Brief for the United States in Opposition — Jefferson Standard Life Insurance v. United States

Supreme Court brief1969

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MAA OF EA Bi) SOT

INDEX

Jon . ; S Page

Opinions below. ¢-. . 2.2. \1. 02... nxb pe eean ene i }

Juriabiction: © oo54c.. 2. <2 ceria aie Garmin y <Ogea E SY ee

Questions presented ___-____- wo howe penne tense een n oe nse 1

Statutes and Regulations involved “_-______--------2--- 3

Introductory statement-_---- Gan ce ater ae tran F 3

Specific statement and argument: sam :

ook Deferred and uiicollected | premiums. _.__...--_--- 6°

2. Prepaid and capitalized interest_____ gi seracinwks |

3. Agents’ debit balances_--..:.....-.-.----- areas 20 .

A. Cr ong Rain Sotd

5. Branch office. Manager’s supplemental retirement — .

; WO aed Cau k ek tw keane wemeed gh

4. Determination of consolidated taxable i income-_-___- oo ae

7. The applicable rate of tax___-_/_.:--.---------- S81:

S. The NAIC computations: .... (2.5... .000u 252 33

9. The significance of this case__...----- SAeieney weak 37

Ci ee wees 39

Di ie. se bce ok iN eee ree

CITATIONS

Cases: Ripteay ,

‘American Automobile Ass’ n. v. United States, 367 U. Ss.

a a ee wis 3 | ae

' Artnell Co. v. Commissioner, 400 fy 2 ARES 19, 20

Commissioner v. Angelus Funeral Home, 407 F. 2d 210_ 20

Commissioner v. General Reinsurance Corp., 190.F. 2d |

148, certiorari dismissed, 342 U.S. 863___-..-,---- 36.

Commissioner v. New Hampshire Fire, Ins. Co., 146 F. |

Matai ciacgcans amneacneeWanaadun 36

Franklin Life Insurance Co. v. ‘United States, 399 F.2d |

757, certiorari denied, 393 U.S. 1418___ 5,9, 13, 16, 19, 20

General Life Ins. Co. v. Commissioner, 137 F. 2d 185_- 27:

Helvering v. Inter-Mountain Life Ins. Co., 294 U.S.°

Sree Re bona nay Simoni Ee NT LE

356-540—69—2-1

‘ 1 we "

° ‘ rhea 5.6

. on <i ‘ AQ

Cases—Continued ~ . ‘

Jefferson Standard Life Ins. Co. v. United States (M. .D. Page

N.C., Civ. No. C-84—C-66)..2...=-....-..---..- 38

Lewis, Charles C., Co. y. United States, 14 F. Sypp. 471. 1g

_ National Life & A Aes Co. ve Unite) States a,

(M.D. Tenn., Civ. s

New York Life Ins. Co. v. Bowerg, 283 U.S. 42 ae _ 27

f . North American Oil v. Burnet, 286 U.S. 417 © ..--- .* <a

Old RelianceIts. Co. v. United-States (Ct. Cl., Rg.

324-68) ..2........ QnatninetsadsedesiNdedsenane 38

Pacifie Ins. a v. United States, 188 F..2d 571, cer-, as

tiorari dismissed;-342 U.S. 857_....-_- {---@----- 37

' Schlude v-Gommissioner, 372 U.S. 428-_-- cipal atiema atte 18, 20

” Southwestern Life Ins. Co. v. /nited States AN D. .

“aps ~ Ces Ts OID. oc oh iwcc cue sp heoosnte —

United States v. Atlas Life Ins. Co., 381 U; J.S,,233-. ro ‘4,

x Qs 29, 30, 31 7

United States»v. Fidelity & Deposit Co. of Maryland,

PP ls et aekdndnsdeddcavepenbosdacneeds 36

Western National Life Ins.-Co. of Texas v. Commis-

sioner, 51 T. C. 824, modifying SOC. 285.....:. 16, 24

Statutes: . Va

- “Internal liietes Code of 1939, wu 204, (36 U SG te

SONS Gl, te. B08). LA cnwedstcaDecéimscobecetocs 6 .,

Internal Rev enue Code of 1954, as ‘mond by Sec.

2 of the Life Inigurance Goinpany Income. Tax Act

of 1959, P.L. 86-69, 73 Stat. 112, et seq.: -

Sec. 11(a) (26 U.S.C. 1964 ed., Sec. 11(a))..---- "ee

: Sec. 11(p) (26 U.S.C; 1964 ed., See. 11(b)). ----- 32.

Sec. 11(c) (26-U.S.C. 1964 ed., Sec. 11(@))......° B

Sec, 401 et seq. (26 USC. 1964 ed., Sec. 401 et

ail i i icttiendedsoscccenskagpedsinpoesdeneses 27

‘ See. 446 (26 U.S.C.-1964 ed., Sec. 446)... -.-_- 20

Secs. 801-826 (26U.S.C. 1964 ed., Sees. 801-820). 6

Sec. 801(b) (26 U.S.C. 1964 ed., Sec. 801(b)).... 2, 26

Sec. 802(a) (26 U.S.C. 1964 ed. Sqr. 802(ajF-62. 82

Sec. 802(b) (26 U.S.C. 1964 of; Bec. 802(b))_... 4

Sec. 804 (26 U.S.C. 1964 ed., Sec. 804)... ___. 6, 10, 23

Sec. 804(a) @6 U.S.C. 1964 od., Sec. 804(a))... 4,7, 28

Sec. 804(c) (26 U.S.C. 1964 ed., Sev. 804(c)).... 2, 25

ee. 805(b) (26 U.S.C. 1964 ed., Sec. 805(b)) ---- 2,

9, 16, 21, 22, 24

* . ® *

Statutes—Cdntimed : :

~~——Fnternal Revenue Code of 1954—Continued @ Page

Sec. 809 (26 U.S.C. 1964 ed., Sec. $09)... --- 6, 25, 29

Sec. 809(a) (26 U.S.C. 1964 ed., Sec. 809(a)).."._7, 28

Sec. 809(b) (26 U:S.C. 1964 ed., Sec. 809(b))---- 4

See. 809(c) (26 U.S.C. 1964 ed., Sec. 809(c))... 2, 9, 10

Sec. 809(d) (26 U.S.C. 1964 ed., Sec. $09(d)).--. 2,

7, 9, 10, 24, 25, 40

gy hee. 809(e) (26 U.S.C. 1964 ed., Sec. 809(e))._ 2, 24, 25

Sec. @18(a) (26 U.S.C. 1964 ‘ed., Sec. 818(a))_ 34, 35, 36

Sec;,832(b) (26. U.S.C. 1964 ed., Sec. $32(b))...- 36

Sec! 1503 (26 U.S.C. 1964 ed., Sec. 1503)... .-- 32

Sec. 1503¢a) (26 U.S.C. 1964 ol. .» Sec. 1503(a))_ 33

~ Revenue Act of 1964, P.L. 88-272, 78. Stat. 19, Sec.

eee Spee ee re SC om A a UTE 33

Miscelluneod:

A. Rep. No. 34, 86th — im Gok... i dk, ERS

: Il Proceedings of the National Association of Insur-

° ance Commissioners (1963)... - 14

oe. . Rep. No.291, 86th Cong., Ist Sess. .2.... 12, 24, 82, 33

Treasury Regulations on ee come Tax:

Sec. 1.405-5 (26 C.F.R., See. 1.805-5)....-. 8, 24

* See, 1.80028 (26 CAF... See. 1.890-4)..... <'

Sec. 1.S18-2 (26 C.P.R., See. i a ae 35

Sect 1.1502-3A (26 C.F.R., Sec. 1.1502- sAj-.. 31

- Sey 1.1502-31A (2@0¢F.R., See. ee tempat 30

rs oe . .

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—_—_

Iu the Supreme Court of the Bited States

% OctToBER TERM, 1969

~ °

JEFFERSON STANDARD LiFE INSURANCE COMPANY,

PETITIONER

Unitep STATES OF AMERICA

ON PETITION FOR. A WRIT OF CERTIORARI TO THE UNITED

STATES COURT OF APPEALS FOR THE FOURTH CIRCUIT

BRIEF FOR THE UNITED STATES IN OPPOSITION

OPINIONS BELOW

The* findings of fact and conclusiobs of law of the

‘district court are reported at 272 F. Supp. 97. The

opinion of tthe court of appeals is repofted at 408 RF.

2d 842. } .

JURISDICTION

The judgment of the "court of appeals was entered

on March 15, 1969. The petitign for a writ of certio-

rari was filed on June 10, 1969. The jurisdiction of this

Court is invoked under 28 U.S.C. 1254(1).

es ‘

QUESTIONS PRESENTED

1. Whether, in determining the income of a life in-

" surance company, the total amount of deferred and

(1)

; No. 220 | +.

uncollected premiums must be included in its ‘‘gross

amount of premiums”’ under Section 809(¢) (1) of the

Internal Revenue Code of 1954 without the offset peti-

- tioner claims for an amount that it calls ‘‘increase in

a on deferred and uncollected premitins.”’

