Fed. Union Ins. Co. v. Comm'r of Internal Revenue, Docket No. 3968.

• Citation: 5 T.C. 374
• Decision Date: 30 June 1945
• Docket Number: Docket No. 3968.
• Parties: FEDERAL UNION INSURANCE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: United States Tax Court

5 T.C. 374

FEDERAL UNION INSURANCE COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 3968.

Tax Court of the United States.

Promulgated June 30, 1945.

1. Since the unearned premium reserve of a fire and marine insurer subject to tax as an insurance company under section 204, Internal Revenue Code, is not a part of its accumulated earnings and profits for income tax purposes, it is not includible in equity invested capital as accumulated earnings and profits under section 718(a)(4), Internal Revenue Code, as amended by the Second Revenue Act of 1940.

2. Reinsurance recoverable on unpaid losses and unearned premiums on reinsurance in force are admissible assets for ratio purposes under section 720, Internal Revenue Code. John S. Breckinridge, Esq., for the petitioner.

Laurence F. Casey, Esq., for the respondent.

The Commissioner determined a deficiency in excess profits tax for the year 1940 in the amount of $756.66. The questions presented for our determination are (1) whether petitioner's unearned premium reserve on fire and marine insurance is a part of its equity invested capital within the meaning of section 718 of the Internal Revenue Code and (2) whether petitioner's reinsurance recoverable on unpaid losses and its unearned premiums on reinsurance in force are admissible assets for ratio purposes under section 720 of the Internal Revenue Code.

FINDINGS OF FACT.

The facts are found as stipulated. A brief summary is as follows:

Petitioner is a domestic insurance corporation organized under the laws of the State of Illinois and having its principal place of business in New York. It filed its Federal income tax return and its original and amended excess profits tax returns for the calendar year 1940 with the collector of internal revenue for the second collection district of New York. It was subject to tax as an insurance company under section 204 of the Internal Revenue Code. During the year 1940 it issued policies on fire and marine insurance and allied lines of insurance and reinsured a portion of the liability assumed by it with other insurers. Petitioner's net unearned premiums as of December 31, 1939, amounted to $766,235.77. The additional reserve for unearned premiums on ocean marine risks required by the laws of the State of Ohio amounted to $26,642.71. Respondent excluded these two items from petitioner's equity invested capital in determining petitioner's average invested capital to be $2,373,858.90. Petitioner's unearned premiums on reinsurance in force were $1,254,125.03 on December 31, 1939, and $1,367,936.29 on December 31, 1940. Petitioner's reinsurance recoverable on unpaid losses was $196,161 on December 31, 1939, and $234,335 on December 31, 1940. Respondent excluded these items from admissible assets under section 720(a)(2).

OPINION.

HILL, Judge:

As a fire insurance company, petitioner is required by state laws to keep a reserve equal to the unearned portion of premiums on unexpired risks, less a credit for risks reinsured. This requirement of a reserve arises out of the fact that the insurer collects the whole premium in advance, whereas the protection can only be given as time elapses. Utah Home Fire Insurance Co., 24 B.T.A. 225, 232; affd., 64 Fed.(2d) 763; certiorari denied, 290 U.S. 679. Since the petitioner writes policies for terms exceeding one year, at the end of a given year there are policies as to which petitioner's liability in the event of loss has not expired. The policyholders are protected by the requirement of such a reserve, which has been defined as ‘that portion of the premium which the company has not yet had time to earn.‘ Huebner, Property Insurance, p. 217. The insurance laws of Ohio required petitioner to maintain a similar unearned premium reserve on unexpired ocean and marine risks.

The first issue involves the question as to whether the unearned premium reserve, including the Ohio reserve, should be included in equity invested capital under section 718 of the Internal Revenue Code, as amended by the Second Revenue Act of 1940,¹ for the computation of petitioner's excess profits credit. In general, section 718 defines equity invested capital as including:

1. Money paid in for stock, or as paid-in surplus, or as contribution to capital.

2. Property paid in for stock, or as paid-in surplus, or as a contribution to capital.

3. The accumulated earnings and profits as of the beginning of such taxable year.

It is the petitioner's contention that the reserve for unearned premiums is a part of its ‘accumulated earnings and profits.‘

Regulations 109 (as amended by T.D. 5059, 1941-2 C.B. 125) provides:

SEC. 30.718-1. DETERMINATION OF DAILY EQUITY INVESTED CAPITAL— MONEY AND PROPERTY PAID IN.

