DOJ Contends UPS Insurance Contracts Were Shams

UPS's business, the delivery of packages, is in competition with the U.S. Postal Service. Initially, UPS charged an additional fee when a shipper declared that the value of a package was more than $100, called an excess value (EV) charge, that UPS reported as income. UPS restructured its EV program and stopped offering shippers EV indemnity directly from UPS. Instead, UPS arranged insurance for its EV shippers with an unrelated insurance company, National Union Fire Insurance Co. (NUF). UPS also created Overseas Partners Ltd. (OPL) in Bermuda to reinsure NUF's EV risks, and distributed as a taxable dividend, OPL's stock to UPS's shareholders. UPS then reported, based on the new structure, that the bulk of EV premium income was earned by OPL.

The IRS issued a deficiency notice, determining that the EV charges must be included in UPS's gross income. The Tax Court agreed, finding that the EV charge restructuring was a sham. (For a summary of that opinion, see Tax Notes, Aug. 16, 1999, p. 1025; for the full text, see Doc 1999-26528 (114 original pages) or 1999 TNT 153-1 .)

The Justice Department argues that the Tax Court correctly determined that the arrangement lacked economic substance, resulting in a prohibited assignment of UPS's income. The DOJ asserts that UPS knew that it had no possibility of realizing profit from the transfers and that its gain, if any, could only come in the form of tax savings. The DOJ insists that UPS continued to conduct its transportation business exactly as before and to hold itself out as if it remained liable for loss and damage of EVCs. The DOJ maintains that the arrangement did not involve any genuine risk for any of the participants because EVC revenues consistently exceeded claims paid by a wide margin. The DOJ contends that UPS's concern with loss was belied by the fact that it could have obtained third-party insurance for a fraction of the amount transferred to NUF and without the formation of OPL, whose only function was to receive UPS's EVC profits and accumulate them tax-free.

2855-8278 Quebec, Inc.

[2] Pursuant to Circuit Rule 28-2 of this Court, counsel for the Commissioner respectfully inform the Court that they believe that oral argument would be helpful to the Court in considering this appeal.

TABLE OF CONTENTS

[3] On May 24, 1995, the Commissioner of Internal Revenue (the Commissioner) issued a notice of deficiency pursuant to Section 6212(b) of the Internal Revenue Code (26 U.S.C.) (the Code or IRC) to United Parcel Service of America, Incorporated (taxpayer or UPS) for the taxable years 1983 and 1984. (R1, Ex. A.) ¹ In the notice, the Commissioner determined deficiencies in taxpayer's federal corporate income taxes in the amount of $2,330,687 for 1983 and $64,870,674 for 1984, together with additions to tax for 1984. (Id.) Taxpayer filed a petition for redetermination in the Tax Court (R1) within 90 days after issuance of the deficiency notice. The Tax Court accordingly had jurisdiction under IRC sections 6213(a), 6214(a), and 7442.

[4] After concessions by the parties, the Tax Court entered a decision on February 25, 2000, determining income tax deficiencies in the amount of $1,141,191 for 1983 and $41,427,191 for 1984. (R268 at 1; R261 at 1 n.2.) The Tax Court further decided that taxpayer was liable for additions to tax for 1984 in the amount of $2,071,360 under IRC section 6653(a)(1), 50 per cent of the interest due on $30,935,415 under IRC section 6653(a)(2), $7,733,854 under IRC section 6661, and increased interest under IRC section 6621(c). ² (R268 at 1-2.) The decision was a final, appealable order that disposed of all claims with respect to all parties.

[5] Taxpayer filed a notice of appeal on May 19, 2000, from that portion of the decision relating to 1984. ³ (R269.) The notice of appeal was timely under IRC section 7483 and Fed. R. App. P. 13(a), because it was filed within 90 days after entry of the decision. This Court has jurisdiction under IRC section 7482(a)(1).

[6] STATEMENT OF THE ISSUES

1. Whether the Tax Court correctly determined that excess value charges that taxpayer, a common carrier, received from its shippers in 1984 were includible in its gross income, because an arrangement by which the amounts received were remitted to an insurance company and then transferred to a Bermuda reinsurer established by taxpayer was a sham and an assignment of income.

2. Whether the Tax Court correctly determined that taxpayer was liable for additions to tax for negligence and substantial understatement of liability.

STATEMENT OF THE CASE

(1) COURSE OF PROCEEDINGS AND DISPOSITION IN THE COURT BELOW

[7] In this income tax deficiency case, taxpayer contested, inter alia, the Commissioner's determination that "excess value charges" (EVCs) in the amount of $99,794,790 received by taxpayer, a common carrier, from its shippers in 1984 constituted gross income to taxpayer under IRC section 61, or, in the alternative, that all or part of the EVC amount should be allocated to taxpayer from Overseas Partners, Ltd., a reinsurance company established by taxpayer, under IRC section 482 or IRC section 845. (R1.) Following a 14-day trial, the Tax Court (Judge Robert P. Ruwe) rendered a memorandum opinion, reported unofficially at 78 T.C.M. (CCH) 262 (1999), in which it upheld the inclusion of the entire EVC amount in taxpayer's 1984 income under IRC section 61 (and the allowance of a corresponding deduction for claims paid to shippers in respect of EVCs), without reaching the parties' alternative arguments under IRC sections 482 and 845. ⁴ (R261.) The court thereafter entered a decision pursuant to an agreed computation under Tax Ct. R. 155. (R267; R268.)

(2) STATEMENT OF THE FACTS

A. BUSINESS AND CORPORATE BACKGROUND

[8] Taxpayer, United Parcel Service of America, Inc., a Delaware corporation based in Atlanta, Georgia, at the time of filing its petition in the Tax Court, is the holding and management company for an affiliated group of companies whose principal business since 1907 has been the pick-up and delivery of small parcels and packages. ⁵ (R147, paragraphs 10-11; R261 at 4-5.) In 1983 and 1984, taxpayer was the largest motor carrier in the United States, providing interstate ground service between all points in the 48 contiguous states and the District of Columbia, as well as statewide instrastate service in all states except Texas. (R147, paragraphs 10, 15.) Taxpayer served both "regular shippers," meaning persons and entitities from which it made scheduled pick-ups, and "counter shippers," meaning those who dropped off their parcels at taxpayer's facilities. (Respt. Ex. AVM at 5, 7.)

[9] Taxpayer was a privately held company not listed on a national securities exchange or traded in the organized over-the- counter market. With minor exceptions, all of its capital stock was owned by, or held for the benefit of, current and former employees, their families, or their estates or heirs; charitable foundations established by taxpayer's founders and their families; and charitable organizations to which taxpayer or its other shareholders had donated stock. Taxpayer had a right of first refusal with respect to any transfer of shares other than by bona fide gift or inheritance. (R196 at 105:7-8; Jt. Ex. 4-D(4) at JK001633, JK001645; Jt. Ex. 4-D(5) at JK001683.)

B. TAXPAYER'S TREATMENT OF EXCESS VALUE CHARGES BEFORE 1984

1. TAXPAYER'S TARIFFS

[10] As domestic motor common carriers regulated by the Interstate Commerce Commission (ICC), taxpayer's ground delivery subsidiaries were required to publish and file tariffs setting forth their transportation rates, along with rules governing its rates and transportation services. ⁶ (R147, paragraphs 12, 14, 16; R149, paragraph 51.) When a tariff provision was changed, a supplement was filed with the ICC. (R149, section56.) Taxpayer also filed tariffs and supplements with the transportation commissions of most states in which it provided intrastate service. (Id., paragraphs 51-56.) The"vast majority" of taxpayer's shippers did not monitor its tariff filings, nor did taxpayer regularly send out the tariffs, other than to a small group of "unusual customers" who requested them. (R196 at 73:24-75:13.)

[11] By the express terms of taxpayer's ICC tariffs, the rate charged for transportation varied according to the weight, destination, and value of the package being shipped. Item 540 of the tariffs in effect until July 14, 1983, set forth the following "METHOD OF DETERMINING RATES":

     To determine rates in this tariff:

[12] Item 1000, which applied to all packages shipped by taxpayer during 1983 and 1984, in turn provided that "[t]he rates for delivery of packages, released to value not exceeding $100 per package, shall be 116.0 cents per package, plus the following rates per pound or fraction thereof . . . ." There followed, in ascending order of distance and cost, a list of geographic zones, and the additional per-pound rate corresponding to each one. (Jt. Ex. 32- AF(2) at JK004170; Jt. Ex. 32-AF(4) at JK004100.)

[13] In the context of an ICC tariff, "released value" refers to the point at which the shipper releases the carrier from liability for the value of the package, i.e., the maximum amount that the carrier will pay the shipper in the event that the package is damaged, destroyed, or lost. ⁷ Thus, under Item 540 of taxpayer's tariff, if a shipper paid only the base rate and did not declare a value in excess of $100, taxpayer was only liable for the value of the package up to $100. If the shipper declared a value exceeding $100 and paid the transportation rate corresponding to that value -- consisting of the base rate from Item 1000 for the package's weight and destination, plus 25 cents for each $100 increment of its declared value above $100 -- then taxpayer was liable for the value of the package up to its declared value in the event of damage, destruction, or loss. (R261 at 11-12.)

[14] The term "excess valuation charges" first appeared in taxpayer's tariffs in supplements that substituted Item 540-A for Item 540 effective July 14, 1983. ⁸ Item 540-A reproduced the existing language of Item 540 verbatim but added new language as follows above the parenthetical citation of authorizing orders:

Unless otherwise directed by the shipper, the carrier may remit

2. PICKUP RECORDS

[15] Shippers indicated their choice between the transportation rates applicable to values of up to and in excess of $100 per package by means of a declaration of value on the "pickup record" they completed for each shipment. (R154, paragraphs 570, 573, 574; Jt. Exs. 441-PY(1)-(19); R261 at 11-13.) Taxpayer did not revise the pickup record in 1983 or 1984 to reflect the tariff language added by Item 540-A. Pickup records in use between 1982 and 1993 contained the following language regarding released and declared value, taxpayer's liability, and shippers' claims (with minor omissions that are not relevant here):

Unless a greater value is declared in writing on this receipt,

3. THE SERVICE EXPLANATION

[16] Taxpayer also did not immediately change its Service Explanation to reflect the new language in Item 540-A. The Service Explanation stated that it "contain[s] the general rules and regulations under which [taxpayer] is engaged in the transportation of small packages in its own territority and jointly through interchange with an affiliated . . . company." It was not generally provided to either regular or counter shippers in the course of a shipping transaction, but was given to counter shippers only upon request and to regular shippers upon commencement of the customer relationship, upon request, and, very infrequently, on other occasions selected by taxpayer. (R154, paragraph 554; R196 at 77:24- 78:3.)

[17] Taxpayer's Service Explanation dated July 1983, like the version dated October 1982, included the following paragraph:

Responsibility for Loss or Damage

4. TAXPAYER'S INCOME FROM EVCs

[18] Taxpayer maintained its books and filed its federal income tax returns on the accrual basis for the calendar year. For the year ending December 31, 1983, taxpayer included all amounts billed to and/or collected from shippers as EVCs in its reported income on its federal and state tax returns, in its financial accounting records, and in required reports to the ICC, the Securities and Exchange Commission (SEC), and state regulatory bodies. (R155, paragraph 728.) During 1983, taxpayer billed and/or collected EVCs totaling approximately $78,000,000 and paid approximately $23,000,000 in shippers' claims above $100 per claim. (Jt. Ex. 1079-AOM(1) at FBH00012.) Thus, taxpayer was left with $55,000,000 in net pretax income from EVCs in 1983.

