Respondents Brief — Commissioner v. First Security Bank of Utah, NA
Supreme Court brief1972
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IERARY -
SUPREME COURT, U. 5:
"Supreme Court, us ; |
ORTLED
pec. 31 1971
° No. 70-305
| £. ROBERT SEAVER, CLERK
.IN THE
'- OctoBER Tee, 1971 .
Supreme out of the Gnited states
COMMISSION ER OF IN TERN AL REVENUE,
Vv.
FIRST SECURITY BANK OF UTAH, N.A, et al. -
On Writ of Certiorari to the United States
Petitioner -
Court of Appeals for the Teitth Circuit —
_ BRIEF FOR THE RESPONDENTS
S. J. Qunusy
Atonzo W. Warson, Ja. .
SrerHen H. ANDERSON.
Ray, Quinxey & NEBEKER
400 Deseret Building
Salt Lake City, Utah 84111 -
Counsel: for Respondents 3
i
+
INDEX
Ce ee ee Pach
QUESTION PRESENTED ....... ere wccckdeat.
(QSTATEMENT 00.00.0000. e ce letceeeeeeeede Seta : ae
“SUMMARY OF ARGUMENT .... eee | Brie T+
ARGUMENT:
I. SECTION 482 CANNOT BE USED TO TAX |
_ ‘THE BANKS ON INCOME WHICH THEY —
- DID NOT_AND COULD NOT LAWFULLY— —
RECEIVE ................. ciaeesiva oooh 3 9
A. The Commissioner misconstrues his own
regulations: § 482 applies only where the _
exercise of common control has resulted in |
understating the true taxable income of one
entity in favor of another ..:............. 9°
- B. The Commissioner has misapplied his own
regulations: the Holding Company’s con-
‘trol over the banks and Security Life did -
>, . -not result in understating the panks’ f
|, dmeome ........2 RUG NESS bon bo nue baw i...-
* ©. The banks realized no. income as 5 that term
is used in the tax laws .................: ~ 1. -
‘ZI. LOCAL FINANCE CONFLICTS WITH ALL ”
— APPLICABLE PRECEDENTS ... garrnrraes 20
IL. THE COMMISSIONER, UNDER THE GUISE
- OF ALLOCATING INCOME, -DOES NOT
HAVE THE POWER TO RESTRUCTURE
BONA FIDE BUSINESS TRANSACTIONS. . 3°
IV. THE COMMISSIONER’S POSITION TRAPS -
" (THE. BANKS BETWEEN CONFLICTING —
| FEDERAL LAWS AND CREATES AN UN-
REASONABLE DILEMMA ............ re
OONCLUSION .....0...0.cecfeseeeeseeeeees vaetee SL
CASES: =. PASE BOT Bipei
_ Alinco Life Sasinieie Company y. ‘United Btaten: BS...
“F.2d 336 (Ct. + RR ME NINA Pre ee ie Cae es 21, 24 -
_ Basye v. United States ‘(9th Cit.), decided September 7 |.
> 16,. 1971, unofficially reported at 112 UST. T |
hago p. 87,552, | ail’ 295. F. Supp. 1289 (WD. en |
) | aa
ABD.) occ csscccssees Nicéadeuece Parks 2:
Boseman v. Connectiout General Life Ins. 06,
US. 196 ..... VARTA ."
Campbell County State Bank,
Commissioner v. Glenshaw Glas Co., 348 U.S. 426 . . 16,17 .
Corliss v, Bowers, 281 U.S, 876 \,......0-0604-+.-- 16,17 ©
Farmer’s Loan & Trust Co. v. State of Minnesota, 280 os
TR os ie ca hh sec peéacabesesseseieenes ‘30,
"First State Bank v. United States, (D.C. S.D., ‘decided
June 25, 1962; “unofficially — at 62-2 U. 8. T. C. : |
\ SAM eee sata. geeveetids SLO. 21
\ First Security Bank v. United States,213F.Supp.362
\ (Mont.), afPd. 334 F.2d 120 (9th Cir.) fee. m1. :
Gaidy- Motor Company, Inc. ‘v. Commissioner, mo.
Memo. 1958-189 (17 TCM. AE ee 20
. Gregory v. Helvering, 2S eee 20
~.° Grenada. ries, Inc. v. Commissioner; 17 TC. 231,
aff'd, F.2d 873 (5th-Cir.) cert. denied, 346 U.S.
ela eae 17
_ Helvering v. Horst, 311 U.S. 112 .........4.0.000006 16
Jaeger: Motor Car Co. v. omealadenen: T. C, ‘Moms
- 1958-223 (17 T.C.M. 1098), aff'd. 284 F.2d 127 (7th ea
Cir.), cert. denied, 365 U.S. 860 ............0s0000- 20
Local Finance Corp. v.- Commissioner, 48 T. C. "173,
. aff'd. 407 F.2d 629 (7th Cir.), cert.,denied; 396 U.S.’ 3
. 956. AS eRe ag psionic 8»
‘Moke Epstein, Inc. v. Commissioner, 29 T.C. 1005 . al
Mary. Archer Morris Trust, North Carolina Nar.
Bank, Trustee v. “Commissioner, 42 T. Cc. TT,
aff’d, 367 F.2d 794 (4th Cit.) ......... page cutenes on.
Moline Properties, Ine. "v. Commissioner, 319° Us. rated
05 ee Beis eae 29
| National Carbide Corp. v.: Commissioner, pe Us.
er Pr or oe ee ee ae |.
Nichols Loan Corp. v. : Coinmlasionte, T.C. Memo. 1962- ;
149, (21 T.C.M. 805), rev’d. on other grounds, 321
F.2d 905 (7th Cir.) atdy Weitiedile bie vices ean Mp4 18, 21,24 ts
Paramount Finance Co. v. United States, 304 F'9d 460 eo
(Ct. C1.) byte ieee Ce Ee eRe OT cot emer 21
L. E. Shunk Latex Products, Ines v. Commissioner, mt 3
TAL iC a on :
: Teschner. v. Beuelasioeet. 38 T.C. 1003 net ag Spe 19
. Ray, Waits Motors, Ine. v. United States, 145, F. ta
Be CDs OBE): ois vos sc ong ss én on ee tne tway ons 8, 20
Rubin v. Commissioner, 429 F.2d 650- (2a Gir) aE eater
Soi Pr Co. v. Commissioner, 49.C. 1215..... 28
_ Stearns Magnetic Mfg. Co. v. COE 208 F.2d - :
ee CPOE? 5 63 ao no neko cine du Veetesstene os ee) ee
‘STATUTES: Rt
’* Bank Holding Cepany Act of 1956 a use. 1841 s
et Seq.) v....-.--. eee b eens eee ce cc ewasesecceese’ 2
Ma Ge at fe
of, ;
“ Internal Revenue Code of 1964: - j . Page.
Bes etree comer arrrer yt lee
§ FALE 1, 6, 7,8, 9, 10,11, 12, 13, 14, .
wri on ‘45, 16, 21, 22, 23, 26, 27, 28
Lite Tesivents Company Tax Act of 1959 ore wees 4
Ac - Lifé Insurance Company Tax, Act of 1955 .- Sasebeeedys 23
. Revenue Act 0 of 1928 .. ss pow-eywide se cncceepees es ae? WE
Revenue Act of 1921, 9240 eel CO rey
“REVISED STATUTES: |
> “$5202 (12 U.S.C. [1946 ed.] 92) Basses is Ww
795239 a2 U.B.0, 98)......02+000. bie abussecs, 11
“MISCELLANEOUS: Mel fis , . .
Aland, “Section 482: 1971 Version”, 49 Taxes 815 ve
: . (Dee. 1971) (eth eee sewers Secewecccverteceneseds ; 2°.
ne Cothmittee on Ways and Means, Taxation of Life
- Jnsurance Companies,-: Report by the Subcommittee
- on Taxation of Life Insurance Companies (1955, 83d '
‘ Cong. 2d Sess: (Subcommittee Print) p. 46 ......... 23
i. Rep. No..2, 70th Cong., 1st Sess., (1989-1 (Pt: 2)... .
