UNITED STATES OF AMERICA, on       ) 
 behalf of its agency, the INTERNAL )     No. A92-713 Civil  
 REVENUE SERVICE,                   )       (Consolidated) 
                                    ) 
                 Appellant and      ) 
                 Cross-Appellee,    ) 
                                    ) 
              vs.                   ) 
                                    ) 
 CHUGACH ALASKA CORPORATION,        )         ORDER 
                                    ) 
                 Appellee and       )       (Decision on 
                 Cross-Appellant.   )           Appeal) 
 ___________________________________) 

The United States, through its agency the Internal Revenue Service (IRS), filed claims against Chugach Alaska Corporation (Chugach) in Chugach's Chapter 11 bankruptcy proceeding. The Bankruptcy Court for the District of Alaska issued a final judgment on October 1, 1992. (Joint Appendix to Opening       3 ABR 206  Briefs (JA), attached to Chugach's opening brief, Clerks Docket No. 14, at 65). Both the IRS and Chugach have appealed portions of that judgment. The appeals were timely and this court has jurisdiction over this core proceeding. Federal Rule of Bankruptcy Practice 9006; 28 U.S.C. § 158(a).

Chugach is an Alaska Native Corporation formed under the provisions of the Alaska Native Claims Settlement Act (ANCSA). As an ANCSA corporation, Chugach was entitled to receive lands in Alaska from the federal government in settlement of the Natives' aboriginal claims. After several years of delay, Chugach received certain tracts of land in 1983 and 1984. In 1986 and 1987 Chugach sold several of these tracts of land. One tract, the Bering River coal field, contained undeveloped mineral deposits, while other tracts contained stands of timber on Montague and Knight Islands. Although Chugach valued the Bering River coal field at approximately $125 million on its 1987 federal tax return, Chugach sold it for only $400,000; the result was a $124.6 million tax loss. Similarly, Chugach valued the timber holdings at over $36 million but they were sold for $2.3 million. Chugach therefore claimed combined losses from these sales of approximately $158.3 million on its 1987 return.

The IRS contested Chugach's valuation of these properties in the bankruptcy proceeding. The parties later stipulated that the value of properties was $110.7 million and that therefore the       3 ABR 207  sale of those properties generated losses of approximately $108 million.

Generally, a corporation that experiences a net operating loss (NOL) in one year may deduct the loss over several years. Section 172 of the tax code allows a corporation to take advantage of NOLs over a period of time by carrying the losses forward 15 years or backward 3 years, until all of the loss is deducted. When a loss is carried back to previous years, the taxpayer files an amended return for that year in which he recalculates his tax liability with the new deduction included. Memorandum Regarding Tax Liability, JA, at 47, quoting Landmark, Inc. v. U.S., 25 Cl. Ct. 100 (1992). The result of carrying a NOL back to a previous year is usually a refund for the taxpayer. Chugach's Opening Brief, Clerk's Docket No. 14, at 23 n. 18.

The disputes in this case center on the tax treatment that should be given to Chugach's NOLs. This treatment involves the interpretation and application of special legislation passed for the benefit of ANCSA corporations.

In 1984, Congress decided to aid financially strapped Native Corporations by, in effect, allowing the Native Corporations to sell their NOLs to profitable corporations. The 1984 legislation allowed profitable corporations to file consolidated income tax returns with Native Corporations. Corporations satisfying a statutory test of common ownership, known as an       3 ABR 208  "affiliated group", may file a consolidated return in which all the corporations are treated as a single taxable entity. 26 U.S.C. § 1501-1552. Under this scheme, the NOLs of one member of the affiliated group may offset the taxable income of other member with the result that the group has reduced liability.

