Petition for a Writ of Certiorari — Commissioner v. First Security Bank of Utah, NA

an the Supreme our of the Binited ml

OcTOBER ‘Term, 1970

Es Ye °

(COMMISSIONER OF INTERNAL REVENUE, PETITIONER.

| . . v. : . 4 | P

First Secoriry Bank or Urau, N.A., Ef AL.

PETITION FOR A WRIT OF OBRTIORARI TO THE UNITED -

STATES COURT OF APPEALS FOR THE TENTH CIROUIT

‘ERWIN N. GRISWOLD, : | :

‘ Solicitor General, ‘

JOHNNIE M. ‘WALTERS, -

Assistant Attorney General,

._ | MATTHEW J. ZINN,

om Assistant to the Solicitor General,

_. . BENNET N. HOLLANDER,

S JOHN S. BROWN.

: y f Attorneys,

Department of Justice,

_ Washington, D.C..20580.

_ my .

- 5 .

‘ ; H

Opinions below. ____- nevis gee aes eee ee.

Stedietion TST eT Ts eal a city”

Question presented _ ~~ ~~. --- -- 22 --- eS 2

Statutes and regulations involved_./---:-.--:- . 2

Seahometis — 2 =... Sf ee ee, a:

Reasons for granting the writ_______-..-.-2---. ° . 7. -

I oo ee ite ee ae

Appendix A-~ --.-----.--- =e. Biel Roane eae om 17. -.

PC i a eg en ee 37

ABpONNe Co cso 51

AOWINGIE 37. gee ee 53

ar "CITATIONS

Casts:

| Alsaes Life Ins. Co. v. United States, 373 F.

Od BOG Bai en ck a ie te oe 8

Asiatic. Petroleum Co. v. Canunceniver.” 79 F. |

' \ 26.234, certiorari denied, 296 U.S. 645... -- 12

Bailey v. Commissioner, 52 T.C. 115, affirmed.

, 400.F. Od 190 -es & 15

: cosa Cut Sugar Co. v. Commissioner, 198

_ F.2d 214, certiorari denied, 344 U.S. 874__ 14,15

Commissioner v. Morris Trust, 367 F..2d 794_ 55

James v. United States, 366 U.S. 213_______- 15,

Lecal Finance Corp. v. Commissioner, 48 T.C.

773, affirmed, 407 F. 2d 629, certiorari =

“ denied, 396.U.S. 956. _ --_- est S, 6, 7,8,9 ©

Nat'l Securities Corp..v. Commissioner, 137

‘F.2d 600, certiorari denied, 320 U.S. 794. 15

(Oil Base Inc. v. Commissioner, 862 F. 2d 212, ~~

\ certiorari denied, 385 U.S. 928_....._____- 3.

“Rubin v. Commissioner, 429 F. 2d 650......... B, °

Saxon v. Georgia Ass’n of Independent Ina. =

Agents, 200 F: Od 1010.5 ose cere we 55

, . wigs: © “5

497-821-7111 _

eee ee wee ee we wwe Cr ewe SSC eC Se Se eee

odtedieertir eadeed tetcamrathant -—e<-@e8 ef eee ee eee

ae i Eoeenet Ce Sh to SPT eaegeial MAD

neva het 1586 WS.

War Finance C me es 60 a

2 Com sootier of tise Currency Viedatiee, i 12 Os

Bp Rew No 2, 200k Gong, 1st “gece 2

ae INO. Ist RE a EER

Rey No. 1098, 84th vite 9

<i "oa en rt ai c. re : Deacon 12, 52

‘. @

ie = ,;

x ,

- 4%. : . i}

G Dea

.

¢?

* ge

Mee >

. &

et>t a

ne ; eg |

: tn el =* ,

> ~ ~~ pe > “b $ Pa

re . : < tap

ak ; 4 5; z r

ae th :

4 ‘ . ih ah in a 1 4

2 re — re . a

° é- on) a 5 j Do

ol

= ‘ ; S META

: 3 - tt

b; Fa ° : ‘

<s > :

a : AN

i oar

tna’ .

ye . '

pi ¢:

i #

See. 5202 (12 2 U.S.C. aes 14, 54, 5.

‘Sec. 5239 (1 2 U.S.C. 93).__-- i 14 ss

“Se ‘re - : ¥ " ts : : ya . ‘ . , =%

d i Mehids STA -- 2 RS ae Pig £ bos ib tSirta

*.

t ; ‘mies Tite + bob tr ‘|

3 Sage Get Wd =

Bete ate Ao 0iT

s j ; ; + . ‘ Ws . #23

$f rif ie 7, 2 . 3 s . .

if, t : : tif “ ; ee ttei-g _ :

. , - 7 fs

e .

First Security Bank or Utan, N.A., er at.’

: : eitviet

24 4

re f 4 ; se . ay al . ‘

i pera! if

‘ETITION FOR A WRIT OF OERTIORARI TO THE UNITED. ee

STATES pian OR*APPEALS FOR THE TENTH orkcuIr

Q:*

The: Siatton: Genérat: on behalf of P the Ceuunite:

sioner of Internal Revenue, petitions fora. writ _

certiorari: to’ review. the judgments. of : the Dnited —

‘States Court of Appeals for the Tenth Circuit.in:this

> § t . , 3:8 . ” 4

: ; ee Bs +) ‘ } o ry . r ey ‘fos ' 5 4 Pp outer? ee

‘The’ memorandum ‘ndings % of. fact and opinion of.

_-the‘Tax Court (Appendix A, infra, pp. 17-85),are not

reported. ‘Thé. opinion ‘of the. court of appeals (Ap-

i “pendix iB; infra, pp. 37-50), reversing shee Bax Snr |

te | i}

. fl ipietel hh4De B's PATI! yo) awihighi

on Januazy 21,1971 pe Cintra, 51-52),

(e¢-2 A), eh st eiftesea A} cru ‘

oa

. order dated April 12, 1971, Mr. J ustice White -eX-

tended the time for filing a petition for a writ of cer- -

— SioeE 0) atid ‘inichudditig- June’ 20; 1971, ‘The jurisdic-

_ tion of this Court 1 is s invoked u under 28 U. 8. C. 1254(1).

“L

‘Whether, Wiicdanite to ‘Beetion 482 of. the Internal

Revenue Code, the Commissioner properly allocated

‘to the respondent nptfonal banks the commission por-

'- - tion of the credit life insurance premiums paid by *

their borrowers in connection with loans, where Te-

spondents offeted the life insurance to their. borrow-

ers ultimately on behalf of a life insurance company —

- under common ownership and control with respond-

ents.’

STATUTES AND REGULATIONS INVOLVED —

The pertinent provisions ‘of Sections 61 and 482 of

the Internal “Revenue Code of 1954, of Section 1.482-1

_. of the ‘Treasury Regulations on Income Tax (1954

Code), and of Sections 5202 and.5239 of the Revised *

Statutes are set forth in Appendix D, tnfra, pp. 53-57.

STATEMENT

‘eeaplaihediia: First. Security: Bank a Utah, NA, -

and First Security Bank of Idaho, N.A., are wholly- *

owned : subsidiaries. ‘of: First: ‘Security ‘Corporation |

(“Holding Company”), a publicly owned bank hold-

‘ing company. Since 1948, respondents have offered

to their borrowers credit life, health and accident

insurance * which discharges the debt if ‘a -borrower

dies or becomes’ incapacitated during the term of his

__ loan. (Appendix A, infra, pp. 18-22.) |

3H)

Becan 1948 to April, 1954, the credit life inguranee

7 offered, by. respondents was written by. two. inde; end- .

ent insuranceccompanies. Both companies. ‘paid com-

missions ‘ranging from 40 to 55 percent of the pre —

miums collécted to Ed D. Smith & Sons (“Smith”),

ge wholly-owned subsidiary of Holding Company en-

gaged in the business of selling life and casualty in- --

suranee. (Appeniix A, infra; pp. 50-22.) os

Late .in 1953, American ‘National: Life Insurance

Company of. Galveston, — Texas (‘‘American’ Nation-

al’’) recommended a new plan to Holding Company.

Under American National ’s plan, Holding Company

would create a life insurance subsidiary, and Ameri-

- ean National would -write the credit life insurance to’

be offered by respondents, and then reinsure all of. the

risk under those policies with Holding Company’ 8

life insurance subsidiary. In its initial years, the sub- _

sidiary would utilize American National’s actuarial,

accounting and other operating services on a,fee basis.

(Appendix A, infra, pp. 22-23.) _

2

Holding Company adopted. American National’s ,

plan and in’ June, 1954, formed a wholly-owned life

insurance company, First Security Life Insurance Com- os

pany of Texas (‘Security Life’’). For a fee of ap-

proximately 15 percent of the insurance premiums, ©

American National, from 1954 through, 1959, pro- -

vided operating services to Security Life as planned,

maintained Security Life’s books and records, and

computed its required reserves. Security Life ‘ re-

ceived the balance of the premium dollar for the as-

sumption of all of the risk under the insurance

policies. (Appendis * infra, PP. 20, 24-25. )

-

° ootriky ‘Lites sole source of busineés indome was :

_ Feinsurance premiums, and its reinsurance business

om very profitable. By the end of 1954, Security Life

as reinsuring $6.5 million of credit life insurance.

By the end of 1959,. Security Life was reinsuging

' $413 million of credit life insurance. Security ‘Life .

was able to retain after all expenses—including Amer-

‘iean National’s fee—52.5° percent of the total pre-_

miums. Its expenses, in addition to that fee, con-

sisted. primarily of bank charges, taxes and ‘claim

settlement expenses. Security Life’s profit for the:

‘five-year period was more than $1 milfion. a

A, infra, pp. 26-28.) «|

Respondents | had numerous . “peaking offices and

maintained. a routine procedure for offering credit —

life insurance to their borrowers, A loan officer ex-__

plained the availability and function of credit life in-

_ .. surarice to a customer and, if the. eustomer desired the.

.. insurance, the loan officer. gave him the necessary ap- -

‘plication forms. Upon receipt of the executed applica-

- tion, respondents’ personnel completed a certificate of ©

insurance, and either. collected the premium from the :

eustomer or. added. it’ to his loan.. Respondents’ em- -

* ployees then forwarded. the completed forms and —

premiums/to First Security Company (‘‘Management

es ‘Company’ "), another Holding Company subsidiary

which provided management services for the group.

Management Company made records of insurance - |

purchased and forwarded the forms and premiums to.

, American N ational. Management Compariy also per- ~

formed the necessaty paper. work when claims were

filed under the aaa The. cost to > respondents of

proceesing the eredit life inauranee porebaeed by their

borrowers from 1955: through 1959: was $8,929,.and

$9,826, respectively. ‘The -cost to Management;\Gem-

pany of processing the ‘insurance daring, the; same

petiod was #10, 150. CAgueetie A, infra, pp. 19, 21, 25—"

26.)

‘Both bafors aad after the onpeninstion of: Security

Life in 1954, respondents offered credit life insurance

to customers-at the uniform rate of $1:per $100 of cover-

age per year on a decreasing term basis, This was the

rate commonly charged in the credit life. insurance

industry. (Appendix A, infra, p.'26.). . ;

Sections 5202 and 5239 of the Revised Statutes (Ap- |

pendix D, infra,:pp. 55-57) apparently prohibit na-

tional banks, under threat of criminal sanctions, from

acting.as insurance agents in places having a population

of more than 5,000. From the time respondents began —

offering credit life insurance to, their customers in

1948, their . officers and. those of Holding Company '

believed that it would be contrapy-to’federal banking

“law for respondents to receive income resulting from

their customers’ “purchases of éredit life insurance.

: Accordingly, respondents have never received commis-

sions or reinsurance premiums’ resulting ‘from’ such

purchases ; rather, the commissions and reinsurance i

premiums have ‘always been. paid to corporations |

under common éwnership with respondents. Specifi-

_ eally, from 1948 to April, 1954, the commissions ‘were

paid to Smith, and thereafter the reinsurance pre-

miums were paid.to Security Life. ( patio A, infra,.

pp. 22, 24, 27,29.) >

Section 482 of the Internal Revenue Code (Appen-

s dix D, infra, p. 53) émpowers the Commissioner to

s-

--\nllovate!ineome / among. “two! or. pensoitrunniantions,

_, Marmde cor Apusinesses::* *: *-* owned or. controlled, di-

-reétly' or indiredtly: by the sattie interests * * * if he

“determines ‘that such:* * * allocation is. necessary. in.

