# Opposition — Union Mutual Life Insurance v. United States

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Opposition
- **Published:** January 1, 1978
- **Citation:** 439 U.S. 821

## Text

INDEX

Page
scr ericetisiniesicihdulninsdennidabienmbislinapeiionias |
nt a NRE AAS ERR DO TS |
Re OR Zi Seccieieindnieeinmnaisipliilinrewednine l
SE I iti cnn sclieniliitidnadanisniinsininianesdesicitivdoninvess 2
Eee Sa a SS Oe 4

1. Unearned premiums reserve i sue .................... 4
2. Policy loan interest issue ...... Aarne 6
PRD Uilndcndbadtnddindbctccncsevinstinseviesnvesesevndeteennsceseenses 8
|. Unearned premiums reserve issue .................... 8
2. PORSY TORR TACTOTE ESTE ...0ccccccecccccccccccescccesss 12
LE A ao ee 17
CITATIONS
Cases:
American Automobile Association vy. United
EI Ga MIT cdicccscssesconsensesescccesceccsovcens 14
Artnell Co. v. Commissioner, 400
iia, TI -2aostecteeiehniglenubvesnenleniniinimiebduneres 14, 15
Automobile Club of Michigan v. Commis-
Ts BI WL, TID cecccceecccsecvviivecccsecoscvcccesees 14
Bankers Union Life Ins. Co. v. Commis-
Se es Cicer TIE -cececsnvesenannewreqeneiqnseevaceenseces 16
Boise Cascade Corp. v. United States, 530
2 ERE SERN Se eernene ane ree 14, 15
Brown v. Helvering, 291 U.S. 193 ........ccc cece 14

Page

Cases—continued:

Central National Life Insurance Co. v.
United States, Ct. Cl., No. 194-70,
decided April 19, 1978 ..........ccccceeceeeeeeeeeeeeeeeees 12

Commissioner v. Monarch Life Ins. Co., 114
F, BO BOD: cccestssntocsncsisilddiisila ma cidtpiniensniiain 9

Commissioner v. Standard Life & Accident
Insurance Co., 433 U.S. 148 ............. 9, 15, 16

Franklin Life Insurance Co. v. United
States, 399 F. 2d 757, certiorari denied,
ok Ee ee nen 8, 13, 17

Hagen Advertising Displays, Inc. v.
Commissioner, 407 F. 2d VlOS 2.0.0.0... eeeeeee 14

Jefferson Standard Life Insurance Co. v.
United States, 408 F. 2d 842, certiorari
Gomied, S50 GB.. GP ccentsanstioniadsitienm 8, 13

Mooney Aircraft, Inc. v. United States, 420
F. 2B GED ccssviistnonnticaniltainbeeniainiaiacinione 14

New England Tank Industries, Inc. vy. Commis-
sioner, 50 T.C. 771, affirmed, 413
FF, BB CRD sccharovecnnssiossineisissliaiiiaccicihltindaniniamnieabaisaddinns 14

Schlude v. Commissioner, 372 U.S. 128 ..... 13, 14

Southwestern Life Insurance Co. v. United
States, 560 F. 2d 627, certiorari denied,

April 24, 1978 (No. 77-1124) wo..cccceeeeeeees 8, 13
Spring City © +» Commissioner, 292

Th Peete a st ee 13
United States v. Consumer Life Ins.

Ca.. GD Ga Fae cctvciniaeetenaltnnicibendtdinincion 15

United States v. Williams, 395 F. 2d 508 ......... 15

Page
Statutes and regulations:
Internal Revenue Code of 1939 (26
U.S.C. 1952 ed.):
SETS Te oe a
RE a )
Internal Revenue Code of 1954 (26
U.S.C):
EE ee 12
a 10
| 5, 8, 10, 11, 12
Section B80I1(bK 1) ..............00..2.. siabadaniaiin 8. Il
I sions nnsrnaneiasouaiscenee 11
ET 2
Ee 9
ESI 5. 9
er a 3
eee ee 3
Ee 5.9
NE a 5
a
EE ES 3
I es 3
Life Insurance Company Income Tax Act
I ccnesensone 9
Revenue Act of 1942, Section 163, |
a eestiasions 9

