31 318 Commissioner of Internal Revenue v. First Security Bank of Utah 8212 305, No. 70
| Court | United States Supreme Court |
| Writing for the Court | POWELL |
| Citation | 31 L.Ed.2d 318,405 U.S. 394,92 S.Ct. 1085 |
| Parties | . 31 L.Ed.2d 318 COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. FIRST SECURITY BANK OF UTAH, N.A., et al. —305 |
| Docket Number | No. 70 |
| Decision Date | 21 March 1972 |
v.
FIRST SECURITY BANK OF UTAH, N.A., et al.
Syllabus
Respondent banks were subsidiaries of a holding company that also controlled a management company, an insurance agency, and, from 1954, an insurance company (Security Life). In 1948 the banks began to offer to arrange credit life insurance for their borrowers, placing the insurance with an independent insurance carrier. National banking laws were deemed to prohibit the banks from receiving sales commissions, which were paid by the carrier to the insurance agency subsidiary. The commissions were reported as taxable income for the 1948—1954 period by the management company. After 1954, when Security Life was organized, the credit life insurance on the banks' customers was placed with an independent carrier, which reinsured the risks with Security Life, the latter retaining 85% of the premiums. No sales commissions were paid. Security Life reported all the reinsurance premiums on its income tax returns for the period 1955 to 1959, at the preferential tax rate for insurance companies. Petitioner, pursuant to 26 U.S.C. § 482, granting him power to allocate gross income among controlled corporations in order to reflect the actual incomes of the corporations, determined that 40% of Security Life's premium income was allocable to the banks as commission income earned for originating and processing the credit life insurance. The Tax Court affirmed petitioner's action, but the Court of Appeals reversed. Held: Since the banks did not receive and were prohibited by law from receiving sales commissions, no part of the reinsurance premium income could be attributed to them, and petitioner's exercise of the § 482 authority was not warranted. Pp. 403—407.
436 F.2d 1192, affirmed.
Page 395
Ernest J. Brown, Cambridge, Mass., for petitioner.
Stephen H. Anderson, Washington, D.C., for respondents.
Mr. Justice POWELL delivered the opinion of the Court.
This case presents for review a determination by the Commissioner of Internal Revenue (Commissioner), pursuant to § 482 of the Internal Revenue Act,1 that the income of taxpayers within a controlled group should be reallocated to reflect the true taxable income of each. Deficiencies were assessed against respondents. The Tax Court affirmed the Commissioner's action, and respondents appealed to the Court of Appeals for the Tenth Circuit. That court reversed the decision of the Tax Court, 436 F.2d 1192 (1971), and we granted the Commissioner's petition for certiorari to resolve a conflict between the decision below and that in Local Finance Corp. v. Commissioner of Internal Revenue, 407 F.2d 629 (CA7), cert. denied, Commissioner of Internal Revenue v. Guardian Agency, Inc., 396 U.S. 956, 90 S.Ct. 424, 24 L.Ed.2d 420 (1969). We now affirm the decision of the Court of Appeals.
Page 396
Respondents, First Security Bank of Utah, N.A., and First Security Bank of Idaho, N.A. (the Banks), are national banks that, during the tax years, were wholly owned subsidiaries of First Security Corp. (Holding Company). Other, non-bank, subsidiaries of the Holding Company, relevant to this case, were First Security Co. (Management Company), Ed. D. Smith & Sons, an insurance agency (Smith), and—from June 1954—First Security Life Insurance Company of Texas (Security Life). Beginning in 1948, the Banks offered to arrange for borrowers credit life, health, and accident insurance (credit life insurance). The Tax Court found that they did this 'for several reasons,' including (1) offering a service increasingly supplied by competing financial institutions, (2) obtaining the benefit of the additional collateral that credit insurance provides by repaying loans upon the death, injury, or illness of the borrower, and (3) providing an 'additional source of income—part of the premiums from the insurance—to Holding Company or its subsidiaries.'