» Cum. Bull: 895) . ieieh cmirdhenescs nbatenchen custo’ 9
8. ‘Rep. No. 275, 76th Cong Ist, Sess., (1939 (Pt,. 2) . .
Cum. Bull. 395) .. Li vankhscaNaesmackbcurte evens )oss 10.
S a 86 on 1571,. 34th Cong., 2d Sess, (1956-1 Cum,
io Newbee das sad ea sensecsecreccees pees cea — 23
Seleror & aera “Section: 462—Still Growing at. the eS
_ . Age of 50”, 46 Taxes 893 (Dec..1968) -..... wena’ 19
“Technical Information Release No. 1106 ........... .. 18
“ Treasury Regulations on Ineome Tax: “ee : |
- §1482-1. (a) 6)". 2... eee. err ee cic. eR
Mh LMBRD) (D) occas eet rence cc cceceecees oh} 10,16
-§1,482-1 ‘(b) (3) Pea ssdcnsdetea rae srassersgcnes, ST
3 $1.482-1 PPS inaace ct ena sedees jdned ceases . 11,16
g1.ssr (a). (6) corirernrneeeeeetincechonne 13°
» Supreme Court of the Gnited States
_ OcToBER Tero, 197 1.
No. .70-305
COMMISSIONER vel INTERNAL REVENUE,
. - Petitioner — .
< , " V:
\ FIRST SECURITY BANK OF UTAH, N.A, et al.
On Writ of Certiorari to the United \States
Court of Appeals for the Tenth Circuit
BRIEF FOR THE RESPONDENTS
7
QUESTION PRESENTED
“May the. Commissioner, ieathiniia to Section 482 of the
Internal Revenue Code,: allocate to: the taxpayer national
banks insurance-related income which the Banks did not
and could not receive due to prohibitions of the federal
banking laws, es en in a tax whers | there is no
income? :
STATEMENT.
iceiileiti are Utah avd Idaho antional habe wakdeid
to the control of the Federal Reserve system, the Federal
Deposit Insurance Corporation, and the Comptroller of the
Currency. They are subsidiaries of First Security Corpora- ’
“tS - ‘tion (Holding Company); a publicly owned bank holding ©
_° » company—the oldest in existence. In addition to the Banks, —
~~.
..
the Holding Company had other (non-banking) subsidiaries,
including First Security Life Insurance Company of Texas
(“Security Life”—a life insurance company), Ed. D. Smith .
and Sons (“Smith”— —a corporate insurance agency) and
First Secutity Company (“Management Company”—a man-
~ agement company which, .provided management and account-
ing services to the group).’ (R. 164-166. )
Since 1948, the Banks have made available to their bax ’
customers credit insurance, Which will pay-off the debt if
the customer dies or becomes disabled. This was done to,
offer customers ‘a service which. competing lenders were
increasingly supplying, to obtain additional collateral for
the debt (in the form of insurance), arid to: obtain an addi-
tional source of income from part of the insurance pre-
‘miums. (R.166.). The premium, $1.00 per year per’ $100.00 ©
_ of insurance coverage, Was the rate commonly charged in
the industry and was approved by the insurance commis-
sioners of Utah and Idaho. (R.166, 170.)
Contrary to implications in the ae ’s_ brief
(Br. 6, 8, 13, 17), the banks did not push the sale of i insur-
-ance. They did not require their loan customers to take
credit insurance and less than 50% of their installment loan
customers and 13% of their mortgage loan customers sub-
scribed. It was simply a minor part. of the-routine of the
Bank’s loan. Sfiicers' (who were not licensed insurance
agents) to explain the function of credit insurance and, if
1. In September, 1959, pursuant to a reorganization to comply
with the Bank Holding Company Act of 1956 (12 U.S.C. § 1841
‘et seq.), the Banks and the Management Company were placed
in a newly organized bank holding company, whose stock was
distributed to the stockholders of the old holding company, which —
retained the non-banking subsidiaries, including Security Life-
’. and the insurance agency. Thereafter, as a result of public trad-—
. ing, the stock ownership of the two holding companies became |
——e different. (R 165,. +185.)
the customer wanted it; to take the.application. (consisting
of just four lines), collect the premium,.and give the cus-
tomer his insurance certificate. The cost to the Banks for
the actual time involved in explaining and processing the
insurance, was less than $2,000 per year, characterized by
the courts below as “negligible.””. The paperwork and book-
keeping involved in the Banks’ credit insurance program
were handled by the Management Company, which received
the applications, duplicate certificates, and premiums from.
the Banks, kept records of the insurance written, forwarded .
premiums to the insurance company, and processed claims.
The cost to the Management Company of processing credit-
insurance for both Banks was about $2,000 per year, also
- characterized by the courts below as “negligible”. —(R,169-
_ 170, 184.) ;
Prior to April, 1954, the Banks” credit insurance under-. |
-writers were unrelated insurance companies which paid
commissions ranging from 40-55% of premiums to the.
‘Holding Company’s insurance agency subsidiary, Ed. D.
Smith and Sons, under agency agreements appointing Smith
as their agent to write credit insurance. (R.166-167. ) -
" Late i in 1953, Americar National Insurance Company of }
Galveston, Texas approached the Holding Company with.
a plan under which it would act as the prime underwriter —
for the Banks’ credit insurance, providing record keeping,
insurance accounting, and actuarial services for-a fee, and ©
then reinsure all of the risks with an insurance subsidiary
to be formed by the Holding Company, with the “oe Ms
_ 2. Contrary to the Commissioner’s assertions (Br. 6, 12-13, 28),
in. performing the incidental activities required to make credit -
insurance available to borrowers, the Banks’ loan officers ‘were
agents of the customers and acting for the Banks’ benefit; they
. were not agents of the insurance company. (R. 69.) Boseman v.:
- Connecticut: General id ——— Co., 301 U.S. 196, 204-205.
that the reinsurance subsidiary would ultimately grow into ;
- @ full-line, direct-writing insurance company. American
National evolved this plan anticipating that sophisticated
- Tending institutions would recognize that credit insurance
was profitable and, sooner or later, would form their own
- insurance companies to underwrite the business. At least,
‘under the proposed plan, ‘American National would recoup |
something, through the service fee, for its experience and
facilities for handling credit insurance. (R.167-168.)
The Holding Company adopted American National’s plan
and, with the approval of the Texas Board of Insurance
. Commissioners, formed a new subsidiary, First Security
Life Insurance Company of Texas, with an initial capital
and paid-in surplus of .$37,500 (later increased to
$100,000). In April, 1954, the, Banks began placing their
credit insurance with - American National, which in turn
Treinsured all of the risks with—and remitted all of the pre- -
miums to—Security Life, under reinsurance treatiés which
allowed American National to keep 15% of net premiums
for keeping First Security’s books and records and comput-
_ ing its actuarial reserves. (R.168-169, 185.)
Although ‘Security Life’s credit insurance business was
successful, there was no way to predict this at the outset; _
for, as the following table shows, Security Life insured -a :
3. There were.a variety of business reasons for forming Secur-
ity Life. Moreover; there was also a possible tax advantage in
taking the credit insurance profit in the form of insurance premium _
income (assuming a favorable - loss. experience), since only the
investment income of a life insurance company was taxed. This
potential advantage. was largely: eliminated .in the Life Insurance
Company Tax Act of 1959. (R. 133,141, 168.) ~
- 4 Security Life was not rare or unusual. It is common practice
_in the insurance industry to begin an insurance company by rein-
suring risks, to avoid sees initial capital poqeireents. ae 83, -
169.)
. sf 5
_ large amount of risk j in relationship to its capital structure
(R.170-171) =
re) Extraclaims —
* which would
Number Amount of have
of policies riskat - eliminated
Year reinsured year-end. surplus*
ae 12,500 $ 6,483,000 . 3
1955 2... 2.00. 27,594: 13,360,000 9
reer 34,388 21,105,000 28
er 29,591 25,570,000 28
ee eee 32,155 36,761,000 . 50
TOO <i ve evesse . 36,416 Pa xcs ‘37
ie
under. Security Life’s ne ag
Security Life was a relatively small company that was
facing the possibility of high mortality claims because the
Banks’ customers could ‘obtain credit“ insurance without
medical examination or a waiting period and customers
- were concentrated in a limited geographical area which
- could be affected by a common disaster or disease. (R.172.)