iV

Page
Statutes and regulation—continued:
Treasury Regulations on Income Tax
(1954 Code) (26 C.F.R.):
SOCTIB EEG MEME ..ccccccccocccccccccccccccccccoscces 13
I 13
I rt 4
M iscellaneous:
H.R. Rep. No. 2333, 77th Cong., 2d Sess.
SUTIN: <ilihiiissnhiniesbiispetenrsiicetsasiplieepbiaididsciMabBiNa tne 10, 11
Noback, Life Insurance & Accounting
RR enc es LSE eon Se OE CE 8
Rev. Proc. 71-21, 1971-2 Cum. Buil.
SUN islslesdnitslsbulitiialaseitietmanaidilinieia cadet scatitisiemntmamannans 14
S. Rep. No. 1631, 77th Cong., 2d Sess.
SRE nN Pree Fa) I Act EL 10

In the Supreme Court of the United States

OcTOBER TERM, 1977

No. 77-1559
UNION MUTUAL LIFE INSURANCE COMPANY, PETITIONER
Vv.

UNITED STATES OF AMERICA

ON PETITION FOR A WRIT OF CERTIORARI TO
THE UNITED STATES COURT OF APPEALS FOR
THE FIRST CIRCUIT

BRIEF FOR THE UNITED STATES
IN OPPOSITION

OPINIONS BELOW

The opinion of the district court (Pet. App. A, pp. 1-66)
is reported at 420 F. Supp. 1181. The opinion of the court
of appeals (Pet. App. B, pp. 74-108) is reported at 570 F.
2d 382.

JURISDICTION

The judgment of the court of appeais was entered on
February |, 1978. The petition for a writ of certiorari was
filed on May 1, 1978. The jurisdiction of this Court ts
invoked under 28 U.S.C. 12541).

QUESTIONS PRESENTED

|. Whether a life insurance company’s reserves for
“unearned premiums” on noncancellable health and

(1)

2

accident insurance policies are includable in its “life
insurance reserves” under Section 801(b) of the Internal
Revenue Code of 1954.

2. Whether annual interest that is payable in advance
on life insurance policy loans is includable in a life
insurance company’s “gross investment income” under
Section 804(b)(1) of the Internal Revenue Code of 1954 at
the time it is due and the company either receives the
interest or adds it to the principal balance of the loan.

STATUTES INVOLVED
Internai Revenue Code of 1954 (26 U.S.C.):

Section 801 [as added and amended by Section 2(a),
Life Insurance Company Income Tax Act of 1959,
Pub. L. 86-69, 73 Stat. 112]. DEFINITION OF LIFE
INSURANCE COMPANY.

* * * * *

(b) Life Insurance Reserves Defined.—

(1) Jn general.—For purposes of this part, the
term “life insurance reserves” means amounts—

(A) which are computed or estimated on
the basis of recognized mortality or morbidity
tables and assumed rates of interest, and

(B) which are set aside to mature or
liquidate, either by payment or reinsurance,
future unaccrued claims arising from life in-
surance, annuity, and noncancellable health
and accident insurance contracts (including
life insurance or annuity contracts combined
with noncancellable health and accident in-
surance) involving, at the time with respect to
which the reserve is computed, life, health, or
accident contingencies.

* * * * *

Section 804 [as added and amended by Section 2(a),
Life Insurance Company Income Tax Act of 1959,
supra). TAXABLE INVESTMENT INCOME.

* * * * *

(b) Gross Investment Income.—For purposes of
this part, the term “gross investment income” means
the sum of the following:

(1) Interest, etc.—The gross amount of income
from—

(A) interest, dividends, rents, and
royalties,

* a * * *

Section 818 [as added and amended by Section 2(a),
Life Insurance Company Income Tax Act of 1959,
supra|. ACCOUNTING PROVISIONS.

