Opposition Brief — Western & Southern Life Insurance v. Commissioner

INDEX

Page

Opinions below ...........-- esse eee eeeee eee e ee eeeeeese 1

Jurisdiction ...........-.ccee cee c cece ne ececeeeeeeeeees 1

Questions presented ......... 22.2.2 eeee reece eee eeeeeeees 2

Statutes and Regulations involved ..............+++++e0+: 2

DRED cccccccccccccccccsccccccscccscosescesoseosses 2

Argument .... 2.2.62. e cece cece cece eee e eee e eee eeeees 6

PEED ccccccccccccccccsceccccsecsccesecoocoescoces 10

Appendix ....-. 2... eee cece cece eee eee eee eeeeeeeeees 11

CITATIONS

Cases :

Dobson v. Commissioner, 320 U.S. 489 ...........00005 9

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

757, certiorari denied, 393 U.S. 1118 ............... 6,8

Jefferson Standard Life Insurance Co. v. United States,

408 F.2d 842, certiorari denied, 396 U.S. 828 ........ 6

Liberty National Life Insurance Co. v. United States, 463

DIT iiccnbekguetanwensmenseetieebeceieebes 8

Occidental Life Insurance Co. v. United States, 25 A.F.

enn deena nebeeeeseenesteesnes 9

United Life and Accident Insurance Co. v. United States,

BP ie GI. FED ccccccsvececcccccsscwecesovesocs 9

United States v. Atlas Ins. Co., 381 U.S. 233 ........... 3

United States v. Snyder Bros. Co., 367 F.2d 980 ........ q

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

sioner, 432 F.2d 298, reversing and remanding 50 T.C.

285, as modified by 51 T.C. 824 .................. 6, 8,9

Statutes :

Internal Revenue Code of 1939, Sec. 1141(a) (26 U.S.C.,

et eed cadet eeeew ee 9

Internal Revenue Code of 1954 (26 U.S.C., 1958 ed.,

Supp. IT) :

Ol emivaweus 2

FEL EA RO ee 3

| EAE ES Eee Na 2,7

EEE EI a 3,4

A a a mee 2

dae 2,5

Sergrwnee

———

In the Supreme Court of the Gnited States

OctToBER TERM, 1972

No. 72-559

THE WESTERN AND SOUTHERN

Lire INSURANCE COMPANY, PETITIONER

Vv.

COMMISSIONER OF INTERNAL REVENUE

ON PETITION FOR A WRIT OF CERTIORARI TO THE UNITED

STATES COURT OF APPEALS FOR THE SIXTH CIRCUIT

BRIEF FOR THE RESPONDENT IN OPPOSITION

OPINIONS BELOW

The opinion of the court of appeals (Pet. App. 13-23)

is reported at 460 F.2d 8. The opinion of the Tax Court

(Pet. App. 35-50) is reported at 55 T.C. 1036.

JURISDICTION

The judgment of the court of appeals (Pet. App. 24)

was entered on May 12, 1972. A petition for rehearing

en bane was denied on July 12, 1972. The petition for

a writ of certiorari was filed on October 6, 1972. The

(1)

a ne

Se |

1 AREER ORR ERE EO IORUE Boge ond

a

jurisdiction of this Court is invoked under 28 U.S.C.

§ 1254(1).

QUESTIONS PRESENTED

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

surance company, the total amount of deferred and

uncollected premiums must be included as assets, under

Section 805(b)(4) of the Internal Revenue Code of

1954, without the adjustment petitioner claims for an

amount it calls “‘loading on deferred and uncollected

premiums.”’

2. Whether a life insurance company must include

the total amount of deferred and uncollected premiums

in its “‘gross amount of premiums’’ under Section

809(¢)(1) without the deduction or offset it claims for

an amount it calls ‘‘increase in loading on deferred and

uncollected premiums.”’

STATUTES AND REGULATIONS INVOLVED

The relevant provisions of the Internal Revenue

Code of 1954, Sections 804, 805, 809 and 818, as amended

by the Life Insurance Company Income Tax Act of

1959,* and pertinent provisions of the Treasury Regu-

lations, Sections 1.805-5 and 1.809-4, not set forth in

the petition, are reproduced in the appendix to this

brief, infra.

STATEMENT

Petitioner raises two related legal issues concerning

the determination of a life insurance company’s tax

liability under the Life Insurance Company Income

Through apparent inadvertence, the statutory provisions set

forth in the petition include amendments not applicable to the

years in issue.