‘The officers of the Holding Company. and the Banks
believed, on advice of counsel, that it would be a criminal
- violation of federal banking law for the Banks to receive -
any income from their customers’ purchase of credit insur-
ance. Consequently, the. Banks never received—or at--
tempted to receive—commissions.or any other compensation
from the credit insurance program. (R. 172.) The Commis-
‘sioner now accepts (Br. 29). the fact that the Banks’ under-
standing of federal banking law. prompted them to “strue-
ture their affairs so as to: remain aloof from the receipt of
insurance-related 1 income.”
°
. : e
° .-
. : °
- a
: 5 ‘ - :
. = :
In his statutory notices of deficiency, the Commissioner |
- determined that all of the insurance premiums received by
Security Life from 1955 through 1959 should have been
reported by the- Banks or, alternatively, by the Management
Company, without citing any statutory authority. Two days
. before trial in the Tax Court, the Commissioner gave notice
__ that he would rely on § 61 and § 482 of the Internal Revenue
: Code of (1954, During trial, the Commissioner abandoned
his attempt to reallocate premium income attributable to
“mortgage, borrow-by-check' and twin-dollar forms of credit ~
- insurance, leaving for the proposed reallocation. only” -
Security Life’s. installment loan credit life and disability
insurance premiums. The Commissioner also urged, during
trial, that only 40%—rather than all—of those premiums
- be taxed, alternatively, to the — or the Management _
Company. (R.172-173.) |
Feeling that the result was dictated by the Tax: Court’s
decision in Local Finance Corporation v. Commissioner, 48 —
'T.C. 773, affirmed, 407 F.2d 629 (7th Cir.), certiorari denied,
396 U.S. 956, from which he had dissented, Judge Fay of
the Tax Court approved the Commissioner’s allocation of
40% of Security Life’s ‘net credit insurance premiums on
" installment loans for 1955 through 1959 (about $800,000).
‘as income to the Banks and entered decisions determining
_ income tax deficiencies, attributable to the additional in-— :
come, aggregating about $400,000. (R.173-179.)
Rejecting the Commissioner’s theory that the Banks
should be taxed on First Security’s premium income be-
cause they generated the insurance business and finding
that the Commissioner’s allocation under § 482 of the
Internal Revenue Code was arbitrary, capricious, and in-
consonant with basic concepts of federal income taxation
because the Banks|neither earned nor -received nor could
‘ -have lawfully received any income from the credit insurance
program, the Tenth Circuit reversed the Tax Court’s deter-
>
ae
mination of seeiencion against the Banks and cintiiled
_ the case involving the Commissioner’s alternative allocation
to the Management Company to the Tax Court for further
factual consideration. The Tenth Circuit expressly noted—
and disagreed with—the Seventh Circuit’s decision in the |
Local Finance case. (BR. ia-198. )
SUMMARY OF ‘snouuciee
|
L _ : %.
The underlying premise of Section 482—-which permits
the Commissioner to reallocate incorne between controlled
- entities—is the unfettered power of the controlling parties
arbitrarily to understate the income of one entity in favor
of another. Here, no power existed to understate the Banks’ -
-income by excluding insurance commissions, since federal
. banking law made it impossible for the Banks'to receive -
_insuranice-related income under any circumstances. -
Thus, the: Commissioner has misconstrued and niisap-
plied his own § 482 regulations by: reclassifying reinsurance,
premium income as commission income and attributing it
to National Banks which did not—and could not lawfully—
receive it, regardless of the common control of the Banks
and the Insurance Company by the Holding Company. In
order to achieve that result, the Commissioner urges dis-
regard of all applicable precedents and a novel interpre- |
. tation of 4 482 which would expand—and distort—the ac-
cepted definition of gross income in the tax laws. |
Through the years there have been many cases involving
an attempt by the Commissioner, on one theory or another,
to restructure transactions involving insurance-related in- ~
come derived incidentally to banking, finance company, and -
automobile sales transactions. Such cases frequently in-
volved state laws which inhibited any form of | compensa-
6
ei
tion, by commission or otherwise, to the business involved .
in the principal transaction.
With the exception of Boost Finance, which generated
four opinions in the Tax Court and which the court below
considered and rejected, the courts have uniformly refused '
to accord the Commissioner the power to rearrange the |
transactions to exact the maximum tax by attributing 1 1n-
‘come to one who could not lawfully teceive it.
’ Til. | : ; . | . -
_ Under the guise. of reallocating gross income the Com--”
missioner is really passing hindsight judgment on the rate
structure of the credit insurance industry. and the. profit
of ‘Security Life, insisting that a life insurance company
_ must always pay.a certain amount of commissions and that
the minimum effort required for the Banks to offer their
-loan customers a mutually beneficial service earned those
commissions. This argument completely disregards the
Record, which shows that the premium charged by the un-
related insurance company was the ‘ ‘going rate,” there is
- no fixed commission, element in insurance premiums, and
Security Life took a great risk for the premiums it received,
for which it was entitled to be compensated.
Notwithstanding the broad scope of Section 482, there is
no power on the part of the Commissioner to create income
in the hands of a taxpayer who did not—and could not—
“receive it because of legal prohibitions. A rule attributing
illegal income and taxing such attributed illegal income
would create an ‘unthinkable dilemma between federal tax-
ing and banking laws and produce the unconscionable result
of exacting a tax where there could be no income and, hence,
where no part of the money being taxed is available to dis-
charge std tax nN :
“ e@
ARGUMENT _
I. SECTION 482 CANNOT BE USED TO TAX THE -
BANKS ON INCOME WHICH THEY DID NOT—
AND COULD NOT LAWFULLY—RECEIVE.
A. The Commissioner Misconstrues His Own Reguls-
tions: § 482 Applies Only Where the Exercise of
_ Common Control Has Resulted in Understating the
‘True Taxable Income of One Entity in Favor of
. Section 482 authorizes the Commissioner to allocate in-.)
come ‘and deductions among commonly controlled business
entities if he determines that such allocation is necessary in
_ order to prevent “evasion of taxes or clearly to, reflect the
income” of any such entities. This: provision, which first
appeared in its present form in the Revenue Act of 1928, °
- was designed— = =—>— ;
“8 8 ® to prevent evasion (by the shifting of profits, the
making of ficticious sales, and other methods frequently
adopted for the purpose of ‘milking’), and in ordér
clearly to reflect their true tax liability.” H.-Rep..No. -
2, 70th Cong., p. 16 (1939-1 Pt. 2 Cum. Bull. 395). =
The ‘Commissioner mistakenly assumes (Br. 15-16) that
‘there is no dispute between’ the parties over his statement —
that ‘the test under 4482 is whether. the “arrangemgnts”
_ would not have been the 55 or whether the related pgrties
“have not acted as they would have in identical, but uncon-
trolled, arm’s length déalings.” This statement is far.
broader than the statute—or the Commissioner’s own regu-
lations implementing the statute—warrants.® - According to
the regulations (set forth in Pet. Br. App. 37-38), the scope
and purpose of (482is— | .
5. For a comprehensive current discussion of judicial develop-
ments with respect to §'482 see, Aland, “Section 482—1971 Version”
49 TAXES 815 (Dec. 1971). mA .
. _ e #, Koes ;
2 nl oS -
\
10
useeto place a controlled taxpayer on a tax parity with :
- an uncontrolled: taxpayer, by determining, according .
to the standard of an uncontrolled taxpayer, the true
- taxable income from the property and business of a
: controlled taxpayer.” Regs. §1.482-1 (b) (1). \ ‘eo
‘The premise underlying the statute is that—_ - . ° 7
“Thg interests controlling a group of cimteciio® an ,
payers are assumed to have complete power to cause
each controlled taxpayer so to conduct its affairs that.