~order to prevent: evasion of taxeés or. clearly to reflect

the income of any, such organizations, trades, or busi-

’ nésses.?’ Acting under this provision, the Commission-

= Yep allocated 40 percent of the premium income to re-

'- spondents ‘for the period January 1; 1955 to Decem-—

‘ber 31, 1959, and determined deficiencies accordingly.

.. This ‘allocation | was, to compensate respondents for.

selling and processing the credit life insurance and _

thereby to reflect theif income clearly. For protective.

purposes, the Comimissioner’ alternatively asserted

Geficiencies against | ,

“of ‘a similar allocation f premium income. Both re-

spondents and Management Company sought redeter-

_ Iinations of the deficienci 8 in: the Tax Court,” (Appen-

' dix A, infra, pp.29-31.)

* ‘That court held that the «: case was ‘Salton by - its

reviewed decision favorable to the government (two

judges dissenting) in Local Finance Corp. v. Com-

missioner, 48 T.C. 173, affirmed, 407 F. "2d 629 (C.A.

\.. 1), certiorari denied, 396 U.S. 956, and sustained the ~ ,

-_Commissioner’s: determination that 40 percent of -the

“ premium , income was allocable to respondents. It ac-

cordingly did not reach the Commissioner’s alternative

allocation. . (Appendix A, infra, pp, 31-32, 34-35.) Re-

spondents appealed, and the Cominissioner took a pre-

a The Tex Court’s jurisdiction to ‘edetcculie the dnthciesicies

“rested on. hen se — of the eumares Revenue Code.

> ‘

: and also reversed the decision-of the Tax Court for ge

Management Company. It remanded. the! dase for fur-

ther consideration of the viprasonnee fs alternative

allocation. (Appendix B, infra, p. 50.) *

-BEASONS FOR ouairing sah wees.’

4. ne Se a

sion of the Seventh Circuit in Local. Finance Corp. v.

Commissioner, 407 F. 2d 629, certiorari. denied, 396 -

US. 956. The court below acknowledged the conflict, &

observing (Appendix B, infra, p. 46) that Local

Finance presents a fact situation quite comparable _

. to that confronting us”’, and‘stated (Appendix’ B, .

infra,.p. 50). that “It]o- the extent: that this.opinion — |

is ‘inconsistent with that int Local Finance we respect-_

fully disagree with that decision.”’ These conflicting

- decisions have created uncertainty and ‘inequity i in the

application of Section 482 of the Code to lending. in-

stitutions ‘under common “ownership and Lar with

so-called “ captive i insurance companies.” 7

There are no significant factual diffedenecs between .

Local Finance and this case. As the Tax Court ~

_ ‘pointed out: (Appendix A, infra,-p. 31), the facts of.

the tye cases “[i}m all essential respects * ** are the .

hs *.” The critical facts are that in both cases

/ lending institutiozis, performing virtually the same ie

’ ‘aa solicited insuranée business for a commonly Ce

controlled insurance company, and reported none of“

‘the income: resulting from: the i insurance aqevines as

ee

-

i “conceded below (Appendix B, infra, p. 45).

in Local Finance were prohibited. from- acting asin-. -

" . surance agents. by Indiana law, whereas here the

_ : source of the alleged proscription i is federal law. This

“qhe'o own.’ eh both cases, ‘controle ‘corporate groups

sought to achieve considerable tax savings by having

"the ‘commission ‘element of the insurance premiums —

_>,. in@luded) in’ the ‘income ‘of ‘their jlife insurance sub-'

sidiaries,’ which’ are subject to a) lower effective tax

* than their: other subsidiaries. The only: distine-

tion ‘between! the cases is that the lending. institutions

isa ‘distinction without a difference, as respondents

-2.'The arrangements typified by the instant caseand

by: Local Finance are, moreover, common to the lend-—

3 x ing business, because of the natural relationship he- ;

_.. * Even the piremiuiia Charged in the two cases were the: same. :

‘The Tax Coart (48°1.C. at 777,786) and the Seventh Circuit

(407 -F. Qd at 631) in Loeal Fiviance, and the Court of Claims

- ini Alineo Life Ina. Co. v. United States, 373 F. 2d 336,°837-338,

all have recognized that the standard $1 per $100 premium raté

- is sufficient. to allow insurers to pay commissions or a

. Costs.:.

2 Since ‘he ‘Cancels: ‘allocation was to. opnpiailine ;

‘ respondents - for selling and processing insurance, the fact that

- they had no underwriting risk, ‘relied upon by the court of .

lending instituti

. appeals (Appendix, B; infra, p. 49), is irrelevant.. What. is

relevant is that. here, as in Looal Finance (407 F. 20 at 633), the | |

ons “performed ‘those minimal [but crucial]

_, Services which were the. sine qua non of the insurance business.”

\r

All of the years involved in Local Finance were subject to

. | . the provisions of the Life Insurance Company, Income Tax Act

-. of 1959, P.L. 86-69, 73: Stat. 112: Here, the. years 1955-1957

‘are governed by the Life Insurance Company. Tax Act of 1955,

- 88,70 Stat. 36. The later years are subject to the provisions

of the 1959 Act, which, as amended, remain in force today. See

- Sections 801-820 of the Code. Under both acts, life insurance

ho SE EE RE pe ae +

hc. a

neg

‘tvitem think oninend intel: this edit Jifeinmixance, bjt

ness. Indeed, when Congress: enacted the Life Insur-

ance Company Tax Act of 1955, c. 83, 70 Stat. /36, it

_ recognized this relationship and the potential tax

abuses, and specifically contemplated ‘that Section 482

‘would be used in captive insurance company cases.‘

Both committee reports on the Act provide (H. Rep.

No; 1098, 84th Cong., Ist Sess., p. 75 8. Rep. No. 1871, a,

" 84th Cong., 24 Sess.,’p. 8): |

oe There is a potential’ abuse situation i in the

case of the so-called captive.insurance compa-

- nies, It may be possible for. a finance company,

~ for example, to establish a subsidiary life insur-

ance company that. will issue life i insurance pol-

icies in connection with the business of the

parent. If the subsidiary charges ‘excessive pre-- .

mium on this business, a portion of the income -

of the parent company can be diverted to the

' life insuranee company. It is-beliéved that sec-

_. tion 482 of the Internal Revenue Code of 1954

(rasting to allocation of income and deductions

among related taxpayers) provides the Secre-

tary of the Treasury ample regulave | — .

_ ity to deal with this problem.

‘The congressional concern 1 has proved well-founded. ,

x’ Since the irefertettial rbatiinesit of life insurance com-

- panies continues under the 1959 Act (see n. 4, supra), the problem

caused by a diversion of income from a lender to a related insurer

_ persists as illustrated by the instant, case and by Local Finance.

* Respondents contended ‘below, i in reliance of} the tax-writing

- Committees’ reference to “excessive premium,” that Congress was

* not concerned with cases such as this one, where borrowers paid

the ‘industry- wide premium rate for credit insurance (see n.+2,

supra), but only with situations in which borrowers paid more :

ae

10 - .

‘We are advised by the Internal Revenue Service that,

in addition to the instant -case, there are presently

pending, judicially and administratively, substantially

identical cases involving 22 groups of related taxpay-

ers' in which the net tax in dispute is estimated to

exceed $67 million.’ The largest of these groups con-

Wsists of some 1 ,000° related: taxpayers. Moreover,

after’ the decision in-Local Finance and before the

decision below, the Internal Reveniie Service . settled

cases, strictly on the basis of the Local Finance hold-

- ang, with: seven groups of related taxpayers which,

agreed to pay approximately $10: million of net. tax.’

A: substantial number of additional cases is certain to -

than the standard rate. This reading of the legialstive history

‘is incorrect. So long as a lender is fairly compensated for its -

services, there would be no diversion of income to the related —

insurer, and therefore no occasion to invoke Section 482, even

if the borrower pays.more than the going ate is a di-

version, and’ Section 482 would come into play, however,

whether the borrower’pays the going or a higher. rate, if the

insurer fails to compensate the lender for its services. In such

a situation, the insurer has ‘charged an “excessive premium,”

and it is in this sense that Congress used, the quoted term.

* One of these 22 groups is the First Security group (includ-

ing respondents), which has docketed cases pending for later

years.

* We refer to the “net tax in dispute” to make it clear that |

the revenue estimate is based only on the Commissioner’s pro-

posed primary allocations and 'is not inflated by the inclusion

“> of the alternative allocations made to protect the revenues if

: the primary allocations are not sustained. Further, the estimate

. has been adjusted downward to reflect the fact that the de-

. ficiencies arising from the Commissioner’s primary allocations

would be partially. offset by reductions in the income of the.

captive i insurance companies. .

_ *.Four of these seven groups are. among the 22 groups | which |

have cases pe for later years.

at cane

arise in view of the. obvious advantages acertiing to

an affiliated group of corporations which engages in

' both lending and credit life ‘insurance activities. Un-

til this Court provides a definitive solution, respon-. _

sible government officials and private counsel will, as

a practical matter, be unable to advise their respec-

tive clients to resolve. problems such as those raised

here, short of litigation. And, | unless the Court resolves .

the present. conflict in the circuits, lending institu- ..

tions and captive insurance companies in different

' parts of the nation will be taxed differently even’

though they are involved in virtually identical com-

~ mercial undertakings. =>

"There is, to be sure, a substantial factual aaa bia

cases of this type. Factual differences between cases

‘might justify a particular percentage allocation in-

-one case and a higher or lower percentage allocation i in

another. But the court below did not hold that the

- Commissioner, should have allocated some percentage —

less than 40 percent ‘of ‘the premiums to respondents,

but rather that he was without power to make any.

allocation at all. As the court put it (Appendix B, »

infra, p. 50), thie Commissioner’s* Section 482-alloca-

tions were “arbitrary and capricious and inéonsonant —

with the basic concepts. of federal income taxation:’’ |

. Furthermore, where as here and i in Local Finance, the

underlying facts are not in-dispute, the differences i in

result, cannot be ascribed to.the facts, but must be at-—

tributed to differing iiterpretations of Section 482 by

_ the Tenth and Seventh Circuits. The issue posed thus .

- goes to the meaning and scope of that provision; and .

is one that is appropriate for resolution by this Court.

~

rs | Tie

8.-Although Seetion 482 was first enacted as Section

. 45 of the Revenue Act of 1928, ¢. 852, 45 Stat. 791, 806, it

has not: previously’ been considered: -by the: Court on

the merits: "The statute!’ was designed “to prevent

evasion {of taxes by related: taxpayers} (by the shift-

ing of profits, the-making of fictitious sales, and other

methods frequently adopted for the purpose of ‘milk-

ing’), and in order clearly to reflect their true tax

liability.” H. Rep. No. 2, 70th Cong., Ist Sess., pp. 16-

17. It is settled ‘that in applying the provision, the ©

applicable standard is “that of an uncontrolled - tax-

_ -payer dealing at arm’s length with ariother uncon-

trolled’ taxpayer.” Treasury Regulations on Income

Tax (1954 Code), Section, 1.482-1(b)(1) (Appendix ©

_D, infra, pp. 538-55) ; Otl Base Inc. v. Commissioner, 362 -°

F. 2d 212, 214 (C.A. 9), certiorari denied, 385 U.S. 928,

While purporting to adhere ‘to: this standard (Ap- —

: pendix B, infra, pp. 43-46, 49-50), the court below ap-

- plied Section 482 erroneously ; and in a manner which we ~

believe seriously threatens to impair its continuing

_ effectiveness. Respondents, the court said, could not

be taxed on any part of the commissions or insurance

premiums because they” did not receive them (Appen-

dix B, infra, pp. 4546, 49-50), or earn them (td., p. 50),

but only generated the business or‘ineome (¢d., pp. +

50). All of this misconstrues Section 482. ot

_. Application ‘of ‘that: section is, of course, not ies .

pendent ‘on the receipt of income. See- Asiatic Petro-

lewm-Co. ¥. Commissioner, 79 F. 2d 234, 236 (C.A. 2), —

certiorari denied, 296 U.S. 645. Indeed, ait allocation

: of fone income thereunder A sets stent that the in-

“~- . ”

«

4B

come was not received by the taxpayer, which i so

arranged its affairs as to divert the i income to. another.