(a) Method of Accounting.—All computations
entering into the determination of the taxes im-
posed by this part shall be made—

(1) under an accrual method of accounting,
or

(2) to the extent permitted under regulations
prescribed by the Secretary or his delegate, under
a combination of an accrual method of accounting
with any other method permitted by this chapter
(other than the cash receipts and disbursements
method).

Except as provided in the precedirg sentence, all such
computations shall be made in a manner consistent
with the manner required for purposes of the annual

4

statement approved by the National Association of
Insurance Commissioners.

* * * * *
STATEMENT

|. Unearned premiums reserve issue.

Petitioner is a mutual life insurance company which
issues various types of insurance, including “non-
cancellable” health and accident insurance policies. Unlike
“cancellable” health and accident policies, “non-
cancellable” policies may not be cancelled by the company
as long as the policy holder pays the required annual
premiums.' These annual premiums remain level over the
stated life of the policy (Pet. App. A, pp. 1, 50).

The premiums on noncancellable health and accident
policies are generally payable annually and in advance of
the period of coverage to which they apply. These
premiums are treated as earned ratably over the period of
coverage. Thus, at any particular time, the pro rata
portion of the gross annual premium received by the
company that is attributable to the unexpired portion of
the policy year is considered to be “unearned.” The
aggregate amount of “unearned” premiums as of the end
of the calendar year is reflected as a reserve for “unearned
premiums” on the company’s annual statement. That
statement must be filed, in accordance with procedures
established by the National Association of Insurance
Commissioners (N.A.1.C.), with the insurance
departments of the various states in which the company
does business (Pet. App. A, p. 50).

‘Under Treasury Regulations on Income Tax (1954 Code), Section
1.801-c) (26 C.F.R.). a health and accident policy will qualify as a
“noncancellable” policy for federal income tax purposes only if the
company is obligated to continue or to renew the policy at specified
premiums at least until the policyholder attains the age 60.

5

The reserve for “unearned premiums” is determined and
maintained in essentially the same manner for both non-
cancellable policies and cancellable policies. However,
an additional reserve must be maintained and separately
stated on the N.A.1I.C. annual statement with respect to
noncanceliable health and accident policies representing
the company’s obligation to provide continued insurance
coverage Wh future policy years at the same level annual
premium, even though the risk of morbidity increases as
the policyholder grows older. The actuarially determined
amount that the company must hold, at the end of the
policy year, to meet these increased insurance costs in
excess of premiums in subsequent policy years is called
the “terminal” reserve. The terminal reserve represents the
excess of the present value of projected future benefits
over the present value of future premiums. The addi-
tional reserve on the N.A.I.C. annual statement for
noncancellable health and accident policies as of the end
of the calendar year reflects the average of the terminal
reserve for the current policy year and the terminal
reserve for the prior policy year. It is therefore called the
“mid-terminal” reserve (Pet. App. A, p. 50).

Net additions to both the reserve for “unearned
premiums” and the mid-terminal reserve are deductible
by the company in the computation of its “gain from
operations” under Section 809d)(2) of the Internal
Revenue Code of 1954 (26 U.S.C.). The mid-terminal
reserve also qualifies for inclusion in the company’s total
“life imsurance reserves” under Section 801(b) and is
therefore taken into account in the determination of the
exclusion of the “policyholders’ share of investment yield”
in the computation of the company’s “taxable investment
income” under Sections 804 and 805 of the Code.

On its income tax returns for 1958-1968, petitioner in-
cluded a portion of its “unearned premiums” in its “life

6

insurance reserves,” thereby increasing the amount of the
tax exclusion for the policyholders’ share of its investment
yield.2 On audit, the Commissioner eliminated petitioner's
“unearned premiums” from its “life insurance reserves,”
which resulted in an increase in petitioner's “taxable
investment income” (Pet. App. A, p. 51).