Tax Act of 1959 (Sections 801 through 820 or Part I of

Subchapter L of the Internal Revenue Code of 1954,

as amended). The Act provides that the taxable income

of a life insurance company includes the full amount

of its ‘‘gain from operations’’ up to the amount of its

“taxable investment income’’ plus one-half of any addi-

tional ‘gain from operations’’ (Section 802(b) ). “*Tax-

able investment income”’ and ‘‘gain from operations’’

are each the result of detailed calculations and are

defined in Sections 804(a) and 809(b), respectively.’

In determining the income of a life insurance com-

pany, the calculation of ‘‘gain from operations”’ and of

“taxable investment income’’ requires a determination

of a life insurance company’s “‘gross amount of prem-

iums” during the taxable year. In calculating ‘“‘gain

from operations’’ the gross premiums constitute part of

the basic figure—i.e., that comparable to “‘gross re-

ceipts” or ‘‘gross income’’ from which ‘‘gain from

operations’’ is computed by subtracting statutorily de-

fined deductions. In determining ‘‘taxable investment

income’’ the gross premiums are included in the com-

pany’s ‘‘assets,’’ which control the fraction of invest-

ment income that is deemed ‘‘taxable.”’

The ‘‘gross annual premium’’ on a life insurance

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 subsequent an-

niversary date. The ‘‘net valuation premium’”’ is the

part of the ‘‘gross annual premium,”’ computed on the

basis of state required interest and mortality tables,

* A description of the calculations performed in computing tax

liability under the Act is contained in United States v. Atlas Ins.

Co., 381 U.S. 233.

Sa EPO

TT Th etude aan oer eee —

4

that must be added to reserves for policyholders for

each policy year. Petitioner defines the difference be-

tween the ‘‘gross annual premium’’ and the ‘‘net valua-

tion premium’’ as the ‘‘loading.’’ (Pet. 4-5; Pet. App.

37.) *

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 in

installments over the policy year or the premium is due

but unpaid (a grace period having been provided in the

policy). Where payment of part of the premium has

been deferred, the premium is increased by an amount

designed to compensate petitioner for the loss of in-

terest on the deferred portion of the premium and for

the added cost of servicing the account (Pet. App. 37).

Petitioner accrues its reserves on the basis of the

assumption 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. App. 15, 38). This method of ealeulating reserves

increases the reserves which taxpayer is entitled to de-

duct under Section 809(d) (2) in caleulating gain from

operations and also increases the reserves used in deter-

mining the policvholders’ share of investment income,

which under Section 804(a)(1) is excluded from tax.

’ Conceptually, ‘‘loading’’ represents long-range projections and

estimates of expenses and profit for the life of the policy which

are then prorated to each annual premium. There is no necessary

correlation between the ‘‘loading’’ on a premium in a given year

and the actual expenses and profit with respect to the policy in

that year.

—_—

5

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

(ii), Example (1), and 1.809-4(a)(1)(i), Appendix,

infra, expressly require the inclusion of deferred and

uncollected portions of gross premiums in the calcula-

tion of both gross premiums and assets. Petitioner

claims an adjustment—i.e., a deduction or exclusion—

for an amount called ‘‘loading’’ in determining its

“eross amount of premiums’’ uncer Section 809(¢) (1)

and its assets under Section 805(b)(4). Essentially,

petitioner would calculate its net valuation premium

(i.e., the annual addition to reserves), subtract that

from the gross annual premium, label the remainder

“Joading’’ and offset against the gross premiums the

part of ‘‘loading’’ petitioner deems allocable to the

deferred part of the premium. The end result is to

include only the portion of the gross premium that has

in fact been paid plus the portion of the deferred por-

tion that is included in reserves.‘

The court of appeals, reversing a divided Tax Court’s

approval of petitioner’s contentions, held that the

statute requires the inclusion in full of deferred and

uncollected portions of gross annual premiums in

“sross amount of premiums’’ and ‘‘assets’’ without

the offsets claimed. In so concluding, the court agreed

with the unanimous holdings of the three appellate

courts that had heretofore considered these issues.

* Petitioner follows the treatment provided on the annual state-

ment form of the National Association of Insurance Commissioners,

which petitioner must file annually in the states where it does

business (Pet. App. 16). The annual statement form is intended

to demonstrate the solvency of the company using purposefully

stringent and conservative accounting standards (Pet. App. 22).

LEE LILLE SAE LOG BONG: Ome Re

wom Sere are,

Franklin Life Insurance Co. v. United States, 399 F. 24

757 (C.A. 7), certiorari denied, 393 U.S. 1118; Jeffer-

son Standard Life Insurance Co. v. United States, 408

F. 2d 842 (C.A. 4), certiorari denied, 396 U.S. 828;

Western National Life Insurance Co. of Texas v. Com-

missioner, 432 F. 2d 298 (C.A. 5), reversing and re-

manding 50 T.C. 285, as modified by 51 T.C. 824.

