SIXTH CIRCUIT AFFIRMS LIMITATIONS EXPIRED FOR FTC CARRYFORWARD.

This case essentially involves three discrete appeals. For that reason, we will abandon our usual practice of beginning our opinion with a generalized background section in favor of treating each issue individually, providing the necessary factual context in conjunction with our legal analysis.

The parties agree that this court reviews de novo a grant of summary judgment by the Tax Court.¹Roberts v. Comm'r, 329 F.3d 1224, 1227 (11th Cir. 2003).

In tax years 1984 and 1985, Chrysler included deductions of $567,943,243 and $297,292,155 on its federal income tax returns on the basis that it incurred those amounts as warranty expenses for motor vehicles sold in those years to its dealers. A sale generally occurred when a vehicle was delivered to the carrier for shipment to the dealer.

New vehicle warranties, which are at issue here, cover defects in material and manufacture. As Chrysler points out, state and federal laws regulate the entire warranty regime. Specifically, the Uniform Commercial Code, as adopted by virtually every state, state "lemon" laws, and the Magnuson-Moss Warranty-Federal Trade Commission Improvement Act, 15 U.S.C. §§ 2301-12 ("Magnuson-Moss"), impose warranty obligations on the seller. During the period at issue, every new vehicle sold by Chrysler was covered by a warranty. When selling a new vehicle, dealers would provide buyers with a warranty manual that explained its terms and limitations.

Chrysler offered two kinds of express warranty: a basic warranty that applied to the first 12 months or 12,000 miles, and an extended warranty that covered certain types of repairs after the basic warranty had expired. In turn, Chrysler contracted with its dealers to repair vehicles under warranty. Typically, dealers would make repairs and then seek reimbursement from the company. However, dealers were required to comply with certain agreed upon procedures to substantiate their reimbursement requests that, if not followed, could result in non-payment. By 1984 Chrysler had installed a computer system known as the Dealer Information Access Link ("DIAL"), which an increasing number of dealers used to report warranty repairs that were subject to reimbursement. DIAL made it easier for Chrysler to track and respond to warranty claims.

Chrysler engaged consultant Arthur D. Little, Inc., to calculate the amount of warranty expenses the company incurred for tax years 1984 and 1985. Chrysler uses the accrual method of accounting and a tax year based upon the calendar year. It is undisputed that the expenses incurred by Chrysler to fix conditions covered by warranty constitute "ordinary and necessary" business expenses under 26 U.S.C. § 162. During the period at issue, Chrysler accrued the entire estimated cost of its warranties in the year that it sold the vehicles to the dealers. Chrysler included this liability on its balance sheet and took it into account in the calculation of net (BOOK) income.

The Commissioner reduced Chrysler's warranty cost deduction for 1984 by $287,939,317, which had the ripple effect of increasing the company's 1985 deduction for such costs by $62,767,885.

The Tax Court framed the legal question in these terms:

Having set the legal stage, the court then examined and distinguished two Supreme Court opinions urged upon it by the parties: United States v. Hughes Prop. Inc., 476 U.S. 593 (1986), and United States v. Gen. Dynamics Corp., 481 U.S. 239 (1987). Because we agree that these cases are central to the resolution of this particular question, we find it useful to begin our discussion with reference to the construction given to them by the Tax Court:

As the decision of the Tax Court makes clear, the central issue on appeal is precisely what a taxpayer must do in order to establish liability with sufficient certainty to satisfy the first prong of the "all events test."² We would be less than candid if we did not acknowledge a degree of sympathy with Justice O'Connor's observation in General Dynamics that "[t]he circumstances of this case differ little from those in Hughes Properties." Gen. Dynamics, 481 U.S. at 248 (dissenting). However, given that the Court reached the opposite result in successive terms when faced with similar sets of facts, we must do our best to distinguish the two cases. As did the Tax Court, we see no viable way of reconciling Hughes Properties with General Dynamics other than by reading the former to stand of the proposition that "[t]he first prong of the all events test may be met when a statute has the effect of irrevocably setting aside a specific amount . . . by the close of the tax year and to be paid at a future date." Chrysler Corp. v. Comm'r, supra. The Court in General Dynamics held that the "last link in the chain of events creating liability for purposes of the 'all events test'" was the actual filing of a medical claim. Gen. Dynamics, 481 U.S. at 245. It based its reasoning on the fact that "General Dynamics was . . . liable to pay for covered medical services only if properly documented claims forms were filed." Id. at 244.

