Lafayette Life Ins. Co. v. Commissioner

LAFAYETTE LIFE INSURANCE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Lafayette Life Ins. Co. v. Commissioner Docket Nos. 41721, 42663. United States Board of Tax Appeals 26 B.T.A. 946; 1932 BTA LEXIS 1218; September 6, 1932, Promulgated *1218 1. Petitioner issued deferred dividend life insurance policies. At the end of the tontine period it voluntarily paid to the holders of such policies, in addition to the deferred dividends, amounts equal to 3 1/2 per cent interest on the dividends compounded over the tontine period. Held, such voluntary payments did not constitute interest paid upon indebtedness under the statute and are not deductible from gross income. 2. Held, that petitioner's gross income should not be increased by the amount of rental value of space occupied by it in its own building, nor should its deductions for expenses respecting said building be denied or abridged because of the omission of such rental value from gross income. 3. Petitioner's business was conducted through two departments, that of investments and that of underwriting insurance policies. Held, that petitioner is entitled to deduct a reasonable allowance for depreciation upon furniture and fixtures used in both departments of its business. A. E. James, Esq., for the petitioner. John D. Foley, Esq., for the respondent. MARQUETTE *947 These proceedings, which were consolidated*1219 for hearing and decision, are for the redetermination of deficiencies in income taxes asserted by the respondent as follows: Year Total tax Deficiency [1925] $7,747.94 $584.65 [1926] 7,205.92 3,672.55 [1927] 7,206.93 348.47 Petitioner alleges as errors: (1) That respondent has added to petitioner's taxable net income amounts of interest paid on indebtedness as follows: for the year 1925, $7,888.33; for the year 1926, $30,465.62; for the year 1927, $7,760.19; (2) that respondent has included in gross income for each taxable year the rental value of space occupied by petitioner for its business purposes in a building owned by petitioner during said years; (3) that petitioner omitted to claim in its returns, and respondent failed to allow, reasonable deductions for the exhaustion, wear and tear of property amounting to $1,201.49 for the year 1926 and $2,058.34 for the year 1927. Respondent admits this error in his amended answer. By his amended answer respondent alleges that he erred in allowing depreciation deductions of $788.88 for the year 1926 and $861.60 for the year 1927; that the correct amounts allowable are $201.07 and $217.20, respectively, and*1220 prays that petitioner's net income as shown by the deficiency letter be increased by the amount of $587.81 for the year 1926, and by $644.40 for the year 1927; and he further prays that the deficiency for each year be increased accordingly. FINDINGS OF FACT. Pursuant to stipulation of the parties, we find that petitioner is a mutual life insurance company, duly organized under the laws of the State of Indiana and having its principal place of business in that state. *948 During the years 1905 to 1909, inclusive, petitioner issued deferred dividend insurance policies which contained, among others, the following provisions: Dividends in Case of Death. In the event of the death of the insured within 20 years from date, this Policy being in full force and effect, the Company will pay the principal sum of Dollars, and in addition thereto this Policy's full share of the surplus profits, as appointed by this Company. Dividends if Living. If the insured be living and this Policy is in full force and effect on the day of , (20 years from the date of issue of the Policy) the Company will then apportion to this Policy its full share of the surplus profits, as determined*1221 by this Company, and the insured shall then have one of the following options: [Then follow a number of options, none of which are here material.] In connection with its determination of surplus earnings petitioner annually determined the amount of dividends applicable to the deferred dividend policies, but, pursuant to the terms of the policy contract, retained the said dividends so apportioned and recorded. Said dividends were neither paid to the insured nor applied in the reduction of premiums prior to the death of the insured or a date 20 years after the date of said policy, whichever date was the earlier. In or about the year 1906, petitioner discontinued issuing deferred In or about the year 1909, petitioner discontinued issuing deferred for annual participation by the policyholders in the yearly surplus earnings and savings of the petitioner. The policyholder had the option to leave such dividends with the petitioner, in which event petitioner agreed to pay interest upon the amounts so left. At about 20 years after the date the deferred dividend policies were first written, petitioner determined that it would pay to the living holders of such policies, as and when*1222 the date for distribution of dividends was reached, an amount equal to the interest at 3 1/2 per cent compounded annually upon the surplus profits of the several years apportioned to said policies and theretofore retained by petitioner. In the year 1925, as to some of the deferred dividend policies, in the year 1926 as to a larger number of said policies, and in the year 1927 as to a smaller number, the date for distribution of the said dividends was reached, and in each of the said years petitioner computed an amount equivalent to interest at 3 1/2 per cent compounded annually on the surplus profits theretofore apportioned to and set aside for the policyholders under said policies. Said amounts were $7,888.33 in 1925, $30,465.62 in 1926, and $7,760.19 in 1927, and these amounts computed as hereinabove set forth were paid or credited to policyholders during the respective years 1925, 1926 and 1927, and where credited to the said policyholders were applied by them in each of the said years respectively to payment of premiums upon the said or other policies. *949 In its returns of income for the years 1925, 1926 and 1927 petitioner deducted in each year, respectively, the*1223 sums of $7,888.33, $30,465.62 and $7,760.19. The Commissioner thereafter audited the returns, disallowed the $7,888.33 as a deduction in the year 1925, the $30,465.62 as a deduction in the year 1926, and the $7,760.19 as a deduction in the year 1927, and determined the deficiencies here in issue. Petitioner kept its books and made its returns on the basis of cash receipts and disbursements. In its income-tax returns petitioner included as a part of its gross income for each taxable year the rental value of the space occupied by it as its home office in the building owned by petitioner, as follows: For 1925, $13,067.61; for 1926, $8,546.33; for 1927, $7,862.03. The book value of the building during each taxable year was $425,952.92. Petitioner determined the rental value of the space it occupied by subtracting the net amount of rentals received from other tenants from $17,038.12, which was 4 per cent of the building's value. In computing net rentals petitioner made the following deductions from gross rentals received from tenants other