American Cent. Life Ins. Co. v. Commissioner

AMERICAN CENTRAL LIFE INSURANCE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. American Cent. Life Ins. Co. v. Commissioner Docket Nos. 30133, 31998, 56024, 63436. United States Board of Tax Appeals 30 B.T.A. 1182; 1934 BTA LEXIS 1208; July 17, 1934, Promulgated *1208 1. An "insured's personal benefit fund" consisting of contributions by policyholders with fixed interest contributed by the insurance company, the fund to be distributed among the surviving persistent policyholders as provided by the insurance policy, sanctioned and required by state law and regulation, held a "reserve required by law" under the revenue acts. 2. Premium reduction coupon policy reserves held reserves required by law. 3. The statutory rental value of space occupied by an insurance company in its own building must be included in gross income as a condition to the deduction of taxes and expenses; and the failure of the company to include it prevents such deduction. 4. Interest was derived by an insurance company upon loans when the mortgaged property acquired by voluntary deeds in discharge of the debt was not shown to be worth less than the loans, costs, and interest. 5. Interest was not derived by an insurance company upon loans when the mortgaged property was acquired by foreclosure for a bid price no larger than the principal of the loan; but when the bid exceeded the principal, costs, and taxes, the excess was taxable as interest. *1209 Robert A. Adams, Esq., and Abbot P. Mills, Esq., for the petitioner. James C. Maddox, Esq., and John D. Foley, Esq., for the respondent. STERNAAGEN *1183 Respondent determined the following deficiencies in petitioner's income tax: [1925] $3,133.98 [1926] 2,050.62 [1928] 6,005.52 [1929] 12,626.90 Respondent excluded from petitioner's insurance reserves required by law amounts held to meet its obligations on a personal benefit fund and no policy coupons. Respondent included in gross income for 1925, 1926, and 1928 the rental value of space occupied by petitioner in its own building, and disallowed in 1929 the deduction of expenses connected with the building because of petitioner's failure to report as income the rental value of the space which it occupied. In Docket Nos. 56024 and 63436 unpaid accrued interest on defaulted loans, secured by mortgages on lands, was added to income. FINDINGS OF FACT. Petitioner, a life insurance corporation organized under the laws of Indiana, with principal place of business at Indianapolis, Indiana, is a stock company, engaged in issuing nonparticipating policies. 1. During 1925, 1926, 1928, *1210 and 1929 petitioner had outstanding certain policies designated as "Whole Life Premium Reduction Payable at Death." A feature of this policy is an "Insured's Personal Benefit Fund", which entitles the holder to share in the fund at maturity upon the following conditions: Additional to the rights provided in the above Table of Values and Options, the insured shall have the right to share in a fund known as the Insured's Personal Benefit Fund for the year 1912, which will be accumulated and distributed in the manner following: (a) When payment of each premium, beginning with the second and including the twentieth, is made, the insured shall have the right to pay the Company with such premium of $22.10 the sum $6of.23 as a contribution to such fund, to be immediately credited thereto upon receipt by the Company. (b) At the end of each calendar year the Company will credit to said fund compound interest at the rate of three and one-half per centum per annum on the amount of said fund at the beginning of such calendar year. *1184 (c) On the thirty-first day of December, 1931, the Company will apportion said fund to those who, having made each contribution thereto provided*1211 for in section (a) above, are alive at the date of such apportionment, each being credited with a share proportional to the credits to said fund on account of his Policy. (d) Should the death of the insured occur subsequent to apportionment of the fund but prior to the end of the twentieth year of the policy, his proportional share of the fund shall become a part of the proceeds of the Policy payable to the beneficiary. Should he survive to the end of the twentieth policy year he shall have the following settlement options: (1) Continue the policy by the payment of the stated renewal premiums and withdraw full share of fund IN CASH. (2) Continue the policy and apply share of fund to purchase an annuity at the rates then in use by the Company, such annuity to be payable IN CASH or applied to reduce future premiums on the policy. (3) Surrender the policy for its guaranteed CASH VALUE and withdraw share of fund IN CASH. (4) Surrender the Policy for paid-up life insurance for the amount guaranteed in this Policy and withdraw share of fund IN CASH, or, subject to satisfactory evidence of insurability, if total paid-up insurance exceeds face of policy, apply the sum of such*1212 share and the reserve on the policy as a net single premium to the purchase of paid-up life insurance. (e) If the insured shall make the required contributions to said fund he may, upon written request, at any time, have a statement from the Company of the condition of the fund. The following ruling