                          T.C. Memo. 1997-160



                     UNITED STATES TAX COURT



    STEVEDORING SERVICES OF AMERICA, INC. AND SUBSIDIARIES,
Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 13399-95.                       Filed March 31, 1997.



     P. Bruce Wright, George R. Abramowitz, and Diana E. Buckley,

for petitioners.

     Terri A. Merriam and Keith G. Medleau, for respondent.



                          MEMORANDUM OPINION

     COHEN, Chief Judge:     Respondent determined a deficiency in

petitioners' Federal income tax of $2,018,147 for the fiscal year

ended January 26, 1990.

     The issue for decision is whether, upon disaffiliation from

Hanseatic Eastern Insurance Company (Bermuda), Ltd. (Hanseatic)
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and Eagle Pacific Insurance Company (Eagle), petitioners are

entitled to an insurance premium deduction in the fiscal year

ended January 26, 1990, for payments made to Hanseatic in the

fiscal years ended 1977 through 1985 and to Eagle in the fiscal

years ended 1986 and 1987, in excess of deductions previously

allowed for Longshoremen's and Harbor Workers' Compensation Act

Amendments of 1984 (LHW Act), Pub. L. 98-426, 98 Stat. 1639, 33

U.S.C. sec. 901 (1994), claims paid.

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year in issue, and

all Rule references are to Tax Court Rules of Practice and

Procedure.

Background

     The material facts have been stipulated, and the stipulated

facts are incorporated herein by this reference.   The parties

have stipulated to the detail and characterization of various

contracts entered into during years prior to the one in issue.

Because those details are not disputed and do not affect our

analysis of the issue for decision, we have not burdened this

opinion with them.

     At the time the petition was filed, the principal place of

business of Stevedoring Services of America, Inc. (Stevedoring),

was Seattle, Washington.   Stevedoring and its wholly owned

subsidiaries primarily engage in stevedoring operations.

Stevedoring and its includable subsidiaries (petitioners) filed a
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consolidated Federal income tax return for the tax year that

began April 5, 1989, and ended January 26, 1990.

     Prior to April 5, 1989, petitioners were wholly owned

subsidiaries of Services Group of America, Inc. (Services Group).

Services Group and its subsidiaries filed consolidated Federal

income tax returns.   Prior to April 5, 1989, there were a number

of restructurings within the Services Group corporate entities

and renamings of various corporations.   In addition to

stevedoring operations, prior to April 5, 1989, Services Group

engaged in wholesale food distribution and the insurance business

through separate wholly owned subsidiaries.

     On April 4, 1989, the Services Group entities were divided

in a tax-free transaction pursuant to section 355 (the splitup).

Prior to the splitup, Services Group was owned equally by two

shareholders, FRS Capital Corporation (FRS) and Thomas Stewart

(Stewart).   In settlement of a shareholder dispute, FRS

relinquished its 50-percent stock interest in Services Group in

exchange for all of the stock of Stevedoring.   Petitioners

carried on all of the stevedoring operations of the former

Services Group entities.   Petitioners' ownership affiliation with

the food services and insurance operations of the former Services

Group entities terminated on the effective date of the splitup.

As part of the splitup, Stewart received the insurance group and

the wholesale food operations of the former Services Group

entities. In the splitup, the stock and other consideration
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received by FRS had a fair market value that was approximately

equal to the fair market value of the Services Group stock

surrendered by FRS.

     Hanseatic was incorporated in Bermuda on April 10, 1974.    As

of April 10, 1974, Hanseatic was equally owned by Seattle

Stevedore Co. (a predecessor of Services Group) and Marukyo

Company, Ltd. (Marukyo).   On June 30, 1978, Seattle Stevedore Co.

purchased all of Marukyo's interest in Hanseatic.

     From 1975 through December 31, 1984, Services Group's

stevedoring affiliates contracted with Martin Re-Insurance

Company and its successor Manhattan Re-Insurance Company (Martin

will be used to refer to Martin and/or Manhattan where

appropriate) concerning their LHW Act risks.   The LHW Act risks

encompass an employer's liability, under the LHW Act, to pay

workers' compensation benefits (including medical, income

replacement, death and survivors, and employee rehabilitation

benefits) in respect of injured employees covered by the LHW Act

(generally stevedores and longshoremen).   Martin then contracted

with Hanseatic to pass on 100 percent of the risks.   Martin was a

licensed U.S. insurance company that was unrelated to Services

Group.