Prior to 1984, section 1504 of the Internal Revenue Code defined the term "affiliated group" in a way that tempted some corporations that held losses that were otherwise unusable to form ventures with profitable corporations merely for the purpose of using those tax losses. The IRS fought this practice on several grounds. Sections 269 and 482 of the Internal Revenue Code permit the IRS to disallow certain deductions or allocate income in order to prevent evasion of taxes. In addition, the IRS used the principle of "assignment of income" to defeat these sham transactions. The assignment of income doctrine is that taxes are to be paid by the person or entity that earns the income, and taxes may not be avoided by transferring the income to another person. Lucas v. Earl, 281 U.S. 111 (1930).

In order to prevent further abuses, the 1984 legislation amended the definition of "affiliated group" in such a way that the selling of NOLs were limited. However, Congress specifically excepted Alaska Native Corporations from this restrictive       3 ABR 209  definition, thereby allowing them to continue to file consolidated returns.⁽¹⁾

By 1986 it was clear that merely excepting ANCSA corporations from the restrictive definition of the groups allowed to file consolidated returns was not enough to provide the ANCSA corporations with the necessary financial relief. The ANCSA corporations sought and received further legislation. Congress included the following amendment in the Tax Reform Act of 1986:

Subsection (b) of section 60 of the Tax Reform Act of 1984 is amended by striking out paragraph (5) and inserting in lieu thereof the following new paragraphs:

          • • • • 

(B) Except as provided in subparagraph (C), during the period described in subparagraph (A), no provision of the Internal Revenue Code of 1986 (including sections 269 and 482) or principle of law shall apply to deny the benefit or use of losses incurred or credits earned by a corporation described in subparagraph (A) to the affiliated group of       3 ABR 210  which the Native Corporation is the common parent.

In 1987 Chugach filed a consolidated return with Winn-Dixie Stores, Inc. (WD) and Waste Management, Inc. (WMI). Both WD and WMI had shown substantial profits in 1987. Chugach entered into contracts with both under which Chugach sold them approximately $141 million of NOLs for 31 cents on the dollar. WD and WMI in turn assigned approximately $140 million of their income to Chugach. When the IRS and Chugach stipulated that Chugach's NOL's for 1987 were considerably less, the result was that WMI and WD had "overassigned" approximately $40 million of income to Chugach. In addition, in 1990 Chugach sold another tract of land which resulted in a NOL of approximately $23 million in that year.⁽²⁾

The IRS argued to the bankruptcy court that the assignment of income doctrine required that all of the $40 million overassignment should "spring back" to WMI, the entity that earned the income. Chugach, on the other hand, argued that it should be allowed to carry back the $23 million of NOLs from 1990 to offset an equal amount of income on the consolidated 1987 return. The Bankruptcy Court agreed with Chugach and concluded that Chugach       3 ABR 211  could carryback the NOL it suffered in 1990 to its 1987 return. Memorandum Regarding Tax Liability and Objection to Claim, May 4, 1992, JA, at 43. The IRS has appealed this ruling.

Thus, the first of the two issues before this court is whether Chugach should be permitted to carryback its 1990 losses to be used against the 1987 assigned income. This is a question of law that this court reviews de novo. In re New England Fish Co., 749 F.2d 1277, 1280 (9th Cir. 1984).

The IRS's main argument focuses on the following language of the amendment: "no provision of the Internal Revenue Code ... or principle of law shall apply to deny the benefit or use of losses incurred . . . by a [Native Corporation]. . . . "Tax Reform Act of 1986, § 1804 (emphasis added). The IRS contends that the term "losses incurred" was written in the past tense in order to prohibit the sale of future losses. It argues that a loss in 1990 is not "incurred" in 1987, and therefore is not protected by the admonition that the IRS may not use any principle of law, such as the assignment of income doctrine, to deny Chugach the benefit of its losses. The IRS cites authority for the proposition that when the meaning of a statute is plain on its face, a court must follow such meaning and should not resort to extrinsic sources such as legislative history. The sum of the IRS's position is that losses incurred by Chugach before or during 1987 can be deducted in that year, but losses occurring after 1987 can not be carried back.