: its-transactions and accounting records truly reflect the ©
_ taxable income from the property and business of each.
' of the controlléd taxpayers.” ”- Regs. $ 1 .482- vey (1).
canes supplied. )
‘The key to 6482, therefore, is. the existence. of power to
cause “the arbitrary shifting of: profits among related
business entities.” See 8. Rep. No. 275, 67th Cong., Ist Sess.
(1921), 1939-1 Cum. Bul]. (Pt. 2) 181, 195 discussing § 240 of
the Revenue Act of 1921—the- -predecessor of § 482. It. is..
only where the power exists—and has been exercised in such -
a way that “a taxable ineome of a controlled entity has been,
“onderstated”—that the. Commissioner is authorized to
reallocate. Regs. §1. 482-1(b) (1). Stated differently, the
Commissioner may not allocate income in ways that the
controlling interests did not themselves have the power to
accomplish. ae :
. The test for determining shee an allocation i is auth- -
~ -orized under Sedtion 482 because the power exists and has
been exercised to shift: (and therefore, understate) income. a
is whethe ae
‘22 © the taxable i income, in-whole or'in part, of a con-
- trolled taxpayer, is other than it. would have been had
» the ee 5 in = conduct of his affairs been. an un-’.
11
‘controlled taxpayer, dealing at arm’s length with an-—
other uncontrolled taxpayer.” Regs. $1.48 ~
The Tenth Circuit explititly adopted that test (R187). a ay
_ the Commissioner doés not directly repudiate the test hiére.
He does, however, ‘attempt to change the focus of the statute™,
‘by urging that the test is ‘whether the “arrangement” would
have been different’ absent the controlled relationship. (Br. .
15, 16.) Section 482, its legislative history, and the Regula- |
tions clearly indicate that the only pertinent inquiry. is
_ whether the Banks’ income was “understated” by reason of |
. the common control of the Banks and Security Life and’
- whether the Banks’ income would have been any different'in’ .
an uncontrolled situation. ‘These are the questions which
“must be answered. tare 7
‘B. The Commissioner Has Misapplied His Own Regula-
tions: The Holding Company’s Control Over the
Banks and Security Life Did Not Result In Under-
Bi stating the Banks’ Income. -
National yanks in towns over 5,000 population are pro-
hibited from receiving insurance commissions. Rev. Stats.
§5202 (12 U.S.C. (1946 ed.) 92; Pet. Br. App. 39).° Penalties
for violating that federal law are fe Forfeiture of the
_bank’s charter and personal liability on the part of the
Directors. Rev. Stats. § 5239 (12 U. S. C. 93; Pet. Br. App.
40).
E J
6. While the Commissioner raises @me question whether
a 5202 remains in force, he acknowledges that the Comptroller of
~ the Currency’ s current regulations’ incorporate that proscription. ©
and that the Courts have invalidated a 1963 — of a prior :
Comptroller to the contrary. (Pet. Br. 28, n. se
x
4
ae Commissioner now inkswindbes that it was the
Banks’ understanding of this statute t “prompted them
2B. a. sp
* 0
a to akenetars ‘their affairs so'as to remain aloof foci the
ss “receipt of insurance-related income”. (Br. 29.)
Due to ede&l banking. law, the fundamental pre-
' requisite of §482 is nt in this case: The Holding Com-
pany did not have “comple ipower” to cause the Banks
« . ‘to take.commissions, and thus lacked the powers arbitra ily
“to shift any such income away: from, the Banks. ~ (
io
a
Tn the leading case dealing with the application of § 48 ~
-yto a situation where the controlled entity was prohibited
7 ..by law. from receiving the income sought to be allocated, -
- the Tax Court squarely held that the Commissioner could .
not allocate i income which could not lawfully be received. .
eon In LE. Shunk Latex Products, Inc. v. Commissioner, 18
'T.C. 940, a classic § 482 situation,’ the same interests con-'
_ trolled a manufacturer and a distributor of rubber pro- -
" phylactics. During. the sharply rising market following
Pearl Harbor, the distributor raised its prices to retailers,
_ but the manufacturer failed to raise its prices to its related
_ distributor. Shortly thereafter, an OPA regulation froze |
_- the manufacturer’s. price as of December 1, 1941, so that
a wae it could not have lawfully chatged more—either to-its own ~
- or an unrelated distributor. The Court held that the. OPA :
~> pegulation had the effect of— 2
i we ee prohibiting petitioners. from receiving the ‘yery
a
income sought to be attributed to them.” We think that’ ,
eae the Commissioner | had: no ‘authority to attribute to peti- i
~ contrast, to Shunk and many other § 482 cases, this case -
; does not involve a | closely held egrporation. ‘situation where director- 7
officer-owners stand to enrich themselves through corporate devices.
’ The Banks are publicly owned through the Holding Company, with ~
' independent businessmen from many ne of industry as
directors. (i 17, 21. -)
; ’
“,
.
: tenets income which ay could nat Ret received. ad
(18 T.C. at 961.) (Himphasia supplied. )°
ten
Moreover, the Commissioner himself has recognized, in
other contexts, that eg prohibitiens against the receipt |
of income will péiselnde e application of § 482...On October
8,. 1971, the Commissioner issued Technical Information ‘-
Release No. 1106, with respect to the current wage-price
\ freeze, stating that taxpayers who accumulate earnings in
_excess of the reasonable needs of. their business will not be
subject to the accumulated earnings penalty tax of § 531 of
the Code, to the extent that the excess accumulation could —
not be distributed as a-dividend without violating the Cost
of Living Council’s Guidelines. And i in § 482-1(d) (6) of the
Regulations, the Commissioner states that no tax will be
| imposed. on a domestic parent as a résult of a § 482 alloca- —
tion if the parent i is unable to receive the allocated i income
8. The’ Commissioner (Br. 33) atteanpte | distinguish Shunk —
on the ground that the taxpayer could not. its price since it \ °
was fixed by law (“de jure”). But the taxpayer certainly cbuld
have raised its price—it would simply have vidlated the law by so
* doing. The same is true here: The Banks could have taken com-
missions if they had been willing to violate the law. The Court’s .
statement in Shunk that the Commissioner may not “attribute ‘to —
petitioners. income which they could not have received” (emphasis .
supplied), does not mean that the taxpayer could not physically
have received the money in violation of the law, since it obviously
could. It means that when taxpayers in good faith structure their
affairs in compliance with ‘a law which vitiates the controlling tax-
_payer’s power to shift income, the Commissioner may not (1) force
_ them into gn uhlawful act by virtueyof an aftificial allocation, or
(2) by Stich an allocation, exact a tax where there can never be |
any income. - a se
ee _“sidiary.°
dne to legal prohiitions of the Scnién
to receive the income sought to be allocated, it is the: legal
prohibition—and ‘tiot the control element—which i is respon-
sible for any conceivable economic understatement of in-
come; hence, there is nothing on which § 482 can operate.
So here, because ‘of the legak prohibition in the federal
banking laws, the Banks’ income would not have been
greater regardless of the control element.
. Both cougts below found that the banks “* * “never:
retaiesd or attempted to--receive commissions or reinsur-
- ance premiums resulting from their customers’. purchase of
eredit. insurance.’”° (R. 172, 188.) Conversely, as pemnted
out by the Court of Appeals—
“«*® © * the Tax Court made no finding that if Security
Life did not exist the Banks would ‘then receive or
attempt to receive any such i income.’ ” (R.188.) (Em- |
‘phasis- supplied. >
—
.. “a 9. In this case, the Commissioner's dhiesiion would result in ©
imposing @ tax‘on the Banks, although they could. never, obtain the
income which gave rise to the tax from Security Life, which, in |
1959, became a subsidiary of an unrelated corporation. That sepa-
ration renders ineffective the correlative adjustment reducing —
Security Life’s income, suggested by the Commissioner. (Br. 8, h. 3.)