Nor is the question whether ‘respondents. “earned”

_ the income relevant under Section 482. See Rubin a

| Commissioner, 429. F. 2d 650, 653 (A, 2). ‘That i is the

ue under Section 61 of the Code (Appendix D,

Mfra, p. 53), which provides, to. the “extent pertinent

aS that “gross income means all income from what-. |

ever source derived, including * * * _[cJompensation

for services, including fees, commissions, and similar.

- items * * *.” To hold that. the same standard applies -

under Section 482 would make that ‘provision re-.

dundant, at least insofar as allocations of, gross, income

“shed

are concerned. =.’

a

_. It is unclear precisely what the court of aed

meant when it said that respondents only ‘‘generated”

the business or income. Use of this term, however, sca

cannot conceal. that respondents’ j income was less than

it would hate been had they been dealing with an -

unrelated insurance company during the years in is-

__ sue. From‘I948 to April, 1954, respondents performed

_ all of the services incident to the sale of credit life:

insurance to their borrowers, ‘and during that period

two independent. insurers paid commissions of 40 to

do percent ofthe premiums collected to Smith, an .

affiliate of respondents, Thereafter respondents per-

_ formed the same services for Security Life, a related .

- insurer, but did not charge Security Life for’ these

_ services. These facts atone are sufficient to show that - ;

respondents did not deal with Security Life as they

} : : 14 |

had dealt with unrelated insurers, and that an alloca-’

tion is necessary to reflect their income clearly.*

The apparent prohibitions of federal banking law -

cpaniia alter: this result. Respondents interpret Sec-

tions: 5202 and 5239 of the Revised Statutes as pro-

hibiting them from receiving income from acting as

life insurance agents, but: not from, offering life in-

surance at the industry-wide premium rate. Their

principal argument, apparently accepted by the court

of appeals (Appendix B, infra, pp. 44-46, 49-50), is that .

- the Commissioner’s allocation is unauthorized because

> Section 482 is limited*to allocations of income which

may be lawfully received. But Section 482 grants the

Commissioner authority to allocate income and deduc-

tiéns between related: organizations not only when this

“is necessary [in order] to prevent evasion. of taxes”’

but also when nedessary “clearly to reflect the income of

' any such. organizations. ”” Central Cuba Sugar Co. v. _

Commissioner, 198 F. 2d 214, 215 (CA. 2), certiorari —

Z 1° The fact, relied on by. the court of appeals (headin B, infra,

2 pp. 45-46, 49, 50), that even before Security Life’s organization _

' in 1954, no portion ofthe insuranee premiums was paid td respond-

‘ents, is no more relevant than the same fact in later years, The

critical point is that when respondents dealt with indepéndent in-. - a

_ surers, those insurers paid a commission, whereas Sécurity Life did °

not. That the commissions were paid to Smith, which was in no _

way involved ‘in’ the sales of credit life insurance here in dis-

pute, does not help respondents’ case, but rather emphasizes

Holding: Company’s power to designate which of its sub-

sidiaries would receive the ‘commissions. And. even Holding.

Company did consider the fact of receipt dispositive of

the income tax for although it: selected Smith

to receive the ions, it nevertheless had . aisanqement |

a Company report tm for tax purpose

1b

dinied, 344 U.S. 874. Thus, even if ties bei ar- .

_., Fangements adopted were required to, and did, satisfy _

federal banking law, the question remains whether re-

spondents’ income. was clearly. reflected. The answér

to this: question tuins on federal tax law, not on fed-

lea banking law (cf. Nat'l Securities Corp. v. Com-

| issioner, 137 F. 2d 600, 602 (C.A. 3), certiorari —

denied, 320 U.S. 794), and under the illegal.

gains, like egal gains, are taxable whether received -

or not. Compare James v. United States; 366 U.S. 213,

— with Batley v. Commissioner, 52 TC. 115, 119, affirmed

per. curiam, 420 F. 2d 777 (C.A. 5).

. CONCLUSION

+ i

The petition for a writ of ‘certiorari should, be.

- granted.

we

Respectfully submitted. may

_ Erwin N. Grisw OLD,

Solicitor General.

‘Jor OHNNIE M. WALTERS, _.

Assistant Attorney General. .

_... Marrnew J. Zinn, Site SH. ¢

Assistant to the Solicitor General. on,

~ >. BENNET N. HOoLranver, 3

J OHN S. Brown,

; Ke Aer neg. :

JUNE 1971. :

od

427-821—71—-3 .

_. APBENDIX A :

| Tax Court of the United States

Fist Securiry Bank or Uman, NA, er at; |

_PETETIONERS v. COMMISSIONER OF INTERNAL REv-:

Docket Nos. 1190-63, 1191-63, ne gQ err? -

- Filed December 9, 07

MEMORANDUM FINDINGS OF FACT AND OPINION

.4

Fay, J udge: Respondent determined deficiencies in

the petitioners’ income taxes as follows: | ate oe

Docket.No. Petitioner Taxable Deficiency

1190-68_.... 2... First Security Bank of Utah, N.A_..” 1964 _ 988, 250.00

_ O.) gots 1985 28, 775.81

a 1956 - , 54, 626.56

1967 77, 662,91

oy 1956 ‘180, 371. 46

: i * 1989 «=~ §D8, 188. 60

1191-68. ........ First Security Company 1956 96,997.48

1957 «128, 400.83

; : 1968 124.10

ee slid, ik . * 1980 , 550. 34

1216-63......... First Security Bank of Idaho, N.A ee a 1954 qy 68, 250.00

ee ae : + 1965" * 26, 139. 85

i Ee ; s 1957 @ 100,202.56

| , 1968° 102, 752.67

os During the trial, | respondent stated that he would:

not pursue one of the issues. raised in the pleadings: -

1 Proceedings of the following petitioners are consolidated

herewith: First Security Company, Docket No. 1191-63, and

_. First Security Bank of Idaho, NA., Docket No, 1216-68. -

ee ee ss

18 >

We hneiediee conclude that he has abandoned it. The. |

_ issues remaining for decision are: . os

_. (1). Whether respondent erred in allocating, pur-

. guant to sections 61 and 462," to petitioners. First Se-

_‘eurtty Bank of Utah,, N.A,, and First. Seeurity Bank -

of Idaho, N.A., a portion of the income which. First

. Seciirity Life ‘Tnenrance Company of Texas réceived

from January 1, 1955, to December 31, 1959, for rein-

suring ‘credit. life, health; actident ‘tristifance,* or

in alternative, whether rred in allocating, pur-

suant to said sections, to petitioner First- Security .

Company a.portion. of said income which First Se- '

-‘eurity Life Insurance Company of Texas. recéived

from January ,1, 1956, to December’ 31, 1959; and.

(2) whether respondent properly put section’ ‘482 :

in issue and, if 80, whether he sane have the rue

of eaves , | “$s

FINDINGS OF FACT:

; - Some of ‘the facts have .been stipulated, and the |

_ stipulation of facts, . together with the exhibits at- .

tached thereto, is incorporated herein by this refer-

ence.

Petitioner First Security. Bank of. Utah, N.A. (here-

inafter referred to as Utah Bank), is a national bank

' incorporated in 1882. It filed its Federal income tax.

_ returns for the taxable years involved herein on a .

_ calendar year, basis. -with the district director of in-_

_ ternal: revenue, Salt Lake City, Utah. Its principal ©

*

2A statutory referen¢es are to the Internal Revenue Code, ;

of 1954; unless otherwise specified.

* The statutory notice. received: by, petitioner First Security’.

Bank of Idahe, N.A., contgined adjustments to certain net op-

erating loss carrybacks. Because of these adjustments, this Court

° Ihas’ jurisdiction under séction 6214(b) to determine the cor-

rectness of respondent’s allocations: to, this — ie ed ig

years 1956 and 1959.. | s

e

ice: moe ae

place of business was Sait Lake City) Utah,. when dt:

filed its petition:in.this dase;). i) OF ie matt

.

. Pétitioner First Security Bank of dghc Ore

Cheteinafter | referred ‘to as Idaho Bank), ig: ha

- tional -bank,' incorporated: as gueh in 1941 after op-

erating since 1865. as a state bank: It'filed its Fe exak

‘income. tax returns for ‘the taxable yéars. ifivolval

“herein on a-calendar year basis. with the district di- |” |

rector of internal revenue, Boise, Idaho. Its principal —

_ place of business was Boise, Idaho, when; it filed. its ..

|. petition im this ease.” 4 a ue ca

_. Petitioner First Security Company (hereinafter :

referred to as, Management Company): is @ corpora-

tion organized under the laws of Utak in:1929, It filed

its Federal income tax returns for the taxable years

involved ferein ot a calendar year basis with ..the

- district. direetor of internal ‘revenue, Salt Lake City,

Utah, Its principal place, of business was Salt Lake

City, Utah, when it filed its petition: in. this'case, |

Petitioners are . wholly-owned subsidiaries of! the |

- First. Security. Corporation - (hereiggfter referred te

as Holding Company),..It is the o bank holding. -

company in existence, It is under th supervision and —

control of,.and is regularly exam -by; the Federal _

Reserve System. It ig qualified. under and subject te

the Bank Holding Qompany. Act; 12 U.S.O: ‘sections

1841 et seg. From 1964 through: Septetaber 15,2959,

| Holding Company had approximately 1,044,963’ shares

- | of cominon voting: stock . ge and from 2,000

“to 3,000 shareholders residing i Various states and -

foreign countries...) 5. i, r ertht ant estibils -

Ries Holding: Company has iad: lity of business‘ex-

“* pansiex: and: abquisition throughout its étistence. The

banking. offices (of its’, eubsidiasies extend frem the -

»

we | .

ae)

tee

es.

ge Gibsaiaas border ‘to the Arjzpna border. Moreover, it Z

- has entered . into diversified entheprises other. than |

Bari

, e following wholly-owned cubsidiaries, in

addition to peti

_ *-.» (@) Bhe. First Seurity. Life. Yaumaicace Company

. . of Texas (hereinafter geferred -to_as Security. Life),

& corporation organized and licensed as-an insurarice ©

ce

_;eompany pursuant to’ the laws of. Texas. =~

(b) Ed. D. Smith and Sons (hereinsfter referréd:” .

_ to as Smith), a Utah: corporation. It had approxi-

mately twenty| employees ‘arid: sold life and casualty

2 insurance. It had -a yearly — volume | of -

| proximately $800,000.

(c) First Security: Silene 3 higenty, Ine.. Chpees =

inafter referred to ‘as Agency), an Idaho corpora-

tion. It sold insurance and had a yearly ‘Seah

‘volume of about $175,000. ey a

(d) Western Investment Corporation, an erecta

corporation holding various assets.

(e) ‘First Security State. Bank, a: Utah State bank.’

e Bank, @ ‘Wyoming State. bank.

AG ‘Savings and-Loan Association, a Utah

~ “State savings and loan association; and’.

-¢h) First Security Savings and Loan Cindiation: ps

“an Tdaho State savings and loan assotiation. -

‘On September 15, 1959, Holding Company under-

went a reorganization pursuant to the. Bank Holding

. Company Act, supra. The banking subsidiaries, in-

. eluding the: three . petitioners herein, were placed in a

newly-organized yank holding company.“‘The share- _

holders of Holding Company received the sfock of

= new bank holding re rae The re |

to Septembst “15, 1959 “Holding Com:

4

‘ee?

_ subsidiaries, including Security Life, remained in the

' _ old holding company. “°° Al sing ante lela

_ Utah Bank and Idaho Bank have numerous bank=

ing offices. Both are subject to supervisién, inspection, .

and control by the Board.of Governors of the Fed- —

eral Reserve S¥Stem, the Federal. Deposit Insurance

Corporation, and the Comptroller of the Currency and . +

are regularly examined by them. The articles of in=y

corporation of the banks limit them to the business of —

_ banking under the laws of the United Statés. Under °

_ the national banking laws,.the members of the boards ’ :

of directors of the banks are responsible for the _

proper operation of the banks. During the years in

issue, Utah Bank had 141,000: to 192,000: depositors

- and $217,000,000 to $292,000,000 in’ deposits. During

. the same’ years, Idaho Bank had 113,000 to 131,000 _

~~ depositors arid $183,000,000 to $205,000,000 in deposits.