. Whether a life insurance company must include

‘the total amownt of deferred and yncollected premi-

ums as assets under Section’ 8@5(b)(4) of the 1954

Code without the adjustment petitioner claims for an —

amount that it calls “loading on deferred and uncol- .

lected premiums.”’ |

3. Whether a life insurance company, in computing

its ‘taxable investment income,’’ must include the full

amount of policy loan interest received or capitalized

during the taxable year.

4. Whether agents’ debit balances are assets of the

company under Section 805(b)(4) of the 1954 Code.

5. Whether charitable contributions are deductible

only in the computation of gain from operations

under Section 809(d)(12) as. limited by Section 809

' @)(3) of the 1954 Code, or whether a portion may be

deducted under Sectten 804(c)(1) as a general in-

vestment expense in computing taxable investinent

income. | y ~

6. Whether amounts designated by petitinnes for

future benefits which it might pay’ under its own

Branch Office Manager’s Supplemental Retirement

Plan are includible as life insurance reservés under

Section 801(b) of the Internal Revenue Code of 1954.

7. Whether petitioner must take into account the

- stock and dividends of its wholly owned subsidiary in

‘\ ‘cy

- —_

computing its exclusion attributable to the total

policyholders’ share of consolidated investment income.

8. Whether a life insurance company electing to

file a consolidated income tax return was subject to

the additional 2 percent fax required of corporations

filing Se AEA returns for the years in con-

troversy (1958-1959). > : ; |

9.Whether computations made on the Annual .

Statement-promulgated by the-National Association of

Insurance Commigsioners are binding upon the Com-

missioner of Internal Revenue—or whether they may

only be used for tax purposes. when consistent with

the substantive provisions of the 1954 Code, as

amended, and established ‘rules of tax ‘accrual

‘accounting. °

" STATUTES AND REGULATIONS INVOLVED

Relevant provisions of the. Internal Revenue Code

of 1954, as amended’by Section 2 of the Life Insur-

ance Company Income Tax Act of 1959, P.L. 86-69,

¢ 73 Stat. 112, and the applicable Treasury Regulations

are set forth in the petition. (Pet. 94a-126a.)* Section

809(d) of the 1954 Code is set forth in full in the

Appendix, infra, pp. 40-42. .

INTRODUCTORY STATEMEN T

' Petitioner, Jefferson Standard Life Insurance Com-

pany, and Pilot Life Insurance Company, its wholly

® owned subsidiary, are domestic life insurance com-

panies taxable under the Life Insurance Company

+“Pet.” references are to the Petition for Certiorari and Pa

Appendix thereto. “R.” references are to the printed record

filed in the Court of Appeals.

ete

Income Tax Act of 1959 (Sections 801 through 820,

or Part I of Subchapter L of Chapter 1 of the In-

ternal Revenue. Code of 1954, as amended) (Pet. 41a).

The Act provides that the taxable income of a life in-

surance company includes the full amount of its

“gain from operations” i to the amount of its “tax-

able investment income,’ ’ plus one-half of any,‘addi-

tional“ ‘‘gain from operations” (Section 802(b)).

“Taxable investment income” and “gain from opera-

tions’’ are each the result of detailed calculations and

are defined in Sections 804(a) and 809(b), f-espec-.

tively. A description of the calculations performed in

determining tax liability under-the Act is contained in .

United States v. Atlas Life Ins. Co., 381 U.S. 233.

Jefferson filed consolidated income ‘tax returns in

behalf of itself and Pilot for 1958 and 1959 (Pet.

41a—42a). Petitioner thereafter filed suit for refund

of income taxes paid for those years. The Government

filed a counterclaim Yor each of the years, asserting -

liability for additional income taxes (Pet 43a). The

_ issues were tried before the United St District

Court for the Middle Disgrict of. North Cafolina: The

eourt found for petitioner on some issues and for the’

Government on others. On crosseappeals, the Fourth ,

Circuit affirmed all issues appealed by petitioner and

reversed’ two of the three issues appealed by the

| Government.

Petitioner now raises “nine legal issues relating to

the détermination.of its tax liability under the Life

Insurance Company Income Tax Act of 1959, Eight

are the questions of statutofy : inter pretation which

the court of capoents decided adv ersely to petitioner.

‘The first two involve. the proper treatment of the

mounts petitioner ealls “INCTEASE in loading”’ awd

“leading” on “deferred and uncollected premiums.”

The third involves the treatment of prepaid and cape

italized interest on ‘policy loans. These most important :

of the issues raised were presented ‘to the Court in ‘

the petition for a writ of certiorari in Franklin Gere --.. ¥

Tnsurance Co, v. United States, No. 780, Oc ober Term.

1968, certiorari denied, 393 U.S. 1118. The other ive

questions involve the treatment of the companies’

agents’ **debit” balances, their charitable contribu- * ;

tions, amounts put aside for f uture retirement. behe ie

for branch office managers, dividends which Pilot ip

- to the petition eY, as well. as stock-of Pilot. held by peti-

tioner, and the rate applicable for the consolidated

return for the vears in issue. W ith resiiect te two of

these other issues, as well as to the loading and, un-

earned income issues, petitioner makes _the broad

general assertion that the treatment of the item on thé.

Annual Statement promulgated by the Nationak Asso-

ciation of Insurance Commissioners is binding upon ¢

the Commissioner of Internal Revenue and must be.

followed for tax purposes. It-is on this last contention %

that petitioner’s concepts of the signific ance of this.

case largely rest.

These quéstions present a series of essentially inde-

pendent problems of statutory interpretation. With no

a. view to simplifying this brief, we shall separately |

set out and discuss the facts and jegal issue relating |

$36-540—09-——-2 sue sol %&

”

deemed “taxable.”

o— oe 6”

to each problem. On none of them is there a conflict

of decisions among the courts of appeals. None. of the

questions presents any basis for further review.

SPECIFIC STATEMENT AND ADGUMERE

1. DEFERRED AND UNCOLLECTED PR EMIUMS

Statement. In determining the income t tax of a life

‘insurance company, the ¢ aleulation of “oain from

operations” under Section 809. of the Internal Rev-

‘enue Code of 1954, as amended, and of “taxable in-

vestment income” under Section S04, es a

_determination of a jife insu ‘anee company’s ‘ ‘ oOSS

amount of premiums” during the taxable year. In

calculating “gain from operations,” the gross pre-

mins constitute. part of the basic figure—i.e., pages

_ eomparable to “oross receipts” or “gross incomé”

from which: “gain from operations” is apmipated Sy by

‘ subtracting statutorily defined “deductions. In deter-

mining “taxable investment inc ome,”

mitms are included in the company ’s “assets,” which

control the fraction of investment income, that is

the . grossa pre-

The “gross annual premium” on a life instirance

contract is the consideration the insured pays for a.

year’s coverage; each premium covers. an annual

- period beginning on the date of issuance or a subse-

quent anniversary date, Fhe “net. valuation pr emiwh”

is the part of the “gross annual* premium,” computed

on the basis of State required imterest aad mortality

tables, that must be addéd to reserves for policy-

holders in each policy year. Petitioner refers to the

& | Sones ry

racy af?

al oH

difference: tatween: the “eross annual premium” and

the “net annual valuation premium?’ as the * ‘loading.”’

(Pet. 23a.) The district court found that’ there was ;

no ‘elation between the “loading” and expenses in-

curred during the policy year (Pet. 72a).

_ Deferred. and uncollected premiums are ‘portions

of gross annual premiums ‘(on policies in force at the

end of the taxable year) which. have not been. collected,

either because the gross annual premium is being paid

i installments over the policy year, or the premium is

due but unpaid (a grace period having ‘been provided

in the policy) (Pet. 23a-24a). Where payment of part

of the premium has been deferréd, the premium is

increased by an amount ey to conipensate peti-

tioner for the loss of interest oo the deferred . portion

of the premium, and for the adddd cost of servicing

the account (Pet. 70a). sare

~Petitioner accrues éts reserves on the basis s of the as-'

sumption that the full.annual premium is received on-

the anniversary date of every policy in force, whether

or not the full premium has been. paid as of that date

(Pet. 24a). This method of calculating resewves Has

a threefold effect in decreasing petitioner’s tax base:

(1) it ine reases the reserves which petitioner is en-

titled to deduct under Section 809(d) (2) in calculating

gain from operations ;" (2) by reason of. Section 809.

(a) (2), it increases the fraction of investment income

that is excluded frum tax under Section 809(a) (1) 3.

and (3) it increases the reserves used in determining

the policyholders’ share.of investment income, which,

under Se ‘ction 804(a) (1), is also excluded. from tax.