The decision below is correct. There is no appellate

conflict or any other reason for further review.

The proper treatment of deferred and uncollected

premiums depends on the meaning of the statutory

reference to ‘‘the gross amount of premiums”’ in See-

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

define this phrase, Congress, as the courts of appeals

have recognized, was aware of the accounting practices

of the insurance industry under which life insurance

companies in accounting for their gross premiums in-

clude the full year’s premium as of the anniversary

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

Congress thought the same assumption would not be

made in defining the phrase ‘‘gross amount of pre-

miums”’ as used in the statute. The basic answer to

petitioner’s contention that it is entitled to an adjust-

ment or deduction for ‘‘loading’’ or tlie like is that

Congress has not provided for one. Although Sub-

chapter L of the Code is filled with detailed provisions

which define a number of allowable exclusions and de-

ductions in the computation of the income tax liabilities —

of life insurance companies, there is not one reference,

direct or indirect, to ‘‘loading”’ or ‘‘increase in load-

|

ing.”’ It is no less true here than in any other tax case

that exclusions and deductions must have an explicit

statutory basis and, as the court below recognized (Pet. .

App. 22-23), the absence of such a statutory provision is

fatal to petitioner’s claim.*

The defects in petitioner’s position are particularly

apparent with respect to the related determination of

its assets. The computation of the policyholders’ share

exclusion, which is critical to the determination of

taxable investment income under Section 804, turns on

the proportionate relationship between reserves (as-

sets held for policyholders) and total assets.* Petitioner

accrues reserves on the premise that the full annual

premium on each policy in force, including the entire

deferred and uncollected portions thereof, has been

received and that, accordingly, it has a full annual

reserve liability with respect to each policy. While this

is not true where there are deferred and uncollected

premiums—the insured parties are not legally obligated

to pay those premiums and petitioner has no obligation

to continue coverage if they are not paid—petitioner

nevertheless uses this assumption in accruing reserves ;

28 A BL DOMED TS 70> 78

5 Petitioner, of course, receives deductions under Section 809(d)

for all actual insurance expenses in the years micurred. The “‘load-

ing’’ adjustment sought is independent of those deductions.

* In simple form the formula may be expressed as follows:

Investment yield

= x Reserves= Policyholders’ Exclusion

or as

Assets held for reserve purposes

Total assets

x Investment yield= Policyholders’ Exclusion

a

8

in the tax formula. As the appellate courts have unan-

imously stressed, petitioner may not accrue as a liabil-

ity the full annual reserve and then, in the same

fraction, not show as an asset the full amount of the

annual premium that gives rise to that liability (the

gross annual premium). As the Seventh Circuit ob-

served in Franklin Life Insurance Co. v. United States,

399 F’. 2d 757, 761, ‘‘[t]he gearing of the tax statute to

an annual reserve requires recognition of no less than

the annual premium.’’

2. Petitioner’s reliance on the holding of the Fifth

Circuit in Liberty National Life Insurance Co. v.

United States, 463 F’. 2d 1027, to the effect that mortgage

escrow funds held in trust by a life insurance company

are not its ‘‘assets’’, is misplaced. There the taxpayer

never claimed that the escrow funds should be taken

into account for any purpose in the tax formulae. The

opposite is true here. Petitioner assumes that deferred

and uncollected premiums are received and are, in

effect, ‘‘assets’’ with respect to accruing reserves in

the tax formulae, but then abandons that assumption

in accruing total assets. The Fifth Circuit, in Western

National, supra, has expressly rejected this dual stand-

ard of accounting for deferred and uncollected pre-

miums and has upheld the Government’s position. Its

opinion in Liberty National dealing with the question

of separate escrow funds does not purport to overrule,

in any way, its Western National decision.

3. Petitioner concedes (Pet. 9) that, ‘‘there exists no

conflict in decisions in the Circuits directly involving

the issue of loading on unpaid premiums,’’ and indeed

four courts of appeal have now unanimously rejected

9

its position. It suggests, however, that the contrary

view taken by the Tax Court should be given special

weight because (Pet. 7) it ‘‘is made up of experts in

the field of federal taxation.’’ But Congress has ex-

pressly rejected this theory and has provided in Section

7482 of the Internal Revenue Code of 1954 that Tax

Court decisions are entitled to no greater weight upon

review than decisions of federal district courts.’ Fi-

nally, petitioner urges that the issues involved are (Pet.