The equity invested capital for any day is determined as of the beginning of such day. The basis or starting point is found in the amount of money and property previously paid in for stock, or as paid-in surplus, or as a contribution to capital. The terms ‘money paid in‘ and ‘property paid in‘ do not include amounts received as premiums by an insurance company subject to taxation under section 204.

SEC. 30.718-2. DETERMINATION OF DAILY EQUITY INVESTED CAPITAL— ACCUMULATED EARNINGS AND PROFITS.

(a) IN GENERAL.— The term ‘accumulated earnings and profits‘ is not defined in the Internal Revenue Code. See, however, section 115 and the regulations prescribed thereunder as to the effect of certain transactions on earnings and profits, and section 30.718-4 as to the effect of the declaration and distribution of dividends. In general, the concept of ‘accumulated earnings and profits‘ for the purpose of the excess profits tax is the same as for the purpose of the income tax. See, for instance, section 19.115-3 of Regulations 103, as amended, relating to the computation of earnings and profits in the case of a corporation computing net income on the cash, accrual, or installment basis, or in the case of an insurance company taxable under section 204. * * *

Thus, the regulations declare that, except where it may be otherwise specifically provided, ‘the concept of 'accumulated earnings and profits' for the purpose of the excess profits tax is the same as for the purpose of the income tax‘ and refer to section 19.115-3 of Regulations 103, as amended, with specific reference to insurance companies taxable under section 204. Regulations 103 (as amended by T.D. 5059, 1941-2 C.B. 125, 126), section 19.115-3, in turn provides that ‘ * * * an insurance company subject to taxation under section 204 shall exclude from earnings and profits that portion of any premium which is unearned under the provisions of section 204(b)(5) and which is segregated accordingly in the unearned premium reserve. ‘ It is patent that this latter income tax regulation is well within the intendment of section 204. The scheme of taxation of insurance companies under that section does not include in income the gross receipts from premiums. It is only premiums earned during the year which are included in gross income. ‘Premiums earned‘ are defined as gross premiums written during the taxable year (excluding therefrom return premiums and premiums paid for reinsurance) plus unearned premiums as of the close of the preceding year less unearned premiums as of the close of the taxable year. It is the net decrease in the reserve for unearned premiums that is subject to income tax and becomes accumulated earnings and profits. The receipt of unearned premiums thus is not treated as income. Gross premiums do not go through income to become surplus until they are earned in the sense that the risk for which they were paid has expired. It is only as funds leave the unearned premium reserve that they become taxable income and become a part of accumulated profits and earnings. These reserves for unearned premiums are not drawn from surplus, but represent and arise solely out of the receipt of gross premiums. Utah Home Fire Insurance Co., supra; Central National Fire Insurance Co., 22 B.T.A. 1054. Thus, although the term ‘accumulated earnings and profits‘ is not defined in the Internal Revenue Code, it is clear that an item may not become a part of accumulated earnings and profits for income tax purposes except by going through the income account (Central National Fire Insurance Co., supra, p. 1058), and section 19.113-5 of Regulations 103, as amended, was valid in providing that ‘an insurance company subject to taxation under section 204 shall exclude from earnings and profits that portion of any premium which is unearned under the provisions of section 204(b)(5) and which is segregated accordingly in the unearned premium reserve.‘

The question thus narrows to one of the validity of the excess profits tax regulation in declaring that ‘the concept of 'accumulated earnings and profits' for the purpose of the excess profits tax is the same as for the purpose of the income tax.‘

In Butternut Baking Co., 3 T.C. 423, the excess profits tax was correlated with the income tax in the sense that that which was excluded from earnings and profits for purposes of the income tax was likewise excluded from accumulated earnings and profits for excess profits tax purposes. In that case the taxpayer realized gain in 1938 from insurance proceeds above the adjusted basis of its property which had been destroyed by fire, immediately used the entire amount in replacement of the destroyed assets, and in its income tax return for that year reported and was allowed the gain as nonrecognizable. In 1941 it claimed the amount of the realized gain as part of its invested capital as ‘accumulated earnings and profits‘ for excess profits tax purposes. We held that, since under section 501(a) of the Second Revenue Act of 1940 such realized gain was not recognized for income tax purposes, the taxpayer could not utilize it to increase earnings and profits in computation of invested capital under section 718(a)(4), supra.

Congre...