‘Treasury Regulations, Sections 1.805-5(a) (4)

iyample 1) * and-1. 809-4(ay (1) (i),". expressly

the inclusion of deferred and uncollected por-

/ premiuns in the caleulati8ns of both 2rOSs

premiuins, and assets. Petitioner apparently Glaims an

tions oO

2 See. 1.805-5 spi aan reserves, rate and CAPNINGS« rates

(a) Tn general. ea ‘ : ,

* Bo / : eee : fe fe —_

(4) A sscis—* Se 2 oie \ l

a me Es Sere ae wf, ok :

(ii) Iustration of priseiples, beat ‘Le

—Bwample (1). Included in the statement of. assets of

P, a life insyrance company, are the following items: +

Bonds, stocks, mortgages, home office and. branch office

buildings owned and wholly - occupied by the company,

ae furniture and equipment owned hy the company ad

‘used in the home office and branch office. buifglings occu-

pied by the company, ‘agents’ debit balances, premiums

deferred and uncollected and-premiums due“and un flaid,

bank deposits (including . tine epmegg and share ac-

counts in savings 2nd loan assoc tions. * * © [Emphasis

| added 1 in Example.] _ ‘

* e. a: : = x wt

(26 CFR, See, 1.805-5.) ee eer ty siete

3 Sec. 1.809-4 Gross amount. ° Dut cy

(a) Items taken inio account, For purposes of deter-

mining gain of loss from operations mnder section 809(b)

» — (1) and (2), respectively, section 869(c) ,specifies three

categories gf items which shall be taken into account. * *

* * * The * *.*-three =~ items taken into account are:

(1) Premiums. (i) * * * The-term “gross amount of

all premiums” means the premiunts and other considera-

tion provided in the insurancefor annuity contract, * *-*.

Such term includes advance premiums, premiums defer-

red and uncollected and premiums due and unpaid, ‘nie

~ [Emphasis added in last sentence. | aa

* we: Ps 4 ©, * é * oe es, ; /

(26 C.FR., Sec. Ane ae en cae

‘ ‘

. | ee eee

. __

adjustment—i.e., a deduction Ol exclusion’ —for an

amount called ‘loading’, in determining its “eros:

crags of premiums’”’ under Section 809(¢) (1) and:

its‘ ‘assets’? under Section 805(b) (4). Essentially, pe-

titioner would calculate its net valuation. “premium ©

(t.egthe, addition to- reserves), subti‘act” that from the ;

gross annual premium, label tlie remainder ‘loading,’ :

and oifset against the gross. premiums the part of

“loading” petitioner deems allocable‘to the deferred

part of the premiuni. The end result is to include only »

the portion of the grdss premium that has in facet been &

paid plus the part of the deferred portion that is.in-

~cluded in reserves... _ > oes yas

The court of appeals affirnied thee district court’s

rejection of “petitioner’s contentions. It Ireld that 1”

if a life insurance company aleulated the dedu

Séetion 809(d) (2) allows with respect _to reserve

* Petitioner strongly asserts that what it seeks is an “adjust-

«- ment” for loading, rather than a “deduction” and seeks to dis- a

oe ‘Franklin Life Insurance Co. vy. U nited States, 399 F.

6d 75 7 (6 Ay 7), certiorari denied, 393.U.S . 1118, ‘on the ground

that se the taxpayer inistakenly ] labelled the relief ‘sought a

“deduction” (Pet. 19-20.) =e petitioner urged below

: ‘thiat the Regulations requiring reppiting of gross premiums in-

cluding loading are not inconsistent with its position since it —

re 4

only thereafter claims an offset or “detluction.” (Court of Ap-*~

pels Br, 25-36.) wenn <s :

- ° Petitioner: follows the treatment provided on the annual

statement’ form of the Natjonal Association of Tpsurance: Com-

missioners, which petitioner. must. file annualle in the States

where it does business, The annual statement form is intended to

demonstrate the solvency of the company, using puypesely

stringent. and conservative accounting standards designed, to

show an. assumed net: worth 7 on liquidation of the company..°

. Pet, Ha: R. 88, 226.) fe om

”

__ ae

liabilities on’ the basis of a full year’s net valuation,

even though it had not received and had no legal right

to receive all of the premiums therefor, it should be

required to include gross annual premiums, including

loading, as the gross income figure under Section —

809(¢)(1), and (2) if the full annual net valuation

- premium. is treated as a reserve liahility in determi-

nation of the policyholders’ share exclusion under

gross annual, premiui; otherwise the formula would

be unbalaneed and provide the cowpany with an

. unwarranted benefit. .

Argument. The court of appeals did not, as peti-

_tioner seems to elaim (Pet. 19), base its decision on

__ the, premise that deferred and uncollected premiums

“re ’ always or necessarily ‘aceruable in ineome.

ather, it found that inclusion of the gross annual

premium ( including the deferred And unieollee ted jfor-

tion) in “gross amount ofe premiums ***on** *

S " contracts” pursuant to Sectigh 809(ey(1) reasonably

follows’ from the inelitsion.in reserves, Which are de-

ductible under Section 809(d)(2), of the .annual

valuation premium, which is itself caleulated pn the

assumptionthat the fulk gross premium has been ré-

‘Section. 804, the corresponding asset should be the .

ceiyed (Pet. 26a-27a; see also district court findings -

No, 128, 146 and 147 at Pet. Tla, 75a.) The court

_ then cosreétlygfound that. although deductions which

‘may’ be taken. are spelled out in Section 809(d), no

eg» adjustment,” “deduction,”’ or “offset’’ is provided for

*' “loading . on deferred and uncollected piethieatt,,

~ Nor did the court ‘below. hold, as petitioner also as- «

see\ a ae

> or

* ” -

- QP , = > /;

—_

4 . *

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« fette’ (Pet. 19), that the amount of the net valuation

premium bears a fixed mathematical relationship to

the amount ‘of the gross premium. Rather, the court

reasoned that ‘whatever that numerical relationship

might be, Congress did not-intend, different standards

to govern the calculation of*includible gross premiums

and deductible reservet Tle record does not. show

the net effect on petitioner's tax liability of dee

hoth its reserves and it# gress premiums by

amount allocable to deferréd and uncollected

ums unpaid at the end of each taxable year én issue

here. if a“

As the court below recognized (Pet. 26a-27a), the

‘proper treatment—of deferred and uncollected pre-

' miums depends on the meaning of the statute’s refer-

— ences ‘to “the gross amount of premiums” in Section

809(¢)(1). Although the statute does not further de-

fine this phrase, Congress, as the court of appeals

recognized, was aware of the accounting’ practices of

the insurance industry, under which life insurance

companies, in accounting for their gross premiums,

.- inelude the full vear’s premium as of the anniversary

~ “date of each policy. There is no reason.to suppose that

Congress thought the same assumption would not Ist

senile in defining the phrase “gross ‘amount of

’ premiums”’ it used in the statute. ar Pe tee Mee

The Basie answer to petitioner’s contentions is ~

that Congress has not pravided an ‘exemption or

deduction for “loading’’ or the like. Although Sub-—

chapter L of the ‘Code is filled with detailed provisions

which define a number_of- allowable exclusions and

a .

i, - .

i sing

2 °

deductions in computation of the income tax liabilities

of life Insurance companies, not one refers, directly or

indirectly, to “loading” or “‘increase in loading.” -It is

no less true here than in any other tax case that ex-

clusions and deductions must have an explicit statu-

tory basis, and, as the, court of appeals recognized

here (Pet. 27a), the absence of such a statutory proti-

sion is fatal to petitioner’s claim.

The net effect of allowing petitioner the “adjust-

ifent” it claims would be a substantial tax windfail.

As Congress was fully aware (see’S. Rep: No. 201,

86th Cong., Ist Sess. pp. 6-7), “loading’’ includes

whatever profits petitioner might realize from the

particular gross premium. Therefore, the cffect of

petitioner’s claimed offset would be to defer tax h-.

definitely on part of its first year’s profit on policies

having deferred premiums. In the first policy year,

petitioner would take deductions for ail eypchises:

incurred during the taxable year,’ 2 fuli year’s reserve

on tife policy, and the loading dedugtion claimed heye.

In later taxable years, the first year’s loading deduc- f>

tion’ would not be recovered into income, for loading

“on the deferred and uncollected portion of the pre-

mium would remain constant and petitioner would -

‘deduct expenses in fact inctirred in succeeding years.

As the district court Tecognized here *(Pet. 72a—73a);,

"The only point at which the additionai deduction . .

*P etitioner receives deductions under Section x09( d) for all

actual insurance expenses incurred. Moreover, the district eéurty

found that there’ was no relation-hip between any amount ,

claimed deductible as “loading” and expenses for any given

year. (Pet. 72a.)

‘ t

is—— se Fae

would be recovered for tax purposes would be in the

last year of the policy, or in the event the terms were,

changed so as to proyide for no more deferred pay-

ments; * * *. In the case of a stable or growing com-

pany, such overall. deductions would not be recoverd ,

for tax purposes * * * until some indefinite time in

the future.” ;

The defects in petitioner's position are particularly

apparent with respect to the ‘Phase I’ determina-

tion of its assets. It is an elementary principle of ac-

crual accounting that assets and liabilities must =

related in point of time.’ ' ‘

This accounting rule is the essence of “Phas 1,”

which is grounded in the proportionate relation ship

(see Franklin Life Insurance Co. vy. United St tes,

' 399 FB. 2d 757 (C.A. 7), certiorari denied, 393 U.S.