10. The Comnjissioner’s comment that lack of ““feceipt” of
money is irrelevant to the application of § 482 (Br. 22), completely
misses-the_point. made by the Terith Circuit that due to prohibi- .
tions of federal banking law, the Banks had-ne-power_to_ receive _
the income. Conversely, since the banks had, never taken insurance-
; related i income illegally, the Commissioner’s citation of cases taxing
income actually, — illegally, received is irrelevant. (Pet. Br.
39-20. )
Biry of the sub-
_ Thus, where the bata, controlling ¢ a iadehea group do
-, * not have the legal powey to cause thé taxpayer in question
&
.
: 15 °
. The Court of a concluded that—” 7a |
Tn an uncontrolled situation with arm’s lelgth tnolibg,
- the Banks, on the basis of the findings made, would not .
have taxable income from she credit insurance traks-
actions.” (R.188. ):\
These findings by the Courts helow are buttressed i the
fact that for six years prior to the formation of Security
Life, the Banks (due to federal law) did not receive any
- income from the purchase of credit ‘life i insurance by their
_ loan customers. (R.188. .)
The fatal underlying weakness of the Commissioner’ 8
brief i is his refusal to accept those facts. His entire. argu- ©
ment i is premised upon the false and unsupported assump-
tion that the Banks. would unlawfully take insurance
commissions in an uncontrolled situation (e. g., Br. 19-20,
. 23-24,.25, 31, 34). Such a premise erroneously assumes that
the directors. of the Banks would break the law.
The Commissioner, lacking” any factual support for his
posited, resorts to a novel legal definition of the word
* @
“income” as {oan in § 482.
C. Tho Banks Realized No Tacome As that Term i
Used in the Tax Laws.
For the first time in this litigation, and, to our : benniadion 7 y
in any court anywhere (including Local Finance), the Com- —
missioner is urging a definition of “income” under § 482
_ larger i in cencept’ and scope than the same word when used
anywhere else in the Internal Revenue Code and Regula-
tions. (Br. 23.) Only through this approach can he sustain
- his argument that, although the Banks did not—and cannot
ever—receive any income, they must have received some
theoretical income which the Commissioner may now allo-
cate and upon which he proposes to meres a sid real
tax to the Banks. .
£ ; , +
y
eo 16
- There is no indication in the legislative history of § 482
that Congress intended to redéfine gross income, as used in. -
that Section. Section 482 only authorizes the Commissioner.
to allocate “gross income”—a term that is defined i in § 61. -
- Moreover, the thrust of § 482 is merely to determine the
~ same taxable income for a-controlled taxpayer as he would
. have had if uncontrolled. Regs. § 1.482-1 (a) (6),.(b) (I), and’ ©
(c). All roads, therefore, lead back to the concépt of income |
fs it has | volved through the interpretation of § 61.21 ~~
It‘is not hard to see why the Commissioner 1 now. wishes
‘to recisfins' income altogether and avoid the §61 guidelines |
and concepts of- -incomegleveloped by this and'other courts ©. |
over the years, which are wholly incompatible with the ree
sult the Commissioner is urging here. | |
As this Court said in Commissioner v. Glenshaw Glass
Ce, sa U. Ss. 426, 431, income has been held to- encompass
ay
_ &*-.*.* accessions to. wealth, dearly realized, and over »
-which the taxpayers have e complete oe ad mesial
sis supplied. :
2 mids qomenipl Ate Soqetustt-vith ta eistunate of “ “volition” or =)
voluntary conduct, and the existence in the. taxpayer of
alternatives, as developed in such cases.as Helvering v.
Horst, 311 US. 112, Corliss v. Bowers, 281 US. 376, and
11. To hold that § 482 is but. a spécitfic application of the in--
come principles of § 61 in a. controlled entity situation would not.
make § 482 sitperfluous, as the Commissioner i
2. is wel] established that. the Commissioner’s dete ion under
is entitled to such. great weight that it cannot be-overturned
pense arbitrary and .capricious—a much greater burden than in —
the ordinary deficiency case, where the Commissioner’s determina-
_ tion ig merely prima facie evidence. See Grenada Industries, Inc.
i "¥. Commissioner, 17 'T.C. 231, affirmed 202 F.2d 873 (5th Cir.),
certiorari denied, 346 U.S. 819. Other reasons are stated-by the
. Second. Cireuit in Rubin v. Commissioner, 429 F.2d 650, 56-654.
t
ries
res
_ Harrison v. Schaffner, 312 U.S. 579. The concept is ex-
4
pressed in Corliss y. Bowers, supra, at E 378, where: Mr. Jus-
tice Holmes remarked for the Court:
' &® ® ® income that is subject to. a man’s ’s unfettered com-
mand and that he is free to.enjoy at his own optionmay .
be taxed to him as his income, whether he sees fit to
enjoy it or not. ” (Emphasis ad apace tag
- No decision of this. Court pre wees from the concept. that .
- before-there is income the taxpayer must have the alterna-
_ tive, at-his option, of either taking the incomefor himself
of diverting it to someone.else. Voluntary conduct based on
the existence of alternatives is the very heart of that con-.
‘cept. Conversely, this Court ‘has never held that a person
. may be taxed on income. which he could not ever have
received. : ar
In this. case, Qo Banks had no NG There. was no
question of volyatary conduct with respect to alternatives
in electing ope ?
This is’ the aAswer to. the Commissioner’s a rgument (Br,
___19)-that-the Banks must be taxed: because ‘their minimal — -
services were the sine qua non of the credit - -insurance
7 business. ak a
Taxation has never ‘been predicated saledy upon whether c
person performs activities constituting the sine qua ‘mon
of income (such as employees, trustees, parents’ investment
decisions for children, etc.): The touchstong has beén’ the -
i in the taxpayer of an “unfettered command” over
the income—the right to enjoy it at his own option. Corltss
‘v. Bowers, supra; Commissioner v. Glenshaw Glass, supra.
‘The result of the Commissioner’s novel theory would be
to substitute the subjective judgment of the ‘tax adminis- m
trator (as to whose effort produced what, and the quantum
and “value” of effort measured cont areas income,
te.
We
eive or not receive the i ingome in question. "~~
"18 -
etc.) for ‘ai recognized: sieiliepie~-abeitien a tax con-
.. cept virtually impossible to administer. It would also create
26 climate of uncertainty for taxpayers and their advisors.
- One of the reasons why the sine qua non of: business,
“ alone, will not subject the generating party to a tax on all.
succeeding profit is that the generating : party often will
, initiate the transaction in question for reasons unrelated to ;
~ such profit. For example, in this case, making credit insur-
ance available to borrowe! contained its own -built-in re-
wards to the Banks quite apart from the. profit which-pre-~ :
occupies the Commissioner. George Eccles, ‘President, of
_ the Banks, testified that credit life, heal alth and accident i in- .
surance on borrowers wi was beneficial to the Banks as ‘secu-
_ _u—rity Tor | their loans. (R.'57.) No truer statement was ever
es ", made. During the years in suit ‘such insurance paid. off - .
_more than $500,000 in bank loans on death claims alone, ..
against a negligible processiig, cost of toMy $2, sty per year 3
= Per Bank. (R. 184.)..
On’ similar facts, the Court of Appeals for the Seventh. :
Cireuit stated :
| This ‘Court should be slow to brerride the business
. Ju =) of petitioners that lending their facilities ‘to
the ciedif' insurance business was beneficial.” Nichbls |
“Loan U8 Tp. Vv. Commissioner, 321 F. 2d. 905, 907.
The fa t that its minimis senojmnts of tine and expense
were infolved in the insurance paperwork i in‘question, plus _ .
the fact that insurance was merely a minor incident to the
Banks’ major business of making loans, is also significant.
‘In making. the point: that insurance was simply an incident
to the main purpose of the. business, the court in Ray
"Waits Motors, Inc.'v. United States, 145 F. Supp. 269, 271,
272 (E.D. S. Car.), refused to. allocate insurance income
- ?
Dei Sarita) Riki” caer tes
s—
_— .
a“
=
19°
‘to a car dealership, saying that the actions-of the salesmen :
in asking customers about insurance. were— > 4 |
. “* © © merely perfunctory dutiés connected with the
_ maim object, which was the sale of the motor vehicle.