The Bankruptcy court's analysis of the "losses incurred" language is based on section 172 of the Internal Revenue Code, which allows carrybacks of NOLs. It provides in part:

Except as otherwise provided in this paragraph, a net operating loss for any taxable year --

(i) shall be a net operating loss carryback to each of the 3 taxable years preceding the taxable year of such loss . . .
. . .The entire amount of the net operating loss for any taxable year. . . shall be carried to the earliest of the taxable years to which . . . such loss may be carried.

The IRS complains that the bankruptcy court erroneously defined "losses incurred" to include the entire § 172 NOL deduction provision. It argues that defining the term in this way results in difficult systemic consequences. First, it contends that under the bankruptcy court's analysis, one could not compute the 1987 tax liability of either Chugach or WMI until all three potential carryback years have been resolved. This runs counter to the system of annual tax accounting, which states that taxes are to be imposed on the net result of all events occurring within each particular taxable period, even though related events producing a different aggregate result might occur in a later year. Burnet v. Sanford & Brooks Co., 282 U.S. 359 (1931).

In adddition, the statute of limitations on making assessments is three years. 26 U.S.C. § 6501(a). The IRS argues that it makes no sense to wait until after the statute of limitations has passed before being able to determine the amount of a tax assessment to make against the profitable corporations. The IRS objects that the effect of the bankruptcy court's analysis is to inject a three year period of uncertainty into the audit process.

Chugach counters that the NOL deduction authorized in section 172 is just as much a distortion of the annual accounting principle when it is comprised on carryforwards as when it is comprised of carrybacks. In either case, the taxpayer is permitted to move deductions from one period to another, effecting a type of income averaging in violation of the annual accounting requirements generally imposed. Furthermore, Chugach contends that the IRS's concern over the administration of the limitations period is unfounded. Chugach states that if a taxpayer will not consent to extend the statute of limitations to permit the IRS to conclude its audit, the IRS will simply issue a conservatively calculated notice of deficiency to the taxpayer, effectively preserving its position.

The court agrees with Chugach. The assignment of income doctrine is clearly a principle of law, with which the IRS attempts to limit Chugach's use of its NOLs. The IRS's contention that a ruling that allows Chugach to carry back its 1990 NOLs to 1987 will run counter to the annual accounting principle is unpersuasive. Even if this ruling does create logistical difficulties for the IRS, those difficulties have no bearing on the meaning of the amendment, which prohibits the application of any principle of law to deny a Native Corporation the use of its NOLs. Also, as Chugach ably points out, the IRS has means of protecting itself during disputes with taxpayers.

In addition, the IRS's argument regarding the tense of the phrase "losses incurred" is less persuasive than Chugach's observation that the word "incurred" in this context should be read as part of the phrase "incurred . . . by a [Native] Corporation", which modifies the word "losses", and does not impart a temporal limitation on when the losses may be incurred. In sum, the bankruptcy court's conclusion that Chugach may carryback its losses from 1990 to offset income assigned from WMI in 1987 is affirmed.

The second issue in this case involves the application of the Alternative Minimum Tax (AMT) provisions of the Internal Revenue Code to Chugach's sale of its NOLs. In general, the AMT works virtually as a second tax system paralleling the regular corporate tax. A corporation computes its regular tax liability and also computes its AMT using special rules which apply to that computation. The corporation pays as its tax the higher amount.

In computing its regular tax liability, a corporation may offset its total income with its NOL deduction under section 172. If the NOL deduction is great enough, the income will be totally offset and there will be no tax liability. However, Congress defined the AMT NOL deduction as no more than 90 percent of the AMT income. Thus, the AMT NOL deduction may never offset more than 90 percent of ANT income. Unlike the regular tax system where income can be completely eliminated by section 172 deductions, AMT income can never be completely eliminated by the AMT NOL deduction.