_' . Management® Conipany. provides accounting arid .

other management services to the other subsidiaries:

of Holding Company. Management Company i8 \sub-

. Jeet to control, supervision, and inspection by the ~ .

' Board, of Governors of the Fedéral Reserve ‘System

and is regularly examined by it.. ; aaa ae

_ In 1948 Utah Bank and Idaho Bank began making’

available credit life, health, and accident insurance -

(hereinafter referred to as credit insurance)* to their —

_ customers. They did this for séveral reasons, includ-

ing (1) to offerg service increasingly supplied by com-

* Although the new holding company received the name of the

. old qne—First Security Corpdgation—while the old one changed

itefame to First Security Investment Company, the term “Hold-

ing Company” will continue to refer to the pre-reorganization ~ |

holding company. | ev en ee Oe

* For-a description of the credit insurance industry, see Local -

“Finance Corporation, 48 T.C. 773 (1967), at 776 et seq.

} . .

ee

- peting Qnaricial Snatitesonti

of the ‘additional collateral ich credit. insurance

provides by repaying loans upon the death, i injury, Or

seioin the etaafite

illness of the borrower, and (3) to provide an addi-

. tional source of inconie—part of the premiums from

the insPAnGe79R Holding Company oF its subsidi-

aries.

Wess “1948 through 1952, ‘Credit Life ru aie °

Company of Springfield, Ohio, wrote the credit in-,

surance which Utah-Bank and. Idaho Bank had avail-

able for their euistomers.: Credit Life Insurance Com--,

pany and Smith entered into-agency agreements des- %

ignating Smith as Credit Life’s agent in writing the

thé insurance. Pursuant’ to the agreements, Credit:

Life pees cémmiissions to Smith as follows:

Qotéed. 4.

Sane Amount of parent to Smith per agency : Carneteriaton of paren

* ; agreement: . in’ ageney agreernent

9-24-48 through m to 50 percent of net premiums collected, based on Commisstons..

6-1-50. volume. ~

6-1-80 through . 55 percent of premiums. -............-------- amie - 45 percent commission, 10

12-31-62. - percentexpense

aa __- Feimbursement.

From January 1, 1953, through April1, 1964, _

_Ameriean Bankers’.Life Assurance Company of Fo- .

‘rida wrote the credit insurance which Utah Bank and.

° Tdaho Bank had available for their customers. Ameri-:

ean. Bankers Life Assurance Company and Smith en-

tered into. an agency agreement designating Smith as

Ameriéan ‘Bankers’ agent in writing the insurance.

| | _Parsuant to the agreement, American Bankerg paid

commissions to Smith of 55.pereent o of the net premi-

‘ums collected on life insurance and 50 percent of the ~

net amegreR eollested on health and, accident in-

surance, .

Late in 1958, Aerinels: ‘National Zniiniatbe, Cont

= of bara: _— Cuereina tier referred toas

ne .

\

- a ae

+, 23 -

National),’ snesiesia Holding Company with aplan —

| | _-whereby National would write thg credit insurance |

_ . which Utah Bank and Idaho ‘Bank-made available .

~ to their customers. The, plan calledfor Holding Com-

pany to créate a life insurance subsidiary. The sub-

' sidiary’s business woild be to reinsure the Nsks of the

eredit insurance policies written by National for the

customers of the two Banks. Profits from the business

could be retained if the subsidiary for investment, .

In its initial /years, the subsidiary would utilize Na-

- tional’s established and experienced operating serv-

ices—actuarial, accounting, etc.—on a fee basis. If the _

plan. proved successful, the new insurance subsidiary. -

_ could. grow into a full-line, dineet-writing aciamaal .

- company.

Holding Company was one of many financial insti--

_ tutions which: National approached with such a plan. -

During 1953 National concluded that lending institu-

tions. would. soon begin to form their own life ‘insur-

ance companies to write the ¢redit insurance which

they made. dvailable.to their customers. They based.

their conclusion upoh the facets that writing credit

insurance was pro to be a -very profitable busi-

ness(gnd__ that there were considerable tax savings on

premium jneome.” This potential move. by lending

institutions would ultimately deprive National.and _

other independent i insurance companies of their credit —

*. insurance business. To salvage what it. could from

the situation, National’ decided to encourage lending .

— to develop their own life insurance com-

‘s\National is a leading nationwide insurance company. It is

“Gndapendent | ‘of and unrelated : to ee Company and its

. subsidiaries. ==

™The Life Lnatitnane Duoene Income Tax Act of 1959 in

_ __ ange pert eliminaigd the tax savings..See generally Mertens, _

— Sec, 444.01 et seq. |

427-821—71__4

24

panies’ by utilizing the operating. serviees which Na-

tional had developed for writing credit insurance. By

- ghar ving # fee for the. services, National would re-

- coup something from its investment in the credit in-

‘surance business. : 2

Holding ‘Company deeided to adopt . National’s

plan. It did. so for numerous reasons,’ including its.

. policy of business expansion.. To implement the deci-

sion, ‘Holding Company incorporated Security Life

in June 1954. Security Life was incorporated under .

the laws of Texas and approved by: the Texas. State

“4 Board of Ingurance- Commissioners. It had an initial *

capital of $25,000 * and an initial i concen) aa oe .

$12, 500.°. -.

_ National began vniting credit insurance for the cus-“

tomers of Utah Bank and Idaho Bank in April 1954.

- . The insurance was ‘Teirisured with Security Life un-

* der contracts called reinstirance treaties. Under the

treaties National’ received. approximately 15 percent

of the premium dollar for its managerial services and

Security Life received the balance of the premium

_ dollar for its assumption. of 100 petoetis of the risk

under the insurance policies.” . qtay

——¥rom—Aprit “1954 through 1959, “National. main; -

tained Security. Life’s books and.records and com-

puted its required reserves. By purchasing the

services: of National, Holding Company effected con-

; siderable savings -over what’ ‘would have been the case |

* Security Life's. capital was increased to $100,000 in 1956-

_ through a $75,000 stock dividend. 7 os eT

_* This w WAS anunusw atian, with which to be-

gin an insurance senaichets ‘In 1954 Texas. had low. minimum -

capitalization —— for incorporating insurance com-

- panies:

. ©The maximum on one life andes the policies which Secu-

rity r bife reinsured was $5,000

a

%

iad it sheds to lanneh a ‘fullaine, diveat-yitiling é:

_company from the outsét. It is‘a common practice to -

_ begin an insurance company by reinsuring risks and, — .

\if successful; ‘grow into a full-line, direct-writing

company.” -There is no- basic actuarial or business —

: difference ‘between an insurance company which Te-

ins and a direct-writing company.

7 C tah

Bank and Idaho Bank had a routine proce-

dure for making credit insurance available to cus:

tomers. A\loan officer explained: the availability and —

_ function of eredit insurance to a customer. If the cus-

.tomer desired the insurance, the loan officer gave him -

application. forms. The customer then, filled in the ap-

plication. After examining the. application, Bank per-

sonnel filled‘in a certificate of insurance and either _

collected the preimum from the customer or added it, .

_ to his loan. As the final step, Bank personnel for-

warded the completed forms to Management a

for further handling. «. -

Utal"Bank and Idaho Bank did not require. cus-

tomers to purchase credit insurance. During the years

in issue, less-than-one-half of the Banks’ installment

~ loan customers elected to take i insurance and less than

_ 13 percent of the Banks’ real estate loan canteens

elected to take insurance. 7

- The\cost to Utah Bank and Idaho Bank of process- —

2 ing the insurance was negligible: For the five years in.

‘issue, the total cost to Utah Bank was $8,929.30 and

_ the total cost to Idaho Bark was $9,826.43."*

——

[anagement. Company’ s role in processing the

pernsr insurance was in the nature of bookkeeping. It: -_

had no contact with the public with respect to writing

_ ™ Security Life never developed into a full- line, direct- -writing

7 company.

_ 3 These figures are derived from an extensive time-cost study

. — vd an ia of Management Onmiey,

26

credit-insurance. Tt ineiivad the forms, duplicate cer- .

: tifieates, and premiums from Utah Bank and: Idaho

Bank. It then made records of insurance purchased

and forwarded premiums to N ational. It also did the

‘paper work when —. had eas ‘be filed under the +.

/ policies.

The cost to Management Company of processing the

insurance was negligible.’ For. the five years. in more,

the total cost: was $10,150.34." . Lo

Idaho Bank, Utah Bank, and ae ey ‘ial «

“pany ° were not parties to the legal relationships and ~

obligations of the insurance policies. _ National wrote.

..,the insurance and the Banks’ customers were its pol-

icyholders. Unider the-terms ' of the policies, -National

was_responsible for payment of claims. Under the ~

—, reinsurance treaties, Security Life was. senate wd

reimburse National for claims-it paid.

Other than group policies, there were no siaitesials

agency agreements,’ or other legal connections | -be-

tween National and Idaho.Bank, Utah Bank, or the

-, employees of both. ‘There were no contracts, agency

- agreements, or other legal connections. between Na-

ss SS tional and Management Company or its employees.

or er ers was priced at the uniform rate of $k per _ *,

: $100 coverage per year on a decreasing term basis.

- Thjs was the rate commonly charged in the industry. :

' If ‘was accepted by the insurance’ commissioners of.

; —— 12, h supra. - ?

\ Braue 1948 through 1959, e credit insurance which:

Bank and Utah Bank made availablé-to: their LO

€

e states involv herein—Utah, Idaho, and Texas.

‘Thais the’ years ini. issue, Security Life paid state.

Be and Federal-taxes, used its own stationery, made de- .

posits. and withdrawals from bank accounts in its own |

name, and invested in its own name. Tts sole source °

: * This figure is derived froin the time “cost gp described i in

of’ business ‘income. was:.reinsurance premiums.” te.

-and claims settlement expenses: =

-

ct. Security Life’s credit insurance business was, very

© profitable. Its yearly ae erations . for the period 1955

- through 1959. Teflected i in. the: pasate table:

&2

aan Net’ ° National's “anal claims . Net profit to

ya Yea > - Premium! fee = ~ Security expenses a

’ . . ' ' ° . ; ° = 4 ~~

>. MB ehic ce tdi A nace $145,927.55 $24,765.65 : $121,161.90 $45,340. 38 $76, 21.52

. 1986... a ctincinccttuscis cves 277, 487.45 - 48,605.72 © 288,741.78 97,800.66 136, 184.7

: Wn ck ntl ‘--- 867, 612,62 55,800.64 - 812,021.98 114,014.49 198, 007. 40

"MOB, cw canicne cececgeconteccee : Prat ge 62, 954. 22 584,920.68 118,874.46 466,046.22

i ee eee Oe i ewe 477; 880.43 71,008.43 406, 781. 00 140, 948.92 255, 882.08

, Mil eases ea --.. $1, 016,241.96 $288,614.66 $1, 657, 627. 20 $526, 787.91 $1, 131, 899. 38

A, Less closing Life Reserve, 12-81-60 2020022. -. ee ceeceseeteecceeceeecetenee: REET * 1110, 806. 00

” Less general expense on period — through whet oriaR ocwonsed pooee now swat edwin 16; 339.00

a ; #oe% pn a

4 4 Totl profit........... weeccnceeceee enna ee + bebena bece---2--- $1,004, 604.88 -

. .

’ fom prema as aneltins and tent :

a Includes 1958 reserve anes eey oa j| 7

total net’: premiums received. .. .

. ° r) Percent

“ of total.