was issued by the Commissioner of Insurance of the State of Indiana on January 22, 1923: To Indiana Life Insurance Companies: You are hereby advised of the following ruling of this Department effective on and after January 1, 1923. The reserve deposit requirement of the Indiana Statutes shall be construed as follows: net reserve, paid-for basis, plus the extra reserve for disability and double indemnity benefits, plus the present value of supplementary contracts involving and not involving life contingencies, plus the present value of amounts incurred, but not yet due, for disability benefits, plus dividends and coupons left with the company to accumulate at interest and accrued interest thereon. As an offset to excess liability occurring in the above, there shall be deducted from the above total, the net amount of uncollected and deferred premiums, less the excess of premium*1213 notes, policy loans and other policy assets, over net value on individual policies. The amount of contributions to the insured's personal benefit fund by holders of this type of policy, together with compound interest thereon as provided in the personal benefit fund clause, was as follows: Dec. 31, 1924 $118,348.90 Dec. 31, 1925 129,380.91 Dec. 31, 1926 140,519.78 Dec. 31, 1927 $152,269.28 Dec. 31, 1928 163,767.64 Dec. 31, 1929 175,998.22 In computing the reserve funds required by law for 1925, 1928, and 1929 respondent excluded the insured's personal benefit fund and *1185 the amount of outstanding unpaid matured coupons; in his computation for 1926 he excluded these amounts at the beginning of the year, but included them at the end. In determining the net income for 1925 respondent allowed a deduction of $2,587.61 representing 2 percent of the amount of the insured's personal benefit fund on December 31, 1925. 2. During 1925, 1926, 1928, and 1929 petitioner had outstanding policies designated as "Ordinary Life with Premium Reduction Coupon or Twenty Payment Life with Endowment Option", to which were attached numbered coupons, each for the*1214 same amount and identical in all other respects except for date of payment. A typical coupon is as follows: On or After December 1, 1930 AMERICAN CENTRAL LIFE INSURANCE COMPANY will pay to the insured under Policy No. 000X or to the beneficiary in event of the death of the insured after said date, provided all premiums due on said policy to and including said date have been paid, Nine and 16/100 Dollars with 4% interest for each full year after maturity, compounded annually. This coupon when matured may be used in part payment of any premium then due. The policy contained the following provisions in respect to the coupons: The coupons attached may, as they mature, either be used in part payment of premiums, or drawn in cash, or retained by the insured for payment upon presentation at any time with compound interest at the rate of four per centum per annum for each full year after maturity. If no coupons are otherwise used, the Company will, upon their surrender after twenty full premiums have been paid hereon, endorse this policy as fully paid up, or upon such surrender of coupons and written requests therefor. This policy will become an endowment payable to the insured*1215 himself at the expiration of 29 years from the date hereof, if then living. Cancelled coupons may be revived at any time upon payment of the amount received therefor together with compound interest at the rate of six per centum per annum from date of cancellation. The amounts represented by outstanding unpaid matured coupons attached to the policies denominated "Ordinary Life with Premium Reduction Coupons or Twenty Payment Life with Endowment Option", nonparticipating, together with interest thereon at the rate of 4 percent compounded annually from the date of maturity of all the coupons, were as follows: Dec. 31, 1924 $532,711.40 Dec. 31, 1925 690,867.42 Dec. 31, 1926 852.899.04 Dec. 31, 1927 $1,029,744.94 Dec. 31, 1928 1,156,517.48 Dec. 31, 1929 1,340,931.13 3. Petitioner owned and occupied in part a building, the book value of which was as follows: Dec. 31, 1925 $423,958.84 Dec. 31, 1926 423,958.84 Dec. 31, 1928 423,958.84 Dec. 31, 1929 423,958.84 *1186 During 1925, 1926, 1928, and 1929 petitioner received rent from tenants of said real estate in the amounts of $34,255.21, $32,715.16, $34,170.92, and $34,287.74, *1216 respectively. During those years it paid the following amounts as taxes and other expenses thereon: Year Taxes Other expenses [1925] $12,384 $24,864.91 [1926] 13,536 25,646.59 [1928] 12,672 25,311.87 [1929] 12,960 26,355.64 Respondent included in gross income for 1925, 1926, and 1928 the respective amounts of $28,346.76, $30,197.28, and $35,577.09, as representing the rental value of the space which petitioner occupied in its building, and allowed as deductions the amounts of the taxes and other expenses incurred and paid on account of the building. for 1929 petitioner did not report and respondent did not include in gross income any amount representing the rental value of space which petitioner occupied in its building, and respondent disallowed the deduction of taxes and other expenses in connection therewith. 