Life Ins. Co. of Georgia v. United States
| Decision Date | 20 May 1981 |
| Docket Number | No. 135-73.,135-73. |
| Citation | 650 F.2d 250 |
| Parties | LIFE INSURANCE COMPANY OF GEORGIA v. The UNITED STATES. |
| Court | U.S. Claims Court |
Edward J. Schmuck, Washington, D. C., attorney of record, for plaintiff; Randolph W. Thrower, Atlanta, Ga., Carolyn P. Chiechi, George K. Yin, Sutherland, Asbill & Brennan, Washington, D. C., and John A. Helms, Atlanta, Ga., of counsel.
Michael J. Dennis, Washington, D. C., with whom was Asst. Atty. Gen. M. Carr Ferguson, Washington, D. C., for defendant; Theodore D. Peyser, Jr., Washington, D. C., of counsel.
Before FRIEDMAN, Chief Judge, SKELTON, Senior Judge, and KASHIWA, Judge.
ON PLAINTIFF'S MOTION FOR PARTIAL SUMMARY JUDGMENT AND DEFENDANT'S CROSS MOTION FOR PARTIAL SUMMARY JUDGMENT
This case is before the court on the parties' cross motions for partial summary judgment. The controversy at issue is whether interest due in advance and capitalized by an insurance company under the terms of the policyholder loan agreements is includible in plaintiff's gross investment income, I.R.C. § 804(b)(1), in the year of capitalization. Such advance interest was not paid in cash. After consideration of the parties' briefs and after oral argument, we uphold the determination of the Government, grant its motion, and therefore dismiss the petition to that extent.
Plaintiff is a stock life insurance company organized under the laws of Georgia, qualifying under section 801(a) as a "life insurance company." Plaintiff has a calendar year taxable year.
During 1958-1967, the years at issue, a policyholder possessing a policy with a cash surrender value was entitled to borrow money from the plaintiff up to the cash surrender value. No security other than the policy itself was required on these loans.
Under the policyholder loan agreements, annual interest on such loans is due and payable in advance.1 Plaintiff did not, however, have the right to compel a cash payment in advance from the borrower. In fact, no cash in advance was received in the transactions at issue.
Typically, a policyholder would borrow a specified sum and, according to the amount of interest agreed upon, plaintiff calculated the amount of interest to be earned between the date of the loan and the end of the current policy year. This amount was then deducted from the actual cash given to the borrower.
Two possibilities existed for loans outstanding at the end of a policy year. The borrower could either pay in cash the amount of interest due under the agreement for the next year or, if not paid in cash, plaintiff would calculate the amount of interest due for the following year on the remaining amount of the debt and add that amount to the loan principal. We are concerned only with the latter possibility.
The interest capitalization procedure is illustrated by the example given in the affidavit of defendant's expert, Charles M. Beardsley:
For a 100X loan and a 5 percent rate of interest in advance (the loans bore 5 percent advance discounted interest (i. e., .04762 percent (.05/1.05 = .04762))):
The loan agreements allowed the borrower to repay the loan at any time. When a loan was repaid prior to the end of the policy year, plaintiff could retain only the interest earned up to the date of repayment. The death of the borrower or other policy termination would also result in a similar adjustment to the interest charged by plaintiff in advance.2
On both its National Association of Insurance Commissioners' (NAIC) reports3 and its federal income tax returns, plaintiff only reported the amount of interest earned for that calendar year. Specifically, plaintiff excluded from its gross investment income (section 804(b)(1)) that portion of the advance interest relating to the period beyond December 31 of the relevant year. It is this reporting posture which formed the basis of the Government's assessment of plaintiff.4
Generally speaking, section 818(a) requires plaintiff to use the accrual method of accounting.5 Under the accrual method, "income is to be included for the taxable year when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy." Treas.Reg. § 1.446-1(c)(1)(ii) ().
The parties disagree on when the plaintiff was sufficiently possessed with the right to receive the interest it should be charged with its accrual. The Government emphasizes that by the terms of the loan agreements, the interest was due and payable in advance. Plaintiff, on the other hand, would have us hold that this interest should not be accrued until it is "earned" (i. e., the loan is used by the borrower for the full year). Plaintiff specifically argues it could not require prepayment of the interest. Thus, according to plaintiff, since there was no enforceable right to prepayment and since it would have to "return" the "unearned" interest, the accrual of the interest must occur only as it is earned. We think plaintiff's rights were sufficiently fixed to be chargeable to the year in which the interest was due and payable.
