Opinion ID: 779177
Heading Depth: 2
Heading Rank: 1

Heading: The Foreign Tax Credit Issue

Text: 30 The clear language of the Code governs the foreign tax credit issue. Those provisions excluded the policyholders' share from LICTI. 31 As noted above, the section 904 fraction for purposes of the foreign tax credit is calculated in terms of taxpayer's life insurance company taxable income (LICTI), which is, in turn, calculated from the company's taxable investment income and gain from operations. 26 U.S.C. §§ 841, 802(b) (1976). Section 804(a)(1) provides in pertinent part that [t]he policyholders' share of each and every item of investment yield (including tax-exempt interest and dividends received) of any life insurance company shall not be included in taxable investment income. Id. § 804(a)(1) (emphasis added). Section 809(a)(1) similarly provides that [t]he share of each and every item of investment yield (including tax-exempt interest and dividends received) of any life insurance company set aside for policyholders shall not be included in gain or loss from operations. Id. § 809(a)(1) (emphasis added). Thus, both provisions require that the policyholders' share be excluded from any computation of LICTI. Indeed, the Supreme Court recognized that the policyholders' share should be treated as an exclusion in United States v. Atlas Life Insurance Co., 381 U.S. 233, 85 S.Ct. 1379, 14 L.Ed.2d 358 (1965), stating: Each item of investment income, including tax-exempt interest, is divided into a policyholders' share and a company's share. The policyholders' share is added to the reserve, is excluded for tax purposes from the gross income of the company and is not taxed to either the company or the policyholders. Id. at 239, 85 S.Ct. 1379 (emphasis added). 32 Taxpayer's primary argument, adopted by the Court of Federal Claims, is that any exclusion is only a temporary exclusion because the amount of the exclusion is later included in income by an adjustment to the reserves of the company. Thus, according to the taxpayer, this exclusion is in reality a deduction and that deduction... is fully recouped by the corresponding decrease in the year-end reserves under [s]ection 810. Travelers, 28 Fed.Cl. at 613. 7 33 The taxpayer misunderstands the function of section 810. Life insurance reserves may be defined simply as that fund which, together with future premiums and interest, will be sufficient to pay future claims. Atlas, 381 U.S. at 236 n. 3, 85 S.Ct. 1379; accord 26 U.S.C. § 801(b)(1) (1976). Section 810 provides the method of computing its decreases or increases in annual reserves. A net decrease produces a corresponding increase in income, and a net increase produces a reserve deduction (and a decrease in income). 26 U.S.C. §§ 810(a), (b), 809(d)(2) (1976). Sections 810(a) and (b) provide parenthetically that prior to computation of any net decrease or increase in reserves, the items taken into account in calculating the adjustment in reserves 8 must first be reduced by the amount of investment yield not included in gain or loss from operations for the taxable year by reason of section 809(a)(1). Id. § 810(a) and (b) (parentheses omitted). In other words, the policyholders' share is not taken into account in computing the increase or decrease in reserves. While the net effect of section 810 may be that the reserve deduction is decreased (and the taxpayer's income increased) in some circumstances by the policyholders' share, nothing in section 810 alters the provisions of sections 804 or 809 or converts an exclusion into a deduction. 34 As the Supreme Court has repeatedly recognized, [c]ourts are not authorized to rewrite a statute because they might deem its effects susceptible of improvement. Badaracco v. Comm'r, 464 U.S. 386, 398, 104 S.Ct. 756, 78 L.Ed.2d 549 (1984); see also TVA v. Hill, 437 U.S. 153, 194-95, 98 S.Ct. 2279, 57 L.Ed.2d 117 (1978). Here the taxpayer effectively requests that this court rewrite the Tax Code and treat a clearly labeled statutory exclusion as a deduction. Although the parties urge us to consider legislative history 9 and policy considerations to determine the appropriate treatment of the policyholders' share, that is quite unnecessary. The Code is clear on its face, and we are not charged with rewriting it to convert an exclusion into a deduction based on the theory proposed by the taxpayer and adopted by the Court of Federal Claims. See Marsh Corp., Inc. v. United States, No. 02-5002, slip op. at 20 (Fed.Cir. Sept. 6, 2002); Phila. & Reading Corp. v. United States, 944 F.2d 1063, 1074 (3d Cir. 1991). 10 35 Taxpayer relies on our decision in American Mutual Life Insurance Co. v. United States, 267 F.3d 1344 (Fed.Cir.2001), to urge that the policyholders' share is more analogous to a deduction than an exclusion. In American Mutual, the taxpayer argued that it received only a partial tax benefit from the deductions it took for increases in reserves. American Mutual, 267 F.3d at 1349. Consequently, the taxpayer urged that the corresponding reserve releases ( i.e., reductions in reserves) in later tax years should not have been taxed as income, relying on the tax benefit rule codified at section 111. 