4. a. During 1928 petitioner acquired title by voluntary deed to seven pieces of real estate on which it held mortgages securing loans on which interest of $6,708.55 was unpaid. Petitioner, in acquiring the property, spent $129.75 as transfer charges and small advances to the owners. During 1929 petitioner acquired title by voluntary deed*1217 to nine such pieces, on which unpaid interest was $5,393.17, and transfer charges and advances to owners were $1,013.10. b. During 1928 petitioner foreclosed on seven properties and in 1929 on ten properties on which it held mortgages securing loans. The details as to such transactions are as follows: [1928] Mortgage No. Amount of loan Accrued interest at sale Advances made borrower for taxes, expenses, etc. Foreclosure cost Bid price [64] $35,000.00 $3,541.65 $5,007.14 $844.03 $42,532.28 [54] 1,250.00 205.28 205.69 1,000.00 [56] 2,500.00 300.41 40.80 129.10 250.00 [58] 1,600.00 149.97 54.55 126.15 600.00 [59] 2,500.00 166.48 282.91 110.90 1,500.00 [62] 3,000.00 851.68 195.07 184.55 3,200.00 [63] 4,000.00 446.94 515.49 490.40 4,000.00 [85] $3,500.00 $149.36 $528.45 $100.00 $4,573.01 [66] 4,000.00 633.70 141.54 72.12 591.18 [67] 16,000.00 2,529.10 462.16 72.30 2,081.93 [68] 4,000.00 389.90 236.07 31.25 3,000.00 [70] 5,000.00 809.37 476.72 144.74 3,000.00 [74] 2,700.00 259.80 263.79 217.05 3,190.75 [73] 2,778.96 322.89 125.98 20.00 2,000.00 [78] 3,250.00 559.88 15.93 180.70 2,500.00 [86] 2,500.00 432.44 144.26 198.50 2,500.00 [88] 12,000.00 3,245.48 269.92 105.25 12,538.46 *1218 *1187 On foreclosures in states that provide a redemption period it is petitioner's practice not to transfer the account of the property foreclosed to its real estate account until after the redemption period is past, and to include additional interest on its books from the date of the foreclosure to the date of the transfer entry. In determining petitioner's income for 1928 and 1929 the Commissioner included as interest received $15,773.88 and $15,730.09, respectively, representing not only the $12,370.96 and $14,725.03 in the respective years, accrued at date of deed or foreclosure, on defaulted loans, but also the interest set up on petitioner's books from the date of foreclosure to the transfer entry to the real estate account. OPINION. STERNHAGEN: 1. In computing the deduction under section 245, Revenue Act of 1926, and section 203, Revenue Act of 1928, the Commissioner has excluded from the "reserve funds required by law" the stipulated amounts of the insured's personal benefit fund. This fund, as is shown by the findings, consists of amounts of $6.23 each contributed by policyholders as provided in the policies called "Whole Life Premium Reduction Payable at*1219 Death." This fund is by the terms of the policy built up for a period of 19 years, when, with the accretion of the company's fixed interest contributions, it is apportioned among the survivors of the persistent contributing policyholders of the class. Thereafter, at the end of 20 years, the amounts thus apportioned are, at the election of the policyholder, distributed either in cash or by being applied to further insurance or otherwise as expressly provided in the policy. The respondent's disallowance treats the fund as something apart from insurance and hence outside the intendment of the statute. There can be no doubt that this is a reserve, that it is contractually provided in the petitioner's insurance policies, and that it is within *1188 the requirement of the Indiana State law as that law is interpreted and administered by the State Commissioner of Insurance. In practice, it is regarded and treated by the petitioner as among its insurance reserves. Unless, therefore, it is apparent from analysis that the fund is something else and is not within the plan of the statute, its inclusion within the statutory reserve follows. *1220 While nomenclature alone does not determine the nature of the fund, consideration must be given to the recognition and treatment of it in the field of insurance and of state supervision. The scope of the term "reserve funds required by law", as used in the revenue acts, has often been considered in respect of various funds set up by insurance companies under varying circumstances. 1 These different funds vary widely and each requires consideration in respect of its source, function, and sanction as the basis for its classification within or without the statutory provision. *1221 The reserve which has been most recently and perhaps most fully considered is that of a premium reduction coupon fund, and the decisions affecting such reserve guide us as to the present decision. (C.C.A., 3d Cir.); (C.C.A., 9th Cir.); , rehearing denied April 30, 1934 (C.C.A., 10th Cir.). Like the coupon obligation in those cases, the obligation here to each interested policyholder is contingent upon his survival of the term and his election to persist in his participation and to select the method of application of his distributive share of the fund upon its maturity. While the company may be required to pay cash, as in the case of matured coupons, it may also, as in that case, be required to apply the distributive share to further insurance. The Commissioner urges that, although the obligations as to the benefit fund and its contributions are found in the insurance policy, they are inherently not insurance obligations but that the arrangement*1222 