than itself: Item [1927] Taxes on home office $6,300.00 $6,250.00 $6,750.00 Depreciation 6,799.04 6,799.05 6,799.05 Other expenses 22,890.69 20,410.57 19,025.62 Total deductions 35,989.74 33,459.62 32,574.67 *1224 Respondent has made no change with respect to such deductions, or the rental value of the building. In its income-tax return for 1926 petitioner claimed depreciation on its furniture and fixtures in the amount of $788.88. This was allowed by the respondent. In 1926 the depreciation suffered by the furniture and fixtures used in the investment department of petitioner's business amounted to $201.07, and in the underwriting department amounted to $587.81. A like claim for depreciation, but in the amount of $861.60, was made for the year 1927 and allowed by respondent. The furniture and fixtures depreciation suffered amounted to $217.20 in the investment department and $644.40 in the underwriting department. OPINION. MARQUETTE: The petitioner claims as deductions the amounts equal to interest on deferred dividends paid during the taxable years to holders of a certain class of insurance policies written by the petitioner. The policy contract did not require such payment of interest, *950 nor did it contain any optional provisions calling for such payment, Therefore, the respondent contends that such interest payments were voluntary on the petitioner's part, we*1225 really additional dividends, and do not constitute allowable deductions within the meaning of the Revenue Acts of 1924 and 1926. The provision here applicable is section 245(a)(8), which is the same in both statutes, and reads as follows: SEC. 245. (a) In the case of a life insurance company the term "net income" means the gross income less - * * * (8) All interest paid or accrued within the taxable year on its indebtedness * * *. The term "interest" has a well known meaning. It is defined in the Standard Dictionary as "an agreed or statutory compensation accruing to a creditor during the time that a loan or debt remains unpaid." A similar definition has been followed by this Board. Cf. ; ; . In our opinion the amounts paid during the taxable years by petitioner to holders of deferred dividend policies were not interest payments within the proper meaning of the term. There was no agreement between petitioner and its policyholders calling for such payments. There was no statutory requirement compelling*1226 such payments, so far as we are advised. The deferred dividends, upon which the so-called interest was computed, were not loans made by the policyholders to the petitioner. Nor can it be said that the deferred dividends constituted debts owed by petitioner during the 20-year period of the tontine policies. A debt in its general sense is "a specific sum of money which is due or owing from one person to another, and denotes not only the obligation of the debtor to pay, but the right of the creditor to receive and enforce payment." . During the tontine period none of the deferred dividends constituted "a specific sum of money due or owing" from petitioner to a policyholder and enforceable by the latter. Not until the end of such period could it be determined who of the policyholders might be entitled to deferred dividends. Indeed, it is quite conceivable that none would be so entitled. It is clear, we think, that under such circumstances the so-called interest payments could not properly be deemed interest. They constituted additional dividends rather than interest. In *1227 , and again in , the by-laws of each group provided that interest at the rate of 8 per cent should be paid anually on all capital stock. In each case we held that such payments were not deductible as interest *951 paid, but were dividends. We think the same principle applies here and on that point the respondent's determination is sustained. The next question is whether there should be included in petitioner's gross income the rental value of space occupied by petitioner for its business purposes in a building owned by it. We have considered this question on other occasions and have held that gross income of a life insurance company may not be increased by the amount of the rental value of space so occupied, and deductions for taxes and other expenses respecting such building may not be denied or abridged because such rental value is omitted from the gross income. ; *1228 ; . Those cases are controlling here and the petitioner's gross income for each taxable year should not include rental value of the space occupied by it in its own building. The third allegation of error, relating to deductions for exhaustion, wear and tear of property in the amounts of $1,201.49 for 1926 and $2,058.34 for 1927, is admitted by the respondent. Those amounts, therefore, will be allowed as deductions for the respective years in recomputing the deficiencies. The last question raised by the respondent is whether petitioner is entitled to deductions for depreciation of furniture and fixtures used in the underwriting portion but not in the investment portion of its business. The provisions of the Revenue Act of 1926 which are applicable here are as follows: SEC. 244. (a) In the case of a life insurance company the term "gross income" means the gross amount of income received during the taxable year from interest, dividents and rents. * * * SEC. 245. (a) In the case of a life insurance company the term "net income" means the gross income*1229 less - * * * (7) A reasonable allowance for the exhaustion, wear and tear of property * * *. The respondent contends that, as the statute confines petitioner's gross taxable income to receipts of interest, dividends and rents, therefore, the deductible allowance for depreciation of property logically and properly includes only such property as petitioner used in the production of its taxable income. In our opinion that contention is not well founded. In Regulations 69, construing the revenue act, the respondent says, in article 685(2), that "The deduction allowed by section 245(a)(7) for depreciation is identical with that allowed other corporations by section 234(a)(7)." That limits the allowance for depreciation to the "exhaustion, wear and tear of property used in the trade or business." Unquestionably the trade or business *952 of this petitioner covered not only investments of its funds, but the writing and issuance of life insurance policies, collecting premiums, and the like. While there were two phases of petitioner's activities, the underwriting and the investment, the two combined constituted its business. Each was dependent upon and related to the other, *1230 and both were necessary factors for the success of the business. Had Congress desired to limit the depreciation allowance in the manner now urged by respondent, it would undoubtedly have so worded the statute. No such limitation is expressed, however, and we find nothing in the statute to indicate an intention to create such a restriction. In our opinion, therefore, the petitioner is entitled to the amounts claimed by it for depreciation on its furniture and fixtures, namely, $788.88 for the year 1926 and $861.40 for the year 1927. Decision will be entered under Rule 50.