Mutual Ben. Life Ins. Co. v. Duffy

• Decision Date: 19 February 1924
• Citation: 295 F. 881
• Parties: MUTUAL BEN. LIFE INS. CO. v. DUFFY, Internal Revenue Collector.
• Court: U.S. District Court — District of New Jersey

295 F. 881

MUTUAL BEN. LIFE INS. CO. v. DUFFY, Internal Revenue Collector.

United States District Court, D. New Jersey.

February 19, 1924

John O H. Pitney, John R. Hardin, David Kay, Jr., and Jay Ten Eyck all of Newark, N.J., for plaintiff.

Walter G. Winne, U.S. Atty., of Hackensack, N.J., Frederic M. P Pearse, Asst. U.S. Atty., of Newark, N.J., Walter Bacon Asst. U.S. Atty., of Bridgeton, N.J., and Carl A. Mapes, Solicitor of Internal Revenue, and Newton K. Fox, Sp. Atty., Bureau of Internal Revenue, both of Washington, D.C., for defendant.

RELLSTAB District Judge.

The plaintiff, a New Jersey corporation, sues to recover from the defendant, collector of internal revenue for the Fifth district of New Jersey, $83,779.70, war excess profits tax, imposed upon it for the year 1917, which it paid under protest. It has complied with the necessary prerequisites for the instituting of the present suit. The tax was imposed under the Revenue Act of October 3, 1917. The defendant moves to strike the complaint. It has been so framed (several times amended) as to present all the facts necessary to a final determination, and by stipulation the decision on this motion is to be a final disposition of the controversy in this court.

The plaintiff is a mutual company, having no capital stock or stockholders, and never carried on any business other than that of mutual life insurance. The plaintiff's policy holders are its members, and they elect from among themselves the directors who manage its business. This business is conducted upon the 'level premium plan,' under which the maximum annual contribution paid by the policy holder in premiums is uniform throughout the life of the policy. In determining the 'level premium' there is added to the mathematical computation of the cost of insurance an amount to provide for salaries, taxes, and other expenses of conducting the business, and to take care of unforeseen contingencies, which addition is called 'loading.'

The plaintiff's assets consist solely of these premiums, the investment thereof, and the income derived from these investments. Inasmuch as the stipulated uniform premiums are in excess of the cost of insurance during the earlier years of the policy, and not sufficient to pay the cost of the insurance during its later years, a portion of this excess is by law required to be set aside and held as a reserve or guarantee fund (called the legal reserve) to maintain the insurance during the later years. At the end of each year the excess of income over disbursements is ascertained, and, after applying so much thereof as is required for the increase of its legal reserve and an additional sum to care for unanticipated losses, expenses, and shrinking of earnings-- an additional safeguard of the stability and continuity of the legal reserve-- the balance is returned to the policy holders as a dividend or credit upon their next annual premiums.

A detailed statement of this method of conducting mutual life insurance on the 'level premium plan' and the nature and application of the excess payments of premiums is set out in Mutual Benefit Life Insur. Co. (the plaintiff herein) v. Herold (D.C.N.J.) 198 F. 199, 202-204, and Connecticut General Life Ins. Co. v. Eaton (D.C. Conn.) 218 F. 188. The laws of the states in which the plaintiff carries on its business require that its assets shall not be less than this legal reserve. The amount of the latter, as fixed by the commissioner of banking and insurance of the state of New Jersey on January 1, 1917, was $186,258,796. In the plaintiff's management of its assets there is no segregation or special allocation of any part thereof, and the legal reserve is not separately held or invested.

Under the provisions of title 1 of the Revenue Act of September 8, 1916 (39 Stat. 756), as amended by title 1 of the Act of October 3, 1917 (40 Stat. 300), the plaintiff filed an income tax return for the year 1917, showing a net income of $1,808,339.33, and paid a tax of $108,500.36. In this return was included all the interest obtained from its securities and investments not specifically exempt from tax. Under the provisions of title 2 of the last-mentioned act (Comp. St. 1918, Secs. 6336 3/8a-6336 3/8o), the plaintiff also filed an excess profits tax return for the year 1917, showing, on its basis of computation, that no such tax was due. In this return it declared its invested capital to be $202,685,846.45, which included its legal reserve of $186,258,796. Thereafter, on June 10, 1920, the Commissioner of Internal Revenue (hereinafter referred to as the Commissioner) amended the excess profits tax return, deducting this reserve from the invested capital, allowing only $14,719,043.76 as such capital, and imposing the excess profits tax sought to be recovered in this suit. This deduction, or nonallowance, is the basis of the plaintiff's suit.