is merely a sort of investment pool. We may not, however, upon this record, treat this fund as if it were unrelated to the insurance policies. To some extent most modern insurance embodies something besides strict insurance. We do not understand that the reserves which the statute recognizes are only those which can be mathematically related to the insurance function in its strict and narrow *1189 sense. While clearly it excludes distinctly noninsurance funds, such as reserves for dividends, , and while it has recently been held to exclude a "guaranteed dividend fund", , we think that this does not require the exclusion of such a fund as this, which is expressly provided for in an insurance policy as one of its inherent provisions. This fund would no doubt serve to measure the extent of reinsurance available to the petitioner, cf. While it is not suggested by the respondent, the inquiry arises whether, if this fund were not among the reserve funds required by law but were among the petitioner's*1223 noninsurance obligations, there would be a right under section 245(a)(8) to deduct the interest which the petitioner was obligated to accrue. In our opinion, the Commissioner erroneously excluded the insured's personal benefit fund from the statutory reserve funds required by law. Since, however, the respondent did permit the inclusion at the end of 1926, no adjustment as to that date is required. 2. The stipulated amounts held by petitioner as a reserve to meet its coupon obligations under the premium reduction coupon policies are properly parts of the reserves to be used as the basis of the deductible percentage. (C.C.A., 3d Cir.); (C.C.A., 9th Cir.); (C.C.A., 10th Cir.); (petitioner for review dismissed, C.C.A., 7th Cir.); 3. That the statute is valid in its requirement that the computed rental value of space occupied by petitioner in its own building*1224 must be included in gross income as a condition to the deduction of taxes and expenses is now settled by . Hence the respondent's inclusion of the stipulated rental value for 1925, 1926, and 1928 is correct. For 1929, the petitioner's failure to include any rental value for such space supports the respondent's disallowance of any deduction for such taxes and expenses. 4. The petitioner in earlier years had loaned money on mortgages. In 1928 and 1929, interest, and probably principal, being in default, petitioner acquired the mortgaged properties, some by voluntary deed and some by bidding at foreclosure sales. In each instance respondent included in petitioner's income of the year of such acquisition the amount of accrued interest. The petitioner contests this inclusion in toto, saying that such interest was not received either actually or constructively. *1190 Since, under the special method of taxing life insurance companies, profit is not included in gross income and losses are not deductible. the only question is whether in these transactions petitioner derived income by way of interest. *1225 a. As to the property acquired by voluntary deed, it appears only, as shown by our findings, that the properties acquired in 1928 had secured loans upon which interest of $6,708,55 was due and unpaid, and that $129.75 had been expended by petitioner as advances and transfer charges; and that as to those acquired in 1929, the unpaid interest was $5,393.17 and the advances and transfer charges were $1,013.10. From this scant evidence, it can not be said that petitioner did not receive the interest. If the properties were worth more than the loans, costs, and interest, (and the record on this is silent), it could not be said that petitioner did not receive its interest. The property received may properly, without resort to the doctrine of constructive receipt, be treated as cash to the extent of its value, and the interest which a taxpayer is required to include in income is not restricted to cash receipts bearing the label of interest. We may assume, as the Commissioner did, that the mortgagee's debt for the interest was discharged by the transfer. As to the items of $6,708.55 for 1928 and $5,393.17 for 1929, the respondent's determination is sustained. *1226 . b. As to the property acquired by bidding it in at foreclosure, different situations require different treatment. Where the amount of the bid was no more than the principal of the loan, the decisions in , and , have laid down the rule that nothing is to be treated as interest received. Cf. . This applies to 12 of the 17 foreclosures covered by the evidence. In five cases specifically shown in the findings (Nos. 64, 62, 85, 74, and 88) the bid exceeded the principal. The excess should first be applied as reimbursement for expenses and delinquent taxes, and only the remainder included in income as accrued interest. It does not appear whether, in any instance, the entire indebtedness was discharged or whether there remained an undischarged liability to any extent. The Commissioner, however, erred in including the book interest between the date of foreclosure and the transfer entry in the real estate account. That amount was in no sense received, *1227 nor was it accrued at the date of foreclosure. Judgment will be entered under Rule 50. Footnotes 1. ; United states↩v. ; ; ; ; ; ; ; rehearing denied April 30, 1934; ; ; ; ; ; ; .