Central Life Assurance Soc. v. Commissioner

CENTRAL LIFE ASSURANCE SOCIETY OF THE UNITED STATES, MUTUAL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Central Life Assurance Soc. v. Commissioner Docket Nos. 10393, 31066, 31617, 32857. United States Board of Tax Appeals 18 B.T.A. 667; 1930 BTA LEXIS 2612; January 7, 1930, Promulgated *2612 The evidence is insufficient to establish that the nonparticipating insurance take over by petitioner from a stock company constituted a trust and was operated solely for the benefit of stockholders of the stock company and it is held that the income from such insurance should be included in petitioner's income. Richard S. Doyle, Esq., and John Enrietto, Esq., for the petitioner. B. M. Coon, Esq., for the respondent. ARUNDELL *667 Proceedings for the redetermination of deficiencies in income taxes for the years and in the amounts as follows: Docket No. Calendar year Amount 10393 [1921] $499.43 [1923] 13,695.81 31066 [1924] 16,857.69 31617 [1925] 12,305.53 32857 [1926] 8,082.31 In the petitions and amendments thereto several errors are alleged but evidence was offered as to only one of them and at the hearing counsel for petitioner stated that all save that one had been disposed of by stipulation. The only assignment of error urged is *668 the inclusion in income of receipts of petitioner's nonparticipating insurance department, which receipts were distributed to the former stockholders of a stock*2613 insurance company whose assets were taken over and liabilities assumed by petitioner. FINDINGS OF FACT. Petitioner, hereinafter called the Mutual Co., was organized May 10, 1919, under the laws of Iowa, and has its principal place of business at Des Moines. It was organized for the purpose of mutualizing the business of an Iowa corporation having capital stock, the Central Life Assurance Society of the United States, hereinafter call the Stock Co., which was engaged in the business of issuing life insurance policies under both the participating and nonparticipating plans. The principal reason for the change from stock company to mutual was to convert the $200,000 capital stock liability of the Stock Co. into an asset, the immediate cause being the excessive mortality among policyholders in the influenza epidemic of 1918. The laws of Iowa provided no method whereby a stock company could become a mutual company; hence the petitioner herein, the Mutual Co., was organized and took over the assets and assumed the liabilities under a contract with the Stock Co. dated May 15, 1919, which, omitting preamble and signatures, reads as follows: ARTICLE I Section 1. In consideration*2614 of the promises of the said Mutual Company, as set forth in Article II of this indenture the said Stock Company hereby assigns, transfers, conveys, sets over and delivers unto the said Mutual Company all the property of whatsoever kind in or to which the said Stock Company has at this date any estate, title, right or interest of whatsoever character, intending by this general description to include all real property, personal property, choses in action, and every thing or right whatsoever in or to which it has any title or claim. That upon request of the said Mutual Company at any time made or to be made, the said Stock Company will execute as of this date any and all such deeds, assignments or other conveyances as may be necessary or convenient better to effect or evidence the general transfer hereby made. Section 2. The said Stock Company hereby empowers and authorizes the said Mutual Company in its behalf to collect, maintain and apply in accordance with the requirements of contract and of law, each and all the premiums accrued or to accrue and the reserves accumulated or to be accumulated on account of the contracts of life insurance, endowments or annuity, heretofore issued*2615 or assumed by it, and to adjust, contest, settle or pay all contracts in whatsoever manner the said Stock Company would have been permitted or required to do. The said Stock Company hereby further authorizes the said Mutual Company to take all such contracts into its own account and to transact any and all business appertaining thereto in its own name. *669 Section 3. The transfer hereby made is subject to the requirements of the statutes of the State of Iowa relative to the deposit with the Insurance Commissioner of securities representing the net cash value of outstanding contracts or life insurance, endowment or annuity, and it is understood that many of the securities hereby transferred are now in the custody of the Insurance Commissioner by virtue of the deposits made in pursuance of such statutes. The said Stock Company hereby warrants that its annual report made to the Insurance Commissioner of the State of Iowa as of December 31, 1918, truly exhibits its condition on that date, and that save for the rights vested by statute in the Insurance Commissioner and the beneficiaries of his trust with reference to the securities deposited with him the said Stock Company*2616 then owned by absolute and unencumbered title all of the assets scheduled in said report. ARTICLE II Section 1. In consideration