First Security Bank of Utah, NA v. CIR, No. 611-69

• Decision Date: 21 January 1971
• Docket Number: 612-69 and 613-69.,No. 611-69
• Citation: 436 F.2d 1192
• Parties: FIRST SECURITY BANK OF UTAH, N. A., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. FIRST SECURITY BANK OF IDAHO, N. A., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. FIRST SECURITY COMPANY, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
• Court: U.S. Court of Appeals — Tenth Circuit

436 F.2d 1192 (1971)

FIRST SECURITY BANK OF UTAH, N. A., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

FIRST SECURITY BANK OF IDAHO, N. A., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

FIRST SECURITY COMPANY, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

Nos. 611-69, 612-69 and 613-69.

United States Court of Appeals, Tenth Circuit.

January 21, 1971.

Stephen H. Anderson, Washington, D. C. (C. Preston Allen and Alonzo W. Watson, Jr., of Ray, Quinney & Nebeker, Salt Lake City, Utah, on the brief) for First Security Bank of Utah, N. A., and First Security Co.

John Brown, Washington, D. C. (Johnnie M. Walters, Asst. Atty. Gen., and Lee A. Jackson, Harry Baum and Stuart A. Smith, Attys., Dept. of Justice, on the brief) for Commissioner of Internal Revenue.

Before BREITENSTEIN and SETH, Circuit Judges, and TEMPLAR, District Judge.

BREITENSTEIN, Circuit Judge.

These consolidated appeals from the Tax Court relate to the allocation of income among taxpayers. No. 611-69 is an appeal by First Security Bank of Utah, N. A., (Utah Bank) from the decision that for the years 1955 to 1959 inclusive there is a deficiency in income taxes due from the taxpayer in the amount of $187,863.92. No. 612-69 is an appeal by First Security Bank of Idaho, N. A., (Idaho Bank) from the holding that for the tax years 1955, 1957, and 1958 there is a deficiency of $210,714.41. No. 613-69 is a protective appeal by the Commissioner of Internal Revenue from the decision that there are no deficiencies in the income taxes due from First Security Company (Management Company) for the years 1956 to 1959 inclusive. The Tax Court held that approximately 40% of credit insurance net premiums paid by borrowers from the two banks, and reported by another corporation, were allocable to income of the banks. Jurisdiction is conferred by 26 U.S.C. § 7482(a). Venue for the appeal of the Idaho Bank is in this court pursuant to a stipulation made under § 7482(b) (2). The findings of fact and opinion of the Tax Court are not officially reported but are found at 26 T.C.M. 1320.

The taxpayers are national banks. They and a Wyoming bank, Management Company, and certain non-banking affiliates were until 1959 wholly owned subsidiaries of First Security Corporation, a bank holding company which is publicly owned. During the years in issue Utah Bank had 141,000 to 192,000 depositors and $217,000,000 to $292,000,000 in deposits and Idaho Bank had 113,000 to 131,000 depositors and $183,000,000 to $205,000,000 in deposits. Management Company provided accounting and other managerial services to subsidiaries of Holding Company.

Since 1948 the banks have made available to their borrowers credit life, health, and accident insurance which pays off the debt in case the borrower dies or is incapacitated during the term of his loan. The Tax Court found that they did this "for several reasons, including (1) to offer a service increasingly supplied by competing financial institutions, (2) to obtain the benefits of the additional collateral which credit insurance provides by repaying loans upon the death, injury, or illness of the borrower, and (3) to provide an additional source of income — part of the premiums for the insurance — to Holding Company or its subsidiaries." The premium charge for the credit insurance was at the uniform rate of $1.00 per $100.00 of coverage per year on a decreasing term basis. This was the rate commonly charged in the industry and was accepted by the insurance commissioners of the states involved — Utah, Idaho, and Texas. The banks did not require their borrowers to purchase credit insurance. During the taxable years less than 50% of their installment loan customers and less than 13% of their real estate loan customers elected to take insurance.

The banks had a routine procedure for making credit insurance available to customers. A loan officer explained the function and availability of the insurance. If the customer desired the insurance, the loan officer gave him the application forms for completion. Bank personnel examined the application, made out a certificate of insurance, and either collected the premium from the customer or added it to his loan. There is no showing that any of the bank personnel were licensed insurance agents. As the final step, bank employees forwarded the completed forms and premiums to Management Company for further handling. Management Company's role in processing the credit insurance was in the nature of bookkeeping. It had no contact with the public in respect to the writing of credit insurance. It received the forms, duplicate certificates, and premiums from the banks, made records of the insurance purchased, and forwarded the premiums to the insurance carrier. It also did the paper work when claims were filed under the policies.

