United States v. OCCIDENTAL LIFE INSURANCE CO. OF CAL.

• Decision Date: 26 October 1967
• Docket Number: No. 21039.,21039.
• Citation: 385 F.2d 1
• Parties: UNITED STATES of America, Appellant, v. OCCIDENTAL LIFE INSURANCE COMPANY OF CALIFORNIA, a California corporation, Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

385 F.2d 1 (1967)

UNITED STATES of America, Appellant, v. OCCIDENTAL LIFE INSURANCE COMPANY OF CALIFORNIA, a California corporation, Appellee.

No. 21039.

United States Court of Appeals Ninth Circuit.

October 26, 1967.

Mitchell Rogovin, Asst. Atty. Gen., Lee A. Jackson, Atty., Martin Goldblum, Atty., Tax Div., Dept. of Justice, Washington, D. C., William M. Byrne, Jr., U. S. Atty., Los Angeles, Cal., for appellant.

John G. Gemmill, Forster, Gemmill & Farmer, Los Angeles, Cal., for appellee.

Before JERTBERG, BROWNING, and ELY, Circuit Judges.

ELY, Circuit Judge:

The Government appeals from a District Court judgment which awarded taxpayer a refund of federal income taxes for the taxable years 1954 and 1955.¹ Suit was instituted by the taxpayer pursuant to 28 U.S.C. § 1346(a) (1) after its claims for refund had been rejected. Our jurisdiction rests upon 28 U.S.C. § 1291.

The taxpayer is a stock life insurance company. For taxable years beginning in 1954, such companies were subject to a tax equal to certain percentages of "1954 life insurance company taxable income." Section 805(a) of the Internal Revenue Code of 1954, ch. 736, 68A Stat. 258, provided that "the term `1954 life insurance company taxable income' means the taxable income * * *, plus 8 times the amount of the adjustment for certain reserves provided in section 806, and minus the reserve interest credit * * *." Computation of the "adjustment for certain reserves" was fixed in section 806 of the Code, which provided:

"In the case of a life insurance company writing contracts other than life insurance or annuity contracts (either separately or combined with noncancelable health and accident insurance), the term `adjustment for certain reserves\' means an amount equal to 3¼ percent of the unearned premiums and unpaid losses on such other contracts which are not included in life insurance reserves (as defined in section 803(b). For purposes of this section, such unearned premiums shall not be considered to be less than 25 percent of the net premiums written during the taxable year on such other contracts."

Int.Rev.Code of 1954, § 806, ch. 736, 68A Stat. 259 (formerly Int.Rev.Code of 1939, § 202(c), as amended, ch. 619, § 163(a), 56 Stat. 870 (1942)).

In computing its "adjustment for certain reserves" so as to determine its taxable income for the year 1954, the taxpayer included as "unpaid losses" the December 31, 1953, to December 31, 1954, mean of its "reserve for amounts not yet due on claims and for future contingent benefits," an account representing unaccrued liabilities on its cancelable health and accident policies.² Omitted from this computation, however, was the amount of $4,707,914.46, which represented the mean, for the same period, of taxpayer's accrued but unpaid liabilities on such non-life policies.³ The Commissioner ruled that the last mentioned amount should have been included within "unpaid losses" in determining taxpayer's "adjustment for certain reserves" and assessed a deficiency of $79,563.76. The District Court held that the taxpayer's accrued but unpaid liabilities arising from its cancelable health and accident policies were not properly treated as "unpaid losses" and awarded a refund of the assessment, plus interest.

Appellee also sought refunds on the basis of section 841 of the Internal Revenue Code of 1954, which provides, "The taxes imposed by foreign countries * * * shall be allowed as a credit against the tax of a domestic insurance company * * * to the extent provided in the case of a domestic corporation in section 901 * * *." Section 901(b) (1) of the 1954 Code allows as a credit "the amount of any income, war profits, and excess profits taxes paid * * * to any foreign country * * *." Furthermore, section 903 extends this credit to "a tax paid in lieu of a tax on income, war profits, or excess profits otherwise generally imposed by any foreign country * * *."

This second refund claim involves both 1954 and 1955, during which years the taxpayer paid certain taxes to the Dominion of Canada and to the Province of Quebec. The Dominion tax, levied pursuant to the Dominion Excise Tax Act, Can.Rev.Stat. c. 100, § 4(1) (1952), was equal to two percent of net premiums received from policy holders resident in Canada, less a credit equal to the Quebec tax. The latter was prescribed by the Quebec Corporation Tax Act, Statutes of Quebec, 11 Geo. 6, c. 33, § 3(3) (1947), and equalled two percent of net premiums received from life insurance business in Quebec. The District Court awarded refunds of $58,599.94 and $77,434.01, plus interest, for the respective years 1954 and 1955, on the ground that appellee was entitled to credit under section 841 for its payment of these Canadian taxes.