< . 7 net

pre-

Item: ee, “ie vo: receioes

Fmpaid to National oe! eee 13.5: -

; | Oldims paid... <2 s2. 2-2 e iene ene ieee Mh

~ 5% _ Life reserve on 12/31/59 and general expenses ceusone apieercepewe’ OS®

‘ Balanoe-._.-.-.-._. ini pl spi ies Tix rss ci enna chine conse, MR

|* Total. :------- 222. ee | re _.. 100.0

5 . i

. ; \

: |

. \

ee

business expenses were primarily bank ¢ charges; tame

Security. Life’ 8 operations for the years in issue are sum— ns

marized in the following tablet in terms of percentages. of -

-

Security Life's, thelaiieh sheets’ for ‘the period January 1, 7

1955, through December 31, 1959, are Arann nice in the

feliowiog table: ceo OS i" eee!

eH | a ; ‘ 7 gt Boy . t “fi ‘

; = 1965 ST 0” 1880

ie eset $161, 370.52 $800,236.87 $648, 586.43 $1, 204, 424.45 $1, 060, 220.71

. Liabilities (including . 2

_/ Peserves).........2.......- 18,076.98 22,206.00 = 90,277.00 = 271, 470.06. 87, 687.00

OO OTE ODIs 25,000°00 100,000.00 100,000.00. ° 100,000.00 100, 000.00

‘Burplus: *

ay”: een cE 12,800.00 ~ 12,500.00 12,800.00 12,500.00 —-—-12, 800,00

; AE nn iecncccnstepecsnccsbutee i I hbo io edn cccetnsucksavbinkesoeiebocust

Bamed. .....-2.1--.-- 110, 708.84 220,902.46 006,808.83 820,445.80" 1 740, 083,71

metic tampa intial etna Sasi ceiieg Sota es: : > -

| "Although Security Life’s business proved to be suc

S cessful, there was no way to judge at thé ‘outset

‘ whether .it would sueceed. In relation to its capital

structure, Security, Life reinsured a large amount of*

risk. The following table shows the number of policies

reinsured, the amount of risk it assumed, and the

number’ of extra maximum ¢laims which would. have

| ES EC ene eee?

a

: . Number

, ates ; te a

- . Amount of would have

Number" riskatend .

Year of policies of year: | surplus.

a Se ON PP ee eee CO 12,600 $6, 488, 000 3

eens OL poo silot 27,504 18, 360, 600 : 9

Wiis pnnincsin cess 34, 388 21, 105, 000 23.

WO a css ccd Penk cenceue nleiametanlanceion 29,501 . 25,570,000 og”

Tans ph cinmivcsonhinebumgénscentvabnues auanpbobe 32, 185. 36, 761, 000 5

Br ickin dino di dstcntaepswbidarmnecpoadkwabesud 36, 416 41, 380,000 ~ 97

da

z

: Surtees there were “several aspects of Beanie .

_ Life’s business which could have invited high’ mor-.

tality rates. Customers of the two: Banks could’ obtain -

_ eredit insurance without a health examination and.

_ there was no. waiting ptriod before the insurance

&

Sie 370,52 $900,268.87 $048, 586,43. $1,204, 424.45 $1, 060, 20,71 ° oo

SEE

. ss

. .

-

pals ae

\. @

went. into — In addition, Security <Life ,was a

_. relatively small sl cuties company -and: its policy-.

holders lived. iz iS relatively limited geographical area, --

Since\ Utah Bank and: Idaho Bank began thaking

. . &¥ailable credit insurance to their customiers in 1948,

_ ® the officers of Holding Company. and of the.two- Banks

-- have held: the belief that it would ‘be contrary. to Fed-

eral banking law for the two Banks to receive income .

| resulting. from their customers’ purchase. of, credit

' insurance. They based the belief on the advice of legal.

counsel, Pursuant to the. belief, the two Banks have

never received. or. attempted to’ receive commissions’

or’ reinsurance premjims resulting from. their eus-.

tomers’ p of credit insurance, —

Petitioners * daho Bank and Utah. Bank reported.

no income from sales of credit insurance on their Fed-

eral income: tax . for the”years 1955 through

- 1959. Petitioner Fanagement Company reported| no.

income from sales of credit insurance on ‘its Federal. -

' -Income, tax returns. for the years 1956 through 1959.

In his statutory, notices of deficiency, respondent

. allocated’ to petitioners Utah ‘Bank and Idaho’ Bank ~

the reinsurance premiums received by Security Life

from: 1955 through 1959. He also, alternatively, al-° is

located to petitioner Management. Company | ie rein- -

‘surance premiums received by. Security Life from:

. 1956 through 1959. The pertinent explanatdty ma-

terial in each notice of deficiency ig as follows:

¢

It ‘is determined that the insurance “pres

: __ 7 mium [s]. zand/or : commission income reported

”; 90 Dating tas trtal and on brief, respondent only urged the oe

* “allocation of 40 percent of the, net: premiums which Security .

__ Life Teceived from reinsuring credit insurance. He did. |. not-al-

locate.‘any income which Security Life received for reinsuring

risks on mortgage, twin-dollar, and borrow-by-check insur-

ance, threetypes of insurance which Security. Life reinsured in

e addition: to what we. _ to herein as’ credit i insurance...

ee i ees Ca

%e

‘

ey

- -asninéome*by the First’ Security’ Life Inge

», Company. of Texas,-a.corporation, the stock o |

WwW is owned, by The First Security Corpota-

- tion, “the. same corporation which owns your .°s

pt oe “shotild ‘have been tepotted by you. There-._

“your™ taxablé ‘income is increased’ as in--

ead tied ‘for éach’ ‘of the* reer tere Lecegll

[1956} through 1959. =

anya different ‘¢ase ‘than the one-at bar, Keapbinabat’

has“ eda deficiency against: Sécurity Life for

the’ years 1955 through 1959.’ More than three years

before’ the trial of the present case; Security Life

filed ‘a: Sworn protest with the’ district director. of in- —

ternal revenue,’ Salt’ Lake’ City, Utah, contesting the.

asserted deficiency. Céunsel- for petitioners herein. —

prepared Security Life’s protest. To explain the dif-

ference’ between Security Life’s case and the’ ‘at

| bar, en rand contains the following language *

issues involved are not at all related;

each turns on its own set of facts and its own

_ . -geetion of the Internal Revenue Code. The is-

_ ,.< ° sue ‘involved: in the bank cases is whether the ©

banks were the true earners of the income, and

hence. taxable under Section 482. The issue in |

this. case is whether the reserves.were estab- -

‘lished and maintainéd on anh actuarial basis

as required by Section S01 (a).

ment prior to the\pretrial conference formally notify- ,

ing petitioners that he intended to rely on section

-" 482. Two. days priogito the trial herein, respondent

filed a motion for a pretrial .conference pursuant. to

Rifle 28, Rutes‘of Practice of the ‘Tax Court. In the -

‘mbtion; respondent stated that he’ would ny. on ‘sec~-

sii) 482'as well as section bond 7

—_ ht

ee

® , 7 ‘is

' ‘<.

oe

. the case at bar, respondent never filed any docu ~ |

. _ rae 21. 2 4, : ma tee ;

ot ‘OPINION :

The first issue is whether respondent has. properly

; put section 482 ih issue.

’ Petitioners argue. that because respondent. did not |

i . specifically mention. section 482 in his notices of defi-

ciency, and because he did not otherwise specifically

and formally notify petitioners . prior to the- pretrial

conference that he would rely on section 482, he is |

barred from .relying on that: section. Alternatively,

petitioners argue that if we permit respondent to rely: .

"on section: 482, he should bear the burden of proof

because the determination with respect to the section —

482 issue in the statutory notices does not contain “+

sufficient legal and factual grounds. _

‘We.do not agree with either argument. Petitioner’ Ss:

--eounsel knew three years in advance of the trial that

Tespondent would rely on section 482. Moreover, peti-

tioners. do not. allege surprise er suggest that they

were prejudiced in any way by” ondent’s alleged .

omissions. It is clear from the record that petitioners’

. counsel wére well. prepared with an. extensive and

thorough case on the sectien 482 issue. view of °

. these circumstances, the cases: which petitioners: cite

on: this point are distinguishable. We. hold that re- -

spondent has properly put section 482 in issue and

that petitioners have the burden of proof. | .

The second issue is whether respondent erred i inallo- |

eating, pursuant to.sections 61 and 482, either to Utah

Bank and Idaho Bank or to Management ‘Company 40

percent: of the net premiums which Security Life re-

eplved during the years in. issue for. een’ credit

surance. « .

‘In all essential respects, the facts of the easeat bar -

are = same. as those in Local Finance a ies

: gs eee MM cot Scot te |

48 T.C. 773-'(1967).- Because of our decision in that .

ease, most of petitioners’ arguments on this issue,are —

‘untenable. Petitiéners do, however; make two'argu--

ments concerning the actuarial soundness of respond-

.‘ent’s allocations which ‘are not coreeeeet by a oe

‘earlier decision.”

~ Petitiohers’ main attniisl argument is mae upon .

the testimony of their expert. actuary. The crux of the

_ “testimony is the opinion contained in the following ,

a3 ganna a

. & ‘What is your. [prac e

_A. The size and nature of the risk “assumed.

ing this company [Security Life] in relation-

~ ship to its capital structure required it to retain . =

vevery dollar that it could possibly do so. |

Q. & ¥e stay on an ‘actuarially, pound basis?

es.

Petitioners’ attuary heied his opinion pon. the

amount of risk which Security Life reinsured and

upon factors in its insurance operation which might

have invited high mortality rates. !

. Petitioners claim that their actuarial evidence dem-

onstrates. that Security Life would have: been. actu-

-arially unsound if it had paid an insurance commission

to the Banks equal to what respondent now allocates

- to them. It follows, petitioners ‘argue, that respond-

-ent’s allocation Pursuant to meeone 61 and 482 is un- |

reasonable.

We do not agree. The central fact upon whieh peti- ~~

tioners’ actuary based his testimony was Security |

Life’s initial capital structure of $37,500. In the above-"

quoted passage he said. that Security Life assumed

great risk ‘‘in relationship to its capital structure.” —

. Respondent’s actuary pointed out that Security Life’s

‘initial. capitalization was. ‘unusually low for an insur-

* See Local. Finance Corporation, eupra, at 791. -

TR

‘

*

ance company. Petitioners’ Gti corroborated this

with the following testimony:

| Now, within the life insurance bviwatey thiere

isa very much used rule of thumb for. néw life.

-* Insurance. companies: that is to establish it with.

.capital and surplus of approximately 100 times --

its maximum risk on one life. |

This is npteiy and a rule of thumb, but it

ds also t sethat throughout the industry. the -

amount 1at_ comp anies will retain on one life |

is closely in n that neighborhood.” :

The maximum risk on one life under: the policies Tein-.

sured by. Security Life was $5,000. Using the formula |

suggested by petitioners’ actuary, Security Life’s ini-

\ tial capitalization should have. been. $500,000, not $37,- . -

500, If its initial ' capitalization had been $500,000

rather . than $37,500, petitioners’ actuarial evidence

would be. meaningless. The validity, of the evidence, in

_ other words, hinges upon the fact that Security Life

began business as an undercapitalized insurance com-

- pany. This evidence does not, persuade us that Zespond- .

ent’s allocation ppreiant to sections 61 L Bind. 482 1 isun- - |

. reasonable; = 3. B

' « Betitioners make another actuarial argument based

upon the fact that.réspondent;. during. trial and, on

brief, did not, allocate to,them. Security. Life's income _ -

; from rejnsuring risks.on: lines of insurance other than

"what, we ,herein, refer to as ¢redit insurance. , Peti-

+ tioners contend, that respondent ignored these lines

, hecause.; Security. Life. had .a,_ much, higher | claims |

experience with them than with, credit insurance. Peti-. ._

‘tioners. argue that this. omission -by. respondent is a

“concession that ‘a 40 percent allocation, on. the other

lines’ of insurance would be unreasonable. They con-

clude that what is“unreasonable for the other lines of

| insurance is algo unreasonable for credit insurance.

“

Pe ae os

\/We: do not agree. Petitioners did ‘not sities to

prove’ ‘any business or actuarial similarities between

Security Life’s, reinsurance of eredit insurance and _ .

its reinsuratice of other lines. It follows that we can-

B ‘riot draw inferenves between the two-lines. We do not

“decide what meaning, if any, attaches to the fact that — -

: respondent did not allocate Security Life’s income

from reinsuring the other lines of insurance. |

“Neither of. petitioners’ actuarial arguments per-—

suaden us that respondent’s allocation pursuant to sec- —

_ tions 61: and 482 is unreasonable. The arguments do .

