ATLAS LIFE INSURANCE COMPANY v. United States, 7424.
| Decision Date | 25 May 1964 |
| Docket Number | No. 7424.,7424. |
| Parties | ATLAS LIFE INSURANCE COMPANY, Appellant, v. UNITED STATES of America, Appellee. |
| Court | U.S. Court of Appeals — Tenth Circuit |
Norris Darrell, New York City (Dickson M. Saunders, Byron V. Boone, Tulsa, Okl., Thomas C. Thompson, Jr., Washington, D. C., M. Bernard Aidinoff and Kendyl K. Monroe, New York City, on brief), for appellant.
Daniel B. Goldberg, New York City, amici curiæ: John Anderson, Jr., Governor of the State of Kansas and Chairman of the Governors' Conference; John J. O'Connell, Atty. Gen. of the State of Washington and President of the National Association of Attorneys General; John F. Collins, Mayor of Boston and President of the American Municipal Association; John J. Gunther, General Counsel of the United States Conference of Mayors; C. Beverly Briley, Nashville, Tenn., County Mayor of the Metropolitan District Government of Nashville-Davidson County, Tennessee, and C. D. Ward, Washington, D. C., for the National Association of Counties; Fred W. Aley, City Atty., Wichita, Kan., President, and Charles S. Rhyne, General Counsel, of the National Institute of Municipal Law Officers; Louis L. Goldstein, Comptroller of the State of Maryland, for the National Association of State Auditors, Comptrollers and Treasurers; Mitchell Wendell, Counsel to the Council of State Governments, Washington, D. C.; Spencer M. Williams, County Counsel, of Santa Clara County, California and President of the National Association of County Civil Attorneys; Daniel B. Goldberg, General Solicitor of The Port of New York Authority, Counsel for the Municipal Finance Officers Association and Secretary of the Conference on State Defense (Charles E. Norman, City Atty., Tulsa, Okl., and Michael S. Zarin, New York City, Attorney, The Port of New York Authority were with them on brief).
Peyton Ford, Washington, D. C., and Devereaux F. McClatchey, Atlanta, Ga., filed a brief as Amicus Curiae of the National Association of Life Companies.
John B. Jones, Jr., (Louis F. Oberdorfer, Lee A. Jackson and Gilbert E. Andrews, Jr., Washington, D. C., on brief), for appellee.
Before MURRAH, Chief Judge, and BREITENSTEIN and HILL, Circuit Judges.
The taxpayer, a life insurance company, appeals from a judgment of the District Court (Atlas Life Insurance Co. v. United States of America, D.C., 216 F.Supp. 457), denying refund of income taxes paid by it, pursuant to The Life Insurance Company Income Tax Act of 1959. 26 U.S.C. § 801 et seq. The Act imposes a tax at ordinary corporate rates upon "life insurance company taxable income" (§ 802(a)), based upon a three-phase calculation under Section 802(b), which, for our purposes, involves only the first two steps, namely: the determination of "taxable investment income" and "gain from operations" as defined in Sections 804 and 809, respectively.
The taxpayer computed and paid its income taxes for the year 1958 in accordance with the statutory definitions. It thereafter filed claim for refund, contending that the application of the statutory definitions "taxable investment income" and "gain from operations" resulted in the imposition of a tax on tax-exempt interest received from municipal bonds, and that it is therefore entitled to an adjustment under the provisions of Sections 804(a) (6) and 809(b) (4).
The Act of 1959 was promulgated in response to the recognized need for a more permanent and equitable method for determining taxable income of life insurance companies, and was the result of a comprehensive reappraisal of former legislation in the area. The formula for the determination of the tax was conceived in recognition of two salient principles of tax immunity: (1) the policy which has inhered in income tax law since its inception in 1913, to the effect that interest on state securities is excluded from gross income in the computation of the taxpayer's federal tax liability;1 and (2) in recognition of the traditional concept that a life insurance company should not be taxed on that part of its income which is required to be set aside as a reserve to meet the company's contingent obligations to its policyholders. See 2 U.S.C. Congressional and Administrative News, 86th Congress, First Session, p. 1575; Wurzel, "Tax-Exempt Interest of Life Insurance Companies", 70 Yale L.J. 15 (1960).