Until 1954, any borrower who elected to purchase this insurance was referred by the Banks to two independent insurance companies. The premium rate charged was $1 per $100 of coverage per year, the rate commonly charged in the industry. The Insurance Commissioners of the States involved—Utah, Idaho, and Texas accepted this rate. The Banks followed a routine procedure in making this insurance available to customers. The lending officer would explain the function and availability of credit insurance. If the customer desired the coverage, the necessary form was completed, a certificate of insurance was delivered, and the premium was collected or added to the customer's loan. The Banks then forwarded the completed forms and premiums to Management Company, which maintained records of the
Page 397
insurance purchased and forwarded the premiums to the insurance carrier. Management Company also processed claims filed under the policies. The cost to each of the Banks for the actual time devoted to explaining and processing the insurance was less than $2,000 per year, characterized by the courts below as 'negligible.' The cost to Management Company of the services rendered by it was also negligible, slightly in excess of $2,000 per year.
It was the custom in the insurance business (although not nvariably followed), regardless of the cost of incidental paperwork, to pay a 'sales commission'—ranging from 40% to 55% of net premiums collected—to a party who originated or generated the business. But the Banks had been advised by counsel that they could not lawfully conduct the business of an insurance agency or receive income resulting from their customers' purchase of credit life insurance. Neither the Banks nor any of their officers were licensed to sell insurance, and there is no question here of unlawfully acting as unlicensed agents. The Banks received no commissions or other income on or with respect to the credit insurance generated by them. During the period from 1948 to 1954 commissions were paid by the independent companies writing the insurance directly, to Smith, one of the wholly owned subsidiaries of Holding Company. These commissions were reported as taxable income, not by Smith, but by Management Company which had rendered the services above described. During this period (1948—1954), the Commissioner did not attempt to allocate the commissions to the Banks.2
Page 398
In 1954, Holding Company organized Security Life, a new wholly owned subsidiary licensed to engage in the insurance business. A new procedure was then adopted with respect to placing credit life insurance. It was referred by the Banks to, and written by an independent company, American National Insurance Company of Galveston, Texas (American National), at the same rate to the customer. American National then reinsured the policies with Security Life pursuant to a 'treaty of reinsurance.' For assuming the risk under the policies sold to the Banks' customers, Security Life retained 85% of the premiums. American National, which furnished actuarial and accounting services, received the remaining 15%. No sales commissions were paid. Under this new plan,3 the Banks continued to offer credit life insurance to their borrowers in the same manner as before.4
Security Life was not a paper corporation. It commenced business in 1954 with an initial capital of $25,000,
Page 399
which was increased in 1956 to $100,000. Although it did not become a full-line insurance company (contemplated as a possibility when organized), its reinsurance business was substantial. The risks assumed by it had grown to $41,350,000 by the end of 1959, and it had paid substantial claims.5
Security Life reported the entire amount of reinsurance premiums, 85% of the premiums charged, in its income for the years 1955—1959. Because the income of life insurance companies then was subject to a lower effective tax rate than that of ordinary corporations, the total tax liability for Holding Company and its subsidiaries was less than it would have been had Security Life paid a part of the premium to the Banks or Management Company as sales commissions.6 Pursuant to his § 482
Page 400
power to allocate gross income among controlled corporations in order to reflect the actual incomes of the corporations, the Commissioner determined that 40% of Security Life's premium income was allocable to the Banks as compensation for originating and processing the credit life insurance.7 It is the Commissioner's view that the 40% of the premium income so allocated is the equivalent of commissions that the Banks earned and must be included in their 'true taxable income.'8
The parties agree that § 482 is designed to prevent 'artificial shifting, milking, or distorting of the true net incomes of commonly controlled enterprises.'9 Treasury Regulations provide:
'The purpose of section 482 is to 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. . . . The standard to be applied in every case is that of an uncontrolled taxpayer dealing at arm's length with another uncontrolled taxpayer.'10
The question we must answer is whether there was a shifting or distorting of the Banks' true net income
Page 401
resulting from the receipt and retention by Security Life of the premiums above described.11
We note at the outset that the Banks could never have received a share of these premiums. National banks are authorized to act as insurance agents when located in places having a population not exceeding 5,000 inhabitants, 12 U.S.C.A. § 92.12 Although § 92 does not explicitly prohibit banks in places with a population of over 5,000 from acting as insurance agents, courts have held that it does so by implication.13 The Comptroller
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