C. TAXPAYER'S TREATMENT OF EVCS BEGINNING IN 1984

1. OVERVIEW OF THE NUF/OPL ARRANGEMENT

[19] For the calendar year ended December 31, 1984, taxpayer billed and or/collected EVCs in the amount of $99,794,790 and paid a total of $22,084,012 for claims in excess of $100, leaving net revenue of $77,710,778 from EVCs. (Jt. Ex. 243-II at JK0048664- JK048665.) This net revenue represented approximately 1 per cent of taxpayer's overall revenues and 8 per cent of its pretax income in 1984. (R216 at 2666:20-2668:23, 2671:6-10.) Taxpayer did not include any amount of EVCs in gross income reported on its 1984 federal income tax return. (R155, paragraph 729; R166, paragraph 1412.)

[20] Underlying taxpayer's reporting position on its 1984 return was a series of transfers and other transactions that we will call the NUF/OPL arrangement. (See R1 at 4, 20-37.) Beginning in January 1984, taxpayer made monthly transfers to National Union Fire Insurance Company of Pittsburgh, Pa. (NUF) of all EVCs billed and/or collected, net of claims paid in excess of $100. (R150, paragraph 321.) These amounts were equal to the premiums under a Shippers Insurance policy issued by NUF for a continuous policy period beginning January 1, 1984, and, by its terms, providing coverage for loss or damage to property of taxpayer's shippers in the course of transportation (the NUF Policy). (Jt. Ex. 780-ACZ.)

[21] Out of the remittances from taxpayer, NUF retained a commission for itself at the rate of $1 million per year and withheld taxes and charges. (R150, sections342, 343.) Except in January and February 1984, NUF each month remitted the balance of the amounts received from taxpayer, plus interest on funds withheld, to Overseas Partners Ltd. (OPL), a Bermuda corporation initially formed as a wholly owned subsidiary of taxpayer and principally owned by taxpayer's shareholders at all times during 1984. (R147, paragraphs 22, 32, 36.)

[22] During 1984, OPL received net transfers from NUF in the amount of $59,956,626. (R261 at 42.) As a Bermuda insurer, OPL was not subject to income tax in Bermuda on these transfers, and it did not pay federal income tax on them in the United States. (Jt. Ex. 27- AA(2) at JK001912.)

2. PLANNING OF THE NUF/OPL ARRANGEMENT

[23] In July 1982, taxpayer's corporate tax manger and its assistant treasurer provided its chief financial officer (CFO), Walter Danielewski, with a memorandum entitled "Tax & Other Implications of the Insurance Business." The memorandum addressed the question "[w]hy is the insurance business attractive from the Federal Income Tax point of view?" and explained that "[m]ajor tax benefits can accrue to the multinational corporation by insuring its U.S. risks and the U.S. risks of its domestic subsidiaries in a tax haven jurisdiction" such as Bermuda. Noting that a captive insurance company would be "subject to intense IRS scrutiny," the memorandum identified several alternatives, including "[e]stablishment of a reinsurance company which would derive a substantial portion of its premium income from insuring outside risks." (Jt. Ex. 1031-AMQ.)

[24] Soon afterwards, taxpayer's national insurance manager, Kenneth Johnson, asked George Corde, a vice president of the insurance brokerage Frank B. Hall (Hall), to analyze the feasibility of creating an insurance subsidiary to reinsure declared value risks underwritten by an outside carrier. (R164, paragraphs 1226, 1232; R197 at 199:3-200:25; Jt. Ex. 1032-AMR at JK007811.) In a report submitted to taxpayer in September 1982, Mr. Corde acknowledged that the protection obtained by shippers who declared value and paid EVCs was "not considered to be insurance." (Jt. Ex. 1032-AMR at JK002466.) The report compared the actual "contribution" made by EVCs to taxpayer's after-tax earnings and the projected contributions of a domestic or offshore insurance subsidiary. It concluded:

Even a cursory review of these results demonstrates that neither

[25] The report proposed that a Bermuda subsidiary of taxpayer participate in a Hall-sponsored reinsurance program that offered "substantial" tax benefits. (Id. at JK002469-JK002473; Doc. 198 at 260:17-261:15.) At a meeting in February 1983 attended by representatives of taxpayer and Hall, taxpayer's outside tax counsel expressed concern that Hall's approach "would not be received favorably by the IRS." (Jt. Ex. 1034-AMT at 011945; R164, paragraph 1226.) Counsel suggested

an alternative whereby UPS would form an insurance subsidiary in

[26] As a result of the February meeting, Mr. Corde understood that taxpayer would offer shippers "the option to obtain or decline" third-party insurance for their packages and would pursue the creation of a Bermuda insurance subsidiary. Both proposals were based on projected payments to a U.S. "front" company that were equal to taxpayer's projected 1983 revenue from EVCs, as well as projected underwriting profits that were below taxpayer's projected pretax profit, but more than 50 per cent above its projected after-tax profit, for 1983. ⁹ (Jt. Ex. 1027-AMT; Jt. Ex. 1033-AMS; Jt. Ex. 1039-AMY at 011952; R203 at 873:18-874:10; R164, paragraph 1240.) Bermuda was chosen as the situs for the subsidiary because, inter alia, it had no income tax, profit tax, capital gains tax, and there also would be no withholding tax on profits paid from Bermuda by way of dividends or interest. (Jt. Ex. 1039-AMY at 011951.) Nevertheless, Mr. Corde warned that "[t]he tax laws are complex in this area and should be discussed with tax counsel." (Id. at 011952.)

[27] Representatives of taxpayer and Hall met again in March 1983 to discuss the "UPS Insurance Company Proposal," including its tax aspects. (Jt. Ex. 1041-ANA.) Mr. Corde's handouts reiterated that the "principal effects on UPS of the conversion from a declared value program to an insured shippers interest program" would be reductions in taxpayer's domestic revenue, domestic expenses, and domestic income, while the activities of a reinsurance subsidiary would produce profits that were less than taxpayer's existing EVC revenue but not subject to tax. (Jt. Ex. 1042-ANB at 011970, 011973, 011978, 011980, 011985.)

[28] After taxpayer declined to have a Hall-owned company underwrite shippers' interest insurance, Mr. Corde requested proposals from American International Group (AIG) and The Travelers Insurance Company (Travelers). (R197 at 214:6-20; R164, paragraph 1270.) His letters specified that "premium rates would be charged per existing UPS rate levels," that taxpayer must have "absolute authority to administer and settle all claims," and that changes in taxpayer's documentation should "be kept at a minimum," with no "insurance certifications if this can be avoided." The letters also stated that reinsurance was planned and "would leave the shippers' interest issuing carrier in a 'fronting' capacity with essentially no risk or exposure to loss under the program." (Jt. Ex. 1066-ANZ; Jt. Ex. 1068-AOB; Jt. Ex. 1072-AOF at 011997.)

[29] Travelers replied that it could not "respond . . . within the time frame required," because "[a]n account of this magnitude and regulatory complexity will require approval from the appropriate legal areas." (Jt. Ex. 1073-AOG.) AIG proposed to have NUF issue a single master insurance policy to taxpayer, with documentation of each shipper's coverage to be provided by a "Service Instruction Agreement" and the declared value entry on the bill of lading (i.e., the pickup record). Although AIG emphasized that it could not "make any guarantees concerning questions or determinations made by various state insurance departments," Mr. Corde took no action to confirm AIG's view that its proposal at least had "a high degree of probability of not being questioned in the various states," (Jt. Ex. 1075-AOI at 012014, 012015; R202 at 847:16-849:10, 865:1-17.)

[30] AIG emphasized that the entire proposal was "subject to our understanding that the current levels of premium and loss are approximately $78 million and $23 million, respectively." It requested and later received confirmation that taxpayer's loss ratio -- EVC claims paid divided by revenues received -- had not exceeded 29 per cent in the previous five years. Even then, AIG contemplated having a letter of credit or an escrow account as "security," and perhaps catastrophic loss coverage as well. Additionally, "[s]ince [AIG] would have no control over the payment of premiums by shippers, [i]t would not take on the responsibility for any bad debt or uncollectables under the program." (Jt. Ex. 1075-AOI at 012015, JK012016; Jt. Ex. 1079-AOM(1); R190 at 451:1-452:20.) Mr. Corde recommended acceptance of the AIG proposal on the ground, inter alia, that Travelers' quotation involved "prohibitive" documentation. (Jt. Ex. 1076-AOJ at JK002519.)

3. FORMATION OF UPSINCO AND SPINOFF OF OPL

[31] Once taxpayer decided to proceed with the proposed NUF policy and the creation of a Bermuda reinsurance subsidiary, its plan was to implement the arrangement on August 1, 1983. (R197 at 227:13- 17.) UPSINCO Ltd. was incorporated in Bermuda on June 28, 1983, and certified as an insurer on August 1, 1983. (R147, paragraphs 22, 25.) Messrs. Johnson and Danielewski, along with taxpayer's assistant treasurer, were elected as three of OPL's five directors and appointed to all four officer positions. (R147, paragraphs 22, 25, 35; R164, paragraph 1226.) The board appointed a Hall subsidiary, Parker & Co.-Interocean Ltd. (Parker), to manage its day-to-day operations. (Id., paragraph 24; R203 at 928:16-22.) Parker did not perform any underwriting or claims handling for OPL during 1984. (R189, paragraph 1480(e).)

[32] On July 21, 1983, Hall sent Mr. Johnson a revised draft policy form that it expected to require only "minor revisions," and NUF sent Hall a signed binder of insurance on July 28, 1983. (Jt. Ex. 1087-AOU; Jt. Ex. 1106-APN(1).) On August 8, 1983, Mr. Corde advised AIG that taxpayer had "postponed finalization of shippers interest program pending their review and evaluation of new tax legislation currently on the floor of the House of Representatives . . . ." ¹⁰ (Jt. Ex. 1090-AOX.)

[33] On November 25, 1983, UPSINCO was reincorporated as OPL, a change of name only. (R147, paragraph 35; Jt. Ex. 19-S.) Taxpayer's management thought it "very important" that the reinsurance subsidiary not be "a UPS company," which UPSINCO "obviously was . . . ." (R199 at 414:4-7; R203 at 913:17-20.) Taxpayer contemplated, however, that reinsurance of NUF's declared value coverage would form OPL's principal business. (Jt. Ex. 25-Y at JK022198; Jt. Ex. 27-AA(2) at JK001908.) In its 1984 annual report to shareholders, OPL observed that reinsurance of this nature did not "expose [it] to the risks of claim inflation and unanticipated sources of liability" that had recently caused "disappointing results" for property and casualty insurers. (Jt. Ex. 27-AA(2) at JK001908.) Taxpayer did not mention the formation of OPL in the "Diversification" section of its Form 10- K annual report to the SEC in either 1983 or 1984. (Jt. Ex. 4-D(4) at JK001639-JK001640; Jt. Ex. 4-D(5) at JK001689-001690.)

[34] On December 31, 1983, taxpayer's shareholders received a dividend in the form of one share of OPL stock for each share of taxpayer's stock. (R147, paragraph 36.) OPL's bylaws imposed transfer restrictions similar to those applicable to taxpayer's stock, including a right of first refusal for taxpayer. (Jt. Ex. 25-Y at JK022130-JK022138.) As of December 31, 1984, nearly one half of taxpayer's stock and of OPL's stock was owned by shareholders whose holdings in the two companies differed by not more than 5 per cent, and over 80 per cent by shareholders whose holdings diverged by not more than 25 per cent. (R161, paragraph 1118; Jt. Exs. 934-AIX(1) and (2).)