After paying the additional taxes assessed, petitioner
brought this refund suit in the United States District
Court for the District of Maine. The district court upheld
the Commissioner. After examining the pertinent legisla-
tive history, it concluded that Congress intended that
only the mid-terminal reserve on noncancellable health
and accident policies would be includable in “life
insurance reeserves” for income tax purposes (Pet. App.
A, pp. 51-59). The court of appeals affirmed (Pet. App. B,
pp. 83-88).

2. Policy loan interest issue.

Petitioner also issues conventional life insurance pol-
icies under which the policyholder has the right to bor-
row against the cash value of the policy. Under the terms
of the policies, interest at a specified annual rate for the
remaining portion of the policy year is payable in advance
at the time the policy loan is made. Thereafter, interest
for each policy year is payable in advance on each suc-
ceeding policy anniversary date as long as the loan re-
mains outstanding. Petitioner bills the policyholder for

2As we have noted (p. 4, supra), the reserve for “unearned pre-
miums” as shown on the N.A.I.C. annual statement reflects the pro
rata portion of the gross annual premiums that is attributable to
the remaining periods of unexpired coverage as of the end of the
calendar year. On its tax returns, petitioner reduced these reserves for
gross unearned premiums to amounts based on “net” unearned
premiums— i.¢., gross annual premiums reduced by the “loading”
element covering administrative expenses, commissions, unforeseen
contingencies and profit.

the advance interest, and, if the policyholder fails to pay it
in cash on the due date, petitioner adds the interest to the
principal balance of the loan. Generally, the advance
interest for the first partial year of the loan is not paid in
cash, but is charged against the cash value of the policy.
The annual advance interest charges for subsequent years
are paid in cash by the policyholders in about half of the
loans. Otherwise, petitioner adds the interest charges to
the principal loan balances (Pet. App. A, pp. 14-15).

Some of petitioner's policies also provide for the
payment of annual premiums as they fall due through the
use of “automatic premium loans” against the cash value
of the policy. The interest on these premium loans is aiso
payabie annually and in advance, and, like the premiums
themselves, is automatically added to the balance of the
policy loan (Pet. App. A, pp. 14-15). In the event a policy
loan of either type is not repaid, the amount of the loan 1s
deducted from any benefits paid or from the cash value if
the policy is surrendered. If the policy is surrendered or
matures during a period for which interest has been paid
in advance or charged against the cash value, the
policyholder or beneficiary is given credit for that portion
of the interest that is allocable to the remainder of the
policy year (Pet. App. A, pp. 15-16).

On its annual statements, petitioner reflected the
advance interest allocable to periods after the end of the
calendar year as “unearned” income. It therefore included
the advance interest in the assets (whether received in cash
or added to the principal balances of the policy loans),
and recognized an offsetting liability in the amount of the
interest allocable to periods after the end of the calendar
year. Similarly, in its computation of “gross investment
income,” petitioner reduced the interest “collected during
the year” by the ainount of “unearned” interest income

8

(Pet. App. A, p. 16; R. 174-175, 179). See Noback, Life
Insurance & Accounting 214, 227, 319 (1969).

On its income tax returns for the years in question,
petitioner excluded the advance interest allocable to the
remainder of the policy year from its “gross investment
income” under Section 804(b)(1) of the Code. On audit,
the Commissioner included all policy loan interest
received or charged against the cash value of the policies
in petitioner's “gross investment income.” The district
court upheld the Commissioner’s determination. It ruled,
in accord with Franklin Life Insurance Co. v. United
States, 399 F. 2d 757, 761-763 (C.A. 7), certiorari denied,
393 U.S. 1118, and Jefferson Standard Life Insurance Co.
v. United States, 408 F. 2d 842, 856-857 (C.A. 4),
certiorari denied, 396 U.S. 828, that interest payable in
advance on policy loans is fully includable in gross
investment income (Pet. App. A, pp. 17-23). The court of
appeals affirmed. Like the district court, it followed the
decisions of the Seventh and Fourth Circuits, and further
observed that the subsequent opinion of the Fifth Circuit
in Southwestern Life Insurance Co. v. United States, 560
F. 2d 627, certiorari denied, April 24, 1978 (No. 77-1124),
was to the same effect (Pet. App. B, pp. 78-83).