The two questions which confront us, therefore, are as follows:

1. In computing its "adjustment for certain reserves," was the taxpayer required to include as "unpaid losses" the amount of its accrued but unpaid non-life policy liabilities, as well as the amount of its unaccrued claims?

2. Were the Canadian premiums taxes imposed upon and paid by the taxpayer either income taxes or taxes paid in lieu thereof, so as to be allowable as foreign tax credits?

UNPAID LOSSES

The scope of the term "unpaid losses" has been previously considered in Prudential Ins. Co. of America v. United States, 319 F.2d 161, 165-166, 162 Ct.Cl. 55, 65 (1963). There, the Court of Claims specifically held that the term "unpaid losses" as used in section 806 includes accrued but unpaid liabilities, in addition to similar unaccrued claims. The taxpayer contends, as the District Court indicated, that this decision lacks persuasive force because the court there did not specifically deal with many contentions which the present taxpayer has advanced. Even so, we are convinced that the Court of Claims reached the correct conclusion.

In order to understand the significance of "unpaid losses" as used in section 806, it is necessary to review the development of the method of taxation of life insurance companies which existed in 1954.⁴ After 1921, life insurance companies were not required to include the amount of premiums received in the computation of their gross incomes. Under section 803 (a) (2) of the 1954 Code, ch. 736, 68A Stat. 256, as well as under the provisions of the prior law,⁵ life insurance company gross income was confined to "interest, dividends, and rents." This treatment represented recognition of the unique nature of a life insurance company's underwriting business.

Many forms of insurance involve short-term, cancelable contracts, wherein the premium rate may be periodically adjusted to reflect the current risk. In contrast, premiums received on level-premium life insurance policies represent both the cost of protection for the year of receipt and also the cost of establishing or enhancing a reserve fund, which must be accumulated at interest to provide protection for future years, since the event insured against is certain to occur and since the probability of occurrence increases with each successive year. The bulk of a life insurance company's receipts, consisting primarily of premiums and the return on investment of reserves, will eventually be returned to policy holders or their beneficiaries when the reserve fund is tapped for payment of claims. See generally 8 Martens, Law of Federal Income Taxation §§ 44.16-.17, at 35-39 (rev. ed. 1964). Only a small percentage of those receipts represents true income, since the company generally derives profit only insofar as the returns on the investment of its reserve funds exceed the rate of interest at which the company is required to supplement its reserves. Thus, in addition to excluding premium payments from income, part of the investment income of a life insurance company should also be excluded from income taxation. That income is added to reserves and will also eventually be returned to the policy holders.

The original provisions of the 1939 Code defined a "life insurance company" as an insurance company engaged in the business of issuing life insurance and annuity contracts whose reserve funds for fulfilling such contracts comprise more than 50 percent of its total reserve funds. Int.Rev.Code of 1939, § 201(a), ch. 2, 53 Stat. 71. However, once an insurance company qualified under this definition, all of its insurance contracts were treated identically, regardless of the fact that the company may have also sold cancelable, non-life insurance policies. In order to allow for the required additions to the reserves from its investment income, a company meeting the definition was allowed deduction of a certain percentage of the "mean of the reserve funds required by law." Int.Rev.Code of 1939, § 203(a) (2), 53 Stat. 72. Many questions arose concerning the scope of "reserve funds required by law," and a number of decisions developed the issue. The result was a definition generally accepted as identifying technical reserves. See Helvering v. Oregon Mut. Life Ins. Co., 311 U.S. 267, 61 S.Ct. 207, 85 L.Ed. 180 (1940); Commissioner of Internal Revenue v. Monarch Life Ins. Co., 114 F.2d 314 (1st Cir. 1940). Under this definition it is clear that the scope of technical reserves was not such as to include amounts reserved to cover accrued but unpaid claims. At the same time, the decisions made it clear that technical reserves generally did include unaccrued claims.⁶

The District Court held that the scope of section 806 is limited to the concept of technical reserves. 250 F.Supp. at 136. As appellee puts it, "section 806 in title and in text refers to the unearned premiums and unpaid losses as `reserves.' Reserves in the insurance sense mean technical reserves, and technical reserves cannot include accrued liabilities."⁷ We cannot accept this view.⁸ The concept of technical reserves was developed under the original provisions of the 1939 Code, as well as under the prior law, in connection with the scope...