[35] Taxpayer's management expected the spinoff to reduce taxpayer's revenues and profits, but to afford tax advantages over using UPSINCO, whose income would have been taxable in the United States. (R199 at 416:13-19; R203 at 913:9-16, 968:1-969:18.) In an information statement issued to shareholders at the time of the distribution, taxpayer explained that, because OPL was a Bermuda corporation owned principally by taxpayer's shareholders, its earnings were not anticipated to be subject to U.S. federal or state income taxes, and, therefore, "a larger percentage of its earnings will be available for dividends and expansion of [its] business." (Jt. Ex. 20-T(1) at 029060.) The same explanation was repeated in the 1984 annual reports to shareholders of both taxpayer and OPL; in "Response Guidelines" for taxpayer's managers to use in fielding questions from employees; and, in an abbreviated form, in the Form 10 registration statement that OPL filed with the SEC in January 1984. (Jt. Ex. 6-F(4) at JK021399; Jt. Ex. 27-AA(2) at JK001909; Jt. Ex. 935-AIY at 027632, 027633; Jt. Ex. 24-X at JK002769.)

4. THE NUF POLICY AND THE AFM POLICY

[36] The NUF Policy was issued for a continuous period beginning January 1, 1984. It named as the insured "Shippers, Consignees 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," but at an address that had previously served as taxpayer's corporate headquarters and was used as a sorting facility at the time. (Jt. Ex. 780-ACZ at 024737; R198 at 301:22- 302:9.) The rate for coverage was 25 cents per $100 of declared value (or part thereof) in excess of $100. (Jt. Ex. 780-ACZ at 024738.) During 1984, taxpayer's shippers could and did obtain excess value insurance from Parcel Insurance Plan, Inc. (PIP), an unrelated company, for a premium of 12.5 cents per $100 on most shipments. (R153, paragraph 520.)

[37] Although the NUF Policy had no maximum aggregate policy limit, its coverage was excess both to taxpayer's liability, "if any," and to other insurance applicable to the insured property, other than insurance effected by a named insured. (Id. at 024742.) From October 1, 1982, through October 1, 1985, taxpayer maintained a policy with an unrelated carrier, Affiliated FM Insurance Company (the AFM Policy), that provided coverage for taxpayer's interest in all personal property shipped by it while in the course of transportation, all real and personal property owned by taxpayer, and all improvements to buildings that it did not own. (Jt. Ex. 317-LE at JK003704.) The AFM Policy had a deductible of $25,000 and limits of liability of $10,000,000 per occurrence on shipped personal property and $100,000,000 per location on taxpayer's own property. (Id. at JK003703.) The total annual premium for the AFM Policy in 1983 was $356,945, of which $86,820 was allocable to parcels in transit based upon total average daily parcel value of $354,369,000. (Id.; R261 at 30.)

[38] In 1983, taxpayer decided not to raise the transit sub- limit under the AFM Policy to $20 million after Hall conveyed AFM's view that the existing $10 million sub-limit was "far more than sufficient." (Jt. Exs. 342-MD, 343-ME.) Taxpayer did not obtain any other written estimate of its catastrophic exposure between 1982 and 1989. (R225, section1657.) The record does not reflect the magnitude of taxpayer's largest catastrophic loss, if any, prior to 1984, nor that taxpayer experienced any such loss after 1984. (R203 at 1000:2- 22.)

[39] Under the insurance binder issued by NUF on July 28, 1983, "evidence of catastrophe coverage in excess of $25,000 per location" from AFM was a condition precedent to coverage by NUF. (Jt. Ex. 1087- AOU.) At the joint request of AIG and taxpayer, AFM endorsed its own policy to provide that the NUF coverage would be ignored in applying the AFM deductible, so that AFM's coverage would supplant NUF's above $25,000 and below $10,000,000 per occurrence. (Jt. Ex. 321-LI.)

5. SHIPPERS' KNOWLEDGE OF THE NUF POLICY

[40] Taxpayer did not provide shippers with individual certificates of insurance under the NUF Policy, nor did it distribute copies of the policy to either regular or counter shippers, even when they filed claims, except upon request. ¹¹ (R155, paragraph 719; R197 at 157:10-159:9.) In November 1983, taxpayer revised its Service Explanation to the extent of having the description of "Responsibility for Loss or Damage" follow the new language of Item 540-A, although without incorporating the tariff by reference. (Jt. Ex. 428-PL.) Thus, the November 1983 Service Explanation stated that taxpayer "may remit" EVCs (and apparently continued so to state until 1990), although it named NUF as the recipient of any such remittances. (Id.; Jt. Ex. 1154-ARJ at N002121.) It too provided that taxpayer would remain liable for loss or damage in the event that NUF failed to pay claims, thereby giving shippers "assurances that they would receive the same kinds of [sic] levels of protection that they had previously received." (Jt. Ex. 428-PL; R197 at 159:10-22.)

[41] The November 1983 Service Explanation was supposed to accompany the December 1983 issue of taxpayer's "ROUNDUPS" publication, which shippers received quarterly, but the record does not establish whether it did so. ¹² (Jt. Ex. 453-QK(15) at JK002379; R197 at 177:1-9; R198 at 292:3-6.) There was no mention of the NUF Policy (or the word "insurance") in either the December ROUNDUPS or an article in the March 1984 ROUNDUPS entitled "Declared Value: How to Obtain Extra Coverage Against Loss or Damage." (Jt. Ex. 453-QK(15) at JK002379; Jt. Ex. 453-QK(16) at JK002382.)

6. THE NUF/OPL FACULTATIVE REINSURANCE AGREEMENT

[42] Along with the NUF Policy, a Facultative Reinsurance Agreement between NUF and OPL (the Reinsurance Agreement) took effect on January 1, 1984. (Jt. Ex. 781-ADA.) Taxpayer did not obtain bids for reinsurance with respect to the NUF Policy from any other companies. (R216 at 2642:10-24.) Under the agreement, OPL was to be liable for 100 per cent of NUF's "ultimate net loss" under the NUF Policy plus loss expense, if any. (Jt. Ex. 781-ADA at JK002879.) No loss expense was anticipated so long as taxpayer adjusted claims under the NUF Policy without compensation. (Id.) The amount to be paid by NUF under the Reinsurance Agreement was equal to 100 per cent of "Gross Premiums Written" under the NUF Policy -- i.e., EVCs received -- less NUF's commission of up to $1 million and an allowance to NUF for underwriting expenses. (Id. at JK002887.)

7. MONEY FLOWS UNDER THE NUF/OPL ARRANGEMENT

[43] Throughout 1984, taxpayer continued to bill regular shippers for EVCs and to collect EVCs from both regular and counter shippers based on the declared value shown on the pickup record. (R150, paragraph 310-315.) All amounts collected from shippers by taxpayer, including EVCs, continued to be deposited into taxpayer's bank accounts, which were usually interest-bearing, and to be commingled with taxpayer's other funds. (Id., paragraphs 316-318.) Taxpayer did not change its method of making accounting journal entries with respect to EVCs from 1983 to 1984. (R261 at 39.)

[44] Through the district offices of its regional ground delivery subsidiaries, taxpayer continued to process all claims for loss or damage to parcels in 1984, including any portion above $100. (Id., paragraphs 319-320, 405-408.) Taxpayer remitted claims payments from a central bank account belonging to it, generally in the form of a single check for the entire amount of a claim. (R150, paragraph 320.) NUF did not compensate taxpayer for handling claims, and it was not involved in the claims process itself. (R155, paragraph 723; R227, paragraphs 1723(e), 1736, 1737; R229, paragraph 1735.) The only information regularly provided to NUF by taxpayer regarding claims took the form of "bordereaux" summarizing, by state, the amount of EVCs billed and/or collected and the amount of claims in excess of $100 that were paid. (R150, paragraphs 322, 323; R155, paragraph 723.)

[45] Taxpayer generally made its remittances to NUF of EVCs billed and collected, less claims paid in excess of $100, by wire transfer in the middle of a month, and it did not pay interest to NUF for the period between collection and remittance of EVCs. (R150, paragraph 321.) If a shipper did not pay a bill that included declared value in excess of $100, taxpayer did not reduce the amount remitted to NUF. Taxpayer's collection activities pertained to the full amount of an unpaid bill, including EVCs, and taxpayer did not deduct collection costs from its transfers to NUF. (Id., paragraph 329.)

[46] After receiving remittances from taxpayer, NUF in turn made monthly remittances to OPL of "net ceded premiums" as shown on bordereaux, representing gross EVCs received, less expenses (comprising NUF's fee, state taxes, and boards and bureaus), federal excise tax, and losses paid. (Id., paragraphs 338, 342, 343; Jt. Ex. 1133-AQO.) Taxpayer did not receive any consideration from OPL for transferring millions of dollars of EVCs to it via NUF, nor any compensation or assistance in kind from OPL for its claims handling and revenue collection activities, which would have cost "a lot of money" to replace. (R216 at 2636:13-16; 2647:1-2648:3.) As John Rogers, who was taxpayer's president and OPL's chairman in 1984, understood these relationships, "UPS dealt with NUF on the claims. . . . [W]e paid the money to the NUF, and they paid it back to us." (Id. at 2647:20-22.)

[47] In 1984, OPL was an unknown start-up enterprise in a "difficult" and "very competitive" industry. It possessed a desk, a telephone, a filing cabinet, and "a couple of chairs," and it occupied space "dedicated" to it in Hall's Bermuda offices. It had no full-time employees, and, apart from Mr. Johnson, none of its directors and officers had experience or training in the insurance industry. (R203 at 928:5-15, 936:2-6, 963:5-967:7.) OPL had net income of $72 million in 1984 and $125 million by 1987, an increase of 70 per cent. (Jt. Ex. 26-Z(4) at 027602.)

D. THE TAX COURT PROCEEDING

[48] Upon audit, the Commissioner determined that $99,794,790 received by taxpayer as EVCs in 1984 was includible in taxpayer's gross income under IRC section 61 and, further, that taxpayer was entitled to a corresponding deduction for claims paid. In the alternative, the Commissioner proposed allocations of income from OPL to taxpayer under IRC section 482 or section 845(a). (R1, Ex. A.) All of the alternative determinations were contested by taxpayer (R1) and briefed in the Tax Court (R240, R241, R245, R246). The parties filed 30 stipulations of fact (R147-167, R189-190, R225-228), and the court admitted some 1,500 exhibits. The court heard testimony from all the planners of the NUF/OPL arrangement as well as 29 experts, among other witnesses.

[49] Relying on this Court's opinion in Kirchman v. Commissioner, 862 F.2d 1486 (1989), the Tax Court concluded that the NUF/OPL arrangement, "the only potentially relevant change" in taxpayer's "functions and activities" with respect to EVCs between 1983 and 1984, was a sham lacking economic substance and business purpose, other than tax avoidance. (R261 at 59, 104-105.) As such, the court treated the transfer of EVCs to NUF and OPL as an anticipatory assignment of income to be disregarded in determining taxpayer's 1984 gross income under IRC section 61. (Id. at 51-59, 105 n.59.)

[50] The court rejected each of the business purposes advanced by taxpayer, beginning with the avoidance of state insurance regulation. (Id. at 62-80.) In this context, the court found that taxpayer was liable to shippers up to declared value under federal law as well as its tariff. (Id. at 73-76.) As to taxpayer's professed desire to leverage EVC profits into a full-scale reinsurance business, the court noted that the intended use of profits had no bearing on how they must be taxed. (Id. at 80.) The court did not believe that taxpayer "shifted EVC income to OPL" in order to justify raising its transportation rates, because that contention was undercut by the testimony of taxpayer's former executives and was not supported by any contemporaneous documentation. (Id. at 80-83.)