Chugach contends it should be permitted to retain sufficient excess assigned income from the profitable corporations so that it may use 100% of its NOLs in computation of the AMT or, alternatively, that it should be permitted to use 100% of its NOLs in computing AMT in spite of the 90% limitation contained in § 56(d).

This court concludes that by failing to address Chugach's first position - that it should be permitted to retain sufficient assigned income to make use of all of its NOLs - the bankruptcy court erred. Chugach makes clear in its appellate brief that it does not contend that it is exempt from the operation of the AMT provisions. The issue before this court is whether Chugach's AMT income may be defined in such a way that no ANT liability arises for the year in question. This issue was not reached by the bankruptcy court.

Chugach argues that under the bankruptcy court's analysis the IRS may use the assignment of income doctrine (under which all overassigned income springs back to the profitable corporations) to prevent Chugach's use and benefit of its losses in the AMT system. This approach protects Chugach's use and benefit of its losses under the regular tax, system but not under the ANT system. Chugach argues that nothing in the special legislation condones disparate treatment under the two systems. Thus, Chugach should be allowed to retain enough of the overassigned income so that it may deduct all of its available NOLs on its 1987 return.

The IRS defends the bankruptcy cour's decision mainly by arguing that Chugach is not exempt from the AMT provisions, and that Chugach must not be allowed to circumvent the 90% limitation on deductibility of NOLs. These arguments merely restate the conclusions of the bankruptcy court, which did not address the real issue in this appeal. It is clear to this court that the IRS wants to use a "principle of law", namely the assignment of income doctrine, to prevent Chugach from the full use of its NOLs. According to Chugach's calculations, if Chugach is allowed to retain an extra $3.5 million of the overassigned income, then it will be able to deduct all of its available NOLs in 1987.

Both parties note that the result advanced by Chugach would have the seemingly anomalous effect of increasing, rather than decreasing, Chugach's total tax liability. Chugach points out       3 ABR 218  that WMI would have to pay tax on the excess taxable income (the overassigned income) whether or not it entered into the tax benefit sale with Chugach. Chugach and WMI therefore provided in their tax sharing agreements that WMI must pay any regular tax due on the Chugach return that is attributable to WMI's assigned income. AMT, on the other hand is tax that would not be incurred by WMI if it did not enter into the tax-benefit sale. Consequently, Chugach agreed to bear its own AMT liability, if any. This so-called anomaly is of no legal significance. It is advantageous for Chugach to maximize the use of its NOLs so as to increase it regular tax and avoid the AMT. No one contends that such was inconsistent with Chugachs agreement with WMI. Chugach is subject to the AMT; but the tax code does not preclude Chugach from structuring its AMT income so as to maximize the use of an available NOL. Here also the IRS seeks to use a principal of law (the assigned income doctrine) to deny Chugach the use of an otherwise available NOL contrary to section 1804(e) (4).

The IRS criticizes this arrangement, mostly on revenue-raising grounds, but the court concludes that this is precisely the type of savings that Congress encouraged when it passed the special legislation in favor of Native Corporations.

The bankruptcy court's decision regarding the applicability of the AMT provisions to Chugach is affirmed; however the result reached by the bankruptcy court must be reversed and the       3 ABR 219  case remanded for further proceedings consistent with the court's above additional ruling on the AMT issue.

DATED at Anchorage, Alaska, this 25^th day of June 1993.

M. Russell Holland
United States District Judge

N O T E S:

      3 ABR 209  1. The exception for ANCSA corporations reads:

The amendments made by subsection (a) shall not apply to any Native Corporation established under the Alaska Native Claims Settlement Act (43 U.S.C. 1601 et. seq.) during any taxable year beginning before 1992 or any part thereof in which such Corporation is subject to the provisions of section 7(h)(l) of such Act (43 U.S.C. 1606(h) (1)).

      3 ABR 210  2. It appears that the bulk of the transfer was between WMI and Chugach. The facts giving rise to this case are undisputed so for the sake of convenience the court has omitted any further reference to Winn-Dixie.