Like General Dynamics, Chrysler faces potential liability, which in its case is based upon the express and implied warranties that accompany the sale of its motor vehicles. However, that liability does not become firmly established until a valid warranty claim is submitted. As the Court explained, "Nor may a taxpayer deduct an estimated or an anticipated expense no matter how statistically certain, if it is based on events that have not occurred by the close of the taxable year." Gen. Dynamics at 243-44 (citing Brown v. Helvering, 291 U.S. 193, 201 (1934)). The court distinguished the Code's treatment of insurance companies -- allowed by 26 U.S.C.§ 832 to deduct reserves for "incurred but not reported" claims -- from its treatment of non-insurance companies restrained from deducting "claims that [are] actuarially likely but not yet reported." Id. at 246. We assume that the DIAL software made it easier for Chrysler to track and process warranty claims; it may also have assisted Arthur D. Little in calculating the cost to the company of future claims. However, even if those claims were predictable with relative accuracy, they were not actually submitted during the taxable year and therefore cannot be deducted because they remain "anticipated expenses." See id. at 245 ("Based on actuarial data, General Dynamics may have been able to make a reasonable estimate of how many claims would be filed . . . [b]ut that alone does not justify a deduction.").

In reaching this conclusion, we readily acknowledge that Chrysler has raised a number of thoughtful points. First among them is the contention that the anticipated warranty claims at issue should be analyzed with reference to the second prong of the "all events test," that is, whether "the amount of the liability can be determined with reasonable accuracy." Despite its surface appeal, this argument fails to recognize that it is not the imprecise amount of the claims that renders them nondeductible but their contingent nature. While Chrysler relies in part upon the existence of statutes, such as Magnuson-Moss, to establish the "fact" of its liability, they impose legal duties with respect to warranties but do not necessarily fix liability. Among other things, Magnuson-Moss prescribes the contents of warranties, 15 U.S.C. § 2302, and remedies available to consumers who seek to enforce their terms, 15 U.S.C. § 2310. However, simply because a manufacturer has provided a warranty to a consumer, the scope of which is defined to a some degree by statute, does not mean that liability has attached; until a claim has been filed invoking the terms of a warranty, liability remains contingent and, because of that fact, non-deductible.

The parties have cited numerous cases to us in their briefs. That we have declined to discuss them here should not be taken as a sign that they have not been fully considered. Rather, it means that, like the Tax Court, we conclude that this issue hinges upon our construction of Hughes Properties and, more importantly, General Dynamics. For the reasons just outlined, we detect no material distinction between General Dynamics and the case before us. Consequently, we affirm the judgment of the Tax Court.

On July 6, 1992, the Commissioner informed Chrysler of tax deficiencies for the years 1984 and 1985. In an attempt to reduce that liability, the company filed amended tax returns on July 24, 1995 for the years 1980 through 1985. At the time that it filed those amended returns, only years 1983 through 1985 were open for purposes of assessment of tax by the Commissioner or for a claim of credit or refund by Chrysler. Nonetheless, Chrysler sought to amend its 1980 through 1982 returns to change the foreign tax deductions to foreign tax credits, which could then be carried forward to its tax liabilities for 1984 and 1985.

In his notice of deficiency, the Commissioner advised the company that "to the extent your claims are attributable to [foreign tax credit] carryforwards from the years ended December 31, 1980, December 31, 1981, and December 31, 1982, the ten-year statute of limitations for making a timely election to claim foreign tax credit has expired and those carryforwards are not allowable." In response, Chrysler filed a petition with the Tax Court.