9) ‘‘universal in the life insurance industry”’ and that,

absent guidance from this Court, life insurance com-

panies are likely to continue litigating them. We agree

that the issues are of a recurring industry-wide nature.

Nevertheless, and despite some differences of opinion

in the lower courts,* four courts of appeals have now

spoken and agreed unanimously that petitioner’s posi-

tion is without merit. In these circumstances we sub-

mit that further review by this Court at this time is

unnecessary and unwarranted.

*Prior to 1948 it had been held, in Dobson v. Commissioner,

320 U.S. 489, that courts of appeal should not reverse decisions

of the Tax Court where the expertise of the judges of that court

might be considered to have an important bearing upon its deci-

sions. By amendment in 1948 to Section 1141(a) of the Internal

Revenue Code of 1939, Congress expressly repealed the rule of

Dobson and made decisions of the Tax Court reviewable by courts

of appeal in the same manner as decisions of the district court.

See United States v. Snyder Bros. Co., 367 F. 2d 980 (C.A. 5).

®See Western National Life Insurance Co. of Texas v. Com-

missioner, 432 F. 2d 298 (C.A. 5), reversing and remanding 50

T.C. 285, as modified by 51 T.C. 824; United Life and Accident

Insurance Co. vy. United States, 329 F. Supp. 765 (D. N.H.); and

Occidental Life Insurance Co. v. United States, 25 A.F.T.R. 2d 796

(C.D. Calif.).

aE we aa De fk

a os ee

10

CONCLUSION *

The petition for a writ of certiorari should be denied.

Respectfully submitted.

ERWIN N. GRISWOLD,

Solicitor General.

Scott P. CRaMPTON,

Assistant Attorney General.

THomas L. STAPLETON,

Attorney.

NoveEMBER, 1972.

APPENDIX

Interyy) Hevenne Code ot 1954 (26 UBM, 19% 4,

Supp, §4)+’

SW), 4 (ae amended by Bee, Zn), Life Tier

anve Company Income Vax Avt of 19, VA, Mit,

73 Stat, 112], TAXABLE INVEBTMENT IN-

COME,

(a) In General,

(1) Exclusion of policyholders’ share of invest-

ment yield,—The policyholders’ share of each and

every item of investment yield (including tax-

exempt interest, partially tax-exempt interest, and

dividends received) of any life insurance company

shall not be included in taxable investment income.

For purposes of the preceding sentence, the policy-

holders’ share of any item shall be that percentage

obtained by dividing the policy and other contract

liability requirements by the investment yield;

except that if the policy and other contract liabil-

ity requirements exceed the investment yield, then

the policyholders’ share of any item shall be 100

percent,

* Section 904(4) (2) wae wmendeh Mective tor years beginning

after Secembver F1, 1901, by Section Ub), Act A Octver 23, 1902,

PLL. 81496, 16 hat, 114A, by string ont “ equal to the sam’ and

insertiyg fy tien thereot “equal to the amount (if any) by which

the ne: longterm capital gain exceeds the net shortterm capital

loss plig the sum’’; similar wording was added as new subpara-

graph (%) to Section 909(b)(1) and (2). The years 1960-1962

were ajded to Section 909(d) (11) by PL, 87-59, 75 Stat, 120, and

P.L. 88.272, 78 Stat. 98.