It is important to bear in mind that in accrual accounting we are concerned with the right to receive the item, not its actual receipt. In Spring City Foundry Co. v. United States, 292 U.S. 182, 184, 54 S.Ct. 644, 645, 78 L.Ed. 1200 (1934), the Supreme Court stated:
Keeping accounts and making returns on the accrual basis, as distinguished from the cash basis, import that it is the right to receive and not the actual receipt that determines the inclusion of the amount in gross income. When the right to receive an amount becomes fixed, the right accrues.
See Koehring Co. v. United States, 190 Ct.Cl. 898, 910, 421 F.2d 715, 721 (1970); Clifton Mfg. Co. v. Commissioner, 137 F.2d 290, 292 (4th Cir. 1943).
In our analysis of the loans at issue, we are impressed by the contractual requirement that the interest is due and payable in advance. As a result of such contractual provisions, not only is the interest required to be calculated in advance, it is due in advance. In examining a prepaid service situation, for example, the Supreme Court noted that accruing an item is a function of the right of the taxpayer to receive such item and that the particular payments should be accrued "at least at the time they * * * become due and payable." Schlude v. Commissioner, 372 U.S. 128, 137, 83 S.Ct. 601, 606, 9 L.Ed.2d 633 (1963).
We are assisted in our determination by the previous decisions of other courts requiring life insurance companies with similar loan agreements to accrue the capitalized interest at the time it was due and payable.6 Union Mutual Life Ins. Co. v. United States, 570 F.2d 382 (1st Cir.), cert. denied, 439 U.S. 821, 99 S.Ct. 87, 58 L.Ed.2d 113 (1978); Southwestern Life Ins. Co. v. United States, 560 F.2d 627 (5th Cir. 1977), cert. denied, 435 U.S. 995, 98 S.Ct. 1647, 56 L.Ed.2d 84 (1978); Jefferson Standard Life Ins. Co. v. United States, 408 F.2d 842, 856-857 (4th Cir.), cert. denied, 396 U.S. 828, 90 S.Ct. 77, 24 L.Ed.2d 78 (1969); Franklin Life Ins. Co. v. United States, 399 F.2d 757, 762-763 (7th Cir. 1968), cert. denied, 393 U.S. 1118, 89 S.Ct. 989, 22 L.Ed.2d 122 (1969); Northern Life Ins. Co. v. United States, 47 A.F.T.R.2d 81-452 (W.D.Wash.1980). Contra, Bankers Union Life Ins. Co. v. Commissioner, 62 T.C. 661 (1974).
Two of the circuit court decisions, Franklin Life and Jefferson Standard, were considered by the Tax Court in Bankers Union Life Ins. Co. v. Commissioner, supra 62 T.C. at 681-682. The Tax Court found those cases not controlling on a similar issue which was before it. Id. at 681. The Tax Court felt the circuit courts had relied solely on the fact of actual payment of cash in advance in reaching their conclusions.7 In the case before it, the Tax Court held that because of the borrower's right of prepayment of the loan the interest should not be accrued until it is "earned," id. at 680, quoting, Guarantee Title and Trust Co. v. Commissioner, 313 F.2d 225, 227 (6th Cir. 1963). The Tax Court also relied on two of its own cases, namely, Gunderson Brothers Engineering Corp. v. Commissioner, 42 T.C. 419 (1964), and Luhring Motor Co. v. Commissioner, 42 T.C. 732 (1964). These cases involving finance charge situations held that the interest was accruable as earned with the passage of time.
The plaintiff urges us to adopt the reasoning of the Tax Court, reject the other contrary decisions, and find that the right to receive the interest was not fixed until "earned" by the passage of time.
The First Circuit considered the Tax Court's analysis in Bankers Union and "declined to follow its reasoning." Union Mutual, 570 F.2d at 386 & n.2. Similarly, the District Court for the Western District of Washington has considered the analysis in Bankers Union and it likewise was not persuaded. Northern Life, supra 47 A.F.T.R.2d at 81-454.
We find it unclear from the opinion of the Tax Court whether it was analyzing a loan agreement which contractually required the interest to be due and...
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