3 ere ke a ee ee ee es
“The place of business of the plaintiff corporation was —
_-—Operated primarily for the sale and repair motor.
vehicles and not for the sale of imsurance.” (Emphasis _
=
supplied.) - | - ea
Ps ges +8 eae a ‘ ee.
_ Even in circumstances where very substantial services _
were rendered, the Courts have rejected the Commissioner’s |
sine qua non theory of income. In Teschner v: Commis-
' gf
_ Stoner, 38 T.C..1003 (1962), the Tax Court refused to tax a
__ father who, disqualified by contest rules from [receiving a
yy
prize, submitted a winning entry in his daughter’s name.
66
The wr acai T.C. at 1007, 1009):
+ “Where an individual neither-receives nor has the right”
to receive income, he is not the taxable individaal
uch results, completely at variance with every ac-—
| feepted concept-of Federal income taxation, demonstrate
Y the fallacy of the premise.. | ce rae
+ within the contemplation of the statute, There is no
basis in the statute or in the decided cases for a con-
struction at variance .with this fundamental Tule.”
\
p. 87,552, affirming 295 F. Supp. 1289 (N.D.° Calif.) ; and,
7 Sieroe and Gerber, “Section 482—Still Growing At the
Age of 50”, 46 Taxes 895, 900-902 (Dee. 1968), referring to .
the Commissioner’s theory in this case as “. .. having truly
frightening implications”. aeeidy an
\}
\
"See also Basye v. United States (9th Cir.), decided Septem-.~
ber 16, 1971, unofficially reported at. 71-2 U.S.T.C. 7 9648,
Rg
at
a
20
“11. LOCAL FINANCE CONFLICTS WITH
"ALL APPLICABLE PRECEDENTS
ae Ea
Over the- ‘years, corporations such as banks, finance com-
ne panies, and automobile dealers, precluded by state law from”
* receiving compensation from the sale of insurance to their
_ customers, have devised different methods of handling their
_° affairs so.as to allow related parties. to profit where they
themselves could not.. "Using as his pivotal argument the’
fact that employees of these businesses sold the insurance °
-and handled the necessary paper work, the Commissioner
. has tried” ‘every weapon in his arsenal to restructure these -
transactions. Until the decision in Local Finance Corp. ?. °
Commissioner, 48 T.C. 773, affirmed, 407 F.2d 629 (7th Cir. j,
certiorari denied, 396 U.S. 956, the lower courts have‘re-
. buffed the Commissioner at every: turn, recognizing the
problem posed by state law. pnd the right of taxpayers to
structure their business ¢ airs as a ee regardless
"of tax savings.® -
The most common irseiiaaineal? was for the individpal :
ene owners of, the corporation‘o take out an insurance agency’
license and receive insurance commissions personally. The
courts readily accepted such arrangements where the. pres-
idents and principal shareholders of family automobile busi- -
nesses acted as casualty i insurance agents—even though the
actual work may have been done by the employees of the
_ corporation’ ‘without additional compensation. Ray Watts
Motors, Inc. v. United States, 145 F. Supp. 269 (E.D. s.°
; Car.) ; Moke Epstewm, Inc. v. Commissioner, ‘29 T.C. 1005;
Gaddy Motor Company, Incav. Commissioner, T.C, Memoz
“1958-189 (17 T.C.M. 944); Jaeger Motor Car Co. v. Com-
missioner, T.C. Memo. 1958-223: (17 T.C.M. 1098); affirmed,
- 284 F.2d 127 (7th Cir. ), eertiorari denied, 365 US. 860.
12. Moline Pipeties,. Inc. v. - Cominiésionér, 319. US. 436;
* National Carbide Corp v. Commissioner, 336 U:S. 422.
—-:138. bits Shi Cc 465.
‘Similarly, i in ‘the field of credit life 3 insurance such indi- ss
vidual or partnership on agencies have been upheld
and no attribution of ssion’ income to: the. related
.- financial institutions has been permitted, despite various
arguments that, under Section 61 of the Code, the insurance .
agencies slrould ‘be disregarded as a “sham,” that the in- _
- eenié was really earned by the.corporation whose employees |
* gold and serviced the. insurance, and that Section 482 au- -
thorized a reallocation of income. Campbell County ‘State
Bank, Inc. v. Commissioner, 37 T.C. 430, reversed, on other
grounds, 311 F.2d 374 (8th Cir.) ; Paramount ‘Finance Co. -
-v. United States, 304 F.2d 460 (Ct, Cl.) ; Bank of Kimball-v.
United States, 200 F. Supp. 638 (£D.); Nichols Loan Corp.
-v, Commissioner, T.C.-Metno. iste (21 T.C.M. 805); .-
reversed on other grounds, 32f F.2d 905 (7th. Cir§; First
Security Bank v. Umited States, 213 F. Supp. 862: (Mont. j, pe :
. affirmed, 334 F.2d 120 (9th Cir. Grirst : State Bank v: United
States, (D.C. 8.D;, decided J une 25, 1962; “unofficially Te-
. ported at 62-2 US.T.C. $0613)\0°:
' ‘Another . type of _ transaction, dovelopit dial. 2
, was. to éliminate the insurance agency “middle mah” and
form a separate insurance company to arrange with the.-- ~ -
unrelated i insurance carrier for reinsurance of the mortality .
A risk.. Although this meant giving up guaranteed cétumis- |
sions, there. was a possibility of a greater profit through the iy
assumption of an underwriting risk. In’ Alinco Life In-
surance Company v. United. States, * 373. F.2d 336 (Ct.
“CL),». the Commissioner attacked this arrangement, con-'.
tending that, ‘tunder Sectien .269, the reinsurance com-
pany was not entitled. tobe taxed as a life insurance .
‘company under Section 801 et seg. of the Code because it.
had been formed i primarily to avoid taxes by securing the
benefit of life i insurance’ status. The Court of Claims, how- —
ever, held that it was not tax avoidance to structure busi- .
ness affairs in response to the requirements of ‘state. law
and that there could be no. objection to arranging one’s. .
oe * et 4 ey | ex ey
q@"
AS
See
Nae
“«
“x
‘SN
'. ‘Unable to ‘distaste the facts in Local Finance from ie
affairs to take acs of the treatment afforded ad life
insurers by the Code. - — 3
In Local Finance, which generated four separate opinions |
_ inthe Tax Court, all of these precedents were swept aside.
J udge Fay, eetittnn. stated (48 T.C. at 803) :
— “Tt iss pérticularly noteworthy in this context to con-
» . sider. the. “past history of respondent’s attempts t6
_ attack’ various husiness-conneeted insurance arrange-
ments. . Respondent has pitched his arguments on sec-
tions 61, 269, 482, and a general argument that income ~
was properly taxable to a lending institution rather
than a controlled. reinsurer or the shareholders of the |
lending institution. as partners of an insurance agency.
. All these approaches have been repeereny ae ret by 2
> - this and other Courts.”
Tax Court’s earlier. decisions’ Judge Fay remarked on the
court’s inconsistency (48 T.C. at 802): . . -s
a ** T am left with the curious result that where em-
ployees of lending institutions perform services re-
garding credit life insurance ‘the stockholders of those
institutions may validly take a profit from the insur-
ance business by setting up a partnership to receive it
-but may not validly take, in effect, the same profit by
setting u up % a legitimate i insurance company to reinsure.
the risk.’
S
--Throughout this_entire litigation the’ Cnauniadioger has
refused to face:up to.the fact that.not one of the cases just
cation of the Commissioner’s theory urged upon this Court.
"4
‘cited could have been decided as they were under an appli-.
- The Court of Appeals recbgnized “that fact, pointing out.
that this case is. indistinguishable in — from those
cases. (R.. 190.) a ~
The Tenth Circuit’s 0 opinion in this ‘case is in accord with
the applicable precedents, making Local Finance the sole
aberration ina long line of cases refusing to tax institutions, .