_ not, therefore, distinguish the present case from Local

Finance Corporation, supra. It follows that we must _

uphold as reasonable respondent’s allocation ‘of part :

of Security Life’s income. i:

‘One problem remains—to which taxpayer should we .

allocate the income in question. Respondent, in his.

notices of- deficiency, allocates: the-income either to

Utah Bank and Idaho Bank or: ‘to Mansgeatyet Com-

-pany.

‘Petitioners argue ‘that the only taxpayers’ ‘to which

we can properly allocate the income are Smith and

_ Agency, neither of which is a a party herein. .Their-

ah "theory 3 is based upon the facts that from 1948 through

“4954 insurance commissions for the sale of credit in- .

_ Suzanee in the two Banks were payable to Smith and

-. that during the years here in issue Smith and Agency

“held lidenses, to sell insurance. Because insurance

, commissions have never beer: ‘payable to petitioners,

and becanse none of the petitioners | has ever held a

license. to sell inguranee, they argue that it 1 is logical °

to allocate the income to ‘Smith ‘and « “Agency, rather

than to. them. — |

35

We do no oty abrge. “Petitioners veitormel’s services

with regard to the sale of credit insurance during the

| years in issue, Smith and Agency didnot. Therefore,

it is not proper. to allocate the income to Smith and ©

"Agency. See. concurring opinion in Local Finance ® 0.

Corporation, supra, at 797. e =

»’ | Among the’ petitioners, we allocate the income to

'. Utah Bank and Idaho Bank. Our decision in Local |

Finance Corporation dictates this result. e

Decistons will be entered under Rule 50.

~

Nite >

A ne

gd

_ “i cape aie "APPENDIX a

an "United: States! Court’ of Appeals, Tenth Citeutt

- January Term, 1971. ?

No. 61169 GH e 3

_ COMMISSIONER OF spre omen RESPONDENT-

Eimer’ “Secon, Banx oF ‘Tnaxid, N.A,, | rermoxe |

Vv.

CoMMISSIONER OF INTERNAL mahi RESPONDENT-.

| No. 613-69" EDIE 0S 38

> Finer SeoumrY Couraxy, PETMONER-APHEILE

é3 : , Vv. . .

Oviatt OF INTERNAL feevaitia! RESPONDENT-

ATERALA, FROM DRCERESED OF Eis PAS: COURT: OF: THR

afar Bammer an Sen, Creu Jaden

“Temptar, District Judge. _

———— oo Judge.

7 $7

oe: a.

Pe TAH, NA, PETTTIONER-

ms)

38

These consolidated appeals 1 from the Tax Court,

relate t6 the allocation of income among taxpayers. .

No. 611-69 is an appeal, by First Security Bank of

Utah, N.A., (Utah Bank) Beals the decision. that, for

_. the years 1955 to 1959 inclusive there, is'a deficiency -

'- in income taxes die from the taxpayer_in the amount

' * of $187,863.92. No. 612-69. is an appeal by First Se-

curity Bank of Idaho, N.A., (Idaho Bank) from thé |

holding that for the tax years 1955, 1957, and 1958.

there is a deficiency of $210,714.41. No. 613-69 is a

protective appeal by .the, Commissioner of Internal. — |

Revenue from’ the decision. that there are no deficien-

cies in the income taxes due from First Security Com-

pany (Management Company) ‘for the years 1956 to”

_ 1959 inclusive. The Tax Court held that approximately

_ 407% of credit insurance net. premiums paid by bor-—

'/Towers from the two banks, and reported by another

‘ eorporatinn, were. allocable to ineome of the: banks

Jurisdiction is conferred; by 26 U.S.C. §.7482(a). _

Venue for the appeal of the Idaho Bank is in this ©

court pursuant to a stipulation made “under

§ 7482(b) (2).°'The findings of fact and opinion of

_ the ‘Tax Court are not. offictally repotted but are

found at 26 T.C.M. 1320. |

. The taxpayers are national harks They and a

_ Wyoming’ bank, Management Compariy, and'certain -.

monbanking affiliates were until 1959 wholly owned —

subsidiaries of, First. Security Gorporation,:a bank

holding company which is..publicly owned. During -

the’years in issue Utah Bank had 141,000 to 192,000.

depositors: and $217 ,000,000: to $292,000,000 in deposits

and Idaho Bank had:118,000 to: 131,000 depositors and

Casha) raya aoe. ne a Ot oabethk

‘provided’ addotin g ‘and a

services ion subsidiaries of mia = wats

mre

sfs

- Since 1948 the banks have made available toithéir

borrowers eredit life, health, and ‘accident insuTanee

which pays off the debt in: cade‘the -borvower didsier _

1s incapacitated during ‘the term: of his:loan: The! Tax +

_ Court found that they did this “for several reasons,

7 ineluding {1) to offer.a service inereasingly supplied

_ by competing financial institutions, (2) to sbtain'the _

benefits of the additional collateral, which: efedit: in-

" surance provides by repaying loans upon the death,

.., injury, or illness of the borrower, and: (3) ‘to provide

"an additional souree of income—part ofthe premiitms. _—

for the insuranee—to Holding Company’ or .its sub--

sidiaries.” The premium charge for the credit insur-

ance was at the uniform rate of $1.00 pér ‘$100.00 of

coverage .per year on a decreasing term basis. This

was the rate commonly charged in the industry and .

was accepted by the insurance commissioners of the —

- states involved—Utah, Idaho, and Texas. The banks

_ did not require their borrowers to purchase eredit in- -

_suranee. During the taxable: years less than 50% of

_ their installment loan customers and less: than’ 13%

of their real estate loan customers elected to! take

insurance. |

CRs

‘The banks had a routine procedure for making

“eredit insurance available. to customers. A loan officer

explained the function and availability’ of the insur-

-anee. If the customer desired the insuraneés, the loan

officer gave him the application forms: for eompletion.

Bank personnel examined the application, made outa -

certificate of insurance, and either collected the pré-_

mium from the eustomer or added it to his loan. There

is no showing: that any of the bank. personnel were

-employees forw the completed forms and pre-.

“ miums to Maylagement Company for further handling.

* Managerient Company’ 8 ins in progessing the credit

insurance was in the nature of bookkeeping. It had no,

Zit voontact with ‘the public. in respect to the writitig of

. \erédit insuranee, It received the forms, duplicate cer-: |

* .of the insurance purchased, and forwarded -the pre- |

| miums to the insurance. carrier: It also did the. paper

work when claims were filed under the policies. :

gard to the credit insurance which concerns us. -

of risk at the end of gach year, 1954 to 1959; inclusive,

varied from a low of 12,500, and. $6,483,000 respec-

- tively in 1954 to a high of 36,416 we #41, 350, 000 re- ;

spectively in 1959.

f°) 2. Phe net premiums for the years’ 1955 to 1959

» Anelusive totalled $1,916,241.95. ei. |

| 3. The claims and claim expenses for the years 1955

to 1959 inclusive totalled $525,787.91. ; =

ee For: osagti years in issue the. total cost to the, Utah

rocessing: the insurance was $8,929.30, to .

Bee ook $9,826.43, and to Management Com-

, pany $10,150.34.. ‘The. Tax Court described these costs

as “negligible.” * -

1948 to April 1, 1954, the eredit insurance

eaverage on the: banks’ borrowers was carri nd

Credit Life Insurance. Company of Springfield,

. and later by American Bankers Life Assurance iv

“eHolding Company and. its subsidiaries. Commissions _

| varying from 40% to 55% of net’ premitims were paid

«to Ed D. Smith & Sons-which was. an insurance -

ae agency and a: mace: owned enetneT of E Molaine, :

tificates, and premiums from the made records . °

The following. items show pertinent -facts with Te

1, The number of policiés written and the amount’. *

pany, of Florida, both: of which were independent of —~ |

o? ;

i

a

yp

* insurance availble to borfowers.. The —— ealled for ©

“Holding Company to create a life.insurance subsidi-

ary. The subsidiary’ 8 business would be te-reinsure

. the risks of .the .credit: insurance policies written by .

. Nati nal for the customers of Utah Bank and Idaho __

Bante Profits from, the business could be retained:'in

‘the: subsidiary for investment. In its initial years, the - — °

_ subsidiary: would utilize. National’s established and.ex- *

perienced operating: services, such as actuarial and

accounting, on a fee basis. If the plan. proved succéss- ;

” ful, -the new subsidiary could: grow into a ftine,. ee

Pe ok oo. direct-writing i lusurance company,,

na ‘Holding Company adopted.-National’s plan and in

| B a une, 1954, incorporated First Security Life Tnsur-

ance Company of Texas under the laws of Texas -«:

with an initial capital of $25,000 and an initial paid-in

surplus ‘of $12,500. The credit i urance written by’ |

National for the two banks was - einsured: with vated

rity Life, under contracts called peinsutance | treaties.

2 _ Thereunder. National received approximately. 15%

_ . of the: premium, dollar. for its technical. services and

_ Security Life received the balance for its assumption :

of 180% of the risks 3 under the policies, The maximum.

. risk on one life under. the Policies reinsured by Seeu- =

~. wify Life was $5,000. . a

yo _ If 1956, Security Life’s capital was increased to.

- $100,000, . During the periog it did. not become: a full-

— line, direct-writing: insurance company. Although |

Segurity Life’ puisipone proved. ofoutar this result

/ + was not assure he, usta pen cea at

*

: oe

i , en

’ 4 ° / ear *

‘ ’ $s ot

. .

.

= pe 7

. “yj P si i da ‘ : _ . ia

| aoe

| -sersiobire Security Lite reinsured: a large ‘amount of

“tiskb As‘vioted by’ the Tax Court; several aspects of its

‘Business: eould have invited high mortality rates. Cus;

+bmers ’dfthe banks obtained credit insiratice without ©

a‘ health: examination and ‘without a waiting period.

‘Also; Seourity: Life was! a relatively small insurance

iy and! its: ‘policyholders. lived in a relatively -

- geographical area. A

‘During the years’ in’ issue, ‘Security Life paid. state *

and' federal taxes; used its own stationery, made de-

posits ‘and withdrawals ‘from bank accounts in its own

‘fiaime,'and reinvested in its own name. Its sole source _

‘of business ‘Ineomé was from, reinsurance premiums.

Its ‘business ‘expenses were primarily bank charges,

‘taxes, and’ claims settlements.’ It paid a dividend to -

. ‘Holding Company of $389,821.61 in 1959.

On September 15, 1959; as a result of a reorganiza-

tion pursuant to the 1956 act. réguiating bank holding

‘companies, see 12 U.8.C. § 1841: et seq., the Utah and -

Idaho banks. beeame owned by First Security Oor-

‘poration, a publicly held corporation, .and Security

‘Life beeame owned by First Security Investment Com-

‘pany, also a publicly held corporation. The, parties

“have. stipulated that as of February, 1967, there was a

substantial difference. i in the entity of ~ shares |

of the two companies, .

“On December = 21, 1962, the Outtiniianibthck sent

‘notices of deficiency. + the taxpayers based on an al- .

_ Joeation to the. banks of approximately 47% of Security

-Life’s premium ineome, during the years in issue,

‘after payment of National’s management fees. An al-

‘ternative’ ‘alloeation was made to=Management Com-

‘pany. On'the authority of Local Finance Corporation

ie) Commissioner ‘of Internal Revenue, 48 T.C. 773,

affirmed, '7-Cir., 40T F. 24: 629; cert. denied $96 U.S. .

(986, ‘the: Tax ‘Court’ wphelt Commissioner’ 8 “aliocation

<a

e °

. ‘of inceine to. the banks and denied tits altertintive ine. =,

- eation to Management Company.. The banks have each

appealed fromthe adverse decision on liability. for tax

_ deficiencies, and the Commissioner has taken a _pro-

tective appeal from the conclusion of no deficiency —

due from Management Company... _—_-

- Section 61 of the Internal Revenue Code. of 1954,+>

26 U.S.C. § 61, defines, gross incqme to mean all income ”

. from. whatever source derived including, among speci-.

fied items, “(1) Compensation for services, including

fees, commissions, and siniilar items: (2) Gross in-

come derived: from business.”