[51] In evaluating taxpayer's contention that the NUF/OPL arrangement helped protect its "core transportation activity" from risks associated with declared value shipments, the court considered whether taxpayer "actually transferred or reduced its liability to shippers in any meaningful sense," i.e., "did the rearranged EVC activity have any real economic impact on [taxpayer]?" The court concluded that it did not, because Item 540-A provided that, even if EVCs were remitted to an insurance company, taxpayer would remain liable up to declared value in the event that the company failed to pay; while Items 510 and 520 still required shippers to assert liability against taxpayer. (Id. at 83-86.)

[52] Even apart from taxpayer's liability to shippers, the court found that the NUF/OPL arrangement did not reduce taxpayer's financial exposure enough to be recognized for tax purposes. Although the court acknowledged that NUF and OPL faced "theoretical exposure" for losses below the $25,000 deductible or above the $10 million sub- limit under the AFM Policy, it pointed out that claims paid in excess of $100 never exceeded 40 per cent of EVCs received in any of the 11 years from 1979 to 1989. Thus, the court viewed the likelihood of any net loss to be "improbable, unrealistic, and insignificant." (Id. at 86-93.)

[53] Another indication that the NUF/OPL arrangement was a sham, the Tax Court said, was the absence of arm's length price negotiations. The court accepted the conclusion of Edward T. Kelley, an expert for the Commissioner, that the rate of 25 cents per $100 under the NUF Policy was "derived directly" from taxpayer's tariff and "bore no reasonable relationship" to an arm's length rate. The court observed that one of taxpayer's experts, Neil Doherty, had "implicitly acknowledged" the possibility of a lower negotiated rate by testifying that the pricing of the NUF/OPL arrangement would have been "very strange" if OPL had not been related to taxpayer. (Id. at 94-102.)

[54] The Tax Court contrasted the lack of support for taxpayer's purported business reasons for undertaking the NUF/OPL arrangement with the available contemporaneous documentation establishing a tax avoidance purpose. Because the arrangement lacked both economic substance and business purpose, the court concluded, taxpayer must include the entire amount of EVC revenue in its income for 1984. (Id. at 104-107.) Although the court did not reach the issue of an allocation under IRC section 482 or section 845(a), it noted that taxpayer had made no argument that a section 482 analysis "should be preferred" to the court's assignment of income approach, and it characterized taxpayer's case as "both 'more extreme' and heavily freighted with tax motives'" than Foglesong v. Commissioner, 621 F.2d 865 (7th Cir. 1980), and Rubin v. Commissioner, 429 F.2d 650 (2d Cir. 1970), in which the courts had relied on section 482. (Id. at 105 n.59.) Finally, the Tax Court upheld the additions to tax asserted by the Commissioner, calling taxpayer a "sophisticated" enterprise that had "engaged in ongoing sham transactions devoid of economic substance" and had cited no authority that supported its treatment of EVCs. (Id. at 111-114.)

[55] Taxpayer now appeals.

(3) Statement of the standard or scope of review

[56] (a) Under this Court's opinions in Karr v. Commissioner, 924 F.2d 1018, 1023 (11th Cir. 1991), cert. denied, 502 U.S. 1082 (1992), and Kirchman v. Commissioner, 862 F.2d 1486, 1490 (11th Cir. 1989), the Tax Court's finding that the NUF/OPL arrangement was a sham is reviewed under the clearly erroneous standard, while the legal standard applied by the Tax Court in reaching that finding is subject to de novo review. ¹³

[57] (b) The Tax Court's finding with respect to the addition to tax under IRC section 6653 is reviewed for clear error. Patterson v. Commissioner, 740 F.2d 927, 930 (11th Cir. 1984). We are not aware of any authority of this Court specifically addressing the issue of review of substantial authority under IRC section 6661(b)(2)(B). In this respect, we find this Court's opinion in Osteen v. Commissioner, 62 F.3d 356, 359 (11th Cir. 1995), to be somewhat ambiguous. Osteen treats the question both as one of evidentiary fact, viz., is there "substantial authority from a factual standpoint for the taxpayer's position," and also as one of the substantiality of the legal authority for taxpayer's position. Id.

SUMMARY OF ARGUMENT

[58] Taxpayer, a transportation company, received millions of dollars in revenues from "excess value charges" (EVCs) paid by shippers as part of its transportation rates. Prior to 1984, taxpayer included the entire amount of EVCs in its gross income for federal income tax purposes. Beginning in 1984, taxpayer did not include any amount of EVCs in gross income. Instead, it implemented the scheme we have called the NUF/OPL arrangement, wherein it transferred the net amount of EVC revenues after payment of claims to an insurance front, NUF, which passed on the vast bulk of the revenues to a Bermuda reinsurance company, OPL, that had been specially formed by taxpayer to accumulate EVCs and was principally owned by taxpayer's shareholders at all times. Since OPL was not subject to income tax in Bermuda and did not pay federal income tax in the United States, taxpayer hoped in this way to shelter its enormous EVC revenues from U.S. federal income tax.

[59] The Tax Court correctly held that the NUF/OPL arrangement was a sham lacking any economic substance or business purpose and that it resulted in a prohibited assignment of taxpayer's income. Taxpayer knew going into the arrangement that it had no possibility of realizing any profit from these transfers and that its gain, if any, could only come in the form of huge tax savings. Taxpayer continued to conduct its transportation business exactly as before and to hold itself out as if it remained liable for loss and damage on account of EVCs. The arrangement did not involve any genuine risk for any of the participants, however, because EVC revenues consistently exceeded claims paid by a wide margin. Taxpayer's professed concern with catastrophic loss was belied by the fact that it could have obtained third-party insurance for a fraction of the amount transferred to NUF and without the formation of OPL, whose only function was to receive taxpayer's EVC profits and accumulate them tax-free. Indeed, the Tax Court rejected every one of taxpayer's asserted business purposes for the arrangement, and taxpayer has not contested those findings on appeal. The Tax Court accordingly correctly sustained the Commissioner's deficiency determination. The court was similarly correct in upholding the Commissioner's imposition of additions to tax for substantial understatement of liability and negligence.

[60] The decision of the Tax Court is correct and should be affirmed.

ARGUMENT

I

[62] The effect of the Tax Court's finding is to require inclusion of taxpayer's EVC revenue in its gross income for 1984, because "[f]ederal tax law disregards transactions lacking an economic purpose which are undertaken only to generate a tax savings." United States v. Heller, 866 F.2d 1336, 1341 (11th Cir. 1989). See Karr, 924 F.2d at 1023. This principle has its origins in Gregory v. Helvering, 293 U.S. 465 (1935), which involved an attempt by the sole owner of a corporation to avoid the consequences of selling certain stock owned by the corporation for her own account. The taxpayer formed a second corporation and directed the first corporation to transfer the shares to it. Shortly thereafter, she liquidated the second corporation and received the desired shares in a liquidating distribution. The Supreme Court rejected her argument that the distribution was made "in pursuance of a plan of reorganization" within the meaning of the reorganization statute, concluding instead that the arrangement was "simply an operation having no business or corporate purpose--a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character . . . ." Even though the transaction came within the literal terms of the reorganization statute, the court said, it lay outside the statute's "plain intent." 293 U.S. at 469-470.

[63] In Knetsch v. United States, 364 U.S. 361 (1960), the Supreme Court applied the principles of Gregory to disallow deductions claimed by a taxpayer for interest paid on non-recourse indebtedness owed to an insurance company. The taxpayer incurred the indebtedness as part of an elaborate scheme wherein the tax savings flowing from the interest deductions inevitably would greatly exceed the actual economic cost. Emphasizing that there was no possibility that the scheme would result in any economic gain for the taxpayer other than the expected tax savings, the Court in Knetsch agreed with the trial court that the indebtedness should be disregarded for federal tax purposes and no deduction allowed for the interest payments made. 364 U.S. at 365-366.

[64] In Kirchman, this Court linked the sham doctrine to "the general notion that courts should look at the substance of a transaction rather than just its form." 862 F.2d at 1491. Although the Court acknowledged, in line with Gregory, that "a taxpayer can structure a transaction to minimize tax liability," it emphasized that "that transaction must nevertheless have economic substance in order to be 'the thing which the statute intended.'" Id. (quoting Gregory, 293 U.S. at 469). The Court concluded that "[t]he focus of the inquiry under the sham transaction doctrine is whether a transaction has economic effects other than the creation of tax benefits," and it recognized that two factors, business purpose and economic substance, are relevant to the inquiry. Id. at 1492.

[65] "The determination of whether the taxpayer had a legitimate business purpose in entering into a transaction involves a subjective analysis of the taxpayer's intent," the Court said in Kirchman, although "[t]he inquiry into whether the transaction had economic substance beyond the creation of tax benefits does not . . . ." Id. Rather, "[t]he economic substance factor involves a broader examination of . . . whether from an objective standpoint the transaction was likely to produce economic benefits aside from a tax deduction." Bail Bonds by Marvin Nelson, Inc. v. Commissioner, 820 F.2d 1543, 1549 (9th Cir. 1987) (cited for this proposition in Kirchman, 862 F.2d at 1492). The two factors, however, "do not constitute discrete prongs of a 'rigid two-step analysis,' but rather represent related factors both of which inform the analysis of whether the transaction had sufficient substance, apart from its tax consequences, to be respected for tax purposes." ACM Partnership, 157 F.3d at 247.

B. THE TAX COURT CORRECTLY DETERMINED THAT THE NUF/OPL

[67] Taxpayer gave up $99 million in revenue and $78 million in EVC profits without shedding its liability for shippers' claims. It took this seemingly illogical action because the EVC profits were funneled to OPL, the Bermuda corporation owned by taxpayer's shareholders, in the hope that they would escape United States income taxation. As taxpayer took in EVCs, paid claims, and sent the difference to NUF each month, it had no possibility whatsoever of realizing any gain from the process, other than interest during the period between receipt and remittance of EVCs, which it would have received in any event. As taxpayer knew from the outset, any profit from the arrangement itself was out of the question, one of the hallmarks of a sham. See ACM Partnership, 157 F.3d at 257; Shriver v. Commissioner, 899 F.2d 724, 725-727 (8th Cir. 1990); Yosha v. Commissioner, 861 F.2d 494, 500-501 (7th Cir. 1988). Instead, the payoff took the form of a $20 million tax saving (for 1984 alone) on funds remitted to OPL in Bermuda, there to await eventual repatriation to taxpayer and its shareholders.

[68] Putting aside for the moment the question whether taxpayer actually retained its liability for shippers' claims (we demonstrate in Part C below that it did), there is no question that taxpayer continued to conduct its transportation business and to hold itself out to the world as if the liability remained. By its express terms, tariff Item 540-A committed taxpayer to pay for loss or damage up to declared value in the event that NUF, for whatever reason, failed to pay any claim. Of course, there was no real possibility that NUF ever would fail to pay a claim, since taxpayer handled all claims payments out of its EVC revenues before sending the balance to NUF, for transmission to OPL.