1118) between resérve liabilities, 1.€., assets held for

policyholders, and total assets.” There is no indication

that Cong: ess intended a departure from the general

rule in this. tax formula—a departure which would

allow petitioner to accrue as a liability the full an-

* For example, it is established that taxpayer who acerues +.

the cost_of goods sold must also accrue in his income the full .

amount: of receivables attributable to the sales even if payment =, |

has in fact not“been made. -See Charles C. Lewis Co. vy. United

States, 14 F. Supp. 471 (Mass.).

*In simple form the seb I formula may he expressed as

Investment yield oe é

Assets x Reserves= Poliey poldery’ Exclusion

or as ~.

Assets hela for reserve purposes x Bios sualeitent ilies ii. en ae

Total assets holders’ Exclusion

356-540—~69——_3

nual reserve .for insurance coverage but then hot show

as an asset the full amount of- the annual premium

which gives rise to the liability. ?

The only support for petifioner’s claim is that the

treatment it seeks is allowed for National Associa-

tion of Insurance Commissioners (NAIC) annual

statement purposes. That-form, however, was designed

to show the financial strength of a hfe insurance com-

pany, using stringent and purposely conservative

standards for the purpose of demonstrating the com-

pany’s strength upon liquidation. That purpose re-

quires a minimization of income and assets, an objec-

tive alien to the function of the incgne taktaws.”

Furthermore, the NALC approach, in line with its

hasie objective, shows the greatest possible liabilitics on —__

the reserve side, while re flecting only the amount of de-

ferred and. une oliec ‘ted premiums ec ‘ual to the reserves —

included with srespeet to those premiums. This case,

hewever, is voncerned with a tax formula wh: ch relies

upon the proportionate relationship between. assets

and reserves in determining the amount of investment

income that is to be excluded from petitioner’s tax

base. For these purposes, as the court of appeals

stated in Franklin, supra, p. cha ay staat cannot

use “an admittedly overstated reserve while at the

same time allowing an accounting entry vith respect

°The life insurance industry’s own Joint Cammalites on

Blanks of tle American Life Conv ention and the:Life*Insurance -

Association of America agreed in 1963 that the basic objec-

tives of the annual statement>are so different in concept as to

preclude the revision of the annual statement blank to conform

to tax accounting concepts. II Proceedings of the National As-

sociition of Insurance Commissioners. (1963), pp. 445-447.

to assets which, while compensating numerically for

the overstatement, does not fully account for the re-

lated asset * * *."’ (Emphasis in original.)

Nor can the reference in Section 818(a) of the Code

to the NAIC form provide the blanket adoption of

NAIC accounting: necessary to sustain petitioner’s

claim. The comprehensive detailed tax formulae set

out in the substantive sections of Subchapter L pre-

clude any asswmption that Congréss merely sought to

adopt the NAIC form ji tuto into the taxing statute.

Moreover, the legislative history of the Act makes

clear that the NAIC form may only be used «when g

* “not inconsistent with the provision of the 1954 Code

and an accrual method of accounting.”? H. Rep. No.

34, 86th Cong., Ist Sess., ». 42. Congress intend: d the

ae NAIC annual statent-nt to play’ only an inter stitial

part i iil the stuiuior Vv structure Lor thie taxution bfaiyve

insurance ‘companies, i:é., that it is to be used “only °

_ When it does not conflict with settled principles of tax

accounting and -that -it never confers a deduction

which the stbstantive provisions of the Code do not

providg Not only does Subchapter L fail to provide a

dediiction or exclusion with respect to loading, but

petitioner’s method in tins instance falls short of meet-

ing elementary accrual standards, fox it would accrue

the deferred and unéoliected premiums for purpdses of

determining deductible and exchidable reserves, ‘but

would not allow the accrual for the rest of the equation

that determines petitioner's overall tax’situation.

The opinion of the Gourt below is in acegrd with

the decision of the Court of Appeals for the Seventh °

Pip a Wipe K

Circuit in Franklin Life Insurance | Co. v. United

‘States, 399 F. 24 757, certiorari denied, 393 U. S. = |

the only other appellate court holding gn these i issues.’

. °2. PREPAID AND CAPITALIZED. INTEREST

Statement. By the terms of petitioner’s policy loan

agreements, a, policyholder who borrows money from

‘petitioner in connection with a specifie life insurance

policy is required to pay the interest ‘annually in ad-

vance’’ on the policy anniversary dates In the event

that an insured does not pay the annual interest as

required on the due date, the policy iganeagreement re-

quires that the interest be “‘capitalized”’ (added to the

principal of the loan), bearing interést thereafter at

the agreed upon rate. (Pet. 28a.)

Petitioner on its own records distinguished between

> and ititerest Goemen, ‘un-

Defember 31 to kis ond pottic ion of the tila it

The only holding to the contrary is Western National. Life

Tus. Co. of Texas v. Commissioner, 51 'T.C. 824, modifying 50

T.C. 285 wherein it has been held that “loading” should ‘be sub-

tracted in deter ‘minine” the amount of deferred and uncollected

premiums included in the “assets” of life insurance companies

in the “Phase I” computation under Section 805(b)(#). The

Western A ‘utional opinion, which resetvgs the question of treat=°

-ment from the income side (Phase I1),/was discussed in supple-

mental memoranda filed with this Court by both the petitioner.

(Franklin) and the United States in Meanklin Life Insurance

Co. v. United States, supra, The final decision in Western Na-

tional. has recently been entered and will be subject to appel--

late review in the-Court of Appeals for the Fifth. Circuit.

> a5

wy ~

. a refunded over f

deemed “to have been ‘“‘earned’’ during the bisatse

year and what portion it considered “unearned.” If.

the annual interest Was in default and had been added

to the principal of the policy loan then, as of Decem-

ber 31, petitioner’ would prorate the capitalized in-

‘terest as of December 31 to show the amount ‘‘earned’’

to that date. In the event that the policyholder repaid

the principal of the loun during.the policy year peti-

tioner refunded the portion of the’ annual interest

deemed “unearned” at that point to the policyholder;

and where the amount deemed unearned ‘had already

_ been a added to the policy loan principal, petitioner. in

the event of repayment of principal,, credited the |

policyholder with the “unearned : » Domgjon of sneh

interest. (Pet. 28a.) ake, orth ts

‘On its tax retims for the vears in suit, petitioner,

“in ¢ omputing itS taxalile investment Income, séught’ to

" reflect only the interest it deemed “‘earned”’ as in-

come, and to defer recognition as income of the re-

mainder of the interest actually received or added to

S policy loan principal until the ‘succeeding taxable

-year. "The district court disallowed. petitioner's treat-

ment and held that both the full amount of “int¢rest

actually received and interest added to policy loan c

“principal | must he recegnized ‘as income in the. years

received or added to the prineipal. (Pet. 22-2.)

The court of appeals affirmed.

Arg ‘gumeit. Petitioner requires borrowers to prepay

a year’s interest on loans made against the cash value

of the Policies.” Af the adv ance interest has hot been

' Petitioner oie no siliion as to any. actual amounts ever

he years, (Pet. 67a.).- ) :

paid on the anniversary date of the policy, and the |

available cash value exceeds ‘thie unpaid interest, peti-.-

tioner capitalizes that interest by adding it to the

principal of the policy loan.

Although a ratable refund of prepaid interest is

made if part or, all of:the principal is repatd during:

the policy vear, the loans have no due date and peti-.

tiorier has no fixed or even predictable future liability

to-repay the prepaid interest. “Thus, the interest which

petitioner collects in advance belougs to it with no re-

sstiictions as to ‘its? use. Such amounts should be ins

cluded in taxable inv estment ’ income, for an accrual

basis taxpay er must report in full amounts ae tially

rec ived by. it mider n claim of tight during the tax-

able year, and this is se-even hen portions of those

AUnOtAES Te present iia tor aieipsiok icndered iba

subsequent vear: “(Sehlude vo C ommissioner, 372. U.S.

12 S) and despite (the fact that’ the, taxpayer later —

my be required to refund some of the maney North °

‘American Oil v. Burnct, 286 Uis417).

Similarly, there*is no reason to omit any part of

the capitalized interest in, coniputing petitioner’s in

come: The interest so added to priicipal of the policy

loan itself bears interc st at the same rate as the. rest of

principal. (Pet. 28a.) The. same logie which requires

the inclusion of interest: received by petitioner in the

vear of eceipt requires the inclusion of capitalized

interes in yhe yea r capitalized. a Jit

a” Sinaiieuntle. even the N NAIC annual statement form (on

“which petitioner seeks to rely ny cenacction with other issues)

requires that the entire ainoynt of interest capitalized during

the year be reflected as assets of the life insurance companies.