Three provisions of the Internal Revenue Code come into play for purposes of this appeal. The first provides as follows:

The United States Court of Claims addressed the same question that faces us some years ago, which it framed in these terms: "[W]hether in cases where there has been a carryover of foreign taxes under section 904(c), the limitations period of section 6511(d)(3)(A) commences with the date prescribed by law for filing the return for the year from which the excess foreign taxes are carried, or with the date prescribed by law for filing the return for the year to which the excess foreign taxes are carried." Ampex Corp. v. United States, 620 F.2d 853, 857 (Ct. Cl. 1980) (emphasis original). In other words, do the phrases "such taxable year" as used in § 901(a) and "year with respect to which the claim is made" as used in § 6511(d)(3)(A) mean the year in which the foreign taxes are paid and the right to claim a credit accrues? Or, do they refer to the year in which the foreign tax credit is to be applied? If the latter interpretation is correct, then Chrysler meets the 10-year limitations period because it sought in 1995 to apply the foreign tax credits to its 1985 return. If the former construction holds, then Chrysler is precluded from amending because the years in which the tax credits accrued (1980 through 1982) fall outside the limitations period.

The Tax Court reached the following conclusion:

Where, as here, the facts are undisputed and the issue is one of statutory construction, we review the judgment of the Tax Court de novo. Intermet Corp. & Subsidiaries v. Comm'r, 209 F.3d 901, 903 (6th Cir. 2000) (citing Estate of Mueller v. Comm'r, 153 F.3d 302, 304 (6th Cir. 1998)); accord Hospital Corp. of America & Subsidiaries v. Comm'r, 348 F.3d 136, 140 (6th Cir. 2003) (Tax Court interpretation of statutory provisions reviewed de novo); Limited, Inc. v. Comm'r, 286 F.3d 324, 331 (6th Cir. 2002) (legal conclusions subject to de novo review).

Chrysler reminds us that the underlying purpose of the statutory scheme governing foreign tax credits, which had its genesis in the Revenue Act of 1918, 40 Stat. 1057, is to "mitigate the evil of double taxation." Burnet v. Chicago Portrait Co., 285 U.S. 1, 7 (1932); see also Ampex Corp., 620 F.2d at 859-60 (discussing history of foreign tax credit); Hart v. United States, 585 F.2d 1025, 1029-32 (Ct. Cl. 1978) (noting inconsistencies between legislative history and language of statutes at issue). When construing a legislative enactment, we must give effect to the intent of the legislature adopting the statute in question. Broadcast Music, Inc. v. Roger Miller Music, Inc., 396 F.3d 762, 769 (6th Cir. 2005), cert. denied, 74 U.S.L.W. 3026 (U.S. Oct. 3, 2005) (No. 05-31). While statutes imposing a tax are generally construed liberally in favor of the taxpayer, Limited, 286 F.3d at 332 (citing Weingarden v. Comm'r, 825 F.2d 1027, 1029 (6th Cir. 1987)), those granting a deduction are matters of "legislative grace" and are strictly construed in favor of the government. Intermet Corp., 209 F.3d at 904 (also citing Weingarden at 1029); Burroughs Adding Mach. Co. v. Terwilliger, 135 F.2d 608, 610 (6th Cir. 1943) ("The right to the [foreign tax] credit claimed is a privilege granted by the Government, and hence the statute is to be strictly construed in favor of the Government."); but see Gentsch v. Goodyear Tire & Rubber Co., 151 F.2d 997, 1000 (6th Cir. 1945) (rejecting strict construction because "[r]elief from double taxation is not so much an act of grace as one of justice").