ARGUMENT
1. Unearned premiums reserve issue.

a. The decision below correctly held with respect to this
question of first impression that “unearned premiums” on
noncancellable health and accident insurance may not be
included in a life insurance company’s “life insurance
reserves” under Section 801(b) of the Code.

“R.” refers to the three-volume record appendix filed in the court
of appeals.

Under the Life Insurance Company Income Tax Act of
1959, 73 Stat. 112, one of the components of a company’s
taxable income is its “taxable investment income.” See
Sections 802(b) and 804 of the Code. A company’s total
investment income is regarded as including a share for the
company, which 5 taxable, and a “policyholders’ share,”
which is excluded from the tax base. The policyholders’
share is determined by the ratio of the company’s life
insurance reserves to its assets so that an increase in life
insurance reserves will reduce the company’s taxable
investment income. See Commissioner v. Standard Life &
Accident Insurance Co., 433 U.S. 148, 155-156; Sections
804 and 805.

The statutory provisions defining life insurance reserves
have their origin in the Revenue Act of 1942, 56 Stat. 798.
At that time, Congress adopted a special definition of the
term “life insurance reserves” for purposes of computing
the exclusion for the policyholders’ share of investment
income. While Section 163 of the Revenue Act of 1942
retained the “required by law” standard of prior law, it
narrowed the definition of reserves to those “amounts
which are computed or estimated on the basis of
recognized mortality or morbidity tables and assumed
rates of interest, and which are set aside to mature or
liquidate, either by payment or reinsurance, future
unaccrued claims arising from life insurance, annuity, and
noncancellable health and accident insurance contracts
***™ See Section 201(cX2) of the Internal Revenue
Code of 1939 (26 U.S.C. 1952 ed.), as amended by Section
163 of the Revenue Act of 1942.4

‘Prior to the 1942 amendment, the statute permitted a deduction
from investment income equal to a specified percentage of “reserve
funds required by law.” See Section 203(a)(2) of the 1939 Code. Since
the statute did not distinguish between “life insurance reserves” and
other “reserve funds required by law.” both the “unearned
premiums” and the additional mid-terminal reserve with respect to
noncancellable accident and health insurance were held to qualify for
the percentage reduction from gross investment income. Com-
missioner v. Monarch Life Ins. Co., 114 F. 2d 314 (C.A. 1).

10

The committee reports accompanying the 1942 legisla-
tion show that Congress was willing to permit certain
non-life insurance reserves to be added to life insurance
reserves for purposes of determining whether the
company qualified as a life insurance company under the
50-percent reserve ratio test. See United States v.
Consumer Life Ins. Co., 430 U.S. 725; Section 801(a).
However, the legislative history further shows that
Congress simultaneously intended to establish a more
stringent test for determining whether a reseive qualified
for computation of the exclusion for the policyholders’
share of income. Thus, the House Committee observed
that while the “pro rata unearned premiums * * * on
noncancelable [sic] health and accident policies are added
to life insurance reserves in determining whether a
company is to be considered a life insurance company,”
the life insurance reserves themselves would include, in
the case of noncancellable health and accident policies,
only “those amounts which must be reserved, in addition
to pro rata unearned premiums, to provide for the
additional cost of carrying such policies in later years
when the insured will be older and subject to greater risk
and when the cost of carrying the risk will be greater than
the premiums then being received.” H.R. Rep. No. 2333,
77th Cong., 2d Sess. 109 (1942). The Senate Report
likewise states that the “unearned premiums” with respect
to noncancellable health and accident policies will be
taken into account under the amended provisions “for
purposes of the definition of a life insurance company
only.” S. Rep. No. 1631, 77th Cong., 2d Sess. 144 (1942).

