Hospital Corporation of America and Subsidiaries - Page 56

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          transaction,' but a sham."  Malone & Hyde, Inc. v. Commissioner,            
          62 F.3d at 841.                                                             
               The Court of Appeals stated:                                           
                    If Humana's scheme had involved a thinly-capitalized              
               captive foreign insurance company that ended up with a large           
               portion of the premiums paid to a commercial insurance                 
               company as primary insurer, and had included a hold harmless           
               agreement from Humana indemnifying the unrelated insurer               
               against all liability, we believe the result in Humana would           
               have been different.  This court accepted the bona fides of            
               the transaction in Humana and recognized the premiums paid             
               to the captive insurance company as deductible business                
               expenses since Humana established the captive to address a             
               legitimate business concern (the loss of insurance                     
               coverage), and the captive was not a sham corporation; the             
               captive in Humana was fully capitalized, domestically                  
               incorporated, and established without guarantees from the              
               parent or other related corporations.  Because Humana acted            
               in a straightforward manner, without any evidence of an                
               intent to create an unwarranted tax deduction based on                 
               payments that largely ended up in its subsidiary's coffers,            
               this court accepted the bona fides of the transaction before           
               examining the brother-sister issue.                                    
                    We disagree with Malone & Hyde's contention that                  
               footnote 2 in Humana refers only to the question of whether            
               Humana's premium payments for its own coverage, as opposed             
               to the coverage extended its subsidiaries, involved risk               
               shifting.  Footnote 2 clearly applies to the fundamental and           
               decisive question of whether there was risk shifting from              
               any insured--parent or subsidiary--to the captive insurer.             
               When the entire scheme involves either undercapitalization             
               or indemnification of the primary insurer by the taxpayer              
               claiming the deduction, or both, these facts alone                     
               disqualify the premium payments from being treated as                  
               ordinary and necessary business expenses to the extent such            
               payments are ceded by the primary insurer to the captive               
               insurance subsidiary.                                                  
                    It is true that Eastland operated as an insurance                 
               company.  As the tax court found, it "established reserve              
               accounts, paid claimed losses only after the validity of               
               those claims had been established, and was profitable."  For           
               purposes of determining the correct tax treatment of                   
               premiums paid to Eastland by Malone & Hyde, however, we                




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