* ‘> .

o ,

The holding of the court, below\as to these issues is -

squarely in accord with the Seventh Circuit’s holding |

in Franklin, supra, the only other appellate court to ~

consider them,* and fiere is hot, as petitioner: urges -

(Pet. 3:2), a conflict between the decisiong in this case

and Franklin, on the one hard, and th decision in

Artuell Co. v- Commissioner, 400 F.2d 981 (C.A. y ze

; Artnell arose because a corporate reorganization and

liqnidation terminated the taxable year of the Chicago" &

- White Sox baseball team: “Phe-issne was whether the

liquidated corporation should he requiréd to report.

sales of tickets and other prepaid revenues relaged to

future games when the later e games were to be played |

by the successor corporation. Petitioner entire ly fails

tr seeeenize that the Seventh Circuit did not hold that

def rerral of the prepaid income was proper. It merely

remanded for further inquiry into the* question

whether (id., p. 984) ‘‘the extent and timexof future’

performance are so certain, and related 4 e@ms properly -

accounted for with such clatity, that a syste um of ac-

*— counting involving deferral of prepaid income is found .

* clearly to reflect income # * #97 And this result must

be viewed in the light a) : the peculiar fact that holders

of tickets ‘to unplayed games could secure refunds

metely by demand. - PES tc .

In oun view, Artiell was w rongly decided and. re-

fleets an improvident. view. of the Conimissioner’s

authority to determine whether a method of account-

; 18 The: prepaid interest issue here is. siiciad with that in

Franklin, supra. Franklin also considered the treatment as an

asset of the-full amount of capitalized interest.

ing clearly, eee income. See ott 4465 of the

1954 Code; compare. Schlude v. hirer apgiens » Supra

American Automobile Ass’in > L7nited d States, 367

U.S. 687. There is not, Lane “a ‘contliet, for there

Oe a

are multiple bases on which the. two Gases may. be dis-

tihguished. For example, this case does’ not involve

dual. taxpayeéts or a pretermitted taxable: year, and _

the contingencies that might cause westori ition of fhe

prepaid amounts are subst: antially different in nature.

Compare Commissioucr Vv. Angelus. Funeral Hone,

407 F. 2d 210 (C.A.9). | |

The final outcome in Artnell will indeed not be

entirely clear until, the Seventh Ciresiit has a fur¢her

oppertunity to consider the Schiude rule in the light’

of whatever evidence is adduced upon remand to the

Tax Court. Meanwhile,. it is particularly noteworthy

that ‘the’ Artnell opinion does not even. refer to the

opinion in Franklin. ts

5 \ 3. AGENTS’ DEBIT BALANCES

Statement. Agents’ debit balances are the 1 result of

charges to the accounts of insurance agents made *

against future . commissions. J efferson did not ‘make

any cash advances, to, agents; Pilot, however, would

_advance money to its agents to provide for their living ™

-expenses until, their commission income was sufficieng

to support them. Both Jefferson and Pilot also debited,

agents’ accounts for. various other charges: : fees

charged | by reason of the cancellation or nondelivery

4 The asserted conflict between Franklin and Avtnell _-

also ur ged 1 in the Frank/in petition, which ‘this Court denied.

~ of insurance policies within a specified time after they

. ~ were written by the agent, charges for premiums ony).

5 _ health and disability insurance on agents and their de-

| pendents, ‘and, in the case of Jefferson, withholding

taxes and charge-backs of commissions previously paid

with respect to policies subsequently eanéelled, (Pet.

a 29a.) mf ; . dite:

Although Jefferson, and apparently Pilot, had

: contractual right to’ charge its: agents interest on the

amounts of the’ “agents” debit balances, ne ia did so.

~ When an agent terminated his connection with the

company ata time. when a debit Dalance existed in his

i accqunt, Jefferson and Pilot would apply commissions »

to which . the’ agent subsequently be came entitled

| fi against the debit balances, Apart From see applica-

tion, however, no attempt was made to collect any

remaining balance, and, the agent’s uncollee ‘ted dp! it

balance would be charged td general insurance ex;

> ; peénses. The large. percentage of the debit balanc Cs of

_ Pilot’s agents vepresented amounts owed Hy agents

_°* who were still agents of Pilot at the. end of the rear,

_ apparently, because Pilot made cash advances to thein.

The, NAIC annual statement calls for" the amount of

agents’ débit balances to be shown _as a “‘non-admit-

ted” asset, a phrase used to describe assets which are

not considered i in a - surplus for NAIC pur-

& ‘poses. (Pet. : 29a-30a.), a e*

oi Petitioner asserts’ that: its agents’ debit balancés

| are assets ‘tised by it in edrrying on an insurance

as trade or business,’ whith the statute excludes from

- . - “assets”? under Seétion 805(b) (#4). Both the district

f |

. . vi

court and the court of — rejected this conten-

tion. — : .

Argument. Section =. (4) shies in pertinent

part:

(4) Assets.—For purposes of this deal, the

term ‘ ‘assets”’ means all assets of the company

4ineluding nonadmitted assets), other than_real

and personal property (excluding money) used

by it in carrying on an insurance tradevor busi-_

ness. * * % [Emphasis supplied. ] ~: mt

The question of statutor Vv interpretation presented’

here is whether the agents’ debit balances are Run

and personal property (excluding money) used * NG

in carrying on an insurance tre ade « or business.’? These

debit balances are in fact accounts receivabie, repre-

' senting advances to agents against. futuré commis-

sions. |

_ The principal basis for petitioner’s argument is an

assumption that the phrase ‘‘used * * * in carrying

on an insurance trade or business” should exem ypt

whichever ‘assets of ‘petitioner’ are not productive of

investment income. This assumption’ is contradicted

not only by the broad language of Section 805(b) (4), .

which defines assets in terms ‘of ‘‘all assets of the

company,”’ but by legislative histéry which plainly

indicates that the test of*includabtiity of an asset for

Section 805(b)(4) is not based upon whether it

produces investment income. Rather, ‘‘all assets of

the company,” subject to a limited exception, are

includible under Section 805()b) (4). tm

The purpose of the allocation of investment income

under Section 804 is to divide. investment income be-

| é a :

‘

oe |

tween a company’s share and the pojicvholders’ share.

This is accomplished through a formula which essdn-

tially results in dividing up intestment income tn the

ratio that assets held ‘for policyholders, 1.@., TESETVES,

pear to total company assets. Section 804, Internal

Revénue Code of 1954. The argument that something

less than total assets held fox policyholders and total .,

assets of the company are te be used—namely, only — iat

assets producing investment income—is negatived by

the fact that the assets held or available for “‘policy-

holder reserves are not zestricted to those producing

investment income but ihetude assets other than those

which are invested and produsing investment income,

The Phase “I formula ‘is, not restricted to invested

assets bat enc ompasses san Apprpsc ‘+h involving the total

“assets of the company and ° ‘the portion theres! de-

voted to alate reserves.” H. Rep. No. 34, 86th

Cong’, Lst Sess., p. 12, fur 1 A tal. states: *‘The

company’s earnings rate actitdlly is determined -by

dividing the company’s ‘investment yield’ iay its total

assets.’ (Emphasis: supplied). Moreover, the Report

emphasizes (H. Rep. No. 34, supra, p. 10) :- 3 }

. Making’ use of a company's .actual earnings

rate in arriving at the reserve deduction in.

effect allocates investment income between life

insurance reserves and surplus, according to -

the total amount of each> [Emphasis stplied. |

5 Even the NAIC form recognizes es assets available for —

reserve purposes any number of assets neither of an invested=

nature nor producing investment income. See “Exhibit 13,

Assets.” (R. 595.)

“As this history makes cleay, Phase JI. determines

the “earning rate.of the company on its assets” (em-.

phasis supplied) (S. Rep. No. 291, 86th Cong., Ist

Sess., p. 2), rather than the earnings rate of Belected

investmen# assets. a

The ‘Treasury Regulations, Section 1.805-5(a) (4)

(i), limit the assets excludable under Metion 805())

(4) to tangible, assets such as home’ and branch offiee |

bujldings, and land, furniture, supplies and stationery

and other similar items used in tlie business. This in-

| teypretation has di bree support in the, legislative his-

tory. ‘'S. Rep. No. 2 291, supra, at p. 70. Under these

circumstances, the court below properly upheld the

validity of the administr ative construction of Section

805() (4) .7 &

; al , re — —— rn b .

4. CHARITABLE CON TRIBE TIONS ~ -

Y rey ° © , oe, 0 .

~~ Statement. The total amount of petitioner’s deduc-

tion for charitable contributions is not here in dispute.

The issue is where they may be deducted. The: gov-

ernment’s position is that they must all be deducted as

an expense in ¢alculating operating income, under the -

terms of Section s09(d) (12) as modified by Section

809(e) (3). Petitioner contends that it need only de-

duet an allocable portion as an operating expense

and that the vemainder-may be deducted as a.gene yal

16 These Reguilatioffs expressly refer to agents’ debit balances

as an example of assets which are includible ieat aaiiniad 805

(b) (4).

7 The only other decfsion as yet on this point is in accord.

Western National Life Ins, Co. of Teas v. Commissioner, 50

T. C. 285.

Ped

Zz ©

ms ~

“ , q st

r .2 . $e Ay .