In light of the legislative history, the decision below
properly concluded that the 1942 amendments were
intended to qualify only the additional mid-terminal
reserve on noncancellable health and accident policies as
“life insurance reserves” for purposes of Section 801(b).
Indeed, as both courts below suggested (Pet. App. A, p.
58; Pet. App. B, p. 87), there would have been no reason

for Congress to distinguish between pro rata unearned
premiums on cancellable policies and those of non-
cancellable policies. The only characteristic of non-
cancellable health and accident insurance that made it
appropriate to bring such policies within the scope of the
life insurance provisions was that noncancellable policies,
like ordinary level premium life insurance policies,
“require the accumulation of substantial reserves against
increased future risks” (H.R. Rep. No. 2333, supra, at
109). Since it is only the additional, mid-terminal reserve,
and not the reserve for pro rata unearned premiums, that
serves to measure the funds that will be required to cover
the “increased future risks” to be incurred when projected
benefits will be greater than the level premiums, only the
mid-terminal reserve can qualify as a “life insurance
reserve” under Section 801(b).

b. Moreover, the language of Section 801(b\(1)
precludes the unearned premium reserve from qualifying
as “life insurance reserves” for purposes of computing the
exclusion for the policyholders’ share of investment
income. Under Section 801(b, 1A), a life insurance
reserve must be based on “recognized mortality or
morbidity tables and assumed rates of interests.” But the
reserve for “unearned premiums” is computed simply on
the basis of the pro rata portion of the gross annual policy
premium that is allocable to the remaining period of
unexpired coverage. It bears no relation to recognized
mortality or morbidity tables.

Given the clear statutory language, petitioner has never
directly contended that the unearned premium reserve
as reflected in its annual statements would satisfy the

12

requirements of Section 291(b).5 However, in order to
circumvent the statutory requirement that a life insurance
reserve be computed on the basis of recognized mortality
or morbidity tables and assumed rates of interest,
petitioner has computed an amount which, given an
assumed interest rate, would be required to pay its
actuarially projected claims for the remainder of the
policy year. In petitioner's view (Pet. I1), this self-
designated reserve for unearned “net” premiums qualifies
as part of its “life insurance reserves” because it is
determined on the basis of an assumed rate of interest.
But in providing for computation on the basis of
“recognized” mortality or morbidity tables, Section 801
and its statutory predecessors premise qualification upon
compliance with established practices in the computation
of reserves for annual statement purposes. The decision

below therefore properly rejected petitioner's abstract
hybrid computation.°®

2. Policy loan interest issue.

a. The decision below also correctly held that the
interest petitioner charges in advance on policy loans
must be included in its income at the time i: is due and

°Cf. Central National Life Insurance Co. vy. United States, Ct. Cl..
No. 194-70, decided April 19, 1978. There, it was found that the
taxpayer had established that a reserve for unearned premiums on
credit life insurance reasonably approximated the amount that would
have been computed on a strictly tabular basis and that would have
qualified for inclusion in “life insurance reserves” under the statute.

*Petitioner further argues (Pet. 12) that the question whether
unearned premium reserves for noncancellable health and accident
insurance qualify as life insurance reserves is important to the entire
life insurance industry. But this the only case in which the issue has

been litigated since the current statutory provisions were enacted in
1942.

13

petitioner either receives it in cash or charges it against
the cash value of the policy. In so holding, the decision is
in accord with those of three other circuits that have
rejected the claim that such interest can be deferred for
tax purposes until the expiration of the period for which
the interest is charged (Pet. App. B, pp. 79-81). Franklin
Life Insurance Co. v. United States, 399 F. 2d 757, 760-
763 (C.A. 7), certiorari denied, 393 U.S. 1118; Jefferson
Standard Life Insurance Co. v. United States, 408 F. 2d
842, 856-857 (C.A. 4), certiorari denied, 396 U.S. 828;
Southwestern Life Insurance Co. v. United States, 56Q F.
2d 627, 641-642 (C.A. 5), certiorari denied, April 24, 1978
(No. 77-1124).’