of the transfers, grants of authority and promises made by the said Stock Company in Article I of this indenture, the said Mutual Company hereby assumes as its own, and promises fully to discharge and to hold equitable liability [sic] of whatsoever character now resting upon the said Stock Company, whether arising out of contract or out of tort, subject, however, to all rights and defenses of which the said Stock Company might avail itself in law or in equity with reference to any such liability. Section 2. As a part of its general contract of assumption expressed in Section 1 of this Article, the said Mutual Company especially hereby assumes as its own liability, and promises fully to discharge and to hold the said Stock Company harmless from each and every legal or equitable liability of whatsoever character now or hereafter resting upon the said Stock Company by reason of its having heretofore issued or assumed, under its present or any former name or character, any contract of life insurance or endowment or annuity or insurance of whatever*2617 description. The said Mutual Company agrees to take into its own accounts all such contracts of life insurance, endowment or annuity now outstanding and in force; and to receive and accept all payments of premiums which the several holders thereof are or shall be legally or equitably entitled to make; and to maintain such legal reserves thereon as the said Stock Company would have been bound to maintain; and to make with the Insurance Commissioner of the State of Iowa, such deposits of securities representing the net cash value thereof, as the said Stock Company would have been bound to make from time to time under the laws of the State of Iowa; and to adjust, settle or pay all claims arising thereunder, as fully as the said Stock Company might or should have done; and all this to do to the complete exoneration of the said Stock Company from loss or expense on account of all such contracts of life insurance, endowment or annuity, but subject to all rights and defenses of which the said Stock Company might have availed itself in law or in equity with reference thereto. That in further consideration of the transfers and promises of the Stock Company, the said Mutual Company agrees*2618 that it will pay to the persons hereinafter specifically mentioned, who are all of the stockholders of the said Stock Company, in such proportions as are herein indicated, any earnings there may be for a period of twenty-two years from the date hereof, from the nonparticipating business hereby and hereunder transferred to such Mutual Company. *670 For that the earnings from such non-participating business may be determined, the Mutual Company agrees that it will maintain a separate department for such business, in which department shall be shown: (a) The gain or loss from loading from such non-participating business. (b) The gain or loss from mortality from such non-participating business. (c) The gain or loss from interest earnings from such non-participating business. (d) The gain or loss from all other sources from such non-participating business. (e) The total surplus of non-participating department. That prior to February 15, 1920, and prior to such date in each year thereafter for a period of twenty-two years, the said Mutual Company shall make up a gain and loss exhibit, as of date January 1st of such year, in such department, and shall on February 15, 1921, and*2619 on February 15th of each year thereafter during such period, distribute all surplus, if any in excess of $100,000, as shown by such exhibit, to the persons hereinafter named, their heirs, personal representatives or assigns, the whole amount to be distributed being represented by 2000 and the distribution to each person, his heirs, personal representatives or assigns so named being in proportion that the amount set out opposite to his name herein herein bears to 2000. George B. Peak, Des Moines, Iowa 1,040 Alice H. Peak, Des Moines, Iowa [60] George N. Ayres, Des Moines, Iowa [20] J. P. Stake, Kansas City, Missouri [40] George A. Peak, Des Moines, Iowa [60] Vesta Long Brennan, Kalispell, Montana [20] Fred P. Carr, Des Moines, Iowa [100] Homer A. Miller, Des Moines, Iowa [10] Mrs. Homer A. Miller, Des Moines, Iowa [90] D. W. Smouse, Des Moines, Iowa [340] H. G. Everett, Des Moines, Iowa [120] O. C. Miller, Des Moines, Iowa [40] Vesta Peak Denny, Des Moines, Iowa 2 1/2 T. C. Denny, Des Moines, Iowa 57 1/2 It is further agreed that fourteen duplicates of this instrument shall be executed and that one of such duplicates shall be delivered to each of the persons*2620 named in the foregoing list of stockholders. The reserve of $100,000, referred to in the contract, was set up at the strong suggestion of the Insurance Department of the State of Iowa as a reserve against liability under the nonparticipating policies. The period of 22 years over which the Mutual Co. was to distribute the surplus from the nonparticipating department to the stockholders of the Stock Co. was the period within which it was expected that the nonparticipating business would be liquidated through the death of policyholders, the