The concept of "reserve deduction" is perpetuated in the Act by the division of each and every item of net investment income into two categories: (1) the policyholders' share which is excluded from tax liability; and (2) the company's share which is subject to taxation. To effectuate the division of the company's share from the policyholders' share of the net investment income, the Act first provides for the determination of net investment income, i.e., "investment yield", or gross investment income, including tax-exempt interest less certain expenses. See §§ 804(c), 804(a) (1) and 809(a) (1). The policyholders' percentage share of investment yield is determined by dividing investment yield into "policy and other contract liability requirements". § 804(a) (1). These requirements are calculated in accordance with the complicated formula provided in Section 805 by adding: the product of the company's "adjusted reserves rate"2 and its "adjusted life insurance reserves"3; the pension plan reserves multiplied by the current earnings rate4; and interest paid. The percentage derived from the use of this formula5 represents the policyholders' percentage share, and the remaining portion of 100 percent is the company's percentage share. The life insurance company's percentage share of each and every item of investment yield is then reduced by its percentage share of tax-exempt interest,6 and the result is taxable investment income.
The second phase for calculating the tax base, i. e., "gain from operations", follows a similar pattern in determining the policyholders' share of investment yield. Though the formula is different,7 it is sufficient for our purposes to note that, as in phase one, the tax-exempt interest is included to determine the respective percentage shares, and the company's share of exempt interest is then deducted to arrive at gain from operations. See § 809. Thus, after the computation of taxable investment income and gain from operations, Section 802(b) specifies their proper relationship to determine "life insurance company taxable income", i. e., the sum of taxable investment income and 50 percent of the excess of gain from operations over taxable investment income.
The Act then finally provides as an "exception" that "if it is established in any case that the application" of the definitions of taxable investment income and gain from operations "results in the imposition of tax on" any tax-exempt interest, "adjustment shall be made to the extent necessary to prevent such imposition." §§ 804(a) (6) and 809(b) (4).
Making application of the statutory formula in its return for 1958, the taxpayer first computed its tax liability to be $62,615.05. And, it does not now dispute the correctness of the calculations of its tax liability under the formula. The contention is rather that the application of the formula results in its tax liability being increased by $11,252.19, solely because of the receipt of tax-exempt interest and its inclusion in the determination of the tax base. The claim for refund is based on computation of the company's tax liability without the inclusion of tax-exempt interest in investment yield as used in the formula for determining the tax base.
An interpretative analysis of the table below8 reveals the extent to which the inclusion or exclusion of tax-exempt interest in or from investment yield permeates the whole computation of tax liability. Thus, in phase one, a reduction of the adjusted reserves rate results because it is the lower of the two earnings rates, which are in essence determined by dividing assets into investment yield. See Footnote 2. The effect of the reduction in the adjusted reserves rate on policy and other contract liability requirements is partially offset by the increase in the adjusted life insurance reserves caused by the greater difference between the adjusted reserves rate and the assumed interest rate. See Footnote 3. Although policy and other contract liability requirements are lower, the policyholders' percentage share is greater because of the exclusion of the exempt interest from investment yield. Conversely, the company's percentage share is greater because of the inclusion of exempt interest in investment yield. Thus, the percentage differential and the ultimate increase of taxable items of investment yield included in taxable investment income are attributable to the inclusion of tax-exempt interest.
Similarly, in the phase two computation, exclusion of tax-exempt interest from investment yield results in an increased policyholders' percentage share, because it is calculated by dividing investment yield into required interest which remains the same. Thus, the difference in the company's percentage shares is attributable to the inclusion of the exempt interest, and this in turn accounts for the variation in gain from operations.
The trial Court's conclusion that the receipt by the taxpayer of exempt interest was not in fact taxed, is apparently based upon the interpretation of the statutory formula, to the effect that the "company's tax-exempt interest is included in gross income and then deducted before reaching the tax base of the Taxpayer." Atlas Life Insurance Co. v. United States of America, supra, p. 460. The fallacy of this interpretation is that it fails to recognize what the Government seems to concede, that the increase in the Company's share of investment yield by the inclusion of exempt interest in the formula for determining the respective percentage shares is not offset by the deduction of the Company's percentage share of exempt interest, and that the...
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United States v. Atlas Life Insurance Company
...326, 74 L.Ed. 870. The District Court rejected these claims, 216 F.Supp. 457 (D.C.N.D.Okl.), but the Court of Appeals reversed, 333 F.2d 389 (C.A.10th Cir.). That court considered the 1959 formula to impose a tax on tax-exempt interest within the meaning of the National Life and Gehner case......