Turning to the task at hand, we note that legislative intent should be divined first and foremost from the plain language of the statute. Broadcast Music, 396 F.3d at 769; Limited, 286 F.3d at 332. If the "text of the statute may be read unambiguously and reasonably," our inquiry is at an end. Limited at 332; accord United States v. Boucha, 236 F.3d 768, 774 (6th Cir. 2001) ("[t]he language of the statute is the starting point for interpretation, and it should also be the ending point if the plain meaning of that language is clear") (quoting United States v. Choice, 201 F.3d 837, 840 (6th Cir. 2000)). Only when our reading results in ambiguity or leads to an unreasonable result, may we look to the legislative history. Limited at 332. Finally, we must construe a statute as a whole and, in so doing, we must strive to "interpret provisions so that other provisions in the statute are not rendered inconsistent, superfluous, or meaningless." Broadcast Music at 769.

With these precepts in mind, we turn to the statutes in question, beginning with 26 U.S.C. § 901(a), the provision generally authorizing foreign tax credits. The critical sentence reads, "Such choice for any taxable year may be made or changed at any time before the expiration of the period prescribed for making a claim for credit or refund of the tax imposed by this chapter for such taxable year." Chrysler concedes that the initial reference to "any taxable" year means the year in which the initial election was made. Like the Tax Court, we agree that the subsequent modifier "such" must refer to something already alluded to -- in this case the year in which the taxpayer elected to claim a foreign tax credit.

If § 901(a) existed in isolation, that would end the matter. However, as mentioned earlier, it is undisputed that the "period prescribed for making a claim for credit or refund" incorporates the limitations period set forth in 26 U.S.C. § 6511(d)(3)(A). That provision establishes a ten-year window for the taxpayer to claim a credit "for the year with respect to which the claim is made." In our view, the most reasonable reading of these two statutes is that the "such taxable year" of § 901(a) and the "year with respect to which the claim is made" of § 6511(d)(3)(A) refer to the same year: the year in which the taxpayer first made its election whether to claim a foreign tax credit. We recognize that the Court of Claims has reached a different conclusion. Ampex, 620 F.2d at 858 ("[I]f the time of the commencement of the limitations period of section 6511(d)(3)(A) is to be determined solely on the basis of the language of that section, the limitations period begins to run on the date prescribed by law for filing the return for the year for which a refund is sought."). In our view, however, nothing in the language of § 6511(d)(3)(A) alters our initial reading of § 901(a), which fixes the year in question as the year of election. All that § 6511(d)(3)(A) provides to the taxpayer is a longer limitations period for altering its election of a foreign tax credit than the three-year limitations period prescribed by § 6511(a). The touchstone for triggering the statute of limitations remains the original year of election.

Lastly, we must consider whether § 904(c), which authorizes a taxpayer to either carry over or carry back its application of a foreign tax credit, affects our analysis. We conclude that it does not. Section 904(c) simply enhances the ability of taxpayers to take full advantage of their foreign tax credits by allowing them to apply credits that cannot be used in the year of election to other years within a prescribed range. If, as in Chrysler's case, the taxpayer did not pay enough taxes to the United States to make full use of its foreign tax credit in the year of election, § 904(c) provides an additional seven-year period to do so. Under those conditions, the Internal Revenue Code allows the taxpayer to "deem" the foreign taxes paid in a year other than the one in which they were actually paid. We see nothing in the language of § 904(c), however, to suggest that the ten-year limitations period of § 6511(d)(3)(A) refers to the year that the foreign tax is "deemed" paid. To the contrary, when read together, the three statutory provisions set forth an unambiguous scheme for claiming and taking foreign tax credits. Section 901(a) requires the taxpayer to elect to take -- or decline to take -- a foreign tax credit in the year the foreign tax is paid. Section 6511(d)(3)(A) then allows the taxpayer a ten-year period from this initial election to amend its election. Finally, § 904(c) provides a way to increase the likelihood that a taxpayer can take full use of its foreign tax credits by either carrying back or carrying forward unused credits to other tax years. However, it has no effect on the ten-year limitations period, which runs from the tax year that the foreign tax was actually paid and the credit accrued.