surrender or lapse of policies, or conversion into participating policies. The intention of the parties to the contract was that at the end of the 22-year period, the $100,000 reserve maintained against the nonparticipating business was to be distributed to the stockholders named in the contract. *671 Upon execution of the contract between the companies, the stockholders surrendered their stock certificates to the secretary of the Stock Co., who canceled them. The Stock Co. has not been dissolved. It has retained its charter and maintained offices in order to make transfers of assets from time to time when necessary. This procedure*2621 was followed rather than to make a complete transfer at May 15, 1919, because of the fact that its assets consisted of several thousand items such as loans, mortgages, and real estate. No physical segregation of assets attributable to either class of policies has ever been made. A statement prepared by the Stock Co., on what is known as the convention form, showing its condition on May 15, 1919, shows the assets and income and disbursements with reference to the business as a whole and without separation between the two kinds of policies. No separation was made in the securities deposited with the State Insurance Department. In accordance with its contract of May 15, 1919, the Mutual Co. maintained a separate department for the nonparticipating business, and further, as provided by the contract, prepared each year a gain and loss exhibit for the nonparticipating department. The items which could be definitely ascribed to that department were so entered and such items as clerical expenses and interest which were not capable of exact separation were arbitrarily allocated between the participating and nonparticipating departments under a method approved by the State Insurance*2622 Department. The contract between the two companies was advantageous to the Mutual Co. in several respects. It obtained the good will of the Stock Co., several million dollars of participating insurance business, and an established agency organization. The nonparticipating business contributed substantially to the Mutual Co.'s expenses and thus enabled it to carry an organization and frame work large enough for the operation of both classes of business and which was considerably larger than the participating business alone could have supported. The surplus of the nonparticipating business is largely derived from three sources, namely, interest in excess of the 3 1/2 per cent required by law to be added to reserves, savings in mortality, and savings from surrenders. The amount of mortality savings in each department can be definitely calculated. Interest earnings are figured as a whole and divided between the two classes of business under a plan approved by the State Insurance Department. Beginning with February 15, 1921, and on the same date each year thereafter, the surplus shown by the gain or loss statement of the nonparticipating department was distributed to the former*2623 stockholders of the Stock Co. in accordance with the contracts of May 15, 1919. The first distribution, made on February 15, 1921, *672 was for the period from May 15, 1919, to December 31, 1920, and was a distribution not only of the surplus realized from earnings of the nonparticipating department, but also of that portion of the capital of the Stock Co. attributable to the nonparticipating policies computed on the basis of the ratio of the admitted assets of that department to the total admitted assets. That distribution left in the Mutual Co. as assets attributable to the nonparticipating business only those assets required to be held as legal reserves and the $100,000 provided for by contract. The subsequent distributions, made on February 15 of each year, were of the surplus of the nonparticipating department for the calendar year ending December 31 next preceding the date of distribution. The amounts of the distributions that have been made are as follows: February 15, 1921 $209,052.33 February 15, 1922 239,912.52 February 15, 1923 239,215.04 February 15, 1924 292,817.18 February 15, 1925 $309,088.84 February 15, 1926 276,229.58 February 15, 1927 216,543.92 February 15, 1928 325,759.22 *2624 The interest, invidends, and rents of the nonparticipating department for the years involved, less the deductions allowed by law, computed under sections 244 and 245 of the Revenue Acts of 1921, 1924, and 1926, and which the respondent has included in the net income of the Mutual Co. are as follows: Calendar year 1921 $34,433.41 Calendar year 1923 89,268.72 Calendar year 1924 95,327.25 Calendar year 1925 64,312.32 Calendar year 1926 38,751.15 The interest, dividends, and rents of the participating department of the Mutual Co., less the deductions allowed by law, as computed under sections 244 and 245 of the Revenue Acts of 1921, 1924, and 1925, for the years involved are as follows: Calendar year 1921 $86,579.52 Calendar year 1923 181,712.96 Calendar year 1924 213,049.07 Calendar year 1925 193,746.63 Calendar year 1926 177,025.32 In petitioner's original income-tax return for 1921, filed in April, 1922, income from