~ | 25. 7

- ' %

e ’

investment expense ™ under Se tien S04(«) (i The:

court of Mpeals sustained the goyernine it’s panes

‘Argument. ,Phe conclusion ‘that the char itable Cone

tributions deduce tion-is limited to Pirase £1 (gain from

operations) is at the outset indicated by the obvious

fact. that the “only ¥#erence to such contributions in

the Act is a¥ a deductidh under Section 809(d) (12)

(as limited by Section 809(¢) (3) ), the section provid-

ing the deductions to be used for purposes of comput-

ing Phase IT income. In addition, the limitations ex-

pressed i in Section 809(e) (3),in respect of the amount

of the allowable deduction are all based on items in-

cident to the Phase IT computation, Lhe 5 percent of

income hi imitation, which parallels the 5 percent lim-

itation on edtitr wwutions of ordinary corporations, 1s

hased entirely on Phase TY ineome minus ceriain

items specified, in Section 809(d). Under established |

: . > : oe . .

principles of statutory. construction, it may be con-

cluded that Congress regarded the deduction as pecu-_

0 to. Section 809, and ‘thus to Phase IT income.

5. SRANC He ‘OPFICE. M ANAGER 's SUPPLEMENTAL

ns PLAN .

— Statement. J effersen established a Branch Office

Manager’s Supplemental Retirement Plan‘in order to

provide supplémental-pension benefits to branch ‘of-

fice managers. Under the plan, Jefferson made con-.

18 Since the ultimate tax base consist of investment income

plus 50 percent of the excess of gain ,from operations over in-

vestment income, the deduction in Phase I (investment incgme)

is worth more to petitioner than the same deductién in Phase

II ( ae. es operations). |

‘ %

”

; 26.

tributic is Tased upon the employee’s. selary. Such

‘contributions were, not set apart or treated as sep-

arate funds but remained a’ part of the general cor-

porate | funds of Jefferson. If the employee reached

the age of 65 while stil in the employ of ee

~ he was-to receive an annuity to be caleulated ‘ ‘on the

- basis of the fet 1957 Male’ Standard "An nuity> Table

with 3% interest.” If. the employee left Jefferson

prior to age 65, died prior to age 65, or if Jefferson

terminated his employment prior to that age, the em-

ployee had no right to any annuity er to any part of

the Jefversen contributions to the plan. This was so

regardless: ‘ the number of years the employee be-

longed to’the plan. (Pet. 32a-33a.) ;

Jefferson did not issue any actual annuity es

to branch office managers upon their inclusion in thé

plan. Mt did notify ‘those employecs OF their rights

under the plan and sent them annual reports of ‘con-

. .. tributions’? mede to the plan in their names. Jeffer-

son expressly reserved an “absolute and unecondi-

tional” right to terminate the employment of mem-

, bers of the plan and also a right (subject to certain

limitations) to terminate the, entire plan. (Pet. 33a.)

__The_ courts shelow rejected petitioner’s claim that

/ the amounts designed to fund petitioner’s own Branch

Office Manager’s Supplemental Retirement Plan con-". te

stitute life insurance reserves within the meaning of

¢ Section 801(b) of the 1954 Code. , 7 ,

Argument. As the court correctly found from the

evidence, petitioner’s ‘‘contributions’”’ to the Riawih

Office Manager’s Supplemental Retirement Plan were

‘ r

not irrevocably dedicated to mature or liquidate future

life insurance or annuity claims but could he invaded

and. used at the will of petitioner: Accordingly, they

were not in the nature of life insurance reserves. New

York Life Ins. Co. v. Boweéts, 283 U.S. 242: ; Helver-,

ing V. Inter-Mountain Life Ins. Co., 294 US. 686 ;

General Life Ins. Co, v. Commissioner, 137 -F. 5d 185, :

_ 189-190 (C.A. 5). :

Petitioner urges that su¢h forfeitability ‘is a very

_ This fay be true. Petitioner, however, has not claimed

a deduction for pension plan reserves (having con-.

ceded that the amounts. do not meet the statutory* re-

quirements for pension plan reserves). Rather it

claims deductions on the ground that these’ ivanks

are true Fife insurance reserves for obligations under.

Annwadst ss Antwan rite «wn ser

bea udey” CULL ATUS, A Gucesticn entirely independen

ones that could arise under.the pension trust provi-

t of

sions of the- Internal Revenue Code, Sections 401

ct seq. y,

6. DETERMINATION OF CONSOLIDATED TAXABLE INCOME

Statement. Jefferson, prior to 1958, acquired by

‘purchase all gpthe outstanding stock of Pilot, another

life imsurance company. During each of the years

1958 and 1959, Pilot- paid cash dividends to Jefferson

out of current earnings and profits in the amount of

$1,250,000. For the years 1958 and 1959, these com-

panies filed consolidated income tax returns. In both

returns, Jefferson and Pilot were treated as a single

taxable entity. At every step in the computations re-

_ common provision” in- pension plans (Pet. Py a, 3

28 : é

quired to determine the Phase I and Phase II taxable

investment income, the figides of both companies were |

consolidated on an item-by-item basis,:and there were

eliminated from all computations J efferson’s invest-

ment in the Pilot stock, together with ‘the dividends

paid by Pilot to Jefferson. (Pet. 6a.) kta

The Government contended betow that the me@hod

Jefferson and. Pilot utilized, on their consolidated

income tax returns was improper, and that it was

necessary to compute separately the excluded ‘‘policy-

holders’ share”’ of. investment income for Pilot and

Jefferson, taking into account in the Jefferson com-

-putation the Pilot stock as an ‘‘asset’’? and ‘the divi-

dends thereon as ‘‘income.’’ After the computation of

the **policyholders’ share’’ for each company and the

‘incident ascertainment of the company’s spare of

each, the companies’ ‘shares would, be added together

to produce consolidated inv estment yield and the

policyholders’ shares would be added together to pro-

duce the excludable policvholders’ share of consoli-

dated investment yield. Upon consolidation the: divi-

“dend income received by Jefferson and, Pilot, which§s

‘not excluded through Jefferson’s policyholders’. -share,

would be eliminated from consolidated investment

yield. (Pet. 50a-52a. )

The courts below agreed w ith the: ‘Government.

Argument. The decision below “is correct and in

accord with this Court’s opinion in United ptates v.

Atlas Life Ins. Co., 381 U.S. 233. A

Both Section 804(a)(1) and Section 809(a) (1)

provide for the exclusion from the tax base of a life

Insurance ¢ ‘company of that. porfion of inv estment in-

come (calleds the ‘policyholders’ share’) deemed a

necessary y addition to the company’s réserve fer. poligy-.

holders. The exclusion is arrived at by application of

the statutory formula to the mean reserves, assets,

earnings, and interest assumptions of each individual’

life’ insurahte company. In light of the fact that tax-

exempt dollars are ,as fully available as taxable dol-

lars in the : satis! 1ctiom of reserves ‘requirements, See-

' tion 804 and Section 809 specifically require that ex-

empt items such as interest on state and municipal

bonds initialiy must ‘be taken into account in comput-

ing the excluded ‘‘policyholders’ share.’’ The tax-

exempt charatter of such income subsequently is. ree-

ognized by dedycting from the tax base that. portion

which is allocated to the taxable “hfe j Insurance com-.

pany’s sharé’’ of investment income. This Court held

in United States v. Atlas Life Ins. Co., supra, that

the statutory method did not result in the imposition

of tax on tax-ex compt interest.

The essence “of the Atlas decision is that the sineeet

excluded as the policyholders’ share constitutes a meas-

)

urement (for tax purposes) of the claim of each com-

pany’s policyholders against its investment income.

The life insurance company thus receives special and

substantial tax relief based upon. the concept of the

division of its income with its own polievholders. In-

cident to this benefit is the requirement that the com-

putation take into account all the investment income

and. assets to’ which’ the policyholders of the mdivid-

ual company may look.. The method petitioner ad-

~—s, . ae

9 ; | 30

vances removes from consideration Jefferson’s invest-

ment in Pilot, even though that is an asset, a pro rata

‘portion of, which is deemed part of Jefferson’s re-

serves, and dividends, .a portion of which (under , -

Atlas) are deemed earned for Jefferson’s policy-

holders. This is not awproper measurement of what -

Jetferson has available to respond to its liabilities to

policyholders. The result would be, as here, that peti« aa

tioner’s consolidéted policyholders’. share exclusion “*.

under Phase I does not equal the sum of the policy- *

holder exclusions of Jefferson and Pilot computed

separately (R: 81-82). Thus, ‘it is apparent that the =:

total- liability of petitioner vis-a-vis policyholders of »

Jefferson and Pilot (the contracts of which run’ s sep-.

arately to each company) li not correctly stated, and*

that it can be stated correctly only if each company’s

| obligations to Ts own policyholders are treated

separately.

