit declined to accept the taxpayers argument and held that in order for an interest_deduction to be valid under sec_163 the underlying transaction must have economic_substance see id pincite in 85_tc_968 affd sub nom 843_f2d_351 9th cir we held that deductions claimed by the taxpayers were not allowable because they were connected to sham transactions we have found that petitioner's restructuring of its evc activity was a sham set up to reduce tax following the reasoning in cases such as kirchman v commissioner supra lee v commissioner supra and brown v commissioner supra we hold that the amounts retained by nuf are not deductible iii liberty transaction respondent disallowed deductions taken by petitioner for premiums_paid to liberty mutual fire for california workers'_compensation and employers' liability insurance coverage in petitioner notified the state of california of its intention to terminate its self-insurance program for workers'_compensation and the state acknowledged petitioner's intention petitioner complied with state regulations and received state approval to terminate its self-insurance activity petitioner's future obligations for under california's workers'_compensation were covered by the liberty mutual policy liberty mutual entered into a reinsurance agreement with opl wherein opl reinsured liberty mutual's exposure for claims not exceeding dollar_figure for any one accident there is no question that the liberty mutual policy was a valid policy that satisfied petitioner's workers'_compensation responsibilities in calculating taxable_income sec_162 permits the deduction from gross_income of all ordinary and necessary expenses_incurred in carrying on a business premiums for insurance including those for workers'_compensation coverage are deductible business_expenses see sec_1_162-1 income_tax regs the insuring taxpayer deducts the amounts paid as premiums but of course cannot deduct covered claims because the source of the payments is the insurance carrier see 811_f2d_1297 9th cir affg 84_tc_948 in lieu of purchasing insurance one may elect to self- insure paying off claims as they arise or setting aside fixed sums into a reserve_account to pay off intermittent losses see id while insurance premiums are deductible amounts placed into self-insurance reserves are not see id 577_f2d_279 5th cir 43_f2d_78 10th cir affg 13_bta_189 instead the self-insuring taxpayer must wait until losses actually occur at which time the reserve funds actually paid out may be expensed and deducted from gross_income see clougherty packing co v commissioner supra neither the code nor the regulations provides a definition of insurance the accepted definition for purposes of federal income_taxation dates back to 312_us_531 in which the supreme court stated that historically and commonly insurance involves risk-shifting and risk-distributing shifting risk entails the transfer of the impact of a potential loss from the insured to the insurer see clougherty packing co v commissioner supra respondent concedes that the liberty mutual policy is a valid insurance_contract which operates to shift the insurance risk from petitioner to liberty mutual with respect to losses in excess of dollar_figure respondent seeks to segregate the premiums related to the liability in excess of dollar_figure from the amounts paid to liberty mutual for liability below dollar_figure respondent argues that amounts paid to liberty mutual under the workers'_compensation insurance_policy related to liability for claims below dollar_figure are not deductible as premiums respondent does not argue that the terms of the controlling documents are insufficient to constitute insurance or that the contractual terms of liberty mutual's reinsurance with opl negate the existence of insurance rather respondent argues that although petitioner had a formal insurance agreement with liberty mutual in practice petitioner and liberty mutual disregarded the transactional documents in subsequent years and allowed opl through liberty mutual to collect an increased premium when losses increased in subsequent years there is no evidence that this alleged practice in later years was part of any agreement in pursuant to the workers'_compensation arrangement liberty mutual accepted a measurable degree of risk in entering the insurance_contract with petitioner ’ apparently respondent's only complaint is that in the years after the year in issue petitioner paid liberty mutual additional_amounts as premiums based on loss experience that it was not required to pay under s respondent questions the validity of dollar_figure of a total_payment to liberty mutual of dollar_figure ‘liberty mutual was also required to investigate and adjust all claims made under the policy consequently petitioner avoided the costs inherent in administrating its own self- insurance program and avoided the regulatory requirements of that activity the terms of the policy and that these amounts were passed on to opl if that is so respondent can no doubt question the deductibility of those payments in subsequent years but there appears to be no question that the premium payments to liberty mutual in were required by the policy the policy was valid and by the written terms of the policy risk was shifted we reject respondent's argument that premiums_paid in were not deductible by petitioner iv additions to tax respondent determined that petitioner is liable for additions to tax for negligence under sec_6653 and for sec_6653 imposes a 5-percent addition_to_tax if any part of any underpayment_of_tax required to be shown ona return is due to negligence or intentional disregard of rules or regulations sec_6653 provides for a separate addition_to_tax equal to percent of the interest payable on the portion of the underpayment attributable to negligence or intentional disregard of rules or regulations respondent's determination is presumed correct and petitioner bears the burden of proving otherwise see rule a 58_tc_757 negligence within the meaning of sec_6653 has been defined as the failure to do what a reasonable and ordinarily prudent person would do under the circumstances see 85_tc_934 with respect to the restructuring of the excess value income we have found that petitioner engaged in ongoing sham transactions devoid of economic_substance during the year at issue petitioner is a sophisticated taxpayer the primary thrust of petitioner's argument was that it had valid business purposes for restructuring its evc activities we have not accepted this explanation on the basis of the record as described above we reject any contention that petitioner had a reasonable basis for the positions taken on the returns we therefore sustain respondent's determination under sec_6653 we further sustain respondent's determination under sec_6653 with regard to that portion of the underpayment_of_tax that is attributable to the excess value charges respondent also determined that petitioner is liable for an addition_to_tax for under sec_6661 sec_6661 a provides for an addition_to_tax equal to percent of the amount of the underpayment attributable to a substantial_understatement_of_income_tax see 90_tc_498 in the case of a corporation other than an s_corporation or personal_holding_company an understatement is substantial if it exceeds the greater of dollar_figure or percent of the tax required to be shown on the return see sec_6661 b a and b the amount of the understatement may be reduced under sec_6661 b for amounts adequately disclosed or supported by substantial_authority respondent's determination of the addition_to_tax is presumed correct and petitioner bears the burden of proving otherwise see rule a hall v commissioner 729_f2d_632 9th cir affg tcmemo_1982_337 the authority cited by petitioner on brief does not support its position with respect to its excess value activity we sustain respondent's determination with respect to the understatement related to the excess value activity respondent also determined that petitioner is liable for increased interest under sec_6621 for on the portion of the deficiency attributable to evc's sec_6621 c provides for an interest rate of percent of the adjusted rate established under sec_6621 on substantial underpayments that exceed dollar_figure and are attributable to tax_motivated_transactions the tax_reform_act_of_1986 publaw_99_514 sec 100_stat_2750 amended sec_6621 to include sham or fraudulent transactions in the list of tax_motivated_transactions set forth in sec_6621 the amendment applies to any underpayment with respect to which there was not a final court decision before the enactment of the act e date and to interest accruing after date see 88_tc_860 tax-motivated transactions include any sham or fraudulent transaction sec_6621 a v we have held that with respect to the restructuring of the excess value activity petitioner engaged in sham transactions lacking in economic_substance on the basis of the findings set forth herein and the fact that the underpayment_of_tax will exceed dollar_figure in sec_6621 is applicable to the underpayment attributable to those transactions that we have found to be shams see 88_tc_860 decision will be entered under rule see supra note