_ whose. business contact with customers provided an inci-
‘dental opportunity to offer insurance, on income which ~_—
did not receive. ~.
i
. |
;
SY
4
a
XO
‘S
Il. THE COMMISSIONER, UNDER THE GUISE OF
‘ALLOCATING INCOME, DOES NOT HAVE THE _
<, POWER TO RESTRUCTURE BONA FIDE |
'.. BUSINESS TRANSACTIONS. —
d A recurring theme. of the Commissioner’s brief is that
40% of the credit i insurance premiums received by Security
Life belonged to the Banks as. commissions and did not con- ~ _
‘stitutestrue income to which Security Life was entitled as
compensation for reinsuging risks. Implicit in this argu-—
ment are several unsuppirted and erronéous propositions: -
that the premium. rate Was excessive, that life insurance
companies must always pay. commissions, that commissions
are a fixed element of the premium rate, that Security Life .
made excessive profits, and that’ taxes were improperly
avoided. The Commissioner then arrogates to himself the
right to determine, on hindsight, how much of Security
Life’ s credit insurance premium income repre ited excess
profit to be.classified and disgorged as commission income
‘to the: Banks, purportedly to compensate them for. offering
insurance to their customers incidental te loan transactiops.
Factually, however, the record shows: that the premium
charged to the Banks’. customers was the prevailing rate
approved by the insurance commissioners" (R.68, 104, 170) ai
14. The Commissioner’s ideeenas ri Br. 20) to the legislative ..
history of the Life Insurance Company Tax Act of 1955 is mis-
placed. The committee reports statéd'the belief that § 482 would
come into play where a finance company had a ¢redit life insuranée -
subsidiary oyly when “the subsidiary charges excessive premium”—
“higher the going rat®™—and the finance company’s interest
rate was correlatively reduced. S. Rep. No. 1571, 84th Cong., 2d
Sess., 1956-1:Cum. Bull. 967,- 971-972) ; Committee on Ways and :
Means: Taxation of Life ‘Insuranee Companies, Report By The.
Sybcommitteeen Taxation of Life Insurance hae cna (1955, 83d.
‘Cong., 2d Sess. (Subcommittee Print) ); p p. 4§: This refers, to what
would be a classic § 482 situation, nam ‘where the insurance
premium was excessive and the interest rate was correlatively
-weduced: Here, the ‘premium was not excessive (it was the “going”
“Hite apa there wen no “anibion of the Banks’ interest income.
@
~~
7
. j
- ; .
.
that there is no fixed amount of arly premium which is set
aside for the payment of commissions “(R. 84-85), that it
was only “fairly “common” . (certainly not universal) for wet. t
lending institutions to ask for compensation for offering
‘insurance to their customers (R.105), and that the cost to
+ the Banks of handling credit insurance, incidental to the
Lt. principal loan transactions, was minimal and was a service |
required by competition and - worthwhile to the Banks —
' (R.166, 169) : see’also Nichols Loan Corp. v. Commissioner,
_ Supra, where because of the minimal cost and commensurate
benefits to the finance companies, the court refused to dis-
allow: : deduction to the finance companies for the cost of
. selling and” servicing credit insurance, even. tptngge com-
missions were paid to a related insurance agency.
‘One of the reasons ‘why, the Commissioner has failen into.
these factual errors is that he fails to separate the function
of insuring risks from the business of selling insurance. The
business structure involving a»guaranteed commission pay-
able to Smith, on which the Commissioner relies so heavily,
was quite different from the underwriting venture of Se- —
curity Life—and Security Liféwas entitled to be compen-
_ sated for its great risk. (R.83.) As the Court of Claims
commented i in Alinco Itfe Insurance Co. Vv. United nets
(373 F.2d at 345) : ae
“e * © what [the finance iia really did in this
_, case was to give up guaranteed commissions in return
. for the possibility of a-greater profit through the
: assumption of an underwriting. risk.”
And as J udge Scabies said, dissenting from the majority
: opeeen. in Local Finance i in the Tax Court (48 T.C. at 799) :
aye the premiums chargeable and charged for this type
insurance were more than adequate to cover the cost
of writing it and the risk involved, I do not believe
either the Commissioner or this Court should attempt _
“to allocate the excess to.the cost of performing the serv-
-. j¢es of writing the insurance | rather than to the risk |
-. involved, Which [the reinsurance company] assumed.”
25
“The Commissioner completely i ignores the magnitude and .
significance of the risk, assumed: by Security Life, which ~
grew from $6,483 at the end of 1954 to $41,350,000 ‘at the
end of 1959: (R.171:) The evidence in this case, offered _
“ptimarily through two expert witnesses who testified with-
- “out challenge by the Commissioner on cross-examination,
is that the size and nature of the risks assumed by Security
Life required it to retain every dollar it received. (R.33, ,
- 85-86, 94, 100, 147-153, 171.) The Commissioner’s submis-.
_ sion to the contrary (Br. 5, 18) is based upon the testimony
_ of Clarence Tookey, and averages derived by hindsight
"from the lump sum result, of six years’ operation. © ,
“On cross-examination, Mr. Tookey, after prodding by the
__ trial judge, admitted that his experience in the credit insur-
ance industry was limited to three companies : two i in which’
he appeared as a witness for the Government, and one client. .
(R:113-115.) He aléo admitted. (1) that he had not consulted -
publications or been in contact with representatives
credit insurance industry (R. 123) ; (2) that he u sgt ie
from outdated reports whick:had: ‘very little useful Saad
- (R.113, 115), although he had current reports i in his posses-
sion. (R.125. See R. 91, 95-97): (8) that lie had no “idea
- what rates he would have considered safe in 1954 (R. 116); |
and (4) that,.he sess not studied the sd pactamnae of ony
Life (R. 109-110): :
By averaging, the Commissioner avoids the rite trend
of losses suffered by the Company. (the Company’ 8 annual .
statements (Ex. B0-40) show losses of 37% i in 1959 (com-
, pared to 20% in 1955), and lumps’accident and health insur-
ance lines with life ’i insurance, thus avoiding the fact that by
1959 losses on accident and health i insurance were in excess
of 50% of premiums (Ex. BO-40) 25° Depriving his hindsight
| 45.: By 1964, ‘Ameriéan via loses. on alt Vines: of credit.
7 inwarance in the state of Utsh.vare 509%.of premiums... _
ee
5. z six year. profi . figure of averaging and aoping, the Com-
missioner’ s allocation theory would result in a. 1.4% profit.
te ecurity Life on credit life insurance in 1959, and a loss
11.6 cents on each credit accident and health premium —
| dolar ¢R.170-171, Ex. BO-40). Stated another way, the Com-
missioner’s theory would allow Security Life a profit of
. $5,075. for reinsuring $6,483,000 of risk covering 12,500
policyholders in 1954 (less than one-tenth of. one percent
profit on risks assumed) ; a profit of $48,300 for carrying
$13,360,000 in insurance risk on :27,594 policyholders in
1955 ; $43,703 profit on $21,105,000 of risk on 34,388 policy-. -_
‘holders in 1966, and so on. (R. 170-171, Ex. BO-40.) . Such -
" profits are not reasonable when, on a prospective rather
than‘ hindsight basis, just a few extra-deaths out of thou-
- sands of shareholders would have entirely eliminated. any
‘profit at all-each year. In fact, the Commissioner’s theory
that Security Life had excessive profits'‘was so untenable
that just prior to trial he decided ta eliminate from his pre-
posed allocation premiums on mortgage, borrow-by-check,
' and twin dollar credit insurance, all of which canes
high losses. (R. 125, Exs. B0-40, BZ-51.)_- -~ —,-- - =~.
- On these facts, the question.must be asked whether there
is any legal basis for the-Commissioner to use specious hind- _
sight analysis to transform $800,000 of Security Life’s pre-
- mium income (subject toi insurance risk and reserve require-.
ments when reéeived) into commission. income and ‘claim
that it merely represents compensation for services which
. cost each Bank less than $2,000 annually to perform.