As accrual basis taxpayers (see Section 818(a) of the
Code), life insurance companies are subject to the
controlling principle that income must be reported
“[w]hen the right to receive an amount becomes fixed”
(Spring City Co. v. Commissioner, 292 U.S. 182, 184),
i.e., when the item becomes “due and payable” ( Schlude v.
Commissioner, 372 U.S. 128, 137). See also Treasury
Regulations on Income Tax (1954 Code), Sections |.446-
I(cMii) and 1.451-l(a) (26 C.F.R.).

Here, the terms of petitioner's policies provided that the
interest on policy loans is due and payable in advance. If
the policyholder failed to pay the interest as due, it was
charged directly against the cash surrender value of the
policy, i.e., the fund invested and held by petitioner for
the benefit of the policyholder. In these circumstances, the
decision below properly concluded that petitioner was
required to accrue the advance interest at the time it was
due and either collected in cash or charged against the
cash value of the policy. While petitioner complains (Pet.

The petition for a writ of certiorari in Southwestern Life did not
seek review of the ruling on the advance interest issue. The question
was presented, however, by the petitions filed in Franklin Life and
Jefferson Standard Life.

14

15) that the accrual of advance interest distorts its income,
the plain fact is that “[w]Jhen received, * * * [petitioner's]
right to * * * [the interest] was absolute. It was under no
restriction, contractual or otherwise, as to its disposition,
= or enjoyment.” Brown v. Helvering, 291 U.S. 193,
199.

b. Despite the uniform rejection of its position by the
four circuits that have considered the question, petitioner
urges (Pet. 16-17) that review by this Court is necessary in
order to clarify the “disagreeinent and uncertainty” caused
by the Court's decisions in Automobile Ciub of Michigan
v. Commissioner, 353 U.S. 180; American Automobile
Association v. United States, 367 U.S. 687; and Schlude
v. Commissioner, 372 U.S. 128. In each of those cases, the
Court refused to permit tax deferral of advance payments
in exchange for the performance of future services.

The lower courts have expressed various views as to the
extent to which this Court's decisions preclude deferral of
advance payments for services.* But that question is not
presented here since the advance payments in this case
were not tied to the performance of future services. To the
contrary, once petitioner loaned funds to a policyholder
on the security of the cash value of the policy, it was
under no obligation to perform any services or incur
additional expenses during the future period to which it
seeks to defer the advance interest charges. As the court
of appeals observed (Pet. App. B, p. 83 n. 2), the advance

“Compare New England Tank Industries, Inc. v. Commissioner, 50
T.C. 771, affirmed, 413 F. 2d 1038 (C.A. 1), Hagen Advertising
Displays, Inc. v. Commissioner, 407 F. 2d 1105 (C.A. 6), and
Mooney Aircraft, Inc. vy. United States, 420 F. 2d 400 (C.A. 5), with
Artnell Co. vy. Commissioner, 400 F. 2d 981 (C.A. 7), and Boise
Cascade Corp. vy. United States, 530 F. 2d 1367 (Ct. Cl.). discussed at
p. 15, n. 9, infra. See also Rev. Proc. 71-21, 1971-2 Cum. Bull. 549.

15

interest charges are analogous to prepaid rent, which has
been held to be accruable in the year of payment. United
States v. Williams, 395 F. 2d 508 (C.A. 5). Artnell Co. v.
Commissioner, 400 F. 2d 981 (C.A. 7), and Boise Cascade
Corp. v. United States, 530 F. 2d 1367 (Ct. Cl.), upon
which petitioner relies (Pet. 16-17), are therefore dis-
tinguishable. Those cases involved advance payments for
future services and turned on considerations of matching
related revenues and expenses.’

c. Petitioner further argues (Pet. 18-19) that the
decision below conflicts with Commissioner v. Standard
Life & Accident Insurance Co., supra. There, the Court
held that unpaid premiums must be reflected in the
computation of a life insurance tax liability “in a manner
consistent with the manner recuired for purposes of the
annual statement approved by the National Association
of Insurance Commissioners” (see Section 818(a); 433
U.S. 148). It therefore approved the inclusion of the net
valuation portion of unpaid premiums in reserves, assets,
and gross premium income. Since petitioner's deferral of

