Holyoke Mut. Fire Ins. Co. v. Comm'r of Internal Revenue, Docket No. 51780.

• Decision Date: 23 April 1957
• Docket Number: Docket No. 51780.
• Citation: 28 T.C. 112
• Parties: HOLYOKE MUTUAL FIRE INSURANCE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

28 T.C. 112

HOLYOKE MUTUAL FIRE INSURANCE COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 51780.

Tax Court of the United States.

Filed April 23, 1957.

Roger P. Stokey, Esq., Nicholas S. Kiefer, Esq., and Charles D. Post, Esq., for the petitioner.

Paul J. Henry, Esq., for the respondent.

Petitioner was chartered in 1843 as a mutual fire insurance company under the laws of Massachusetts. Since 1873 it has had a guaranty fund of $100,000 divided into 1,000 shares. The shareholders are entitled to receive interest at 7 per cent per year, cumulatively, and to elect half the board of directors all of whom must be policyholders. Held, the petitioner is taxable under section 207, I.R.C. 1939, as a mutual insurance company.

TIETJENS, Judge:

The respondent determined a deficiency in income tax for the calendar year 1950 in the amount of.$4,695.28. The sole issue is whether the petitioner was during that year an insurance company other than mutual, and taxable under section 204, Internal Revenue Code of 1939, or a mutual insurance company other than life or marine, and taxable under section 207 of such Code. Some facts are stipulated.

FINDINGS OF FACT.

The facts stipulated are so found and the exhibits to the stipulation are incorporated herein by this reference.

The petitioner is operating under the laws of Massachusetts and is engaged in the business of writing fire and allied lines of insurance in 15 States of the United States. Its principal office is in Salem, Massachusetts. Its income tax return for the year 1950 was filed on Form 1120M, entitled ‘Mutual Insurance Company Income Tax Return’ with the collector of internal revenue at Boston.

The petitioner was chartered in 1843 under an act of the Legislature of Massachusetts. In 1872 an extensive fire in Boston caused large losses to many insurance companies doing business in Massachusetts. The petitioner paid losses of $203,486 incurred in that fire. These payments exhausted the petitioner's surplus. A special session of the legislature, called because of the fire, enacted chapter 375 of the Massachusetts Acts and Resolves for 1872 which authorized any existing mutual insurance company to acquire a guaranty capital. Pursuant to such statute the petitioner in 1873 acquired $100,000 in guaranty capital, divided in 1,000 shares, and at all times since has had this amount. The petitioner paid $5,000 to guaranty capital shareholders in 1873, $10,000 in each year from 1874 through 1880, and $7,000 in each year from 1881 through 1950. In 1950 the 1,000 shares of guaranty capital were owned by 68 persons. The largest number of shares held by one person was 55.

During 1950, the petitioner had over 100,000 policies of insurance in force and on December 31, 1950, the amount of its insurance in force was $365,708,453.

The petitioner's management is vested in the board of directors. The petitioner's bylaws provide for a board of from 8 to 12 directors, one-half to be chosen from the members and one-half from the guaranty capital shareholders. In 1950 the directors owned 97 shares.

Each policy issued by the petitioner contains the provision:

The Assured is hereby notified that by virtue of this policy he is a member of the HOLYOKE MUTUAL FIRE INSURANCE COMPANY IN SALEM, and is entitled to vote either in person or by proxy at any and all meetings of said company. The annual meetings are held at its home office on the fourth Tuesday of January in each year, at 10:00 o'clock A.M.

In 1950 all the officers of the petitioner were policyholders. The chairman of the board, the president, and the treasurer were shareholders.

During 1950 and for many years prior thereto the petitioner's net assets above its reinsurance reserves and all other claims and obligations have been less than 2 per cent of its insurance in force and have been more than 25 per cent of the amount of the guaranty capital.

Notice of the annual meeting is sent to all shareholders. Votes were cast at the annual meetings in 1950 and 1951 as follows:

+-----------------------------------------------------+
                ¦                                       ¦1950  ¦1951  ¦
                +---------------------------------------+------+------¦
                ¦                                       ¦      ¦      ¦
                +---------------------------------------+------+------¦
                ¦By policyholders in person             ¦49    ¦54    ¦
                +---------------------------------------+------+------¦
                ¦By shares of guaranty capital in person¦20    ¦31    ¦
                +---------------------------------------+------+------¦
                ¦By shares of guaranty capital by proxy ¦684   ¦682   ¦
                +-----------------------------------------------------+
                

For a number of years 6 of the 12 directors have been policyholders who were not shareholders, the other 6 have been shareholders, at least 5 of whom were also policyholders.