. Petitioner setseatedy argues (Pet. 33-39) that the” a

“Treasury Regtilations w ith respect ‘to consolidated es

‘income tax returns—which antedate the 1959 Act—. ®

| require a different result. This is not so. Section Xa

1.1502-31A (a), defines consolidated taxable income as >

the combined taxable income of the affiliated corpora--

tions. Section 1.1502-31A(b) (1) say$ that the taxable ~

_income of each corporati6n shall be computed in ac-..

_ cordance with the provisions covering the determina-

tion of taxable income of separate corporations except

that “C) There shall be eliminated * * *- dividend

distributions from one member ofthe group to another

member ofthe group * * *.” Of course, this means

¢"

”

. > © e's

31 yy

é / 2

that the Pilot ividends- are to be “eliminated”. But

this does not #esolve the question of /:ow. to. eliminate

them and from what. The. consolidated return provi-

sions do not speak to this point. Rather, Section

* 1.1502-3A goes on ‘to provide that any: ‘matters in the

determination of which the. Regulations “‘are not ap-

» plicable shall be determined in accordance with the

provisions of the Codé or other law applicable |

-_ thereto.”? (Pet. 7a.) The consolidated return provi-

‘ sions, ‘therefore, simply show that the dividends are

‘pe of tax-exempt 1 income. The consequence of this

a mination for a life insurance company was given

by this Court in- the rationale of Atlas.

7. THE APPLICABLE RATE OF TAX

Statentent. Jefferson elected res file consolidated in-

come tax returns Ww ith Pilot, its wholly-owned -sub-

sidiary, for: the years 1958 and 1959: It computed its

, tax ‘aceording to the rates specified in the corporate

income tax. returns for life insurance tompanies

(Form 1190L) i upon which it was required to report.

its income. (Py et. 20,.) Those rates were two pereent

ne higher for life insurance companies fiing consolidated

: returns” than for life insurance companies: ‘filing sep-

arate ‘returns. Subsequently, however, petitioner took

the position that life-insurance companies are entitled

to file gonsolidateil returns without payment of the

two percent higher rate, The issue was resolved against

petitioner hy the district equrt and the court of ap-

peals. (Pet. 20a.) °. “Vi

Argument. The decision below is Icio Section

= ‘

ee ees

802(a) of the 1954 Code provides that a tax “‘is here-

by imposed”’ on life insurance companies.which is to

consist of the’ normal tax “computed” at the rate

specified in Section 11(b) and the surtax “computed”’

at“the rate s: ccified in Section 11(¢). Seetion 1503

provides that where a consolidated return is made,

the tax ‘‘imposed under section 11(¢)’’ shall be in-

ereased by two percent. Accordingly, the crux of the

issue is whether the tax ‘‘imposed”’ by Section 802 is

to be “computed’’ at the rate provided by Section 11

(¢), as modified by Section 1593, even though the latter

section speaks of a tax “imposed imder” Section

11(¢). .

Significantly, Section ihe) 2), which ‘‘imposes’”’ a

tax on gther corporations, has the same structure as

- Section 802(a), i., the tax whiclr it Impos¢s is “com. |

puted’? under Section ‘f1(b) and Section 11(c). Ac-

cordingly, Section,1J(¢) never, by itself, imposes a

tax on the income,of any corpora tion. Thus, when Sec-

tion 1503 increases the tax ‘‘imposed under section

1l(c),’’ it either refers to all taxes computed under

Section 11(¢) or it is a nulljty. :

This interpretation is sup] orted by the structure and_

legislative history of the 1959 Act evidencing the in-

tention of Congress that the wiique tax treatment of

life insurance, companies should stop with the deter-

mination of the tax base. Once that base was arrived

at, life insurance companies were to be taxed at the

same rates as other egyporations. H. Rep. No. 34,

86th Cong., Ist Sess., p. 25; 5. Rep. No. 291, 86th

33° ‘

Cong., Ist’Sess., p. 44; S. Rep. No. 291, 86th Cong., 1st

Sess., -p. 127 (Supplemental Views on H.R. 4245).

' There is no conflict as to this unique legal issue,

and the number of life insurance companies filing con-

solidated returns is believed to be minimal. Finally, ,:

and of particular importance here, the *issue lacks

, Vitality-

peted as to all corporations for taxable years begin-

ning after December 31, 1963, by» Section 234(a),

Revenue Act of 196+, P.L. 88-272, 78 Stat..19.

‘s. pHe ‘Nate ComPUTATIONS

Argument. + .**

1. Petitioner-also seeks to prescnt the broad asser-

tion that deductions and computations required on the

annual statement fori promulgated by the National

~~Association of Insurance ‘ommissioners are control-

: ling under Subchapte v L and may be used. indiserimi-

nately for tax: purposes. As we have «own above—

~in Our discussion ofthe treatment of deferred and un-

collected premiums—the NAIC rules are designed to

Serve a purpdse that is not fully compatible with the

a%- .

Petitioner’s suggestion that the decision is somehow “con-

trary to a longstanding administrative interpretation of Section

1503(a)” is wrong. Petitioner's objection (Pet. 39-40) is ap-

parently to a sentence in the opinion to the effect that the ad-

ditional tax “increased” -the surtax. Petitioner states that ‘the

increase is considered an “addition” to the surtax, not an in-

creased surtax. Section °1503(a) states that the suxtax “shall be

increased” by the additional tax, and the court merely used the

same language as the statute. That the “increase” is consid-

» ered to be an “addition” for the purposes of the $25,000, surtax

exemption has no bearing on the ‘issue here and is nowhere

contradicted in the ¢ourt’s opinion. —

** . ; “fle

the additional. two percent tax was elimi-

Ww,

needs of tax accounting. Thus, the NAIC is not in-

terested in reflecting earnings in a fashion that satis-

fies the needs of an income tax statute. Its design

rather is regulation that helps guarantee the-financial

integrity of the insurance companies in order to safe-

guard the interests of the policyholders. To achieve

this objective, the NAIC uses purposely stringent and

conservative standards, having as their objective the

identification of the minimum amount of quick assets

_ that would be available to satisfy the policyholder

claims in the ev ent of insolvency.

The necessary result is a conscious understatement—

indeed, a minimization—of income and assets in the

NAIC statement. Of course, it would be advantageous

for petitioner and ‘other insurance companies to use

the NAIC rules wherever possible in order to minimize “oe

their federal income tax liabilities. But that is not —

what the income tax statute allows. The critical pro-

vision, Section 818(a), provides:

* * * All computations entering into the de-

-termination of the taxes imposed y this part

shall be made—

. (1) under an accrual method of account, or.

(2) to the extent permittéd under regula-

tions prescribed by the Secretary or his detk-

gate, under a combination of an accrual méthod

of accounting with any other method permitted

by this chapter (other than, the cash reepipts

. and disbursements method).

Except as‘ provided in the preceding sentence,

all such computations shall be made in a manner

consistent with the manner required for pur-

poses of the annual statement approved by the

National Association of Insfirance Comniission-

ers. [Emphasis supplied. ]

Thus, Section 818¢2) does not purport to grant de-

ductions over and above those authorized: in the de-

tailed substantive provisjéns. setting out the tax

formulae. Even where a d duction is there*authorized,

the use of a computati from, the ‘NAIC form is _

subordinated to (1) th rules gf’ accrual accounting -

setting forth “a combination of an acertial method of

accounting with any other méthod permitted by this

chapter (other than fhe cash receipts and dishurse-

ments method).’’ For/thesge purposes, each issue under

Subchapter L, and all. pertinent Regulations, must. be

examipied for its own worth. They cannot, as peti-

tioner suggests, all be lumped together. All that -is

" necessary for present purposes is that,-as we have

shown, the Regulations ‘t at apply to this case are

_ reasonable rules within the context of the statute.

2. Petitioner cannot seriously argue, as.it how seem- - -

ingly attempts, (Pet. 26-28), that there is a conflict

between courts of appeals as to the meaning of the

reference to the NAIC computations in Section

818(a). In support of its position, petitioner cites a

. past conflict of authority in respect of the weight to

*°To the same effect are Treasury Regulations (Section

1.818-2(a)(1)): |

“* * * Except as otherwise provided in part I, the term ‘accrual

method’ shall have the same meaning and application in sec-

tion 818 as it does under -section 446 (relating to general: rule

for methods of accounting) and the-regulations thereunder.”

; ’

° ¥

be -given a reference fo the NAIC Annual Statement

in Section 204 of the Internal Revenue Code of 1939,

~ Which dealt with the determination of casualty insur-

ance company taxes and not with life insurance com-

panies.” That section, in contrast to the subordinating

reference to NAIC computatiens in Section 818(a),

specifically provided that the income of such compa-

nies was to be ‘‘computed on the. basis of the under-

writing and investment exhibit of the annual statement

approved by the National Convention of Insur- _

ance Commissioners * * #22. The statute defining ,the.

income tax liabilities of. casualty companies said very :

little else, and unlike the detailed formulae encom-

passed in the 1959 Life Insurance Company Act, fur-

nished little or no guidance with respect to the items

to be taken into account for tax purposes. The First

Circuit in Commissioner v. New Hampshire Fire Ins.