11

12

(2) Tasable investment income defined —Yor

purpomes of this part, the taxable itvestinent in

wns tor any taxable year Hall be an amount (neh

lows than vero) equal the sum of the lite inoup-

ans comnpony's have of each and every Nem of

investinenl yield (indluding ak-exempl interest,

parvially tax-exempt interest, and dividends ve

ceived), reduced Wyo~

(A) the sum of-—

(i) the life insurance company’s share of

interest which under section 103 is excluded

from gross income,

(ii) the deduction for partially tax-exempt

interest provided by section 242 (as modified

by paragraph (3)) computed with respect to

the life insurance company’s share of such

interest, and

(iii) the deductions for dividends received

provided by sections 243, 244, and 245 (as

modified by paragraph (5)) computed with

respect to the life insurance company’s share

of the dividends received; and

(B) the small business deduction provided by

paragrayh (4),

Vor purposes of the preceding sentence, the Vite

insurance company’s share of any item shall be

that percentage which, when added to the percent-

age obtained under the second sentence of para-

graph (1), equals 100 percent,

(3) Partially taz-exempt interest—For pur-

14

poses of this part, the deduction allowed ty section

YA2 shall be an amount which bears the same ratio

to the sina determined under such metion with

out vegavd to thie paragraph as (A) the normal

tax vole tov the taxable year prescribed by seetion

11, heave 0 (14) the sun of the normal tax rate

and the surtax vate for the taxable year preserihed

by seetion 11,

(4) Amall business deduction-Vor purposes

of this part, the small business deduction is an

amount equal to 10 percent of the investment yield

for the taxable year, The deduction under this

paragraph shall not exceed $25,000,

(5) Application of section 246(b).—In apply-

ing section 246(b) (relating to limitation on ag-

gregate amount of deductions for dividends

received) for purposes of this subsection, the limit

on the aggregate amount of the deductions allowed

by sections 243(a), 244, and 245 shall be 85 per-

cent of the taxable investment income computed

without regard to the deductions allowed by such

sections,

(6; Ezcephion —Vt tt is estaliished in any case

that the application of the déinition of taxaihe

investment income contained in paragraph (2)

restlts in the imposition of tax on—

(A) any interest which under section 102 is

exaiuded from gross income,

(B) any amount of interest which under see-

tion 242 (as modified by paragraph (3)) is al-

lowable as a deduction, or

lS oe een

ACE I LEE IRER BN WI EAN Ae EK MS TLE TEN OP TERT NS A API EY a

14

(¢)) any amount of dividends received which

under sections 243, 244, and 245 (as modified by

paragraph (5)) is allowable as a deduction,

aA justment shall be made to the extent necessary

(4 prevent such imposition.

() 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,

(B) the entering into of any lease, mortgage,

or other instrument or agreement from which

the life insurance company derives interest,

rents, or royalties, and

(C) the alteration or termination of any in-

strument or agreement described in subpara-

graph (B).

(2) Short-term capital gain.—In the case of a

taxable year beginning after December 31, 1958,

the amount (if any) by which the net short-term

capital gain exceeds the net long-term capital loss.

(%) Trade or business income.—The gross in-

“nee from any trade or business (other than an

insurance business) carried on by the life insur-

ance eopopany, or by a partnership of which the

life inewrance company is a partner. In computing

gross income under this paragraph, there shall be

exeluded any item described in paragraph (1).

Except as provided in paragraph (2), in computing

sn am, eR LitARSEE ASR WE Hey DIESEL ARP LDA SIAR LIE LENE ATLL ENN ILE LIES AALS I IOAN mms 1

eal "

oo “s

s

iy

3

rs

15

gross investment income under this subsection, there

shall be excluded any gain from the sale or exchange

of a capital asset, and any gain considered as gain

from the sale or exchange of a capital asset.

(c) Investment Yield Defined.—For purposes of

this part, the term ‘‘investment yield’? means the

gross investment income less the following deduc-

tions—

(1) Investment expenses.—Investment expenses

for the taxable year. If any general expenses are

in part assigned to or included in the investment

expenses, the total deduction under this paragraph

shall not exceed the sum of—

(A) one-fourth of one percent of the mean of

the assets (as defined in section 805(b) (4) ) held

at the beginning and end of the taxable year,

(B) the amount of the mortgage service fees

for the taxable year, plus

(C) whichever of the following is the greater:

(i) one-fourth of the amount by which the

investment yield (computed without any de-

duction for investment expenses allowed by

this paragraph) exceeds 3%4 percent of the

mean of the assets (as defined in section 805

(b)(4)) held at the beginning and end of the

taxable year, reduced by the amount described

in subparagraph (B), or

(ii) one-fourth of one percent of the mean

of the value of mortgages held at the begin-

ning and end of the taxable year for which

RENE RES ELI NE SELL DEOL EME ELA ORS

a

16

there are no mortgage service fees for the

taxable year.

(2) Real estate expenses—The amount of taxes

(as provided in section 164), and other expenses,

for the taxable year exclusively on or with respect

to the real estate owned by the company. No

deduction shall be allowed under this paragraph

for any amount paid out for new buildings, or for

permanent improvements or betterments made to

increase the value of any property.

(3) Depreciation—The deduction allowed by

section 167. The deduction under this paragraph

and paragraph (2) on account of any real estate

owned and occupied for insurance purposes in

whole or in part by a life insurance company shall

be limited to an amount which bears the same

ratio to such deduction (computed without regard

to this sentence) as the rental value of the space

not so occupied bears to the rental value of the

entire property.

(4) Depletion—The deduction allowed by sec-

tion 611 (relating to depletion).

