Court Opinion

ID: 4485364
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:17:21.823549+00
Date Added: 2024-06-11T14:54:06.041705
License: Public Domain

Gerber, J., dissenting: The majority has transcended the natural boundaries of the holding in Carnation Co. v. Commissioner, 71 T.C. 400 (1978), affd. 640 F.2d 1010 (9th Cir. 1981), and has incorrectly applied the rule of law in Helvering v. Le Gierse, 312 U.S. 531 (1941), upon which Carnation is based. I further disagree with the majority’s statement that "the operative facts in the instant case are indistinguishable from the facts in Carnation.” In essence, the majority has adroitly avoided the result which should occur by applying Carnation and Le Gierse to the facts of this case. Le Gierse, a narrowly drawn holding of limited application, stands for the principle that an insurance relationship does not exist where the risk does not shift from the "insured” to an insurer. In Le Gierse, offsetting annuity and life insurance contracts, measured by the same life, were found to be insufficient to transfer or shift the risk of loss from the insured to the insurer. In Carnation, a wholly owned offshore captive insurance company reinsured 90 percent of the risk which its parent placed with an unrelated insurer. Only $120,000 of $3 million in authorized capital had been contributed to the captive. The unrelated insurer would not reinsure with Carnation’s captive unless Carnation agreed to pay the $2,880,000 unpaid portion of the captive’s capital upon demand, if the captive was required to pay claims on the risks of Carnation. The essence of these transactions is that Carnation would be paying claims against it by means of "contributions” to capital as the claims arose. Thus, the contract to insure followed by the 90-percent reinsurance with the captive subsidiary was offset by Carnation’s agreement to pay additional capital or indemnify for x£s own losses. This application of Le Gierse is axiomatic inasmuch as no risk shifted to the captive. It is to be noted, however) that "The key was that [the unrelated insurer] refused to enter into the reinsurance contract with [the captive subsidiary of Carnation] unless Carnation agreed to capitalize [the captive].” Carnation Co. v. Commissioner, 640 F.2d at 1013. Since the transaction in Carnation did not result in a shifting of the risk, 90 percent of the premiums (the amount reinsured) did not constitute insurance but was self-insurance1 and not deductible. This result could be and properly was accomplished without questioning the separate corporate existence of the captive subsidiary. The validity of the insurance and reinsurance contracts was not in question. Further, no determinations or findings were made concerning the captive’s status as an insurance company, either under the law of the situs or within the meaning of sections 801 et seq. of subchap-ter L, chapter 1, Internal Revenue Code. The majority would now have us believe that the indemnification agreement in Carnation was not a critical factor and instead focuses our attention on the conclusion that the risk did not shift. This circuitous approach ignores the express holdings of Le Gierse and Carnation. The majority then states that "The test continues to be whether, considering all of the facts, the risk of loss [has] shifted away from the taxpayer who seeks to deduct insurance premiums.” The majority correctly states the test established in prior cases to be that an insurance relationship has not arisen if the risk has not shifted under the facts and circumstances. The majority then mystically espouses a factual pattern where the test cannot be met (p. 958): When petitioner sustains losses covered by its workers’ compensation insurance, 92 percent is sustained by Lombardy. Accordingly, because petitioner, through its wholly owned Arizona corporation, owns all of Lombardy, it has not shifted the risk of sustaining such losses to unrelated parties in exchange for insurance premiums because the premiums were paid to the wholly owned subsidiary of its wholly owned subsidiary. This explanation presents a completely new theory which has no roots in Le Gierse or Carnation and is without support in existing statute or case law. In essence, this new theory would disallow a deduction solely because of the ownership relationship between an insured and insurer. It assumes that no risk can shift between related corporate entities. Although the majority expressly disclaims respondent’s concept of "economic family” (see Rev. Rul. 77-316, 1977-2 C.B. 53), the theories are the same. The agreement to limit the application of the theory to insurance transactions does not cure its inherent deficiencies. There is no explanation as to the reason or principle that automatically precludes insurance between related entities. Additionally, the majority has stated, but not explained, how it is able to disregard the transactions in this case without crashing head on into the holding in Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943). Petitioner, in this case, has not elected to file a consolidated return and there is no reason to disregard the separate existence of Lombardy. The only fact that the majority emphasizes as supporting a finding that the risk did not shift is that the sequence