Section 482 of the Code,. 26 U.S.C: 6482, covers gi

locations-of income and mactnetinns Some foxpro

and provides that: “@. .

In aniy case of two or more organizations ee.

_ owned or controlled directly ‘ or indirectly by

the same interests, the Secretary or his dele.

gate may. distribute, apportion, or R, allocate

gross income, deductions, credits, or allowances

between or among such organizations, * * * if

_ he determines that such distribution, 2 apportion-

ment, or allocation is necessary in order to pre-

vent evasion of taxes or clearly to reflect the

- income of any such organizations, * * *.

In Likins-Foster H onolulu Corp. v. Comebiasioner .

of Internal Revenue, 10 Cir., 417 F.2d 285, 292,:cert.

denied 397 U.S. 987, we recognized the purpose and

effect of § 482, and the regulations. thereunder: Treas-

_ ury Regulations on Ineome Tax +(1954), 26 C.F.R.

_§ 1482-1 (6) and (c), provide that) the standard: to”

be applied in every case of a {482 allocation ‘‘is:that

of an uncontrolled taxpayer dealing at arm’s Tength —

. with another uncontrolled taxpayer” and that: 9°

: Phe authority to ‘determine the true- taxable

7 -incomie’ extends to ‘atiy’ vsise: in which either by -

inadvertence or design the taxable income, in

>

ee a tee. At

. wee BE in pat of a. ‘conteolted tax] yer, is

. than it would have been had the. tax-

s Saye? in the conduct ‘of his’ affairs been an un-

controlled taxpayer dealing’. at. arm’s: length

: with: smother uncontrolled taxpayer. atanatabad: ¢

During: the tax years in: question ‘Utah ‘Bank, Idaho.

Bank, Management Company, and Security Life were

all ‘wholly youd subsidiaries of Holding Company

and under’ its control. We are concerned with alloca- —

. ‘tion of: 4ncome from’ Security Life to the two banks.

That income consists of *@ portion of Security Life’s

_ ghare of premiums paid by horrowers from the banks

and received by Security Life undér itsreinsurance

"treaties. The test’ to be applied’ is whether the banks’

income. with respect to the borrowers’ purehase of

. .eredit insurance was other than it “would have. been

had the banks in the conduct of their affairs been

oo uncontrolled yer dealing at arm’s length with .

another. uheohtralléd xpayer. Davis v. United States,

. 10 Cir, 282 F 2d 623, 626, Application of that test to

the facts presented is not,easy.

gregh Ui Ee 12

-U.S8.0.; authorizes national binks located in a place

having a population not to exceed inhabitants

td act as an insuranee.agent. In 1 an administra-.

tive ruling by the Comptroller of the Cenanay pur)

portedly authorized every national bank, regardless -

. lof where located, to enter the insurance agency field. |

‘That ruling was’ nullified by Georgia, ‘Association of

Independent Insurance Agents, Enc. v. Sazon, N.D.

Ga., 268 F. Supp: 236, affirmed 5 Cir, 399 F. 2d 1010,

on ‘the ‘ground that; although § 92 does not ‘explicitly

‘prohibit ‘banks in ‘places with a population of. over

4 5,000 from acting as:insurance agents, it does, so’ im-

‘In. a different factual situation the Fourth

- Gireuit held that a national bank is prohibited from |

i

f.

| / es -

speaiie an. insurance , department. except. in senna

of less than 5,000. inhabitants, See Commissioner of

Internal, Revenue y. Morris Trust, 4 Cir, AGT, Ms 2d

‘794, 795. We agree. .,. | eo ’

Section, 93, 12 U.S G. ; ‘provides, thet, for any ‘niole: —

tion of the. chapter. bn. national banks, the. franchise.

ofthe banking association, shall. he. forfeited and the.

_ directors individually shall be liablé for damages sus-;

tained: The Tax ‘Court found that because of. the stat-

utory: provisions, .and,the advice ‘of: counsel -re :

thereto, the banks pelieved that it would: De, contrany

to: federal banking. law to, receiye.income. result-

"ing. from. their,;eustomers’ purchase , of eredi@ansur- vf

_ anee and. they have never, received, commigsions or.

reinsurance premiums arising: from, credit, ANSUR REA 7

transactions, °° |... i.

The. ‘Commissioner argues ‘that the. inhibitions of.

the banking Jaws, do not preclude the operation. of et

the tax laws. The, banks concede. the supremacy of |

the federal tax laws. Their position is that ig

_ of the, prohibitions of the federal banking Jaws the

banks have: consciously remained aloof from, any en-.

titlement to income from: the sale of i Insurance...

For the six years after the banks began. offering’: .

credit insurance and before the formation of Security

Life, the: banks, dealt. exclusively with unrelated in-

-Surance companies in, an uncontrolled. situation: The

Tax Court found that in the eqnduet of their affairs —

with these insurance companies the barks “never -

received or attempted to receive commissions or re-

insurance premiums resulting from their customers’

purchase of credit insurance,” Conversely Tax

Court made no finding that if Security Life | id not

- exist. the banks would then receive or attempt, to re-

ceive any such’ income.In,an uncontrolled situation —

with easily Denes Sealine. ip Seals, ae :

AR

. a,

46

the findings: niade; would not have taxable income °

from the credit insurance transactions. .

‘When all the underbrfish is cut away, the ‘theory of |:

‘the Commissioner appears as a claim that the genera-

tion of: the credit insurance b by the banks

sustains the allocation of a portion of .the premium .

income to them. He relies on Local Finance Corpora-

- tion -v. Commissioner of Internal Revenue, supra. We

turn to that decision.

Local Finance presents a fact aitnations quite com-

parable to that confronting us. Commonly owned

Indiana small loan companies offered credit insurance ~

to their borrowers and about 90% of those borrowers. __ .

“took the insurance at the rate of $1.00 per year per

8100 of coverage. For a part of the period the insurer

| ._;. paid a guaranteed commission of 40% of the net pre

. “umiums, plus certain ‘extras, to an officer of the finance -

companies who, upon receipt, assigned the amount to

' the parent company. Later, a controlled life surance

company was organized and: it, reinsured the risks. ©

Indiana law forbade finance companies from receiv-

ing any income other than: interest on loans. Each

' finance -office. had a licensed insurance agent. The

Commissionex allocated a portion of both the com-

mission income and the reihsurance income to the.

parent.. The rationale of the Tax Court opition in

; Loeal Finance is not clear. We believe that dissenting

Judge Fay’s analy@is is correct. He sald, 48 T.C. FI3>

at 802: =

‘The inajority opinion leo relies upon section

482 for support in allocating the income to pe-

| titioners in order to clearly reflect income. The

- ° premise of this. approach is the previously

“ peached conclusion that petitioners have earned |

Zine tne ie west formance of various serv- i:

ices “and have exercised a power of . disposition

ove® this income to channel it to. the reinsur- a

ance company. . .

In: affirming the Tax. Court, the Seventh Cireuit

said, 407 F. 2d 629 at 632 and 633:

The commissioner’s allocation had the effect

_ of compensating the finance companies for their

_ efforts in generating’ and processing the lf

"insurance. sgtis: naan

* : - fi Fee Gli fe Tmt

However. little “the finance companies did to .

earn this money, they performed those minimal

services which were the sine qua non of the in-

surance business. .

_- The Commissioner now urges on us the generation | 7

- of business theory. He says in his brief that “the effect -

of the Commissioner’s allocation is: to compensate :

Utah Bank and Idahg Bank for their efforts in gen-

erating and processing the credit insurance.” .. -

‘Generation of income differs from ‘assignment of

income. It is fundamental that a “taxpayer cannot as-

-* sign a portion of his income in order to avoid tax

liability on it. See Lucas v. Harl, 281 U.S. 111. |

Also the power to dispose of income is the equivalent

of ownership. Helvering v. Horst, 311-U.S. 112, 118.

These principles are grounded on rights in or ‘ flowing

from income. See Poe v.. Seaborn, 282 U.S. 101, 117.

The position of the Commissioner in effect is that

whoever generates income must ‘include the amount

thereof in his gross income. The fallacy of this posi- _

tion was exposed by the Tax Court in Teschner v.

Commissioner of Internal Susie, 38 EG. 1003,

1007, when it'said: ~ ..

peek this were the aw, agents, ‘eaeidaits: fidu-. :

ies, and others in a similar capacity would

a nally taxable on the proceeds of their

- efforts. The ‘charity fund-raiser _wquld : be tax-

~}

. J

4

‘able ‘on sums: contributed’ as’ the ‘pesuilt of his Bo

* ‘efforts. The ‘etiployee ‘would’ be‘ taxable on in-

geome generated for. his employer by his efforts.

-) Such results, completely at. variance with every

accepted concept of Federal income taxation, ,

= = demonstrate the-fallaey-of the.premise. _

| See also Basye v. United States, N.D. Calif., 295

- - Supp. 1289, 1292-1295.

a ee .

_—

Aer nen on

‘Indeed, the acceptance of the generation of business _

; theery would have alarming consequences on normal

commercial practices such as all types of referral busi-

ness and security. commission giveups. See Seteroe and —

_- Gerber, “Section 482—Still Growing at the Age. of

50,” 46.Taxes 893, 900-902 (Dec. 1968). We believe

that ‘in principle it runs contrary ‘to all court and ‘Tax

os Court decisions except Local. Finance.

From the standpoint of principle the case at bar is

-indistinguishable from such cases as Nichols Loan’ Cor-

poration of Terre Haute v. Commissioner of Internal

Revenue, 21 T. C.M. 805, reversed on other grounds, T

Cir., 321 F. 2d 905 (deduttion by small loan companies

. of expenses attributable to credit insurance); Camp- —

bell County State Bank, Inc., of Herreid, South

a

‘Dakota ¥. Commissioner of Internal Revenue, 37 T.C.

~~ -430, reversed on -other grounds, 8 Cir., 311 F. 2d. 374)

~ (attribution. of: income and expenses of commonly

f “owned i insurance agency to bank); L. E: Shunk Latex

Products, Inc. v, Commissioner .of Internal Revenue, -

18 T.C. 940 (allocation to manufacturer of part of in-

_ come of controlled outlet whén manufacturer was pro-

hibited by maximum price regulations from receiving

the income sought to be allocated) ; Jaeger Motor Car

Company .v. Commissioner of Internal Revenue, 17

T.C.M. 1098, 7 Cir., 284 F. 2d 127, cert. denied |365-

U.S. 860 (anticipatory transfer of insurance income .

from agent to controlled company); Moke Epstein,

a sll

—

f is

2

a 49

Ine. v: Comeacdseinay of Pacers! -Raionid, Pa re"

1005 (insurance commissions received by. president of {

taxpayer); and Ray Waits ‘Motors, Inc. V. Tnited'

States, ED. 8. Car, 145 F. Supp. ‘269. (insurance |

commissions received by president of taxpayer).

» Even though the credit i ance emanated from

. the banks in connection with their loan business, the»

result does not follow that the banks should be taxed -

‘for income which they neither earned nor. received.

They did not earn it because “(1) they were not

licensed insurance agents, (2) they were ‘impliedly

prohibited by. federal law from operating an insur-

ance business, (3) their participation required mini-

- mal effort and negligible cost compatible with the

added protection which ‘they secured “for loan pay-

7 ment, and (4) they had no underwriting risk. True

it is that. they physically received the premium pay-

ments but in so doing they acted only as a conduit to

- ‘pass them on | intact foc others who were legally entitled |

thereto.

’ Consideration of §§ 61 and 482 dilfieirhtilty or in tan-

dem does not change the result. The § 61 cases such as

Lucas- v. Earl, supra, and Helvering v. Horst, supra,

are not pertinent because the banks neither assigned

nor otherwise disposed of income. They simply had ~

no. income from the eredit insurance business. We

| are unwilling to extend those’ decisions to, situations

where the taxpayer has the power to channel profita- |

ble business.

‘ The test for alisealtovin'y diwey § 482 3 is arm’s length

dealing with an uncontrolled taxpayer. As the Tax

' Court recognized, i ‘in arm’s length dealings with inde- ~

pendent insurers before the “orgahization ’ of Security.