(5) Trade or business deductions.—The deduc-

tions allowed by this subtitle (without regard to

this part) which are attributable to any trade or

business (other than an insurance business)

earried on by the life insurance company, or by

a partnership of which the life insurance company

is a partner; except that in computing the deduc-

tion under this paragraph— 7

(A) There shall be excluded losses—

17

(i) from (or considered as from) sales or |

exchanges of capital assets, :

(ii) from sales or exchanges of property :

used in the trade or business (as defined in

section 1231(b)), and

(iii) from the compulsory or involuntary

conversion (as a result of destruction, in whole

or in part, theft or seizure, or an exercise of

the power of requisition or condemnation or

the threat or imminence thereof) of property

used in the trade or business (as so defined).

(B) Any item, to the extent attributable to

the carrying on of the insurance business, shall

not be taken into account.

(C) The deduction for net operating losses

provided in section 172, and the special deduc-

tions for corporations provided in part VIII

of subchapter B, shall not be allowed.

SEC. 805 [as amended by Sec. 2(a), Life Insur-

ance Company Income Tax Act of 1959, supra].

POLICY AND OTHER CONTRACT LIABIL- :

ITY REQUIREMENTS. a

(a) In General.—For purposes of this part, the

term “policy and other contract liability require-

ments’’ means, for any taxable year, the sum of—

SS ESN VRE re ip DO ae SR ta te DPR Ts

(1) the adjusted life insurance reserves, mul-

tiplied by the adjusted reserves rate,

(2) the mean of the pension plan reserves at the

beginning and end of the taxable year, multiplied

by the current earnings rate, and

a |

18

(3) the interest paid.

(b) Adjusted Reserves Rate and Earnings

Rates.—

(1) Adjusted reserves rate-—For purposes of

this part, the adjusted reserves rate for any tax-

able year is the average earnings rate or, if lower,

the current earnings rate.

(2) Current earnings rate—For purposes of

this part, the current earnings rate for any taxable

year is the amout determined by dividing—

(A) the taxpayer's investment yield for such

taxable year, by

(B) the mean of the taxpayer’s assets at the

beginning and end of the taxable year.

(3) Average earnings rate.—

(A) In general.—For purposes of this part,

the average earnings rate for any taxable year

is the average of the current earnings rates for

such taxable year and for each of the 4 taxable

years immediately preceding such taxable year

(excluding any of such 4 taxable years for which

the taxpayer was not an insurance company).

(B) Special rules—For purposes of sub-

paragraph (A)—

(i) the current earnings rate for any tax-

able year beginning before January 1, 1958,

shall be determined as if this part (as in

effect for 1958) and section 381(¢)(22) ap-

plied to such taxable year, and

19

(ii) the current earnings rate for any tax-

able year of any company which, for such

year, is an insurance company (but not a life

insurance company) shall be determined as

if this part applied to such company for such

year.

(4) Assets —For purposes of this part, the term

‘“‘assets’’ means all assets of the company (includ-

ing non-admitted assets), other than real and per-

sonal property (excluding money) used by it in |

carrying on an insurance trade or business. For

purposes of this paragraph, the amount attribut-

able to—

(A}-real property and stock shall be the fair

market value thereof, and

(B) any other asset shall be the adjusted

basis (determined without regard to fair market

value on December 31, 1958) of such asset for

purposes of determining gain on sale or other

disposition.

(ec) Adjusted Life Insurance Reserves.—

(1) Adjusted life insurance reserves defined.—

For purposes of this part, the term “‘adjusted life

insurance reserves’’ means—

(A) the mean of the life insurance reserves

(as defined in section 801(b)), other than pen-

sion plan reserves, at the beginning and end of

the taxable year, multiplied by

(B) that percentage which equals 100 per-

cent—

OD ew Cee or

i iad to te nat, ee ee ee

Vo! oe

aad

(i) inereased by that percentage which is

10 times the average rate of interest assumed

by the taxpayer in calculating such reserves,

and

(ii) reduced by that percentage which is 10

times the adjusted reserves rate.

(2) Average interest rate assumed.—For pur-

poses of this part, the average rate of interest

assumed in calculating reserves shall be com-

puted—

(A) by multiplying each assumed rate of in-

terest by the means of the amounts of such

reserves computed at that rate at the beginning

and end of the taxable year, and

(B) by dividing (i) the sum of the products

ascertained under subparagraph (A), by (ii)

the mean of the total of such reserves at the

beginning and end of the taxable year.

SEC. 809 [as amended by Sec. 2(a), Life Insur-

ance Company Income Tax Act of 1959, supra]. IN

GENERAL.