*Artnell arose in the context of a corporate reorganization
involving a professional baseball club. The question presented was
whether the liquidated corporation should have accrued the prepaid
revenues received with respect to future baseball games to be played
by the successor corporation. The Seventh Circuit concluded that the
Tax Court had erred in refusing to.consider the factual details of the
taxpayer's deferral method of reporting such income, and remanded
for the Tax Court to consider the merits of that method and to
determine whether the Commissioner had abused his discretion in
rejecting that method (see 400 F. 2d at 984-985).

Boise Cascade involved contracts for engineering, construction,
architectural and consulting services requiring, in certain instances,
payment to be made prior to the period in which the services were to
be performed. The court concluded that deferral was appropriate as a
means of “accurately matching costs and revenues” (530 F. 2d at
1377). In reaching this conclusion, however, the court stated that the
fact that a deferral method was in accord with generally accepted
accounting principles was not a controlling consideration for tax
purposes (see 530 F. 2d at 1372).

16

advance interest is consistent with N.A.I.C. annual
statement reporting, it urges that Section 818(a) requires a
similar result for tax purposes.

But the Court in Standard Life did not hold that the
N.A.1.C. method of accounting governs all tax com-
putations of life insurance companies. As the Court there
observed, “[{t}he legislative history [of Section 818(a)]
makes it clear that the accounting procedures established
by the N.A.1L.C. apply if they are ‘not inconsistent’ with
accrual accounting rules. In other words, except when the
rules of accrual accounting dictate a contrary result,
N.A.1.C. procedures ‘shall’ apply” (433 U.S. at 158-159;
footnotes omitted). Since the general rules of accrual
accounting did not speak to the question of the fictional
assumptions dealing with unpaid premiums, the Court
concluded that Section 818(a) “require{d] use of the
NAIC approach to fill the gap” (id. at 162; footnote
omitted).

Here, however, the general rules of accrual accounting
do speak to the question of the treatment of advance
interest. As we have pointed out supra, pp. 13-14, they
provide that such interest is includable in income when
received and cannot be deferred to the period for which
the interest is charged. The N.A.1I.C. method of account-
ing is therefore inapplicable to the reporting of advance
interest for tax purposes.

d. Finally, petitioner contends (Pet. 19-20) that deferral
is proper at least with respect to that portion of the
advance interest that it added to the principal balances of
the policy loans. This argument has likewise been rejected
by the four courts of appeals that have considered the
question. However, petitioner (Pet. 20) relies upon
Bankers Union Life Ins. Co. v. Commissioner, 62 T.C.
661, in which the Tax Court accepted the argument that
such “capitalized” or “add-on” interest need not be taken
into income until “earned.”

17

A conflict between the Tax Court and the courts of
appeals is not a conflict of decisions requiring resolution
by this Court. At all events, the Tax Court's decision rests
upon an erroneous analogy between a life insurance
policy loan and a common loan on which interest is
discounted. As the Seventh Circuit in Franklin Life (399
F. 2d at 763) and the court below (Pet. App. B, p. 82)
noted, unlike an ordinary discount loan, the advance
interest on a life insurance policy loan does not represent
sums that may never be received by the company. Since
the total principal balance (including interest added)
cannot exceed the cash surrender value of the policy,
there is no doubt that the company will collect the
interest. There is accordingly no basis for the deferral of
the portion of the advance interest added to the principal
balances of the policy loans.

CONCLUSION
The petition for a writ of certiorari should be denied.
Respectfully submitted.

Wave H. McCree, Jr..
Solicitor General.

M. CARR FERGUSON,
Assistant Attorney General.

ERNEST J. Brown,
Gary R. ALLEN,
Attorneys.

JUNE 1978.

DOJ-1978-06

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385005_0961%3A3. Public record. Not legal advice.