463 F.2d 1027 (5th Cir. 1972), 71-2776, Liberty Nat. Life Ins. Co. v. United States

Docket Nº:71-2776.
Citation:463 F.2d 1027
Party Name:LIBERTY NATIONAL LIFE INSURANCE COMPANY, Plaintiff-Appellee-Cross Appellant, v. UNITED STATES of America, Defendant-Appellant-Cross Appellee (two cases).
Case Date:July 12, 1972
Court:United States Courts of Appeals, Court of Appeals for the Fifth Circuit

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463 F.2d 1027 (5th Cir. 1972)



UNITED STATES of America, Defendant-Appellant-Cross Appellee (two cases).

No. 71-2776.

United States Court of Appeals, Fifth Circuit.

July 12, 1972

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Scott P. Crampton, Meyer Rothwacks, Asst. Attys. Gen., Hubert M. Doster, Thomas L. Staplton, Attys., Tax Div., Dept. of Justice, Washington, D. C., Wayman G. Sherrer, U. S. Atty., Charles D. Stewart, Asst. U. S. Atty., Birmingham, Ala., for defendant-appellant.

Ira L. Burleson, Theron A. Guthrie, Jr., John W. Gillon, Ralph B. Tate, Frank P. Samford, Jr., Birmingham, Ala., for plaintiff-appellee.

Before RIVES, COLEMAN and DYER, Circuit Judges.

RIVES, Circuit Judge:

We are here asked to tread through the difficult maze of the federal income tax laws which govern life insurance companies. The Government assessed taxpayer, Liberty National Life Insurance Company ("Liberty"), with a deficiency of $80,389.99 for the tax years in question, 1964 and 1965. Liberty filed this suit in federal district court seeking a refund. The issue distills into whether certain escrow mortgage funds are "assets" within the meaning of section 805(b)(4) of the Internal Revenue Code of 1954. Some of the funds in question were commingled by Liberty in its general bank accounts, and some were held for Liberty by correspondent mortgage companies. The district court held that those funds held directly by Liberty are "assets" but that those in the control of the correspondent companies are not. We reverse in part and affirm in part, holding that none of the funds at issue are "assets" of Liberty for purposes of section 805(b)(4).

I. The Tax Scheme.

This case concerns what is commonly referred to as the Phase I tax levied on life insurance companies. Phase I involves computation of a life insurance company's taxable "investment yield." 1 By the nature of its business a life insurance company is required to maintain a certain level of "reserves." Its reserves are comprised of liquid assets which can readily be converted into cash in order that the company can make good on its insurance contracts. For tax purposes, any investment yield attributable to reserves is not taxed to the company. In effect Congress has recognized that a company's reserves represent its policyholders' share of the company's assets and that the company should not be taxed on income earned by the policyholders' aliquot share of the assets.

In order to determine the company's taxable investment yield it is first necessary to reduce "gross investment income," as defined in section 804(b), by "investment expenses," as defined in section 804(c). Next, the resultant figure, "total investment yield," is pro rated between those assets of the company constituting its reserves and the balance of its assets. That is, taxable investment yield equals total investment yield reduced by that portion of the total yield attributable to reserves. For example, if a company's assets are $1000 of which $250 are reserves and its total investment yield is $100, then the company's taxable investment yield would be computed as follows:

$100 - (100/1000) ($250) = $75

For sake of clarity we have omitted from the above calculation the fact that the "earnings rate" (i. e., total investment yield/total assets) is applied not against actual reserves, but against actual reserves reduced by 10% for each 1% by which the actual earnings rate exceeds the earnings rate assumed by the company

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in computing its reserves. Nonetheless, the above example clearly illustrates that a life insurance company's Phase I tax ( i. e., its taxable investment yield) increases as its assets increase.

II. The Factual Setting.

Liberty is and was during the tax years in question in the mortgage business, as a conventional mortgagee 2 and as mortgagee on Federal Housing Authority and Veterans Administration loans. Principally it is involved in two types of mortgaging arrangements, direct loans and serviced loans.

A. Direct Loans.

Liberty enters into mortgage contracts directly with the mortgagor. Pursuant to such loans, the mortgagor makes installment loan payments to Liberty, usually at monthly intervals. Part of each payment serves to reduce principal, part is...

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