(a) Exclusion of Share of Investment Yield Set

Aside for Policyholders.—

(1) Amount.—The share of each and every item

of investment yield (including tax-exempt inter-

est, partially tax-exempt interest, and dividends

received) of any life insurance company set aside

for policyholders shall not be included in gain or

loss from operations. For purposes of the preced-

ing sentence, the share of any item set aside for

policyholders shall be that percentage obtained by

dividing the required interest by the investment

yield ; except that if the required interest exceeds

the investment yield, then the share of any item

set aside for policyholders shall be 100 percent.

(2) Required interest—For purposes of this

part, the required interest for any taxable year

is the sum of the products obtained by multiply-

ing—

(A) each rate of interest required, or assumed

by the taxpayer, in calculating the reserves de-

scribed in section 810(¢), by

(B) the means of the amount of such reserves

computed at that rate at the beginning and end

of the taxable year.

(b) Gain and Loss From Operations.—

(1) Gain from operations defined—For pur-

poses of this part, the term “‘gain from opera-

tions’’ means the ameunt by which the sum of the

following exceeds the deductions provided by sub-

section (d):

(A) the life insurance company’s share of

each and every item of investment yield (in-

eluding tax-exempt interest, partially tax-ex-

empt interest, and dividends received) ; and

(B) the sum of the items referred to in sub-

section (c).

(2) Loss from operations defined—For pur-

poses of this part, the term “‘loss from operations”

NR ————

"rere ORR

22

means the amount by which the sum of the deduc-

tions provided by subsection (d) exceeds the sum

of—

(A) the life insurance company’s share of

each and every item of investment yield (includ-

ing tax-exempt interest, partially tax-exempt

interest, and dividends received) ; and

(B) the sum of the items referred to in sub-

section (c).

(3) Life insurance company’s share.—For pur-

poses of this subpart, the life insurance company’s

share of any item shall be that percentage which,

when added to the percentage obtained under the

second sentence of subsection (a)(1), equals 100

percent.

(4) Exception.—If it is established in any case

that the application of the definition of gain from

operations contained in paragraph (1) results

in the imposition of tax on—

(A) any interest which under section 103 is

excluded from gross income,

(B) any amount of interest which under sec-

tion 242 (as modified by section 804(a)(3)) is

allowable as a deduction, or

(C) any amount of dividends received which

under sections 243, 244, and 245 (as modified by

subsection (d)(8)(B)) is allowable as a deduc-

tion,

adjustment shall be made to the extent necessary

_ to prevent such imposition.

(ec) Gross Amount.—For purposes of subsections

(b)(1) and (2), the following items shall be taken

into account:

(1) Premiums.—The gross amount of pre-

miums and other consideration (including advance

premiums, deposits, fees, assessments, and consid-

eration in respect of assuming liabilities under

contracts not issued by the taxpayer) on insurance

and annuity contracts (including contracts sup-

plementary thereto); less return premiums, and

premiums and other consideration arising out of

reinsurance ceded. Except in the case of amounts

of premiums or other consideration returned to

another life insurance company in respect of rein-

surance ceded, amounts returned where the amount

is not fixed in the contract but depends on the

experience of the company or the discretion of

the management shall not be included in return

premiums.

(2) Decreases in certain reserves.—Each net

decrease in reserves which is required by section

810 or 811(b)(2) to be taken into account for

purposes of this paragraph.

(3) Other amounts.—All amounts, not included

in computing investment yield and not includible

under paragraph (1) or (2), which under this sub-

title are includible in gross income.

Except as included in computing investment yield,

there shall be excluded any gain from the sale or

exchange of a capital asset, and any gain considered

as gain from the sale or exchange of a capital asset.

2 ETAT reer Ye DETER Tt 2r7

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a ae nS

24

(d) Deductions—For purposes of subsections

(b)(1) and (2), there shall be allowed the following

deductions :

(1) Death benefits, etc—All claims and benefits

acerued, and all losses incurred (whether or not

ascertained ), during the taxable year on insurance

and annuity contracts (including contracts sup-

plementary thereto).

(2) Increases in certain reserves.—The net in-

crease in reserves which is required by section 810

to be taken into account for purposes of this

paragraph.

(3) Dividends to policyholders.—The deduction

for dividends to policyholders (determined under

section 811(b)).

(4) Operations loss deduction-—The operations

loss deduction (determined under section 812).