The following items show pertinent facts with regard to the credit insurance which concerns us.

1. The number of policies written and the amount of risk at the end of each year, 1954 to 1959 inclusive, varied from a low of 12,500 and $6,483,000 respectively in 1954 to a high of 36,416 and $41,350,000 respectively in 1959.

2. The net premiums for the years 1955 to 1959 inclusive totalled $1,916,241.95.

3. The claims and claim expenses for the years 1955 to 1959 inclusive totalled $525,787.91.

4. For the years in issue the total cost to the Utah Bank for processing the insurance was $8,929.30, to the Idaho Bank $9,826.43, and to Management Company $10,150.34. The Tax Court described these costs as "negligible."

From 1948 to April 1, 1954, the credit insurance coverage on the banks' borrowers was carried first by Credit Life Insurance Company of Springfield, Ohio, and later by American Bankers Life Assurance Company of Florida, both of which were independent of Holding Company and its subsidiaries. Commissions varying from 40% to 55% of net premiums were paid to Ed. D. Smith & Sons which was an insurance agency and a wholly owned subsidiary of Holding Company.

American National Insurance Company of Galveston, Texas, an independent company, wrote a large volume of credit insurance. Foreseeing a change in the credit insurance business, National, late in 1953, approached Holding Company and other financial institutions with a plan whereby it would write credit insurance available to borrowers. The plan called for Holding Company to create a life insurance subsidiary. The subsidiary's business would be to reinsure the risks of the credit insurance policies written by National for the customers of Utah Bank and Idaho Bank. Profits from the business could be retained in the subsidiary for investment. In its initial years, the subsidiary would utilize National's established and experienced operating services, such as actuarial and accounting, on a fee basis. If the plan proved successful, the new subsidiary could grow into a full-line, direct-writing insurance company.

Holding Company adopted National's plan and in June, 1954, incorporated First Security Life Insurance Company of Texas under the laws of Texas with an initial capital of $25,000 and an initial paid-in surplus of $12,500. The credit insurance written by National for the two banks was reinsured with Security Life under contracts called reinsurance treaties. Thereunder National received approximately 15% of the premium dollar for its technical services and Security Life received the balance for its assumption of 100% of the risks under the policies. The maximum risk on one life under the policies reinsured by Security Life was $5,000.

In 1956, Security Life's capital was increased to $100,000. During the period it did not become a full-line, direct-writing insurance company. Although Security Life's business proved successful, this result was not assured at the outset. In relation to its capital structure Security Life reinsured a large amount of risk. As noted by the Tax Court, several aspects of its business could have invited high mortality rates. Customers of the banks obtained credit insurance without a health examination and without a waiting period. Also, Security Life was a relatively small insurance company and its policyholders lived in a relatively limited geographical area.

During the years in issue, Security Life paid state and federal taxes, used its own stationery, made deposits and withdrawals from bank accounts in its own name, and reinvested in its own name. Its sole source of business income was from reinsurance premiums. Its business expenses were primarily bank charges, taxes, and claims settlements. It paid a dividend to Holding Company of $389,821.61 in 1959.

On September 15, 1959, as a result of a reorganization pursuant to the 1956 act regulating bank holding companies, see 12 U.S.C. § 1841 et seq., the Utah and Idaho banks became owned by First Security Corporation, a publicly held corporation, and Security Life became owned by First Security Investment Company, also a publicly held corporation. The parties have stipulated that as of February, 1967, there was a substantial difference in the ownership of the shares of the two companies.

On December 21, 1962, the Commissioner sent notices of deficiency to the taxpayers based on an allocation to the banks of approximately 47% of Security Life's premium income, during the years in issue, after payment of National's management fees. An alternative allocation was made to Management Company. On the authority of Local Finance Corporation v. Commissioner of Internal Revenue, 48 T.C. 773, affirmed, 7 Cir., 407 F.2d 629, cert. denied 396 U.S. 956, 90 S.Ct. 428, 24 L.Ed.2d 420, the Tax Court upheld Commissioner's allocation of income to the banks and denied his alternative allocation to Management Company. The banks have each appealed from the adverse decision on liability for tax deficiencies, and the Commissioner has taken a protective appeal from the...