[69] For taxpayer's shippers, too, everything continued as before. Notably, the declared value rate paid by shippers to taxpayer remained unchanged under tariff Item 540-A, at exactly the same level where it had been for some 30 years. (R216 at 2642:16-18.) The problem with taxpayer's contention that 25 cents per $100 was an arm's length rate "[f]rom each shipper's perspective" (TBR 32; see AAI 15-16) is that the rate was not negotiated by "each shipper"; indeed, it was not negotiated at all. (Jt. Exs. 1066-ANZ, 1072-AOF; R216 at 2642:10-24.) At trial, there was abundant expert testimony showing that 25 cents was two to three times the arm's length rate that should have been expected in a transaction of the magnitude of the NUF/OPL arrangement, and between parties of the negotiating power of taxpayer and NUF. (R261 at 94-101.) Although taxpayer offered some opposing testimony, the Tax Court was entitled to accept the views of the Commissioner's experts instead. Negron v. City of Miami Beach, 113 F.3d 1563, 1570 (11th Cir. 1997). See also Anderson v. City of Bessemer City, 470 U.S. 564, 574 (1985) (where there are two permissible views of the evidence, it is not clear error for court to adopt one). Taxpayer's failure to use an arm's length price for the NUF Policy thus provides another indication that the arrangement was a sham. Karr, 924 F.2d at 1024.

[70] Although NUF, unlike taxpayer, did realize income from the arrangement in the form of its fee, it had no possibility of any gain beyond that fee, which was capped at $1 million per year. Taxpayer did not negotiate the fee but accepted Mr. Corde's quote, which was actually one-third higher than NUF had requested. (Jt. Ex. 1075-AOI at 012016; Jt. Ex. 1076-AOJ at JK002520.) Furthermore, the arrangement was an exceptionally easy one for NUF. Taxpayer continued to perform, gratis, all administrative tasks with respect to declared value shipments, including billing, collection, claims processing and claims payment. Even if taxpayer had produced any meaningful evidence of its vulnerability to state insurance regulation, which it did not (R261 at 62-70), its contention below that it declined compensation to avoid such regulation could not have been credited, because the economically rational choice would have been to require NUF to bear the administrative costs and burdens associated with EVCs. ¹⁴

[71] In contrast to taxpayer's diligence on its behalf, NUF showed a marked lack of interest in exercising its own rights under the NUF Policy. During 1984, NUF did not examine claimants or taxpayer in connection with claims, or audit books and records of either, or monitor the assertion of third-party claims, whose waiver would allowed NUF to cancel its own purported liability. (R155, paragraph 723.) It did not challenge taxpayer's handling of any specific claims, nor did it contest the aggregate amounts taken out for claims payments before taxpayer remitted the balance of the EVCs. (R155, section724.) NUF subtracted its fee, taxes, and charges from the amounts remitted by taxpayer, added its own information to the paperwork, and sent the money and the numbers along to OPL.

[72] NUF's unconcern with the details may be the only aspect of the arrangement that makes perfect sense, because it reflects that NUF was unexposed to any meaningful risk of loss. NUF was told going into the arrangement that it faced no risk. (Jt. Ex. 1066-ANZ at 012012) Whether or not this was a marketing ploy, as Mr. Corde claimed at trial, it was also true, as he conceded. (R202 at 839:8- 840:24.) NUF knew that in every one of the previous five years taxpayer's EVC receipts had exceeded claims paid by margins of over three to one, and the evidence adduced at trial showed the same pattern continuing over the next five years. (R261 at 92.)

[73] Nevertheless, taxpayer (TBR 31-36) and the Alliance (AAI 16-17) insist that taxpayer, and hence NUF, potentially faced an enormous risk of loss. The Tax Court, however, heard expert testimony to the effect that the real-life likelihood of loss was both highly predictable and nowhere near the arithmetic maximum. (R. 87-93.) Even in the light of his own worst-case calculations -- which involved, inter alia, the total destruction of every declared-value package in the New York metropolitan area on a single day (Respt. Ex. AVM at 9- 15) -- one of the Commissioner's experts concluded that the risk of a loss in excess of OPL's reserves was so small as to be "economically irrelevant" (R214 at 2402:23-2403:4). ¹⁵ In addition, evidence regarding the AFM Policy weighed in the Commissioner's favor by demonstrating that NUF had no exposure between $25,000 and $10 million per occurrence, that taxpayer considered the $10 million per- occurrence limit more than sufficient to cover its potential liability, and that AFM deemed the risk presented by parcels in transit to be far less than taxpayer has suggested, judging from the fact that its premium was disproportionately low for the aggregate coverage provided when compared to taxpayer's remittances of EVCs. ¹⁶ (R261 at 87-90.)

[74] All of these factors led the Tax Court to conclude that the possibility of a net loss on EVCs was "so remote, that for all practical purposes, it was nonexistent." (R261 at 92-93.) This absence of any meaningful risk that taxpayer or NUF would incur a loss with respect to EVCs provided the Tax Court with strong grounds for reaching its ultimate conclusion that the NUF/OPL arrangement was an economic sham having no other purpose than to shelter taxpayer's EVC profits from U.S. tax. See Kirchman, 862 F.2d at 1492; Bail Bonds by Marvin Nelson, 820 F.2d at 1549; ACM Partnership, 157 F.3d at 250, 252 n.39.

[75] Viewed as a whole, moreover, the arrangement would not have made sense in insurance terms even if the risk of loss were more than speculative. If the intended function of the NUF Policy, which had no aggregate policy limit, had been to reduce the exposure of taxpayer and its shareholders to catastrophic loss, then the NUF Policy could have fulfilled that function on its own, and taxpayer could have dispensed with the formation and spinoff of OPL. Under that scenario, however, the price of protection would have been the permanent loss of all of the EVC profits, something taxpayer never would have allowed to occur.

[76] The conclusion is inescapable that OPL was brought into the scheme solely to receive taxpayer's EVC profits from NUF and to accumulate them tax-free. At trial, taxpayer's former executives tried to downplay OPL's favored tax status by pointing out that its predecessor, UPSINCO, would have been fully liable for U.S. federal income tax. (R197 at 220:24-221:17; R190 at 441:22-24; R203 at 913:11-16, 968:4-8.) Taxpayer, however, made certain to substitute OPL for UPSINCO before the money flows began. By maintaining the same transfer restrictions on its own stock and OPL's, taxpayer ensured that EVC profits eventually reached the same pockets into which they had always gone. A clearer example of a transaction lacking economic substance and a non-tax business purpose is difficult to find.

[77] Against this background of preplanned revenue losses, massive tax savings, and the status quo in all other respects, the Tax Court had every reason to conclude that the NUF/OPL arrangement was a sham. Once the court did so, it necessarily resolved the issue of whether taxpayer should have included the 1984 EVC revenues in its own gross income, irrespective of the remittances to and by NUF and OPL. (R261 at 104-105.) Under Gregory, Kirchman, and Karr, the remittances had to be disregarded, meaning that the income was, as it had always appeared to be, taxpayer's own. The Tax Court's sham finding thus provides a separate and ample ground on which to sustain the Commissioner's deficiency determination. Consolidated Development Corp. v. Sherritt, Inc., 216 F.3d 1286, 1288 (11th Cir. 2000) (Court may affirm on any ground supported by the record, whether or not relied upon below).

[78] It was, of course, entirely permissible for the Tax Court to hold further that a prohibited assignment of income had occurred. (R261 at 105.) As the Tax Court observed (id. at 51), it is "fundamental to our system of taxation that income must be taxed to the one who earns it," and gross income under IRC section 61 includes "all income from whatever source derived." IRC section 61 (emphasis added); Commissioner v. Culbertson, 337 U.S. 733, 739-740 (1949); United States v. Basye, 410 U.S. 441, 447, 449-450 (1973); Lucas v. Earl, 281 U.S. 111, 114, 115 (1930). The record makes abundantly clear (R261 at 53-58, 70-73) that taxpayer earned the EVCs that it received, because it alone held out to shippers the quid pro quo of greater liability in exchange for transportation rates (and it in fact continued to bear such liability, notwithstanding the existence of the NUF Policy, as is discussed below); it alone performed all services and activities relating to both the collection of EVCs and the disposition of claims; and it alone maintained complete dominion and control over the EVCs from the time they were received until, and including, the moment they were remitted to NUF for the sole purpose of being passed on to OPL. See Commissioner v. Sunnen, 333 U.S. 591, 604-606 (1948); Corliss v. Bowers, 281 U.S. 376, 378 (1930); Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431-433 (1955). In these circumstances, it is beyond argument that taxpayer cannot avoid taxation on its EVC income merely by diverting that income to NUF and OPL. Basye, 410 U.S. at 449-450. Indeed, all that distinguishes the NUF/OPL arrangement from the typical assignment of income scenario is that taxpayer did receive the subject income in the first instance and that the mechanism for its subsequent diversion was a manifest sham.

[79] As the Tax Court recognized (R261 at 105 n.59), its overall conclusion that the NUF/OPL arrangement was a sham as well as an assignment of income made it unnecessary for that court to reach the issue of an allocation under IRC section 482 or section 845. We respectfully submit that a remand to the Tax Court for findings with respect to those provisions would be essential if this Court were to reverse the Tax Court's decision. ¹⁷

C. THE NUF/OPL ARRANGEMENT WAS INEFFECTIVE AS A MATTER OF LAW TO

[81] Thus, even though many of taxpayer's and the Chamber's contentions, much of the Alliance's analysis, and the Trucking Association's entire argument are predicated on the assumption that taxpayer had no primary liability for claims above $100 during 1984, this Court may affirm the Tax Court's decision without reaching the issue. Should the Court choose to address the question of liability, it will find that the positions of taxpayer and the amici are demonstrably wrong.

[82] The legal standards governing a motor common carrier's ability to limit its liability to shippers have long been well settled, and especially so in this Circuit. A carrier's liability for loss or damage was virtually unlimited under common law, and during the years in issue here the Interstate Commerce Act likewise imposed full liability for "the actual loss or injury to the property" unless the carrier limited its liability under 49 U.S.C. section10730. 49 U.S.C. sections11707(a)(1), (c)(4); Bio-Lab, Inc. v. Pony Exp. Courier Corp., 911 F.2d 1580, 1581 (11th Cir. 1990); Hughes v. United Van Lines, Inc., 829 F.2d 1407, 1412-1413 (7th Cir. 1987).

[83] In Fine Foliage of Florida, Inc. v. Bowman Transportation, Inc., 901 F.2d 1034, 1041 (11th Cir. 1990), the Court explained that Section (c)(1) of the Carmack Amendment, 49 U.S.C. section 11707, "specifically limits a carrier's ability to exempt itself from liability under Section(a)(1) of the Amendment" by stating as follows:

A common carrier may not limit or be exempt from liability

Thus, "[t]he only situation in which a carrier may limit its liability is under the released value provision of 49 U.S.C. section10730," which permits a carrier to

establish rates for the transportation of property . . . under

[84] The language of 49 U.S.C. section 10730(b)(1) clearly indicates that shippers were to have a choice of rates corresponding to different levels of carrier liability. The legislative history confirms that the publication of released value rates, such as the $100 and declared value rates set forth in the authorizing orders referenced in taxpayer's tariff Item 540-A as well as in Item 540, is meant to increase "the range of choices available to the shipping public" by giving shippers the "option" to pay less for reduced liability on the part of the carrier or, by implication, more for greater liability, as the shipper may declare. H.R. Rep. No. 96-1609, 96th Cong., 1st Sess., sec. 12 at 25-26 (1980), reprinted in 1980 U.S.C.C.A.N. 2283, 2307-2308. It is literally hornbook law that section 10730(b)(1) was not intended to eliminate shippers' choice of full value rates. ¹⁸ See 1 William J. Augello & George C. Pezold, Freight Claims in Plain English, section 8.2.2.1.3 (3d ed. 1995).