of executing the contracts reflects an interdependence of the agreements. I am not able to understand how that finding affects the quality of the contractual relationship or can be a basis for concluding that the risk did not shift. All mutual contractual obligations are by their very nature interdependent, and a party to a contract is not likely to be unilaterally bound or bound in a time sequence to his detriment. The majority has found that no risk shifted and has also found the following facts which do not support such a finding: (1) There was no agreement or understanding that petitioner would indemnify Fremont or pay additional capital into Lombardy or would take any step to assure Lombardy’s performance; (2) Lombardy was fully capitalized with $1 million of paid-up capital, an amount which exceeded the State of Colorado’s statutory minimum requirement; (3) Lombardy was recognized, following an audit and certification, by the State of Colorado as an insurance company; (4) the States of California and Colorado either approved or established the rates of premiums for insurance and reinsurance between petitioner, Fremont, and Lombardy; and (5) Fremont (an unrelated California insurance company) remained primarily obligated to pay any workers’ compensation claims against petitioner, if Lombardy failed, or was unable, to do so. Under these and other facts stipulated by the parties, it is most difficult to understand how the risk did not shift from petitioner to the insurer and reinsurer. To conclude that the risk did not shift because of petitioner’s stock ownership or any shareholder control is without foundation and may require ignorance of a corporate existence. The facts in this case clearly show that petitioner no longer would bear the risk of loss and did not have direct control over the assets of Lombardy, especially those assets jointly held with the State of Colorado. It is important to note that Fremont would be obligated to pay any workers’ compensation claims which Lombardy failed to pay.2 Further, the majority appears unable to explain why risk does not shift in an insurance setting, when risk would shift with respect to all other business transactions between related taxpayers. Neither the majority nor the respondent has provided any persuasive arguments or compelling reasons to deny the possibility of an insurance relationship between related taxpaying entities. How will courts apply the majority’s rationale where: (1) The parent owns less than 100 percent of the captive; (2) the parent is the insurer rather than the insured; (3) less than all of the captive-subsidiary’s insurance business is with the parent (cf. Crawford Fitting Co. v. United States, 606 Fed. Supp. 136 (N.D. Ohio 1985)); (4) the parent’s claims paid by the subsidiary exceed the premiums paid by the parent; or (5) the insurance contract is between corporations related as brother-sister. One might boggle his imagination trying to determine whether the shareholders-insureds of a mutual insurance company could shift risk to their corporation. Although two District Courts have unquestioningly followed the respondent’s and majority’s theory, they leave the same questions unanswered and provide no better rationale than that offered by the majority. I respectfully dissent because the majority, in creating this new theory, has chosen to follow a path which is not in accord with precedent, and transcends established principles of law. Wilbur, Kórner, Shields, Clapp, Swift, and Wright, JJ, agree with this dissent.  In order to find that petitioner was self-insuring, we would be required to either find some form of indemnification, as in Carnation, or offset, as in Le Gierse, or disregard Lombardy’s separate corporate existence.   Petitioner was required by statute to either self-insure or obtain insurance from a California authorized compensation carrier. Cal. Lab. Code sec. 3700 (West 1971). Petitioner’s employees have a direct right of suit against Fremont. Cal. Lab. Code sec. 3753. In California, the employer may be relieved from any claim filed against it and the insurer is substituted in the employer’s place. Cal. Lab. Code sec. 3755. Fremont, as the "insurer” under the laws of the State of California, was primarily liable for the payment of compensation of petitioner’s employees. Fireman’s Fund Indemnity Co. v. State Industrial Accident Commission, 39 Cal. 2d 831 (1952). Fremont remained primarily liable under California law, but was entitled to reinsure. To the extent the reinsurer became insolvent or unable to pay compensation claims, Fremont, not petitioner, was obligated to pay the claims. If both Fremont and Lombardy were unable to pay claims, the compensation claims would be paid from California’s State Compensation Insurance Fund (Cal. Ins. Code secs. 11690 et seq., and 11770 et seq. (West 1972)), or from the California Insurance Guarantee Association (Cal. Ins. Code sec. 1063 (West 1972)), depending upon the circumstances. These special features of workers’ compensation statutes make it especially clear that petitioner shifted the risk from itself and that petitioner’s operating assets and capital would not be subject to claims for which premiums were paid to Fremont, whether or not the insurance coverage had been reinsured with Lombardy.