11 Id. at 1349-50. The tax benefit rule ensures that if a taxpayer takes a deduction attributable to a specific event, and the amount is recovered in a subsequent year, income tax consequences of the later event depend in some degree on the prior related tax treatment. Id. at 1346 (citation omitted). Affirming the Court of Federal Claims, we held that because American Mutual received a benefit from the reserve deductions taken, it cannot resort to the tax benefit rule to exclude from income amounts corresponding to release of those reserves. Id. at 1354. Nothing in American Mutual remotely suggests that the policyholders' share is a deduction from reserves rather than an exclusion. 12 36 Therefore, we conclude that the Code requires that the policyholders' share be treated as an exclusion from both the numerator and the denominator of the section 904 fraction, and we reverse the Court of Federal Claims' decision to the contrary. II The Foreign Currency Translation Issue 37  We turn now to the second issue relating to foreign currency translation. Taxpayer argues that neither the Code nor the regulations required that a particular accounting method be used to translate the foreign currency into United States dollars. Taxpayer urges that its accounting method, which reported its Canadian branch taxable investment income and gain from operations in Canadian dollars and then applied year-end exchange rates to convert those figures into United States dollars, clearly reflected income because it was in essence the profit and loss method identified in Revenue Ruling 75-107. Revenue Ruling 75-107 provides in pertinent part that [t]he balance of the net profits, expressed in [foreign] Country Y's units should be converted into United States money at the rate of exchange as of the end of the taxable year, regardless of the fact that the profits may not have been remitted to M [a domestic corporation]. Rev. Rul. 75-107, 1975-1 C.B. 32, 1975 WL 34670. The taxpayer acknowledges that its accounting method differs from Revenue Ruling 75-107 in that it is applied in two separate phases, which yield two exchange rate conversions, rather than just one phase as the revenue ruling suggests. However, the taxpayer argues that this difference is an immaterial variation. 38 The government urges that taxpayer's accounting method does not clearly reflect income and that the IRS has broad discretion to set aside a taxpayer's accounting method if it does not clearly reflect income. The government contends that the profit and loss method of accounting identified in Revenue Ruling 75-107 differs markedly from taxpayer's accounting method. Specifically, the government urges that taxpayer combined its taxable gain and income from its Canadian operations with the taxable gain and income from other United States operations without first translating the Canadian dollars to United States dollars. The government then states that taxpayer applied an unspecified Canadian Exchange Adjustment to the combined figure using the current, year-end exchange rates. The government argues that taxpayer's method fails to clearly reflect income and contends that the Court of Federal Claims erred by substituting its judgment for that of the IRS when it concluded that taxpayer's accounting method clearly reflected income. 39 A second foreign currency translation issue concerns the calculation of the basis of certain assets. The government urges that section 805(b)(4) dictates that the taxpayer should have used historical rather than current year-end exchange rates for the foreign currency translation of certain assets. The taxpayer urges that section 805(b)(4) does not govern this case because [t]he purpose of section 805(b)(4) is to quantify assets to determine the current earnings rate, App. Br. at 59, and it does not address whether historical or current exchange rates should be used in calculating the basis of those assets. As noted above, the Court of Federal Claims failed to address this issue. B 40 Initially, we note that the decision of the Court of Federal Claims on the foreign currency translation issue rests on two quite mistaken premises concerning the authority of the IRS acting pursuant to section 446 of the Code. Section 446 provides in pertinent part: 41 (a) General Rule 42 Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. 43 (b) Exceptions 44 If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary, does clearly reflect income. 45 26 U.S.C. § 446 (1976) (emphasis added). 46 First, the Court of Federal Claims erred when it concluded that no deference was due the IRS determination because the IRS had not made an explicit determination that the Service Method clearly reflected income. Travelers, 35 Fed.Cl. at 145. There is no requirement in section 446 that the IRS make explicit findings identifying section 446 as the source of its authority. Such a determination is implicit when the IRS substitutes its method for the method of the taxpayer. 