[85] Within this statutory framework, this Court has adopted the standard set forth in Hughes, 829 F.2d at 1415, for determining whether a carrier's purported limitation of liability comports with the Carmack Amendment:

There are four steps a carrier must take to limit its liability

The Court went on to emphasize that, "[a]lthough shippers are charged with notice of terms in a tariff, the maintenance of tariff schedules is not enough." Bio-Lab, 911 F.2d at 1582. Quoting Anton v. Greyhound Van Lines, Inc., 591 F.2d 103, 108 (1st Cir. 1978), the Court further explained that "'a carrier cannot limit liability by implication.'" Rather, "'there must be an absolute, deliberate and well-informed choice by the shipper.'" Id.; Carmana Designs Ltd. v. North American Van Lines, Inc., 943 F.2d 316, 319 (3d Cir. 1991); Hughes Aircraft v. North American Van Lines, Inc., 970 F.2d 609, 612 (9th Cir. 1992) (each citing Bio-Lab).

[86] Applying the four-step standard adopted in Bio-Lab, it is readily apparent that the NUF/OPL arrangement was ineffective as a matter of law to limit taxpayer's liability for shippers' claims to a released value of $100, as opposed to declared value. First, taxpayer's purported "substitution of a third-party insurer's liability" for its own (TBR 40) fails to afford shippers the requisite choice of levels of carrier liability. Taxpayer has never explained how an offer of third-party insurance can be equated with the liability component of its transportation rate, nor has it identified any authority indicating that this may be done. The mere use of insurance terminology (e.g., R1 at 17-21; TBR 6, 10-13; AAI 6- 9; CC 2-3, 7-8) does not fill the bill.

[87] In any event, taxpayer's approach is foreclosed by its own tariffs. Item 540-A preserved the language of Item 540 expressly giving shippers the choice of how much liability taxpayer would bear, either $100 or value as declared by the shipper. (Jt. Exs. 34-AH, 35- AI.) The effect of the new language regarding remittances of EVCs was at best ambiguous. Item 540-A said only that taxpayer "may remit" EVCs to "an" insurance company, not that it would remit them to NUF. Significantly, Item 540-A did not state that taxpayer's own liability would be limited by any such remittances. To the contrary, it expressly reaffirmed that taxpayer "will remain liable for loss or damage within the limits declared and paid for" if for any reason an insurance company -- assuming one was used -- refused to pay. (Id.)

[88] In addition, taxpayer implemented the NUF/OPL arrangement in a manner that made it impossible to obtain shippers' agreement to any choice of NUF insurance or to give shippers reasonable notice of a limitation on taxpayer's liability. Taxpayer's pickup record was the sole means given to shippers to make and express a choice of liability, and the only choice it presented was between declared and $100 valuation, with taxpayer liable either way. Although the pickup record supposedly signified the "existence and amount" of NUF coverage, it failed to mention NUF. Even if a shipper were aware of the policy -- a doubtful prospect -- it would have no way of indicating its choice to taxpayer or of directing taxpayer not to remit its EVCs as premiums, as tariff Item 540-A ostensibly allowed. Even if a shipper were aware of the entire tariff -- another long shot -- and of the NUF Policy, it still would lack a "reasonable opportunity" to select a level of liability, because of discrepancies between the tariff provisions and the policy terms. (See Jt. Exs. 34- AH, 35-AI, 780-ACZ.)

[89] In Bio-Lab, this Court held that a carrier's "unilateral, after-the-fact, alteration" of a shipper's declaration on its waybill "could have no legal effect on the transaction" and thus could not limit the carrier's liability to less than the value originally declared. 911 F.2d at 1583. On this record, it can only be concluded that taxpayer's unilateral, after-the-fact remittances of EVCs to NUF failed to limit its liability below declared value. Indeed, taxpayer's continuing liability for declared value claims explains the otherwise puzzling aspects of its conduct under the NUF/OPL arrangement, including its failure to make corresponding changes in any other tariff provisions after the adoption of Item 540-A; its continuing to accept responsibility for claims processing and payment after the NUF Policy was in place; and its apparently continuing to defend against shippers' lawsuits, long after the arrangement was implemented, on the ground of various departures from its own tariffs, rather than on the ground that it lacked liability in the absence of a default by NUF. See Industrial Risk Ins. v. United Parcel Service, 746 A.2d 532 (N.J. App. Div. 2000); Shull v. United Parcel Service, 4 S.W.3d 46 (Tex. App. 1999), cert denied, ___ S. Ct. ___, 2000 WL 656696 (2000); Shorts v. United Parcel Service, 1999 WL 118791 (N.D. Tex. 1999); The Plaid Giraffe, Inc. v. United Parcel Service, Inc., 1994 WL 544505 (D. Kan. 1994); Rafaella Gallery, Inc. v. United Parcel Service, Inc., 818 F. Supp. 53 (S.D.N.Y. 1993); Fireman's Fund Ins. Co. v. Wagner Fur, Inc., 760 F. Supp. 1101 (S.D.N.Y. 1991); Pierre v. United Parcel Service, Inc., 774 F. Supp. 1149 (N.D. Ill. 1991); Art Masters Assocs., Ltd. v. United Parcel Service, 139 N.Y. Misc. 2d 888 (1988), aff'd following remand, 77 N.Y.2d 200 (1990); Fabulous Fur Corp. v. United Parcel Service, 664 F. Supp. 694 (E.D.N.Y. 1987) ¹⁹

[90] The arguments of taxpayer and the amici with respect to liability are not well founded. Taxpayer's attempt to dismiss Bio-Lab in a footnote, on the ground that the Court had "no occasion to address a carrier's substitution of third-party insurance to cover shippers' claims" (TBR 46 n.29; see ATA 18), ignores the fact that the same four-part test applies to any attempted limitation of liability. Taxpayer's contention that what it calls the "Hughes/Anton test" is inapposite because it "derived from pre-1980 authority" ignores the fact that this test remains the governing rule in this Circuit to this day.

[91] Contrary to taxpayer's contention (TBR 40), its Service Explanation did not give shippers notice of any limitation on its liability or specifically refer to the "termination" of its "primary responsibility for EV losses" in favor of NUF. Because the Service Explanation tracked the language of Item 540-A, it "specifically referred" only to taxpayer's continuing liability and the possibility of remittances to NUF. (Jt. Ex. 428-PL.) Furthermore, taxpayer is seriously mistaken in characterizing the Service Explanation as part of a "written agreement" with its shippers. Although taxpayer cites G.O.V. Jewelry, Inc. v. United Parcel Service, 581 N.Y.S.2d 33 (Sup. Ct. App. Div. 1992), in this context, the court there merely described the Service Explanation as something "published for the use of customers." By its terms, the Service Explanation is a unilateral statement by taxpayer that does not request or express a shipper's agreement in any way. Since it was not incorporated by reference or even mentioned in the pickup record, it did not form part of the shipping contract, and the same was true of taxpayer's tariff. Fine Foliage, 901 F.2d at 1040-1041; Trepel v. Roadway Express, Inc., 194 F.3d 708, 715 (6th Cir. 1999); Sotheby's v. Federal Express Corp., 97 F. Supp. 2d 491, 500 (S.D.N.Y. 2000). Accord, Swift Textiles, Inc. v. Watkins Motor Lines, Inc., 799 F.2d 697, 703-704 (11th Cir. 1986).

[92] Finally, there is no merit in taxpayer's contention (TBR at 41-42) that the "remains liable" language in Item 540-A creates only a "contingent" liability. Under Bio-Lab, taxpayer's liability up to declared value would continue even if that language were missing. Wood-Tucker Leasing Corp. v. Kellum, 641 F.2d 210 (5th Cir., Unit A, 1981), although cited by taxpayer in this context, actually goes against its argument by holding that a guarantor shared immediate and equivalent liability with its principal in circumstances similar to taxpayer's (id. at 215 n.7). ²⁰ In any event, whether taxpayer's liability was "primary" or something less (TBR38-42; AAI16-17), EVCs were still a part of taxpayer's charges for services provided to shippers and, as such, were income to taxpayer in 1984.

D. THE REMAINING CONTENTIONS OF TAXPAYER AND THE AMICI ARE

[94] 2. Although the Chamber (CC 6-11) and the Alliance (AAI 5- 11) each focus on the "commonplace" nature (CC 6) of most corporate spinoffs, the NUF/OPL arrangement was not a spinoff of taxpayer's "insurance business" -- taxpayer did not have an insurance business and could not legally have engaged in such a business (R147, paragraphs 10, 14; R155, paragraphs 720, 721) -- but, instead, was a blatant tax avoidance scheme that served only to transfer a portion of taxpayer's EVC revenues to a related Bermuda entity. In addition, the contention that the arrangement derived economic substance from the shifting of insurance risk among taxpayer, NUF, and OPL (TBR 26- 27; CC 6-7; AAI 12-22) is foreclosed by the fact that taxpayer had no meaningful risk of loss with respect to EVC transactions and that, in any event, taxpayer remained liable for shippers' claims up to declared value. Furthermore, although the Alliance strives to characterize the arrangement as a valid insurance program, the courts have long recognized that "[i]nsurance policies are peculiarly susceptible of manipulation" as a means of avoiding tax. Golsen v. Commissioner, 54 T.C. 742, 754 (1970), aff'd, 445 F.2d 985 (10th Cir.), cert. denied, 404 U.S. 940 (1971). See also Wright v. Commissioner, 66 T.C.M. (CCH) 214, 218, 224-226 (1993) (holding that car dealer's purported reinsurance scheme was a sham and distinguishing Alinco Life Insurance Co. v. United States, 373 F.2d 336 (Ct. Cl. 1967), on which taxpayer and the amici rely here), aff'd, 76 A.F.T.R. 2d section95-5805 (9th Cir. 1995).

[95] Taxpayer (TBR 23) and the Chamber (CC 10) miss the point of Yosha v. Commissioner, which each cites for the proposition that "[a] transaction has economic substance when it is the kind of transaction that some people enter into without a tax motive . . . ." What the court actually said in Yosha was that certain transactions "as we have described them" had economic substance, but that the Tax Court did not err in finding that they lacked substance "as they actually occurred." 861 F.2d at 499 (emphasis in original). The $78 million giveaway that was the NUF/OPL arrangement was manifestly a transaction no person would "enter without a tax motive," and the contemporaneous documentary record confirms that it was tax-driven from beginning to end. (Jt. Ex. 6-F(4) at JK021399; Jt. Ex. 27-AA(2) at JK001909; Jt. Ex. 935-AIY at 027632, 027633; Jt. Exs. 1031-AMQ, 1032-AMR, 1034-AMT, 1039-AMY, 1041-ANA, 1042-ANB, 1078-AOL, 1090- AOX.)

[96] The Chamber's efforts to find rational business behavior in taxpayer's continuing to undertake all claims handling without compensation, to maintain the AFM Policy in force, and to pay NUF a much larger sum than it paid AFM or shippers paid PIP (CC 7-10) are wholly unavailing, particularly in view of taxpayer's inability to justify its conduct. The Tax Court discounted the notion that taxpayer's volunteerism arose from a concern over state regulation. (R261 at 77-80.) Mr. Barone, taxpayer's and OPL's treasurer, could not say at trial why taxpayer would pay an added premium for primary coverage under the AFM Policy if it were "not relevant" to the NUF coverage, as he maintained. (R203 at 971:6-972:4, 990:2-22.) By conceding that the pricing of the NUF/OPL arrangement would be "very strange" were it not for the relationship between taxpayer and OPL, taxpayer's expert Mr. Doherty underscored the fact that taxpayer did not "give off" its profit to an "outsider"; it simply parked its EVC profits with a companion entity in order to insulate them from its own liability for U.S. federal income tax.