Co., 146 F. 2d 697, held that the casualty companies

were entitled to rely completely on the NAIC con- |

vention blank with respect to the computation -of

aa reserves for tax deduction purposes. The

Fourth Circuit in a per curiam opinion in United

States v. Fidelity & Deposit Co. of Maryland, 177 F. 24

805, Ating Commissioner v. New Hampshire Fire Ins.

Co., SUpH As: also held. the Statutory language strong

enough’ ‘to’ make the N AIC convention form con-

trolling. Thereafter, the Second Circuit in Commis-

sioner V. General Reinsurance Corp., 190 F. 2d 148,

. : *

**'The substance of Section 204 is incorporated in Section

832(b) (1) of the 1954 Code, which is not part of the Life Insur-

ance Company Income Tax Act of 1959.

‘37

certiorari dismissed, 342 U. S. 863, and the Ninth Cir-

curt in Pacific Ins. Co. v. United States, 188 F. 2d 571,

a Gertiorari- dismissed, 342 U.S. 857, reached the oppo-

site conclusion, refusing to recognize the NAIC treat-

ment of the reserve items in question despite the

statutory language and the abbreviated form of the

siatute. |

These eases, however, have nothing to do with this

case. The statute applying to life insurance companies

_ is in marked contrast to the casualty company statute

discussed. It spells out in great detail the precise

formulae for the computation of taxes. Both in Franklin

and here, it has been agreed that life insurance com-

panies must look to the statute and Regulations for de-

ductions, not the NAIC form. This is plainly corre¢t,

whatever may be true of the taxation of casualty

companies. ‘. aig <r

9. THE SIGNIFICANCE OF THIS CASE ®

Petitioner argues that review of the issues raised

would provide ‘‘an opportunity * * * to answer the

most troublesome questions of interpretation under the

Life Insurance Company Income Tax Act of 1959’

(Pet. 14). The apparent implication is that review of:

' this case would clear the air for the settlement of life

‘imsurance company tax liabilities in a large number of

penditf® cases. Unfortunately, this is not so. The courts

of appeals are yet to experience any difficulty with

the particular eight issues involved in petitioner’s case.

There are pré&€ntly pending 1 in dispute, sia audit of

* ie re

the ten largest life insurance companies alone, over

one hundred indeperident issues under the 1959 Act,

exclusive of those involved here. Although petitioner

has sought to chart claimed similarities in issues in

cases which have reached the. litigation tage (Pet.

18), its thesis depends entirely on-its view that 20

® * pa . .

different issues may be considered as one because they

all involve the NAIC form. Equally important, peti-

tioner has neglected to point out the large number of

additional issues in .dispute in the very cases it

charts.” Thus, the tax liabilities involved in most of

the cases listed would not be settled by review of the

particular issues involved in this petition. Significant-

ly, petitioner’s pending suit for refund of taxes for

_ 1960 “(Jefferson Standard Life Ins. Co. v. United

States (M.D. N.C., Civ.. No. C-84-C-66)) involves at

least seven issues not raised here. Accordingly, review

of the instant case would not even settle petitioner’s

own tax liability for its next taxable year.

Under these cir cumstances, and in the continued ab-

sence of a conflict in the appellate courts, review of

all or any of the particular issues raised would not

make a major contribution from the standpoint of

facilitating orderly administration of the tax laws.

* For instance National Life & Accident Ins. Co. v. United

Stutes (M.D. Tenn., Civ. No. 4995), cited for three similar

’ issues, involves eight issues not in litigation here; Old Reliance

Tus. Zio. ve United States (Ct. Cl., No. 324-68) involves four

more,. and Southwestern Life Ins. Co. v. United Statés (N.D.

_ Tex., Civ. No. 3-3008-A), an additional three.

CONCLUSION -.

The petition for a writ of certiorari should be

denied, *

Respectfully submitted.

ERwin N. GRIswo_p,

Solicitor General,. .

JOHNNIE M. WALTERS,

_ Assistant Attorney General,

GILBERT IX, ANDREWS,

Tuomas L. STaPLETon,

& Attorneys.

JULY - 1969.

Internal Revenue Code of 1954:

APPENDIX !

SECA809 [as amended by See. 2(a), Life’ Insurance

Company Income Tax Act of. 1959, 73 Stat. 112,

122]. va — er

* % *

(a) Deductions. —For purposes of subsee-

tions (b) (1) and (2), there shall be allowed

the following deductions:

(1) Death benefits, cte.—All claims and

benefits accrued, and all losses incurred (wheth-

er*or not ascertained), during the taxable year

on insurance and annuity contracts (including

“ontracts supplementary thereto).

(2) Tnereases in certain reserves.—The net

increase in reserves which is required by see-

tion 810 to be taken mto accoynt for pur poses

of this paragraph.

(3) Dividends to polic holders. he dedue-

tion for dividends to policyholders (determined

under section 811(b)).

(4) Coerations loss deduction.—The ‘opera-

tions loss deduction (determined under section

(5) Certern nonparticipating contracts —AR

amount equal to 10 percent of the increase for.

’

_the taxable vear in the reserfes for nonpar-

ticipating contracts or (if greater) an amount

equal to 3 percent of the premiums fox the tax-.

able year (excluding that portion of the premi-

ums which is allocable to mnuity features) at-

tributable to nonparticipating contracts (other

than group contracts) which aye issued or re-

newed for peridds of 5 years or more. For pur-

poses of this paragr aph, the term “reserves for :

nonparticip:iing «ontracts” merns such part of

the life insurance reserves (excluding that por-

‘ (40) -

tion of the icine Which is allocable to an-

nuity features) as relates to nonparticipating

contracts (other than group contracts). For

’ purposes of this paragraph and paragraph (6),.

the term “premiums”? means the net amount of

the premiums and other consideration taken

into account under subsection (¢) (1).

(6) Group life, accident, and health insur- ;

ance-—An amount equal to 2 percent of the

premiums for the taxable yegr attributable to

group hfe insurance contracts and group acci-

dent and health insurance contracts. The de-

duction under this paragraph for the taxable

year and aH preceding taxable years shall not

exceed an amount equal to 50 percent of the

premiums for the taxable year attributable to

“such contracts. ‘ :

-. (4%) Assumption by another~ person of” lia-

bilities under insurance, etc., contracts —The

consideration (other than consideration arising

out of. reinsurance ceded) in respect of the as-

sumption by another person of liabilities under

‘Insurance and annuity contracts (including

contracts supplementary thereto)... -

(8) Lar-exenpt interest, dividends, ete.—

(A) Life insurance company’s share.—Each

of the following items: ae

(i) the life insurance ‘company’s share of

interest which under section 103 is excluded

from gross income, Mees

_ G1) theydeduction for partially tax-exempt

interest provided by section 242 (as modified

by section 804(a)(3)) computed with respect to -

the life insurance company’s share of such in-

terest, and

(iii) the deductions for dividends received

provided by sections 243, 244, and 245 as modi-

fied by subparagraph (B)) computed with re-

~ spect to the life imsurance company’s share of

“the dividends* received. :

(B) Application of section 246(b).—In ap-

plying section 246(b) (relating to limitation on

wl oe

~/ @.

ageregate amount of diaetiines ‘for dividends

‘received) for purposes of subparagraph

(A) (71), the limit on the aggregate amount

of .the Aygo ees by sections 243(a),

244, and 245 shalf"be 85 percent of the gain

from 0 erations computed without regard to—

(i) the deductions. provided By’ ‘paragraphs We

(3), (5), and (6) of this subsections

(11) the operations loss deduction provided

by Section 812, and

(iii) the deductions allowed by socthote

243 (a), 244, and 245,-

~ but steh limit shall not. apply for any taxable

_ year for which there is a loss from operations.

». (9) Investment expenses, ‘etc.—Investnient

expenses to the extent not allowed ag a deduc-

tion uhder section 804(¢)(1) in computing in-

_ vestment yield, and the amount (if: any), by

- which the sun of the deductions allowableundeéi:

section 804(c) exceeds the gross’ investment ,

income. 28

(10) Small business deduction —_A smiaJl

business deduction in an amount eqtial to tie

. amount determined under sectipn 804(a) (4).

(11): Certain mutualization distributions:— ~~

The ‘amount of distributions to’ shareholders ,.

made in 1958 and 1959 in acquisition of stoc k

pursuant to a plan of mutualization adopted, he-

fore January 1, 1958.

(12) Other.” deductions.—Subject. to thé

modifications provided by subsection (e), all

, Other. jcdatidhs allowed under this subtitle for

* purposes of computing taxable i income, to the ex-

tent not allowed as deductions in computing

Investment yield. |

E xcept as provided in paragraph (3), no

amount shall -be allowed as a deduction under

this subsection in respect of dividends to policy-

holders. . : |

* %- . * * *

‘ 426 US.C. 1964 ed., See. 809°F

¢e

, ‘ .

iv. 4 : U. ST\GOVERNMENT PRINTING OFFICE: 1965

' ~ .

Bar

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.