Because the statutes at issue may be read "unambiguously and reasonably," Limited, 286 F.3d at 332, we need not resort to legislative history. As the Court of Claims has noted, "the normal understanding of the bare language that is entitled to prevail does not necessarily exclude all possibility of an alternative reading that refined and subtle legal analysis might invent." Hart, 585 F.2d at 1028 (punctuation altered). Moreover, as Hart, Ampex, and the parties themselves concede, the legislative history accompanying these statutes is often inconsistent and not overly enlightening. See, e.g., Hart, 585 F.2d at 1030.

Before concluding, we will take a moment to mention four considerations that lend additional support to our reading of the statutes. First, we agree with Chrysler that Congress permits the use of foreign tax credits in order to allow taxpayers to avoid double taxation. However, Chrysler did not come away empty-handed because it initially elected not to take foreign tax credits for the years in question; it claimed deductions based upon those foreign taxes and, presumably, there were valid accounting reasons for its choice. That it was dilatory in seeking to amend its returns in order to claim foreign tax credits for the years in dispute does not alter the fact that it received some tax benefit for foreign taxes paid. Second, that Congress passed "clarifying" language to the phrase of § 6511 in dispute -- prospectively amending "for the year with respect to which the claim is made" to "for the year in which such taxes were actually paid" -- suggests that our reading is correct. See footnote 3, supra. Third, our reading avoids the uncertainty that would attend Chrysler's interpretation, which could lead to a shorter or longer limitations period depending on the unique fiscal circumstances of the taxpayer.⁴ And, fourth, we are obliged to strictly construe statutes that grant a deduction to a taxpayer in favor of the government. Weingarden, 825 F.2d at 1029.

For the foregoing reasons, we affirm the judgment of the Tax Court, and hold that the tenyear statute of limitations period of § 6511(d)(3)(A) "begins with the date prescribed by law for filing the return for the year from which the excess foreign taxes are carried." Ampex, 620 F.2d at 857.

The facts giving rise to this dispute are relatively straightforward and were summarized by the Tax Court as follows:

Chrysler does not dispute any of the statements made by the Tax Court. However, referring to a declaration of its assistant treasurer (and later vice-president) Robert S. Miller, the company avers that the termination of the ESOP was union-driven. Specifically, as part of the collective bargaining negotiations of 1985, the two sides agreed that the ESOP would be liquidated. The company takes the position that the deduction of $327,595,421 that it made in 1985 in relation to the termination of the ESOP was properly characterized as "compensation" and therefore was deductible under 26 U.S.C. § 162(a). In its view, the LGA obliged Chrysler to establish the ESOP as a means of compensating its employees for the wages and benefits that they relinquished in order to satisfy the terms of the LGA. This position is strengthened by the fact that the union requested the liquidation of the ESOP.

Although the Tax Court's rationale with respect to the details of Chrysler's claim will be discussed in conjunction with the arguments of the parties, it provided the following statement of the core issue, which is worth quoting at the outset:

As with the issues previously discussed, we review the Tax Court's partial grant of summary judgment to the Commissioner de novo. See Tele-Commc'ns, Inc. v. Comm'r, 104 F.3d 1229, 1232 (10th Cir. 1997).

It is undisputed that, as a general rule, "ordinary and necessary" expenses are deductible while capital expenditures are not. 26 U.S.C. §§ 162(a) (ordinary expenses), 263 (capital expenses). As the Court has put it, "If an expense is capital, it cannot be deducted as 'ordinary and necessary,' either as a business expense under § 162 of the Code or as an expense of 'management, conservation, or maintenance' under § 212." Woodward, 397 U.S. at 575.

The Tax Court quoted the origin of the claim test adopted by Gilmore, supra, and the parties agree that it applies to the issue before us. Chrysler argues that the Tax Court failed to apply the test correctly. The company then refers us to a Ninth Circuit decision that explains the proper approach as follows:

Chrysler also relies upon facts, especially those contained in the Miller declaration referenced earlier, that the company believes support its view -- or at the very least require a trial. These contentions, which it argues the Tax Court overlooked, include testimony that 1) it was foreseeable that the union would terminate the ESOP if Chrysler regained its financial strength; 2) the union preferred cash compensation to ESOP shares; 3) termination of the ESOP put the company closer to its position prior to the enactment of the LGA; and, 4) Chrysler did not financially benefit from the ESOP.