[97] 3. Taxpayer's assertion that "[t]his case bears no resemblance to a 'tax shelter' case that involves artificial structures devoid of financial impact other than the creation of fictitious deductions and losses" (TBR 22) would be beside the point even if it were true. Any scheme that would confer tax savings, by whatever means, without "appreciably" affecting the taxpayer's "beneficial interest," Knetsch, 364 U.S. at 366, may be disregarded as a sham. See ASA Investerings Partnership v. Commissioner, 201 F.3d 505, 511-512 (D.C. Cir.), cert. denied, ___ S. Ct.___, 2000 WL 943849 (2000) (Tax Court decision "rejecting bona fides" of a partnership was equivalent to finding a sham, even though court did not use the word and declined to consider whether contested transactions lacked economic substance); Boyter v. Commissioner, 668 F.2d 1382, 1386-1388 (4th Cir. 1981) (sham doctrine was "not inapplicable . . . as a matter of law" in determining whether taxpayers could avoid "marriage penalty" by means of year-end divorce and subsequent remarriage). The NUF/OPL arrangement differs from a run-of-the-mill sham only in that taxpayer skipped the usual scheme of creating artificial losses or deductions to offset other income and instead tried to drastically curtail its tax liability by sending a substantial portion of its income to an entity not subject to U.S. tax. As the Supreme Court observed in Minnesota Tea Co. v. Helvering, 302 U.S. 609, 613 (1938), "[a] given result at the end of a straight path is not made a different result because reached by following a devious path." That taxpayer's chosen method of tax avoidance was more sophisticated than some does not make it any more acceptable.

[98] 4. The contentions of taxpayer (TBR 29-31), the Chamber (CC 11-19), and the Alliance (AAI 22-32) that the Tax Court erred in examining taxpayer's business purpose are seriously misconceived. In limiting its argument to the assertion that a nontax business purpose for the NUF/OPL arrangement is unnecessary (TBR 29), taxpayer has waived any challenge to the merits of the Tax Court's determination that the various explanations for the scheme that it offered at trial were universally implausible and often directly in conflict with the contemporaneous documentary record (R 261 at 62-105). See SunAmerica Corp. v. Sun Life Assurance Co., 77 F.3d 1325, 1333 (11th Cir. 1996). The Alliance's argument that business purpose is irrelevant to the assignment of income doctrine (AAI 22-23, 30-32) is self-defeating, because assignment of income is prohibited regardless of its purpose.

[99] In arguing that no nontax "motive" is required, "absent a specific statutory mandate," in transactions that have "significant economic substance," (TBR 29; CC 13; AAI 24), taxpayer and the amici beg the question whether the NUF/OPL arrangement was such a transaction. Furthermore, they fail to recognize that a nontax business purpose is a necessary element of economic substance without regard to either the specific dictates of the Code or taxpayer's subjective intent. This Court explained in Kirchman that "[t]he analysis of whether something is a sham . . . must occur before analysis of the for-profit test of IRC section 165(c)(2) and Section 108," the statutes there in issue (862 F.2d at 1491), because "transactions whose sole function is to produce tax deductions" -- i.e., which lack a non-tax purpose -- "are substantive shams, regardless of the motive of the taxpayer" (id. at 1492). Accord, ACM Partnership v. Commissioner, 157 F.3d at 253 (finding of economic substance required nontax purpose and reasonable expectation of pretax profit under Code provisions "which . . . do not by their terms require a business purpose or profit motive"); United States v. Wexler, 31 F.3d 117, 124 (3d Cir. 1994) (to the same effect, and stating that "'the principle laid down in the Gregory case is not limited to corporate reorganizations, but rather applies to the federal taxing statutes generally" (quoting Weller v. Commissioner, 270 F.2d 294 (3d Cir.1959)).

[100] Relying on Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943), taxpayer (TBR 30) and the Chamber (CC 13-19) espouse a "very limited" and "deferential" sham analysis wherein a taxpayer's decision to carry on its business in corporate form must be respected so long as the corporation does engage in some business activity, even if its only purpose is tax avoidance. Under this standard, they maintain, the validity of the OPL spinoff is enough to save the entire NUF/OPL arrangement from being disregarded as a sham. In the same vein, the Alliance contends (AAI 27-29) that the arrangement has no improper tax avoidance motive but merely accords to OPL the tax treatment intended by Congress for insurance companies. The result of the Tax Court's analysis, so the argument goes, is to "sever a corporation" -- OPL -- "from its transactions" -- reinsuring insurance risks flowing from taxpayer via NUF -- in a manner the Seventh Circuit deemed "unnecessary" and "inappropriate" in Northern Indiana Public Service Co. v. Commissioner, 115 F.3d 506, 512 (7th Cir. 1997).

[101] This argument has a number of flaws. First, since taxpayer had no "insurance business" to spin-off to OPL (see AAI 23-28), OPL did not engage in any "meaningful economic activity," Northern Indiana, 115 F.3d at 512, in the context of the NUF/OPL arrangement. Second, in Northern Indiana, the Tax Court made a factual finding that the taxpayer had met its burden of proving that its subsidiary was "carrying on sufficient business activity to require its recognition as a separate entity for tax purposes," and the Seventh Circuit upheld that finding under the clearly erroneous standard. 115 F.3d at 512, 514. The opinion also reflects that the formation of a foreign subsidiary was "a financially-strategic measure" related to the taxpayer's business activities, albeit a measure that saved taxes. Id. at 507-508. Here, the record amply supports the Tax Court's factual finding that the entire NUF/OPL arrangement was a sham, the sole purpose of which was to siphon taxpayer's revenues to OPL in order to avoid U.S. taxation.

[102] Hospital Corporation of America v. Commissioner, 81 T.C. 520, 581-584 (1983), upon which taxpayer and the Chamber also rely, is similarly distinguishable. There, the Tax Court held that, because the taxpayer had produced credible evidence of its business purpose for organizing a corporation to operate and manage a hospital, its choice of a tax-free situs was not disqualifying. 81 T.C. at 581-584. Here, the Tax Court properly discredited each of taxpayer's asserted business reasons for funneling $99 million of its revenues to a Bermuda corporation whose only function was to shelter them from U.S. tax.

[103] In ASA Investerings, moreover, the D.C. Circuit rejected the notion that Moline established "a two-part test, under which a tax entity is accepted as real if either: (1) its purpose is 'the equivalent of business activity" (not tax avoidance) or (2) it conducts business activities." 201 F.3d at 512 (emphasis in original). The court noted that other courts had "understood the 'business activity' reference in Moline to exclude activity whose sole purpose is tax avoidance." Id. It agreed that the business purpose doctrine seemed "essential" to reduce "the incentive to engage in . . . essentially wasteful activity" and "achieve reasonable equity among taxpayers who are similarly situated -- in every respect except for differing investments in tax avoidance." Id. at 513.

[104] The approach adopted by the court in ASA Investerings is the right one to follow here. As this Court's predecessor observed in United States v. General Geophysical Co., 296 F.2d 86, 89 (5th Cir. 1961), cert. denied, 369 U.S. 849 (1962), while "tax avoidance implications do not constitute a license to courts to distort the laws or to write in new provisions[,] they do mean that we should guard against giving force to a purported transfer which gives off an unmistakably hollow sound when it is tapped." Although the Chamber seeks to distinguish ASA from the present case on the ground that it involved "a pre-arranged multiple step transaction that essentially left the parties back at square one" (CC 16), that is also what happened here. In this case, therefore, it seems entirely necessary and appropriate to sever OPL from the manipulative transactions that allowed taxpayer's $99 million to wind up in OPL's tax-free hands.

II

[106] The NUF/OPL arrangement falls within the definition of a tax shelter under IRC section 6661, which includes "any . . . plan or arrangement" if the "principal purpose" of the plan or arrangement is "the avoidance or evasion of Federal income tax." IRC section 6661(b)(2)(C)(ii)(III) (emphasis added). As the Tax Court found (R261 at 104-105) and the foregoing discussion confirms, taxpayer's scheme served no purpose except to avoid U.S. income taxation. Taxpayer has identified no authority holding valid an arrangement whose sole function was to transfer income to a related Bermuda reinsurance company in order to shed the corresponding U.S. income tax liability. As to taxpayer's beliefs, the evidence adduced at trial shows only that OPL was "not expected" to be subject to U.S. income taxation. (Jt. Ex. 6-F(4) at JK21399; Jt. Ex. 27-AA(2) at JK001909; Jt. Ex. 935-AIY at 027632, 027633; Jt. Ex. 24-X at JK002769). There is no evidence that taxpayer considered the reasonableness of its own failure to include EVC revenues in gross income for 1984, much less that its position appeared more likely than not to prevail.

[107] Thus, this case is readily distinguishable from Osteen v. Commissioner, in which this Court found "a plethora of cases" decided in taxpayers' favor on similar facts. 62 F.3d at 359. Although taxpayer here faults the Tax Court (TBR 53) for its terse statement that "[t] he authority cited by petitioner on brief does not support its position" with respect to EVCs (R 261 at 113), the factual findings and legal analysis in the opinion provide ample support for the court's determination and, therefore, fully satisfy the standard adopted by this Court in Osteen. What taxpayer calls "substantial evidence that EV premium income was earned by NUF and OPL" (TBR 54) is erroneous, irrelevant, or both. Notwithstanding taxpayer's revised tariff, its liability to shippers remained intact. Taxpayer did not "notify shippers that it had arranged insurance" for them but went to great lengths to ensure that they were unaware the NUF Policy existed. Whether NUF was "contractually bound to cover shipper's EV risks" does not determine whether the NUF/OPL arrangement was a sham. Heller, 866 F.2d at 1343 n.15 ("the regularity of a transaction under local law is often irrelevant to the question of federal tax consequences"). Even if NUF were so bound, which we do not concede, taxpayer's continuing liability to its shippers was independent of any relationship between shippers and NUF. Taxpayer's remittances of EVCs to NUF have no bearing on its liability for tax on the income so remitted, as the entire body of case law with respect to both the sham doctrine and assignment of income makes clear. A fortiori, what NUF did with the money it received from taxpayer does not affect the character of EVCs as income to taxpayer, although it reinforces the conclusion that it made no sense for NUF to transfer revenues to OPL unless the entire arrangement were a sham.

[108] Although taxpayer mentions "reasoned interpretations of the Internal Revenue Code, applicable insurance and transportation law, and controlling Supreme Court and lower court precedents" as legal support for its position (TBR 54-55), it has not shown that the facts in the cited authorities are remotely similar to those presented here. All that taxpayer achieves is to reaffirm the principle that a transaction must have economic substance and a business purpose if it is not to be treated as a sham, and to underscore that the NUF/OPL arrangement lacked both. ²²

B. SECTION 6653(a)

[109] As in effect in 1984, IRC section 6653(a) provided for additions to tax if any part of an underpayment was due to negligence or intentional disregard of rules or regulations. As taxpayer acknowledges (TBR 55), this standard is an objective one, describing a failure to do what a reasonable and ordinarily prudent person would do in similar circumstances. Goldman v. Commissioner, 39 F.3d 402, 407 (2d Cir. 1994); Marcello v. Commissioner, 380 F.2d 499, 506 (5th Cir. 1967), cert. denied, 389 U.S. 1044 (1968).