In 1950 the petitioner paid dividends to its policyholders amounting to $474,021.49. During the year 1950 and all years prior thereto the petitioner furnished insurance to its policyholders at cost after payment of losses and expenses, establishment of reserves for losses incurred and for unearned premiums on policies outstanding, retention of surplus to meet unusual losses, and payment of $7,000 each year to shareholders of guaranty capital.

The petitioner has been subject to catastrophe losses in the past, including fires in Portland in 1866, Boston in 1872, Chelsea in 1906, Salem in 1914, and Fall River in 1932, and hurricanes in 1938, 1944, and 1950.

In its annual statement on the form approved by the National Convention of Insurance Commissioners the petitioner lists the payment to the shareholders as a reduction to surplus and describes it as dividends to shareholders of guaranty capital, and pursuant to instructions on the form lists its guaranty capital in the capital stock section of its balance sheet and not among its liabilities.

The petitioner is a mutual insurance company.

OPINION.

The petitioner was organized as a mutual insurance company and throughout its existence has classified itself as such. However, since 1873 it has had a guaranty capital of $100,000, divided into 1,000 shares, the holders of these shares entitled to receive cumulative dividends of 3 1/2 per cent semiannually, to choose one-half of the directors, and to receive on liquidation the face amount of their shares. The respondent takes the position that the guaranty capital is equivalent to stock and therefore the petitioner cannot be classified as a mutual insurance company taxable under section 207 ¹ of the Internal Revenue Code of 1939, but is subject to tax under section 204² as an insurance company other than life or mutual.

The General Laws of Massachusetts, chapter 175, as applicable in 1950, contain several pertinent provisions. Section 76 provides that every person insured by a mutual fire insurance company shall be a member while his policy is in force, entitled to one vote for each policy held and shall be notified of meetings by written notice or by printing on the policy, and that members may vote by proxy. Section 77 provides for election of a board of directors and states:

After the first election members only shall be eligible, but no director shall be disqualified from serving the term for which he was elected by reason of the termination of his policy. Such companies having a guaranty capital shall choose one half of the directors from the shareholders and one half from the policyholders who are not shareholders.

Section 79 provides that holders of shares of guaranty capital are entitled to a semiannual dividend of not more than 3 1/2 per cent if the net profits shall be sufficient and that the guaranty capital shall be applied to pay losses only when the company has exhausted its assets other than uncollected premiums and when impaired it may be restored by assessments upon the contingent funds of the company. Upon liquidation the holders of guaranty capital are not entitled to share in the distribution of the assets beyond the par value of the shares and any dividends declared and payable thereon. This section also states the conditions upon which the guaranty capital shall be retired, or may be retired. ³ Section 80 provides that the directors may fix the percentages of dividends to be paid, and authorizes a mutual fire insurance company to accumulate and hold profits, but only until such profits equal 4 per cent of its insurance in force.

The respondent says that the company is controlled by its stockholders, the holders of shares of guaranty capital, and therefore is not a mutual insurance company. These factors are pointed out as significant: (1) The shareholders are subject to the same provisions of law as stockholders in stock companies; (2) they have one vote for each share owned in the choice of directors; (3) They have the right to choose one-half of the directors; (4) the guaranty capital is applied to pay losses only if other assets are exhausted and any impairment in the guaranty capital can he restored from contingent funds of the company; (5) the shareholders are entitled to cumulative dividends of a fixed amount; and (6) on dissolution the shareholders are entitled to receive the par value of their shares plus any dividends declared and payable.

The respondent points out that votes cast at the annual meetings of 1950 and 1951 represented principally shares of guaranty capital rather than policyholders, and says that this shows that the democratic control by policyholders which is the essence of a mutual insurance company is lacking.

It is not disputed that the petitioner is classified under the laws of Massachusetts and all the other States in which it does business as being a mutual insurance company, nor that it is a member of various trade associations of mutual insurance companies. The respondent says these evidences are irrelevant to the question whether the petitioner is within the classification under the Federal taxing s...