The Ciemabdinionnn’ s sole reliance is on a novel interpreta-
- tion*of §.482; which, if adopted, would give him: protean
-power to restructure bona fide arrangenients made by an
' affiliated group to comply with regulatory:‘laws, so as to
a)
g
a\n. ae face
‘exact the nee possible tax from the group as a whole.'®
But § 482 will not stretch that far: Its focus is not on the :
arrangements which related taxpayers may make; but on the -
results of those: arrangements, to avoid the arbitrary under- .
statement.of the income of one controlled entity in favor of
another.. Here, since the Banks were prohibited by law from
taking insurance income, there was-no understatement of
_ the Banks’ income to bring § 482 into play.and the Commiis- ©
sioner cites no other law which authorizes him —a7
to restructure the > argangement. saa
16. Certain statements i in the Commissioner’s brief suggest that
he misunderstands the purpose and history of §-482 and would like
~ to tax the Holding Company and its subsidiariegion a consolidated: -
return basis: For example, he refers to the proliferation. of entities .
used to conduct what is basically a “single economic enterprise” (Br.
13); and he scores the reinsurance arrangement under attack as —
resulting “in a smaller total tax liability for Holding Company and
its. subsidiaries.” (Br. 7, 27.) But the Banks and the Insurance
Company performed entirely. different funetions and are not a
_ “single economic enterprise;” and i, in any event, the ioner’s |
"own. regulations emphasize that § 482 is not intended to “produce
a result equivalent to- a computation of. consolidated taxable
income * * *.” Reg. § 1.482-1(b)(3) *° -
17. Although the Commissioner makes a’ passing ‘veference to
the tax. evasion phrase of §482, and tax’ savings accorded life insur-
" ance companies until 1959 (Br. 4, 7, 34); he nowhere undertakes
to argue that his proposed allocation of-income is supported by
that element of the statute. And neither court below made any such
finding. In his discussion of Campbell County State Bank, Inc. v.
Commissioner, supra, the Commissioner concedes (as pointed out
‘by the Tax Court in Campbell, 37.T.C., at. 438-439), that compli- —
ance with the law is a business purpose, not a tax saving ‘purpose
(Br. 33) and in effect admits that tax avoidance motives were not
control factors here (Br. 31, n. 15). More recently, the Court of
Appeals- for the Fourth Circuit found that compliance by a
national bank with the federal banking law involved -in this case
constituted a business, not a tax motive. Mary Archer Morris
Trust, North Carolina National Bank Trustee v. Commissioner, 367
>
e
ies
& .
* E .- ° ‘ ‘ .
5 A { i 5 : ° ; , ee
A : : 5 4 sea
~ : - :
. 33
_ Indeed, his attempt to do so, runs ‘squarely counter to all
of the applicable precedents (except Local Finance) and to |
. the maxim, as well entrenched in tax law as any the Com-
missioner cites, that a taxpayer is free to ‘structure his
_ affairs in any form, to comply with applicable laws, regard-
‘less of whether it results in a tax saving. ‘See the decisions of
‘this Court cited in notes 12 and 13; Stearris Magnetic M fg.
Co. v. Commissioner, 208 F.2d'849, 852 (7th Cir.) ; and Semi.
nole Flavor Co. v. Commissioner, 4 'T.C. 1215, 1235.. The,
Commissioner should not be allowed to use a distorted view
of his powers under § 482 to restructure business transac-
_ tions in accordance with his hindsight view of what the ,
profit and loss of each entity should have been and what tax: :
they should have =, én a » consolidated hasis. |
F.2d 794, 795, 799. Of course, as showp. hy Sha tax returns ob the.
entities involved, for the six years prior to the formation of Secur-
‘ae
- ity Life, commissions paid to Smith were taxed in the highest cor-
_ porate bracket (R. 20). Obviously during that time, the Banks’
motive in remaining entirely aloof from insurance commissions
“was not tax avoidance but, as found by-the courts below and now
admitted by the Commissioner, to ‘ims with federal law (R.
172, 187, Br. 29). 24
“_ @
_ Of AS Ae ee
IV. THE COMMISSIONER’S POSITION TRAPS THE
“Se BETWEEN CONFLICTING. FEDERAL LAWS
CREATES AN UNREASONABLE DILEMMA.
” the Commissioner ‘wants this Court to allow him to allo- ~~
cate, on paper, a theoretical $800,000 from Security Life to: .
the Banks, notwithstanding the fact that the Banks cannot
receive that i income due to prohibitions of the federal |
ing laws. The result will be to tax the B D
-years in suit (and probabl ess of a million dollars -
. for the years 1 e present) on nonexistent income—
: Sperber ia attic! oy application of. the tax laws.
‘\ >.» | Moreover, such a result would have a detrimental effect on .
the financial condition of these national banks.
Y- . + hp Commissioner argues that the fault of the unthink-
_ able predicament created by his theory in this case is not .
really his since he,“never forced” the Banks to have credit
insurance available on*their premises and, at any rate,
all the Banks had to do was lower te premium ‘rate so
that it did not include money for commissions. (Br. 31-
>. $2.) That argument. lacks support from the Record, warps -
~ the facts of.this case and commercial reality beyond recog-
‘nition, and asks this Court to make the. Commissioner’ a &
regulatory agency over the banking and insurance indus-.— _
"tries, The Banks do not set the premium rates. They Have +
no mine over them whatsoever. (R. 68-69.) And even if .
_ the Banks could dictate: rates to independent i insurance com-
' panies, such as.American National, the ‘uncontradicted evi-
dence is. that there. is no such thing as a fixed commission
element i in any ‘premium rate. (R. 37.) A rate could be fixed ~
so low. that the insurance company oper@ted at a loss and -
the.company could still choose to pay commissions. Thus,
. the only way “commissions” could be “eliminated” from © -
premium rates would be for the Commissidner to determine ©
-@-. and promulgate his notion of what ‘such & an amount would
.» be each year for each company.
>
| ‘onan
~The Commissioner’s theory thus traps the Banks in a ©
-- conflict between federal laws, leaving the Banks with the
unreasonable alternatives of (1) paying taxes on income
which they never have and never-can receive; (2) breaking
_ the law and attempting to receive such income from 1972
on, : resulting i in the loss of their bank. franchise and per-
sonal liability. imposed on their directors; (3) diséontinuing
insurance for -their customers entirely, thus stripping the
_ Banks of loan protection and other customer benefits; or-
. (4) foregoing the opportunity of enabling a related entity, .
not forbidden by law,’ from realizing an economic benefit
~ which the Banks. could not take.
- The unconscionable result of the Commissioner’s tax on
nonexistent. income in this case—the impossible dilemma
in which it places the Banks—falls within the language of _
this Gourt i in Farmer's Loan & Trust Co. v. Minnesota, 280
UH B04 12: «
“Taxation is an pied sreuical matter ae laws. in
respect of ‘it should be construed’ and applied with a
_ view of avoiding, : 80 far as possible, unjust and oppres-
sive consequerices.”
@
The decision of the Court of Appeals should be afirmed.
“CONCLUSION
Our tax laws: do not countenance a theory—such as that
now urged. upon’ this Court by the Commissioner—which-
would result in exacting’ a tax where there never. could be -
any inceme to the taxpayer.
os
Respectfully submitted,
| BI. QuinwEy :
Atonzo W. Warsoy, Ji
SrepHen H. Anperson. —
_ Ray, Quinney & Nepexer
400 Deseret Building
Salt Lake City, Utak 84111
3 ’ Counsel for Respondents
4
\ ‘CERTIFICATE OF. SERVICE | e
ie STEPHEN H. ANDERSON, héreby certify that three
copies of the foregoing Brief for-the ‘Respondents, First .
Security Bank of Utah, N.A., et al, were air mailed by me. °
‘by depositing the same in a United States Post Office, post-
age prepaid, pursuant to paragraphs 2 and 3, Rule 33 of
thé. Rules of the Supreme Court of the United States, to -
ERWIN N. GRISWOLD, Solicitor General, Department of
Justice, Washington,,D.C. 20530, this 29th day of December, -
1971, and that all Sasa required to be served have been
—. : |
Seren H. Axpzrson’
«+ + | Counsel for Respondents
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This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.