47 Second, the Court of Federal Claims, following its own decision in Mulholland v. United States, 28 Fed.Cl. 320, 335 (1993), erred in applying a de novo standard of review as to whether the taxpayer's accounting method clearly reflected income within the meaning of section 446(b). See Travelers, 35 Fed.Cl. at 141. We find no support for the Court of Federal Claims' position in the language of the statute. Under section 446, the Commissioner has broad discretion to set aside a taxpayer's accounting method if he believes that it does not clearly reflect income. Over 70 years ago, in Lucas v. American Code Co., 280 U.S. 445, 50 S.Ct. 202, 74 L.Ed. 538 (1930), the Supreme Court emphasized the broad discretion that the Service should be given to interpret the Code, including provisions such as the precursor to section 446: 48 And the direction that net income be computed according to the method of accounting regularly employed by the taxpayer is expressly limited to cases where the Commissioner believes that the accounts clearly reflect the net income. Much latitude for discretion is thus given to the administrative board charged with the duty of enforcing the Act. Its interpretation of the statute and the practice adopted by it should not be interfered with unless clearly unlawful. 49 Id. at 449, 50 S.Ct. 202. See also Thor Power Tool Co. v. Comm'r, 439 U.S. 522, 532, 99 S.Ct. 773, 58 L.Ed.2d 785 (1979) (indicating that section 446, inter alia, vest[s] the Commissioner with wide discretion in determining whether a particular method of inventory accounting should be disallowed as not clearly reflective of income.). 50 So too, our prior decisions reject a de novo standard of review. See LaCrosse Footwear, Inc. v. United States, 191 F.3d 1372, 1379 (Fed.Cir.1999) (finding that the Commissioner did not abuse his discretion when he concluded that taxpayer's accounting method did not clearly reflect income); Morgan Guar. Trust Co. of N.Y. v. United States, 218 Ct.Cl. 57, 585 F.2d 988, 997 (Ct.Cl.1978) (finding that the Commissioner abused his discretion when he rejected taxpayer's accounting method). Accordingly, the Court of Federal Claims must accord substantial deference to the IRS determination that the taxpayer's method does not clearly reflect income. C 51 Applying the correct standard, we conclude that the IRS determination must be sustained. The taxpayer here made no showing that the IRS abused its discretion in determining (1) that the taxpayer's method did not clearly reflect income and (2) substituting its own methodology. The IRS properly required the use of the established profit and loss method. The fact that the taxpayer's methodology may have been conceptually similar to or essentially the same as the IRS-approved method is irrelevant. Contrary to the Court of Federal Claims' decision, it is also of no moment that the IRS did not challenge the taxpayer's methodology in each year. The IRS is not bound by its earlier position. See Dickman v. Comm'r, 465 U.S. 330, 343, 104 S.Ct. 1086, 79 L.Ed.2d 343 (1984); Caldwell v. Comm'r, 202 F.2d 112, 115 (2d Cir.1953). We have considered and reject the taxpayer's other challenges to the IRS determination. However, one aspect of the IRS determination requires further comment. 52 The government contends that section 805 compels that the basis of bonds, mortgages, and joint venture assets be computed at historical rather than current, year-end exchange rates. We are unable to find any such requirement in section 805. Section 805 provides in pertinent part: 53 (b) Adjusted reserves rate and earnings rates. 54 . . . . 55 (4) Assets 56 For purposes of this part, the term assets means all assets of the company (including nonadmitted assets), other than real and personal property (excluding money) used by it in carrying on an insurance trade or business. For purposes of this paragraph, the amount attributable to — 57 (A) real property and stock shall be the fair market value thereof, and 58 (B) any other asset shall be the adjusted basis, of such asset for purposes of determining gain on sale or other disposition. 59 26 U.S.C. § 805 (1976) (emphasis added). Section 805(b)(4) describes how to quantify assets to determine the adjusted reserves rates and earnings rates for any taxable year. Nothing in section 805 specifies whether, for income tax purposes, the basis of assets for computing capital gain or loss should be computed using historical or current, year-end exchange rates. Section 805 does not specifically define adjusted basis. That section evidently contemplates use of standard basis provisions. Section 1011(a), a generally applicable section of the Code, simply provides that the adjusted basis shall be determined under section 1012. Id. § 1011(a). Section 1012(a), in turn, provides that [t]he basis of property shall be the cost of such property.... Id. § 1012. Thus, section 805 does not specify the use of a particular basis for foreign branch assets of life insurance companies purchased with foreign currency. We hold that section 805 does not require the result for which the government argues — namely, determining the basis of bonds, mortgages, and joint venture assets for income tax purposes by reference to historical exchange rates. 13 Nonetheless, we conclude that the IRS could properly, as an exercise of discretion, require the use of historical exchange rates in order to capture the gain attributable to the purchase of capital assets in depreciated foreign currency, which have since increased in value. 14