Western Nat'l Life Ins. Co. of Texas v. Comm'r of Internal Revenue

• Decision Date: 24 February 1969
• Docket Number: Docket No. 1621-64.
• Citation: 51 T.C. 824
• Parties: WESTERN NATIONAL LIFE INSURANCE COMPANY OF TEXAS, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

51 T.C. 824

WESTERN NATIONAL LIFE INSURANCE COMPANY OF TEXAS, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 1621-64.

Tax Court of the United States.

Filed February 24, 1969

J. W. Bullion, for the petitioner.

John W. Holt and Patrick W. Johnson, for the respondent.

Upon reconsideration, held: That net ‘deferred and uncollected premiums' and net ‘due and unpaid premiums' (exclusive of loading) are includable in assets for computing taxpayer's share of investment income under sec. 804, I.R.C. 1954, as amended. Original opinion of this Court filed May 13, 1968, reported in 50 T.C. 285, modified accordingly; affirmed on all other issues.

SUPPLEMENTAL OPINION

DRENNEN, Judge:

Respondent filed a timely motion for reconsideration and revision of the original opinion filed by this Court in this proceeding on May 13, 1968, reported in 50 T.C.AT 285.¹ The motion was that the Court ‘modify said opinion by deciding the gross deferred and uncollected and gross due and unpaid premium asset issues (issues Nos. 2, 3, and 4 in the Opinion) in accord with the contention of the respondent.’ Respondent's motion was set down for oral argument on August 7, 1968, and the Court invited counsel² for the American Life Convention and the Life Insurance Association of America to participate as amici curiae. In addition to the oral argument, extensive briefs were filed by the amici curiae as well as by petitioner and respondent. In the light of the arguments presented, and the decision of the U.S. Court of Appeals for the Seventh Circuit in Franklin Life Insurance Co. v. United States, 399 F.2d 757, certiorari applied for Nov. 27, 1968, promulgated subsequent to the original opinion of this Court, we deemed it appropriate to reconsider the two issues mentioned above and to revise our opinion as a result thereof. Consequently, respondent's motion for reconsideration and revision was granted.

This Court made complete findings of fact and reviewed the provisions of the Code which are pertinent to the issues here under review in its original opinion and will not repeat them here. Reference is made to the former opinion of this Court, supra, for the facts involved in this proceeding.

The only issues before the Court involved adjustments proposed by respondent in the computation of petitioner's so-called phase I tax, or tax on investment income, imposed under the Life Insurance Company Income Tax Act of 1959, sec. 801 et seq., of the 1954 Code as amended. In its original opinion the Court agreed with petitioner and held that ‘deferred and uncollected premiums' and ‘due and unpaid premiums' were not to be included as ‘assets' within the meaning of section 805(b)(4) of the Code,³ in computing petitioner's share (and the policyholders' share) of its investment income under the formula provided for that purpose in section 804. The basic premise upon which the Court based this conclusion was that there should be included in assets for purposes of the computation only such assets as produced the net investment income, and that these bookkeeping assets, not being available to petitioner, should be excluded.

Respondent contends that the entire gross amount of the ‘deferred and uncollected premiums' and the ‘due and unpaid premiums,‘ including ‘loading,’ should be included in assets for purposes of the computation. The amici agree with respondent that ‘deferred and uncollected premiums' should be included in assets to avoid distortion in the computation under the prescribed formula, but that the loading should not be included. The amici took no position with respect to ‘due and unpaid premiums.’

Upon further reflection, we agree with the amici that the net ‘deferred and uncollected premiums' should be included in assets but that the ‘loading’ included in such premiums should not be included; also we conclude that the net ‘due and unpaid premiums' should be included in assets but that the loading included in such premiums should not be included. Accordingly, the original opinion of this Court, supra, is modified to reflect the views herein expressed with respect to those two issues, and the conclusions reached therein with respect to all other issues are hereby affirmed.

The legislative history of the Life Insurance Company Income Tax Act of 1959 indicates that Congress was attempting to tax all of a life insurance company's share of its gross income, both investment income and underwriting income, in a manner as consistent as possible with the accounting procedures required to be used by the company by State regulatory agencies. This involves accepting the assumption, even though it has no basis in fact, that in establishing its reserves for policyholder liabilities in the taxable year the insurance company must assume that the gross annual premiums on all policies in force at the end of the year have been paid in full. Thus the net valuation premiums, i.e., the gross premiums less the loading factor, on all policies in force at the end of the year are added to the company's reserves and are shown on its balance sheet as liabilities. In order to avoid a distorted balance sheet resulting from setting up this admittedly overstated reserve as a liability, the insurance company is permitted to include in its balance sheet as an offsetting asset the items ‘deferred and uncollected premiums' and ‘due and unpaid premiums,‘ which are likewise fictitious assets. As with the liability, the amount to be included on the asset side of the balance sheet on the National Association of Insurance Commissioners (NAIC) forms is the net valuation portion of the premiums, exclusive of loading.

In the scheme of taxing the insurance company's share of its investment income under phase I of the tax, the reserves above mentioned are used to measure the policyholders' share of its investment income. The policyholders' reserves are multiplied by the company's own current or average investment rate to obtain the policyholders' share of the investment yield, which is nontaxable; the balance of the investment yield is the company's share of net investment income which is subject to tax under phase I.

In arriving at the company's current investment rate, certain expenses are deducted from its gross investment income to obtain the investment yield. The investment yield is then divided by the assets of the company to obtain the current rate. The company assets used in this computation are defined in section 805(b)(4) as all the assets of the company other than real and personal property (excluding money) used by it in carrying on an insurance trade or business. Inasmuch as the fictitious assets ‘deferred and uncollected premiums' and ‘due and unpaid premiums' are not assets used by the company in carrying on its insurance business, it would seem that these ‘assets' must be included in the computation used in finding the company's current rate, even though they are not real assets and could not possibly be used to produce investment income.

While it is difficult to understand how amounts which neither have been received nor are due and collectible as of the end of an accounting year can be considered accruable in the usual accounting sense of that term, it is easier to understand that if one starts with the assumption that these amounts have all been paid by the end of the year, they would certainly be accrued if the assumption is accepted as fact. It is also easier to understand that if the objective of the phase I tax is to exclude from the tax on investment income the policyholders' share of that income, and in order to arrive at the amount of that exclusion the measurement used is an amount (the reserves) which includes in it net valuation premiums which are assumed to have been paid in full, it would thereby become necessary, in order to avoid distortion in this scheme of taxation, to likewise assume that all net valuation premiums have been collected and are ‘accrued’ assets in the company's hands for purposes of determining the current rate and the company's share of the investment income or yield that is subject to tax. In other words, it is easier to leave for the moment the practicalities of taxation...