Life. the banks did not receive income from credit

insurance premiums. In our opinion the change to

the reinsurance arrangement with National and Secu-

rity Life did not: chan, ibe situation so far as the

. ‘income. of the banks is concerned. They handled the

‘business in the same way and were under the same

inhibitions. The change in operations was for the

benefit of Holding Company, not the banks.

* We recognize the established rules that pdaishioe

prevails over form, that the Commissioner has a wide .

discretion which we may not upset unless if is used .

arbitrarily or caprieiously, and that the burden of .

persuasion lies on the taxpayers. ay Ai do not change.

the result. eration of business“is not enough to

impose federal income tax liability, The effect of the

action of the Commissioner and the decision of the

Tax Court is to allocate approximately $800,000 in

- -ineome_ to the banks and charge them with nearly

- $400,000 in tax deficiencies thereon. The banks have

not received, arid in all probability never can receive, _

- ‘the income because of the present diverse public own-®

_ ership of the parent of the banks and the parent of |

. Security Life. We believe that the § 482 allocations ©

made by the Commissioner are arbitrary and ca-—

“pricious and inconsonant with the basic concepts of

' federal income taxation. To the extent that.this opin-._

ion is inconsistent with that in Local Finance we re-

spectfully disagree with that decision. __

Because it upheld the Commissioner’ 8 siiceddilinn of

income to the banks, the Tax Court rejected his alter- au’

native allocation to Management . Company. Counsel

for the Commissioner say that there is an adequate .

_ basig for the alternative allocation but we cannot an-

swer that question on the record presented, It. must

es be consideréd in the first instance by the Tax Court.

~ In Nos. 611-69 and 612-69 the. judgments are sev-

erally reversed. In No. 613-69 the judgment is re-

‘versed and the case is remanded to the mex Court for ~

further consideration. | pt .

Shiv: “APPENDIX o

No. 611-69

Firsr Securrry Bank or Uran, N.A., PETITIONER: |

at . “”. :

of COMMISSIONER or INTERNAL REVENUE, RESPONDENT-

. ) \ APPELLEE | ;

| ; Wo. 612-69 | devi

ftanaresey BANK OF ‘Doaséd: NA. PETITIONER- .

\ Se _ APPELLANT:

\ | ON”. ere

\COMMISSIONER OF INTERNAT, REVENUE, RESPONDENT-

“No. 613-69 .

Fuer SECURITY Company, PETITIONER- - APPELLEE .

se |

ima Vv.

Comaisst0NER OF INTERNAL Revaires: PROMOTE

APPELLANT

| Before | Honorable Jean S. Breitenstein Age ‘Hon-

orable Oliver Seth, Circuit Judges; and Hongtable

| XY

\

| These consdlidated canes came on to be head on the \

petitions for review from thé United States Tax

Court and were argued by counsel. On consideration

George reg Istrict Judge.

Fe anuary Term—January 21, 1971

whereof, it is ordered as follows:

arse WG

™ 2 aes

a

“9 o

L Ik Cases Nos. 611-69 and 612-69 the decisions

of the Tax bes. Comat, ang severally xorereed,

> P

. ; . . < pots . J ¢

é ‘ fi oe. Be .

5 .- r *. fy . $

‘ : : SAE x

2. In Case No. 613-69, the degision of the Tax Court

4 ig reversed ad the case is remanded to the Tax Court

ne for further consideration. AO csi

$.enp epi ye ayoere! Fuga, fas, ; | Howanp K. Punurs, at

sseeption Wake ere ‘Clerk. ,

; t ealt? By. Hex R. Barra, :

OK. : Di — Clerk.

T ee :

i _ Howard K. Phillips, :

a Cane Clerk, U.S. Court of Ye ‘

, coy jivvivy Appeals, Tenth Circuit. § : cot

‘ By Helen R. Bartha, -. | We ae ge

Deputy Clerk. pA yah :

4 > . & | / | ¢ hs ve f »

‘ A ee : ‘ \

AS STO i { j

er i

Z ° - es ee 2) ;

i : vi] j y

Pre.

Fo { 4

CM, WO MGE . 4H DAT t¢ ‘0

« ; z -)

+ r~ .

o S

.

‘ ; vs . s

“ \ *

.

‘

. e ‘ ¢. Spee ‘

, © gin wets ’ % 53 ae @ ie 5 6h £4

pitas Tae F ity D ? ph yg at Pe bn

Sere Pe APPENDIX Pate ahSy:

, i ye Me ears

, 4 ; d rot

a

ig ie é F

aaa

“Inlomal Hevenue Code ot 1964 (26 U.8.0.):. | | ‘

Sec.’ 61.” Goss IncoME DEFINED. i ito

(a) General Definition. Except as obhairwise

ier Fe in: this subtitle, gross income, means:

+, all income, from. whatever ‘source. derived; in-

fi _ Sending: (but not, limited to). the following.

“ly Comipensa ei for services, ineluding

+. fees, £0 rm sions, and similar items.

1 5ssistt pe an “ger ry tF phe tee

"See. 482, ‘Abrooeetow: OF Ixcomis AND -Depue.

f TIONS AMONG TAXPAYERS. |

ote. Tm any: case. of. two o Mom ‘¢éganizations, |

trades, or , ita ther or’ not incorpo-

a or whether, or ri ; ed, in. the United. .

wy i. Ss 13

» Be in i ‘oJ 7 iB!

ind he :

ise. et pal

Rit trih , atic wry i

i cena in in order

or clearly Mi relect,

‘izations, Arades, or

£LS

eee & pita: OFR): ie

His 1.4821, ‘Allogation or. income ‘and “gee i tnt

"tons ¢

24 4 oo Hh, a ree if; 4 74 #

Peake 0 a ty aia th this sec-

. - aD BL 4. >

ies tion cfs “ght 4 ‘i 3?

. uF io 2 s ‘a EP e*4 of 4 , ll |

ry il eertes my * wititit:® *

’ Siar p o a

ee) 1173 ? a. ae ‘Pit. 34

| ! puis a(t P A957!

I

| « an

ie : ,

(Zo :

_

3 :

ot

(6) {he term “‘true taxable income”’ means, -

in the case of a controlled taxpayer, the tax-

able jncome (or, as the case may be, any item.

or. element affecting . taxable income) which ._

- ‘would have resulted to the controlled taxpayer,

had it’in the conduct of its affairs (or, as the -

case may be, in the particular contract, trans-

-. action, arrangement, or other, ;act), dealt’ with

J

the other member or members of the group at

~arm’s length. Tt does not’ mean ‘the income,*the

*, deductions, the credits, the allowances, or the.

~ item ‘or élement of- income, deductions, "eredits,

or allowances, resulting fo the controlled -tax- ~~

payer by reason of the particular contract,

transaction, or arrangement, ‘the controlled tax-

payer, or the interests controlling it, chose to

‘make (even though. such contract, transaction,

or. arrangement be legally joshi upon the

| partes: thereto). :

(b) Scope and purpose.—

(1) The purpose of section 482 is to: place

‘a controlled taxpayer on a tax parity with an

ntrolied taxpayer, by determining, accord-

_ Ing’to the standard of an uncontrolled taxpay-

rue taxable income from the property

1 of a controlled taxpayer. The in-

. ga group of controlled tax-

: to have complete power to

‘its’ affairs ‘that its transactions and accounting —

. reeords truly reflect the tax income from”

the. property and businéss of each of the con-

trolled taxpayers. If, however, this has not been

done, and the taxable incomes are thereby un- .

_derstated, the district director shall intervene,

and, by making such. distributions, apportion-

. ments, : or- allocations as he may deem -neces-

sary of - -gross income, deductions, credits, or

allowances, or of any item or element affecting

a + Steaipe income, between or among the controlled

ers constituting the group, shall de-.

_. termine the true taxable income of each con- —

~ trolled. ae The standard to be applied 5°

{faxpayer so to. conduct fa

}. BS

in every esise ‘is’ that’ of "an hinecheveied- tax-.

- payer dealing at artm’s length with = un-’

ented tet ayer: TEI aie

:

‘ wt? 2 MPT Ss -

6% ti eas 2s

nite a dois, Meso ite. between one .

3 conti Losin ag cot Whether *

j to s seru asce whether

.., ,the..common control .is being uséd to reduce,

i “avoid, or escape taxes. In ining the true

at ead le income of a contr ited taxpayer, the die .

.. triet | director,-is not restricted, to, the case of

_ Improper accounting, to the case.of a fraudu-

lent, colotable, or sham transaction, or. to the |

case of a device designed to reduce or avoid tax

_ by shifting or . disto -income, deductions,

cmela, or allowances. The authority to deter-

mine true taxable income extends to ‘any case

in which either by inadvertence or one the

taxable income, in whole or in part, of a con- -

trolled ‘taxpayer, is other than it would have _

been had the taxpayér in the conduct of his *

_ affairs. been: an uncontrolled taxpayer dealing

_at arm’s length with —- uncontrolled °

: hexpyer. bh = i

@ posers oie Mid: 2 ;

Revised Statutes: — , it...

. SEo. 5202 ol amended. by Section 1, Act of .

Septe: 7, 1916,.c¢. 461, 39 Stat. —

152]. * # t+ iy 5 me

* _ , ; ene * hed

_... That in addition to the powers now vested by

., law in-national : associations 0

: under the, laws. of: the United States. any, such

, association located and doing -business in any .

. ».»place, the po popyleson, of ak does. not pee

. five thousand inhabitants, as shown bys

preceding .decennial census, may;

rules. and regulations as may be pn

» . ~ .s the-.Comptroller of the Currency, act.as the -

. +, ‘agent for any fire, life, or other insurance com- - |

: pany authorized by the authorities of the Statein .

©

6 re

skbabi anid Yoon tas looated to.do busineah is aid

< State, by soliciting and selling insurance and col-

lecting premiums on. policies, issuedpy such

. ompany;.and may receive for services so ren-

. dered such fees or commissions as-may be

agreed upon ‘between the said association and

‘ . the’ insurance company for which it-may act as

agent Pega gd hence act B the | sing ls or .

_ agent for others in making er proc oans .

. “on-real estate located. within one‘ huni miles

of the ‘place in which said bank may be located,

: ving for such services a reasonable fee

or commission : Provided, however, That no

| stich: bank shall in'any case ; guarantee either the

’prineipal ‘or ‘interest of any such loans or as-:

Re scans -suime or guararitee the payment of ‘any premium _

-’ ‘on insarance policies issued through its agency

“8 Be Aid Baron And ‘provided fr

eaten caer

‘plication for imisurance... - :

onileat [12° US.C. (1946 ed.) a1"

ik 8x0. ‘5239: : : a ie :

_. “If the directors of any natiotail/ basking as-

‘ sociation shall knowingly violate, or knowingly

. ‘permit any of the officers, agents, or servants

ee wi oe f this Ti ae ~ hime any of the ype

Reet 0 e pri eges, an

franchises of the: association ‘be thereby.

__.__ forfeited. Such’ violation shall, however, be de-

oo this provision: was omitted from the 1918 amend-

ion nl rbstetlt ot Sect! W598 Fis Hctiaed, Beatate

_ by Section 20 of ar’ Finance Corporation ‘Act, c. 45, 40 Stat.

506,519; the revisers of the United Statés Code have omitted it

from editions of the ‘Code, subsequent to ‘the’ 1946: edition, on

‘the y that it ‘was repealed’ in 1918, The impli it statutory

7 ' Régulations! 43°12 OF-R. 2.1.2.5. See

‘Commissioner ¥. Morris’ Trust, 367 F: 90794; 705 & n. 3 (C.A.

4); Stimon ¥. eines of ees ierreet —— 399 F.

2d 1010 {CAL 8).

tf -4h' Wi HON

° »

shit guarantee the truth’ of any -

oO»

_ tained“in consequence o

[12 US. C. 93.]

57

termined and ajudged by a proper district or

Territorial court of the United States in a suit:

brought for that purpose by the Comptroller of

the in his own name, before the as- (

sociation bail -be declared: dissolved. And in ~

eases of such violation, every director who

titi] ted in or assented to the same shall be held

liable in his personal and individual capacity

- for all damages which the association, its share- —

holders, or any other } aeicge ee have sus-

such violation.

U.S. GOVERNMENT PRINTING OFFICE: 1971

?

-