[110] Although taxpayer again relies on Treas. Reg. section1.6661-3(a)(2) in arguing that a negligence penalty cannot be imposed where there is a "reasonable basis" for the tax treatment of an item (TBR 55-56), we have already demonstrated that the record overwhelmingly supports the Tax Court's conclusion that taxpayer had no reasonable basis for its reporting position (R261 at 111-112). A prudent person would not have excluded over $99 million in revenue from gross income in blind acceptance of tax benefits promised by an insurance broker, who was neither a tax expert nor a disinterested party and who relied on taxpayer for his own information. ²³ (R197 at 189:13-190:22, 195:23-196:23; R202 at 781:9-15, 785:7-9.) See Goldman, 39 F.3d at 407 (taxpayer's reliance on offering memorandum advertising "improbable tax advantages" was sufficient for negligence finding).

[111] On appeal, taxpayer contends that the court erred in its application of law to "undisputed facts." (TBR 56.) Taxpayer misses the point (TBR 56) that in Anderson v. Commissioner, 62 F.3d 1266, 1270 (10th Cir. 1995), the "undisputed facts" pertained to the taxpayers' failure to determine whether purported tax benefits would be sustained. What taxpayer calls "undisputed facts" here are merely its own self-serving, conclusory, and erroneous restatement of the legal determination that it wanted the Tax Court to reach. To the extent that taxpayer pins its hopes of avoiding negligence penalties on the truism that the sham doctrine does not permit the Commissioner "to disregard transactions with material economic substance" (TBR 56), the Tax Court's finding that the NUF/OPL arrangement had no economic substance establishes that the additions were properly imposed.

CONCLUSION

[112] For the reasons stated above, the decision of the Tax Court is correct and should be affirmed. In the event that this Court were to reverse the Tax Court's finding that the NUF-OPL scheme was a sham and an assignment of income, the case should be remanded so that the Tax Court may address the Commissioner's alternative arguments with respect to an allocation of EVC revenue from OPL to taxpayer under IRC section 482 or section 845.

Respectfully submitted,

[113] I certify that this brief complies with the type-volume limitations set forth in Rule 32(a)(7)(B) of the Federal Rules of Appellate Procedure, Circuit Rule 32-4, and this Court's order dated August 29, 2000, permitting the appellee to file a brief of up to 17,000 words in response to the appellant's opening brief and the amicus curiae briefs. The Corel WordPerfect8 software package used to prepare this brief indicates that, exclusive of the materials that do not count toward the type-volume limitations under Circuit Rule 32-4, the brief contains 16,647 words.

ANDREA R. TEBBETS

[114] It is hereby certified that service of this brief has been made on counsel for the appellants and counsel for the amici curiae on this 18th day of October, 2000, by mailing two copies thereof in envelopes properly addressed as follows:

Shirley M. Hufstedler, Esquire

"TBR" references are to taxpayer's brief. The briefs of the amici curiae are designated as follows: "AAI" for Alliance of American Insurers (the Alliance); "ATA" for American Trucking Associations, Inc. (the Trucking Association); and "CC" for the Chamber of Commerce of the United States of America (the Chamber).

In accordance with the parties' stipulation (R147, paragraph 1.k), the term "shippers" refers to taxpayer's customers. All facts presented relate to the taxable years 1983 and 1984 unless otherwise indicated. (Id. at 1.) All figures have been rounded to the nearest whole dollar.

² The deficiency amounts and some of the additions set forth in the decision do not reflect payments previously made by taxpayer. (R268 at 1-2.)

³ The notice of appeal expressly excepts the 1983 deficiency. (R269.) The Government has not cross-appealed from the Tax Court's ruling allowing taxpayer's claimed deduction for California workers' compensation premiums (R261 at 3, 107-111).

⁴ A number of other adjustments proposed in the deficiency notice were settled by the time the Tax Court issued its opinion. (R175; R258; R261 at 1 n.2.) The 1983 deficiency did not involve EVCs. ( R1, Ex. A.)

⁵ Because the distinction between the holding company and the subsidiaries is not germane to this appeal, the term "taxpayer" as used in this brief may refer to the parent company or to one or more subsidiaries, as the context requires.

⁶ The federal tariff requirement applicable to a motor common carrier in 1983 and 1984 appeared in Section 10762(a) of the Interstate Commerce Act of 1978, 49 U.S.C.

⁷ Rohner Gehrig Co. v. Tri-State Motor Transit, 950 F.2d 1079, 1082 (5th Cir. 1992) (en banc).

⁸ The abbreviation "EVC" as used in this brief includes "value charges" received pursuant to Item 540 as well as "excess value charges" under Item 540-A.

⁹ A "front" is an arrangement whereby one insurance company allows another to use its name for a fee. (R261 at 55 n.27.)

¹⁰ At trial, Mr. Johnson did not specify the documents that he said were "needed" but not "ready to go" on August 1, and he acknowledged that there had been correspondence between taxpayer and Hall relating the postponement to the tax bill. (R197 at 227:20-25; R198, 255:16-22.)

¹¹ The record does not reflect any specific requests for the policy during 1984 either from shippers or from taxpayer's employees, who otherwise did not receive the Policy unless they were OPL shareholders. (R155, paragraphs 719, 722.)

¹² In The Plaid Giraffe, Inc. v. United Parcel Service, Inc., 1994 WL 544505 (D. Kan.), a 1994 lawsuit involving a shipper's claim for loss occurring in 1993, taxpayer relied on an affidavit by one of its account executives indicating that in June 1984 he had provided the plaintiff with the July 1983 version of the Service Explanation. (Jt. Ex. 980-AKR(2) at 100184 and Ex. 2.)

¹³ This Court applied only the de novo standard in Kirchman, 862 F.2d at 1490, because the Tax Court "itself stated that it was focusing on an issue of law, i.e., whether taxpayers' allegations, if proven, would be sufficient to achieve the tax results desired." The Tax Court did not so characterize its analysis in the present case, and hence the usual dual standard should apply.

¹⁴ Although taxpayer cites Commissioner v. First Security Bank, 405 U.S. 394, 398 (1972), and Kidde Industries, Inc. v. United States, 40 Fed. Cl. 42, 52 (1997), for the proposition that third- party claims handling does not invalidate an insurance contract for tax purposes (TBR 43-44), in those cases the taxpayers used the third parties (NUF, in Kidde) and did no claims handling themselves. Furthermore, the taxpayer in First Security "never received" any premiums or other income, 405 U.S. at 398, 402, 403; whereas taxpayer here not only conducted every aspect of the NUF/OPL arrangement, including processing and paying shippers' claims, but also received every dollar the arrangement produced (R150, paragraphs 314-321, 329).

¹⁵ Although Bruce Barone, who was treasurer of both taxpayer and OPL in 1984, suggested that OPL's catastrophic risk could be measured by multiplying the number of packages shipped by air by the $25,000 valuation limit for air shipments (R203 at 946:23-947:3) or by comparing its capital to total "premiums written" (id. at 984:14- 18), such estimates are patently preposterous. They are akin to computing a life insurance company's risk of loss on any given day as equal to the number of its policyholders multiplied by the face amount of each policy.

¹⁶ Taxpayer's assertion that differences in coverage between the NUF and AFM policies made the Tax Court's comparison of their premiums inappropriate (TBR 35) is not persuasive, because the court's point was simply that the AFM Policy provided vastly more coverage for the premium paid (R261 at 87-89).

¹⁷ The argument that IRC sections 482 and 845 are to be "preferred" over the sham and assignment of income doctrines (TBR 49- 50; CC 20-28; AAI 31-32) should be dismissed out of hand. The Tax Court found (R261 at 105 n.59) that this argument was not made below with respect to assignment of income, and hence it need not be reached here. FDIC v. Verex, 3 F.3d 391, 395 (11th Cir. 1993). As to sham, taxpayer and the amici rely principally on the same two cases distinguished by the Tax Court, Rubin v. Commissioner, 429 F.2d 650 (2d Cir. 1970), and Foglesong v. Commissioner, 621 F.2d 865 (7th Cir. 1980), on remand, 691 F.2d 848 (1982). Both cases turned on the distinction between an individual and the corporation to which he provided personal services, a factual setting entirely unlike that of the present case. Rubin, 429 F.2d at 652; Foglesong, 621 F.2d at 868. In Rubin, 429 F.2d at 654, the court expressly stated that section 482 did not preclude reliance on the sham doctrine, and in Foglesong, 621 F.2d at 871, the Tax Court had "specifically found" that the entity in question was not a sham. Taxpayer's and the Chamber's use of the phrase "blunt common-law tools" (TBR 49; CC24) cannot undermine fundamental principles of federal income taxation, and the instant appeal belies the Chamber's contention (CC 27) that the Tax Court's "methodology limits the opportunity for meaningful judicial review."

¹⁸ The principal authority on which taxpayer and the Trucking Association rely in arguing otherwise does not support the contention that taxpayer could offer a single rate. In Drug and Toilet Preparation Traffic Conference v. United States, 797 F.2d 1054, 1056 (D.C. Cir. 1986), the court upheld, under a highly deferential standard of review (id. at 1057), an ICC determination permitting a bus company to file a tariff providing for "zero released valuation" (i.e., no liability) for shipments of window glass. In making that determination, the ICC panel repeatedly stressed that the result was "limited to the unique circumstances of [the] case," including the fact that until the zero valuation was permitted, the carriers would not transport window glass at all. National Bus Traffic Ass'n, Inc., Automobile Windshields and Window Glass, 367 I.C.C. 691 (1983). Neither the court's opinion nor the ICC panel ruling in Drug and Toilet provides any support for the contrived and deliberately ambiguous rate regime adopted by taxpayer here.

¹⁹ Pertinent pleadings by taxpayer in Art Masters, Rafaella Gallery, Plaid Giraffe, and several other matters appear in the record as Jt. Exs. 943-AJG, 960-AJX, 965-AKC, 975-AKM, 980-AKR(2), and 1365-AZR.

²⁰ Another case cited by taxpayer (TBR 41), Hennigan v. Chargers Football Co., 431 F.2d 308 (5th Cir. 1970), is distinguishable from the present case in every respect and turns on the difference between "renewal" and "extension" of an employment contract.

²¹ Taxpayer's challenge to the interest addition for a tax- motivated transaction under IRC section 6621 rests on (TBR 57), and thus falls with, its argument that the NUF/OPL arrangement was not a sham.

²² Taxpayer's attempted use of a 1990 Field Service Advice (FSA) memorandum as evidence that the IRS shared its view of the transaction is futile, not least because the IRS's analysis in 1990 could not have influenced taxpayer's reporting position in 1984. See Goldstein v. Commissioner, 364 F.2d. 734, 740 (2d Cir. 1966), cert. denied, 385 U.S. 1005 (1967) (Tax Court properly rejected documents that were prepared for litigation and did not affect taxpayer's calculations at the outset). As the Alliance concedes (AAI 3 n.1), FSAs are "exploratory " and not binding. Tax Analysts v. IRS, 117 F.3d 607, 609 (D.C. Cir. 1997). The Alliance also fails to mention that the 1990 FSA recommended that the case deserved "further development" because it had "excellent potential." (Jt. Ex. 609-WK at JK002991, JK002997.)

²³ Taxpayer's sole evidence of recourse to outside tax advice was a memorandum from its accountants, Touche Ross & Co., warning its tax manager that the creation of a Bermuda reinsurance subsidiary could have "adverse tax consequences" and that the only way to know if a spinoff would avoid these results would be to request an advance ruling from the IRS. (Jt. Ex. 1078-AOL at 029126, 021930. Taxpayer's failure to follow up on such a direct caution is further evidence of its negligence.