     From 1974 into 1984, Hanseatic entered into various other

insurance and reinsurance contracts with related and unrelated

companies with respect to risks of Services Group's stevedoring

affiliates.   Hanseatic ceased accepting new risks of Services
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Group's stevedoring affiliates at the end of December 1984.

Hanseatic continued to be responsible for all risks that it

assumed under contracts that it issued for prior years.

     Norwesco Insurance Company Limited (Norwesco) was

incorporated in Bermuda on September 14, 1979.   On the date of

incorporation, Norwesco was wholly owned by Brady-Hamilton

Stevedore Company (Brady-Hamilton), a stevedoring company that

was then unrelated by ownership to Seattle Stevedore Co.     On

November 9, 1979, Seattle Stevedore Co. purchased a 50-percent

interest in Norwesco.   On November 15, 1982, Seattle Stevedore

Co. purchased Brady-Hamilton.   Also on November 15, 1982,

Norwesco merged its portfolio into Hanseatic, and, shortly

thereafter, Norwesco liquidated.

     On June 30, 1983, Services Group acquired Crescent Wharf and

its subsidiaries.   Crescent Wharf had formed Executive Insurance

Company (Executive) in Bermuda in 1980.   Crescent Wharf

contracted with Insurance Company of North America (INA), a

licensed U.S. insurance company, concerning Crescent Wharf's LHW

Act risks.   INA then contracted with Executive to pass on 100

percent of the risks.   Effective January 1, 1984, Executive

entered into a portfolio transfer agreement with Hanseatic.

     Eagle was incorporated in the State of Washington on June 7,

1978.   On August 6, 1982, Seattle Stevedore Co. purchased a 100-

percent interest in Eagle.   On January 1, 1985, Services Group

contributed all of Hanseatic's stock to Eagle.   During the years
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relevant to this case, Eagle held licenses to conduct the

insurance business in the States of Washington and Alaska.

     Beginning on January 1, 1985, and through the subsequent

years relevant to this case, the stevedoring affiliates of

Services Group insured their LHW Act risks with Eagle on a direct

basis.   After the splitup, Eagle continued to insure all of

petitioners' LHW Act risks.   In the fiscal years ended

January 31, 1986, and January 30, 1987, Eagle received

approximately 29 percent and 41 percent, respectively, of its

premiums from unrelated insureds.   The transactions among

Services Group and its subsidiaries and Eagle that were not

treated as insurance for tax purposes in 1985 through 1987 would

have been treated as insurance transactions in those years if the

transactions had been entered into with nonaffiliated parties.

Audit History

     Services Group and its affiliates claimed deductions for

payments, directly or indirectly, to Hanseatic, Norwesco,

Executive, and Eagle as insurance premiums under section 162 in

the years paid.   Services Group and its subsidiaries were audited

for each of its fiscal years ended January 31, 1977, through

January 25, 1987, except the fiscal year ended January 25, 1980.

As a result of the audits, respondent proposed to disallow

insurance premium deductions for payments made in those years

directly or indirectly to Hanseatic, Norwesco, Executive, and

Eagle.
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     Services Group filed a petition in this Court for its fiscal

years ended January 31, 1977; January 31, 1978; and January 31,

1979.   One of the contested issues was the deductibility of the

Hanseatic payments.   The case was resolved by a Stipulation of

Settlement dated September 24, 1986.   The Internal Revenue

Service (IRS) and Services Group resolved the proposed

disallowance of premium deductions for the fiscal years ended

January 30, 1981; January 29, 1982; January 28, 1983; January 27,

1984; and January 25, 1985, on terms similar to the Stipulation

of Settlement dated September 24, 1986.

     The IRS audited Crescent Wharf's 1982 income tax return and

disallowed claimed insurance premium deductions made to Executive

through INA.   The case was settled on terms similar to the

Hanseatic settlement.   The parties resolved the proposed

disallowance of premium deductions for the fiscal years ended

January 31, 1986, and January 30, 1987, by agreeing to treat 75

percent of the arrangements with Eagle as insurance for tax

purposes and, therefore, to allow 75 percent of the payments to

Eagle in each year as deductible insurance premiums in the year

paid.   The remaining 25 percent was disallowed insurance

treatment.

     The amounts disallowed as insurance deductions in years

prior to the year ended January 26, 1990, were treated as capital

contributions to Hanseatic and Eagle, respectively.
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     As a result of the splitup of the Services Group entities in

April 1989, Hanseatic and Eagle became disaffiliated with

petitioners, although Hanseatic and Eagle each remained liable

for losses under the terms of the contracts they previously

entered and assumed that covered the LHW Act losses of

petitioners.