Just as it contends the Tax Court misconstrued the origin of the claim, so, too, Chrysler argues that the court mistook the character of the claim, which it states was "compensation, pure and simple." In support it cites Wells Fargo & Co. v. Comm'r, 224 F.3d 874 (8th Cir. 2000), which involved amounts paid to cancel employee stock options in connection with an acquisition. Despite the fact that this would appear to be a capital expense, part of the deduction was allowed on the theory that the origin of the payments was not the acquisition but the employment relationship between the company and the option holders. Id. at 887 (explaining distinction between benefit directly related to acquisition, which is typically capitalized, and an indirect relationship between salaries originating from employment relationship and acquisition).

As the Commissioner points out in response, however, the employees here did not receive a premium upon redemption because Chrysler paid the fair market value of its stock. In other words, the ESOP would have received the same amount had it simply sold the shares on the open market. Furthermore, not all employees chose to receive cash in lieu of stock upon the termination of the ESOP. That some employees remained shareholders in essentially the same financial position as before the liquidation of the ESOP highlights the non-compensatory nature of the redemption. Those employees who elected to receive stock distributions had made the same wage and benefit concessions as those receiving cash distributions, but received no part of the amounts that taxpayer now seeks to deduct. If, instead of compensating its employees with ESOP stock, Chrysler had compensated them in cash that they subsequently invested in Chrysler's stock, the company could not deduct the appreciated value of that stock as compensation if it ultimately redeemed the stock.

In Harder Servs., Inc. v. Comm'r, 67 T.C. 585 (1976), a corporation redeemed an employee's stock when it terminated him and attempted to deduct the $100,677 redemption cost. The Tax Court refused to allow the amount to be deducted as compensation, rather than as a capital expense, in part because "there is nothing in the record to indicate that [the employee] would have been paid anything with respect to the termination of his employment had he wished to retain his 22 shares of Harder Tree thereafter." Id. at 597.

The Commissioner also distinguishes Wells Fargo, supra. He cites with approval the statement from that case, "the ultimate question is whether the expense is directly related to the transaction which provides the long term benefit." Wells Fargo, 224 F.3d at 886. According to the Commissioner, the flaw in Chrysler's argument is its attempt to portray its contribution of stock to the ESOP and its later redemption of the stock as one claim. While Chrysler's stock contributions to the ESOP were compensatory in nature, its agreement with the UAW to terminate the ESOP and to redeem the shares of those participating employees who chose to take cash in lieu of shares represented a distinct, non-compensatory transaction that was not compelled by either the LGA or the terms of the ESOP. Thus, the costs incurred were "directly related" to the stock redemption, but only tangentially related to the LGA and to the establishment and funding of the ESOP.

We conclude that the Tax Court correctly characterized the nature of the stock redemption as non-compensatory. Although the redemption may have been "in consideration of wage and benefit concessions," the company deducted the cost of those benefits as they were incurred in the years leading up to the liquidation of the ESOP. At the time of redemption, it simply paid the employees fair market value for their shares. Under these circumstances, the Tax Court correctly held that Chrysler could not deduct its redemption-related expenses as compensation.

² "The taxpayer has the burden of proving its entitlement to a deduction." Gen. Dynamics, 481 U.S. at 245 (citing Helvering v. Taylor, 293 U.S. 507, 514 (1935)).

³ We note that, while this version of the statute applies to the instant appeal, it was amended by Congress in 1997 so that the highlighted language now provides, "for filing the return for the year in which such taxes were actually paid or accrued." Taxpayer Relief Act of 1997, Pub. L. No. 105-34, 111 Stat. 788, 945.

⁴ As the Court of Claims observed, however, even under our interpretation, the limitations period could be increased to as much as twelve years in which a taxpayer sought to carry back foreign tax credits as provided in § 904(c). Ampex, 620 F.2d at 860 n.10.