both the participating and nonparticipating departments was reported without segregation. In an amended return filed November 29, 1926, petitioner reported only the income from the participating department, which was*2625 computed as 43.36 per cent of the income from both departments. Beginning with 1923 the income from the two departments was separated in the returns filed. *673 The contract of May 15, 1919, was entered into between the two companies without reference to the effect it might have on the tax liability of either. OPINION. ARUNDELL: Petitioner contends that its gross income should not include the rents, dividends, and interest from the nonparticipating insurance because under the contract of May 15, 1919, it carried such insurance only for purposes of liquidating it and for the sole benefit of stockholders of the stock company, hence any receipts from it were received by petitioner as trustee for the stockholders. The respondent's position is that the contract of May 15, 1919, between the companies created no trust agreement, but is purely a contract of purchase and sale. Looking at the contract itself and considering inly what lies within its four corners, it appears apply to be contract of purchase and sale. Under its terms the Mutual Co. purchased all the assets of every kind of the Stock Co., the consideration being the assumption of the Stock Co.'s liabilities*2626 and the payment of the earnings from a part of the business to the former stockholders of the Stock Co. We fail to see any ground for construing as a trust that part of the agreement providing for the payment of earnings from the nonparticipating department to the former stockholders. While it may be that the amount of assets attributable to the nonparticipating insurance was ascertainable, the evidence is clear that there was no segregation of assets; nothing was set aside which could be labeled a trust fund. Moreover, a part of the assets taken over by the Mutual Co. consisted of securities on deposit with the State Insurance Department as a reserve for the protection of policyholders and as long as that state of facts continued it is difficult to see how such securities could be impressed with a trust in favor of the stockholders. The relation of the stockholders to the transaction seems to us to be that of third persons for whose benefit the contract was made, in so far as the nonparticipating business is concerned, rather than that of cestuis que trustent.The practice in Iowa, where this contract was made and was to be performed, allows such third persons to sue on the*2627 contract and it is not necessary for them to proceed in equity as they would if a trust were involved. ; ; ; . See also . Petitioner's counsel attempts to distinguish this case from cases of contracts for the benefit of a third party and quotes from Williston on Contracts. That author, on pages 676 and 677 states: *674 Whenever property is delivered to one person under such circumstances that the legal title passes to him, but he undertakes to deliver that specific property or its proceeds to a third person or use the property for his benefit, the relation of trustee and cestui que trust arises. * * * The inquiry whether a specific fund or res is to be transferred to the beneficiary furnishes a ready test. This quotation, which is pointed to by the petitioner, emphasizes the shortcomings of petitioner's case, because, as pointed out above, there was no specific property or fund transferred to the petitioner for the benefit of the stockholders. The*2628 property and business of the old company was transferred en masse and as far as we can find no part of it was earmarked in any way that would distinguish it from any other part of the property involved. While the contract provides and the testimony is to the effect that a separate gain and loss statement was to be made up for each department, it is not shown just how this was accomplished. It is said that certain items such as mortality savings and taxes were definitely ascertainable, but "the expense, interest earnings, and things of that kind are divided between the two departments under plans or methods approved not only by the Iowa department, but a number of others." It is also testified that "the interest is figured as average earnings of the company." It would seem to us if there were any fund or property here sufficiently definite in quantity that it could be called a trust fund, the income and expenses ascribable to it would also be definite and it would not be necessary to resort to any method of averaging or allocation. The evidence does not establish that the petitioner operated the nonparticipating business as a trustee for the sole benefit of the stockholders*2629 of the stock company, and the respondent's inclusion in petitioner's income of the interest, dividends, and rents of the nonparticipating department is approved. It appears, however, from the stipulation, and the amendment thereto filed by the parties, that the amounts of such income may be different from that upon which the respondent computed the deficiencies. Accordingly, Decision will be entered under Rule 50.