     In its consolidated Federal income tax return for its fiscal

year that began April 5, 1989, and ended January 26, 1990,

Stevedoring claimed a deduction in the amount of $6,458,916 in

respect of the portions of transactions that were not treated

previously as insurance for tax purposes in connection with

contracts entered or assumed by Hanseatic.   Respondent disallowed

the deduction claimed except for $532,432 that respondent allowed

as a deduction with respect to LHW Act losses and expenses

accrued in petitioners' fiscal year ended January 26, 1990.

     In a claim for refund of income taxes that Stevedoring made

for the fiscal year ended January 26, 1990, Stevedoring claimed a

deduction in the amount of $3,590,614 in respect of the portions

of the transactions between Services Group and Eagle that were

not treated as insurance for tax purposes prior to disaffiliation

from Eagle, and Stevedoring sought a refund of income taxes in

the amount of $1,220,809.   On March 23, 1995, the IRS Appeals

Office at Seattle, Washington, mailed to Stevedoring a notice of

partial disallowance of the claim for refund.   The amount of

refund that was disallowed was $1,097,216.
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Discussion

     Petitioners bear the burden of proving their entitlement to

the claimed deductions.   Rule 142(a); INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992); Rockwell v. Commissioner,

512 F.2d 882, 886 (9th Cir. 1975), affg. T.C. Memo. 1972-133.

"[A] taxpayer seeking a deduction must be able to point to an

applicable statute and show that * * * [the taxpayer] comes

within its terms."   New Colonial Ice Co. v. Helvering, 292 U.S.

435, 440 (1934).

     Petitioners have advanced numerous arguments in support of

their position that the splitup resulted in a deduction under

section 162 for insurance expenses.      They have cited no authority

that supports their arguments.    They have ignored the language

and fundamentals of section 162(a):      "There shall be allowed as a

deduction all the ordinary and necessary expenses paid or

incurred during the taxable year in carrying on any trade or

business."   Emphasis added.   The disputed deduction claimed by

petitioners does not include any payments that were made or

expenses accrued in the year ended January 26, 1990.     The claimed

deduction did not arise out of new contracts entered during the

year ended January 26, 1990.    Instead, petitioners ask us to

"deem" an insurance premium payment as a result of the section

355 splitup.

     With respect to every item of expense that is claimed as a

deduction under section 162, a taxpayer must establish:     (1) That
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the expense was paid or incurred; (2) that it was paid or

incurred during the taxable year in issue; (3) that it was paid

or incurred in carrying on a trade or business; and (4) that the

expense was ordinary and necessary.      Sec. 162; sec. 1.162-1,

Income Tax Regs.   Petitioners did not pay or incur any additional

insurance expenses in the year ended January 26, 1990.      All of

the claimed amounts were paid in years prior to the year ended

January 26, 1990, with regard to insurance contracts entered into

and in effect in those prior years.      See sec. 461(a).

Petitioners made no economic outlay and incurred no liability in

the year ended January 26, 1990, that would give rise to a

deduction.   Therefore, no deduction is allowed under section

162(a).

     Both parties have argued at length about whether or not

certain of the transactions entered into by petitioners and

Hanseatic and Eagle, respectively, were "insurance" for tax

purposes.    We need not decide whether the transactions

constituted insurance because nothing occurred in the year ended

January 26, 1990, that would entitle petitioners to a deduction

even if the transactions were "insurance".

     Petitioners have also argued that, in order to portray the

economic realities of the splitup, a deduction must be allowed.

Disallowance of the claimed deduction, however, reflects the

following economic realities:     Petitioners previously made

payments to related insurance companies for which deductions were
                              - 11 -

denied, at least in part.   The amounts disallowed were treated as

capital contributions to the related insurance companies and

increased the equity value of the related insurance companies.

Petitioners and the related insurance companies subsequently

became disaffiliated in a reorganization involving Services Group

stock.   The value of the Services Group stock reflected the value

of Eagle (successor to Hanseatic).     The stock and other

consideration received by FRS in the splitup had a fair market

value that was approximately equal to the fair market value of

the Services Group stock surrendered by FRS.

     Petitioners contend that "The consideration for the transfer

of risks to Hanseatic and Eagle upon disaffiliation was as an

economic matter separate from the stock exchanged in the arm's-

length disaffiliation transaction."     No evidence has been

presented by petitioners to support their contention, and there

is no basis for a negative allocation of consideration to

"transfer of risks".

     We have considered petitioners' other arguments and have

determined that they are also without merit.

     To reflect the foregoing,

                                           Decision will be entered

                                      for respondent.