(5) Certain nonparticipating contracts —An

amount equal to 10 percent of the increase for the

taxable year in the reserves for nonparticipating

contracts or (if greater) an amount equal to 3 per-

~ cent of the premiums for the taxable year (exclud-

ing that portion of the premiums which is allocable

to annuity features) attributable to nonparticipat-

ing contracts (other than group contracts) which

are issued or renewed for periods of 5 years or

more. For purposes of this paragraph, the term

‘*reserves for nonparticipating contracts’’ means

such part of the life insurance reserves (excluding

that portion of the reserves which is allocable to

annuity features) as relates to nonparticipating

25

contracts (other than group contracts). For pur-

poses of this paragraph and paragraph (6), the

term ‘‘premiums’’ means the net amount of the

premiums and other consideration taken into ac-

count under subsection (¢)(1).

(6) Group life, accident, and health insurance.

—An amount equal to 2 percent of the premiums

for the taxable year attributable to group life

insurance contracts and group accident and health

insurance contracts. The deduction under this

paragraph for the taxable year and all preceding

taxable years shall not exceed an amount equal to

50 percent of the premiums for the taxable year

attributable to such contracts.

(7) Assumption by another person of liabilities

under insurance, etc., contracts—The considera-

tion (other than consideration arising out of rein-

surance ceded) in respect of the assumption by

another person of liabilities under insurance and

annuity contracts (including contracts supple-

mentary thereto).

(8) Tax-exempt interest, dividends, ete —

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

of the following items:

(i) the life insurance company’s share of

interest which under section 103 is excluded

from gross income,

(ii) the deduction for partially tax-exempt

interest provided by section 242 (as modified

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

mel ope

26

to the life insurance company’s share of such

interest, and

(iii) the deductions for dividends received

provided by sections 243, 244, and 245 (as

modified by subparagraph (B)) computed

with respect to the life insurance company’s

share of the dividends received.

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

plying section 246(b) (relating to limitation on

aggregate amount of deductions for dividends

received) for purposes of subparagraph (A)

(iii), the limit on the aggregate amount of the

deductions allowed by sections 243(a), 244, and

245 shall be 85 percent of the gain from opera-

tions computed without regard to—

(i) the deductions provided by paragraphs

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

(ii) the operations loss deduction provided

by section 812, and

(iii) the deductions allowed by sections

243(a), 244, and 245,

but such limit shall not apply for any taxable

year for which there is a loss from operations.

(9) Investment expenses, etc—lInvestment ex-

penses to the extent not allowed as a deduction

under section 804(c)(1) in computing investment

yield, and the amount (if any) by which the sum

of the deductions allowable under section 804(c)

exceeds the gross investment income.

(10) Small business deduction—A small busi-

27

ness deduction in an amount equal to the amount

determined under section 804(a) (4).

(11) Certain mutualization distribution.—The

amount of distributions to shareholders made in

1958 and 1959 in acquisition of stock pursuant to a

plan of mutualization adopted before January 1,

1958.

(12) Other deductions Subject to the modifi-

cations provided by subsection (e), all other deduc-

tions allowed under this subtitle for purposes of

computing taxable income to the extent not allowed

as deductions in computing investment yield.

Except as provided in paragraph (3), no amount

shall be allowed as a deduction under this subsec-

tion in respect of dividends to policyholers.

SEC. 818 [as amended by Sec. 2(a), Life Insur-

ance Company Income Tax Act of 1959, supra]. AC-

COUNTING PROVISIONS.

(a) Method of Accounting.—All computations

entering into the determination of the taxes imposed

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 preceding sentence, all

FI FPR OTe Ute Bey

28

such computations shall be made in a manner con-

sistent with the manner required for purposes of the

annual statement approved by the National Associa-

tion of Insurance Commissioners.

* * * * *

Treasury Regulations on Income Tax (26 C.F.R.):

Sec. 1.805-5 Adjusted reserves rate and earnings

rates.

(a) In general.* * *

* * * * *

(4) Assets—* * *

* * > * *

(ii) Illustration of principles.* * *

Example (1). Included in the statement of

assets of P, a life insurance company, are the fol-

lowing items: Bonds, stocks, mortgages, home

office and branch office buildings owned and wholly

occupied by the company, furniture and equipment

owned by the company and used in the home office

and branch office buildings occupied by the com-

pany, agents’ debit balances, premiums deferred

and uncollected and premiums due and unpaid,

bank deposits (including time deposits), and share

accounts in savings and loan associations.* * *

* * * * *

Sec. 1.809-4 Gross amount.

(a) Items taken into account. For purposes

of determining gain or loss from operations under

section 809(b)(1) and (2), respectively, section

29

809(c) specifies three categories of 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 premiums and other con-

sideration provided in the insurance or annuity con-

tract. * * * Such term includes advance premiums,

premiums deferred and uncollected and premiums due

and unpaid, * * *

* * * * *

vx U.S. Government Printing Office: 1972—487-752/289

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