The government contends that the legal reserve of a mutual insurance company cannot be its invested capital, because it does not belong to it, but to the policy holders; that such fund is in the nature of a trust fund, and is in fact a liability, and not an asset. For some purposes this reserve is a liability, or a trust fund; but so is the capital subscribed by shareholders in a stock corporation. Both are treated as a liability in balancing assets and liabilities. In the case of an insolvent stock corporation, its assets are charged with a trust in favor of creditors. On the dissolution or liquidation of a stock corporation, the capital remaining after the payment of debts belongs to the shareholders. So, on the dissolution of a mutual insurance company, the holders of unmatured policies, after the payment of matured policies, share pro rata the assets of the company, including the legal reserve. Mayer v. Attorney General, 32 N.J.Eq. 815, 822.

If the legal reserve of a mutual life insurance company is a liability or trust fund in favor of the policy holders, as the government contends, so are the other assets of the company. The difference between them is merely that the former is required by law to be maintained intact as a guaranty for the payment of such policies, and cannot lawfully be diverted to other uses. Under certain tax laws the legal reserves of insurance companies are treated as liabilities. Whether they are to be so considered depends upon the particular kind of tax imposed and the legislative policy adopted in regard thereto.

In the instant case the character of the plaintiff's assets is involved, and the specific question is whether its reserve, or at least $25,500,000 thereof, is invested capital, within the meaning of title 2, 'War Excess Profits Tax,' of the Revenue Act of October 3, 1917. The pertinent parts of this title follow:

'Sec. 200. That when used in this title--

'The term 'corporation' includes joint-stock companies or associations and insurance companies. * * *

'The term 'pre-war period' means the calendar years nineteen hundred and eleven, nineteen hundred and twelve, and nineteen hundred and thirteen. * * *

'Sec. 201. That in addition to the taxes under existing law and under this act there shall be levied, assessed, collected, and paid for each taxable year upon the income of every corporation, partnership, or individual, a tax (hereinafter in this title referred to as the tax) equal to the following percentages of the net income:

'Twenty per centum of the amount of the net income in excess of the deduction (determined as hereinafter provided) and not in excess of fifteen per centum of the invested capital for the taxable year. * * *

'Sec. 203. That for the purposes of this title the deduction shall be as follows, except as otherwise in this title provided--

'(a) In the case of a domestic corporation, the sum of (1) an amount equal to the same percentage of the invested capital for the taxable year which the average amount of the annual net income of the trade or business during the pre-war period was of the invested capital for the pre-war period (but not less than seven or more than nine per centum of the invested capital for the taxable year); and (2) $3,000. * * *

'Sec. 206. That for the purposes of this title the net income of a corporation shall be ascertained and returned * * * (c) for the taxable year upon the same basis and in the same manner as provided in title I of the act entitled 'An act to increase the revenue, and for other purposes,' approved September eighth, nineteen hundred and sixteen, as amended by this act. * * *

'Sec. 207. That as used in this title, the term 'invested capital' for any year means the average invested capital for the year, as defined and limited in this title, averaged monthly.

'As used in this title 'invested capital' does not include stocks, bonds (other than obligations of the United States), or other assets, the income from which is not subject to the tax imposed by this title, nor money or other property borrowed, and means, subject to the above limitations:

'(a) In the case of a corporation or partnership: (1) Actual cash paid in; (2) the actual cash value of tangible property paid in other than cash, for stock or shares in such corporation or partnership, at the time of such payment, * * * and (3) paid in or earned surplus and undivided profits used or employed in the business, exclusive of undivided profits earned during the taxable year. * * * ' (Comp. St. 1918, Secs. 6336 3/8a, 6336 3/8b, 6336 3/8d, 6336 3/8g, 6336 3/8h).

The pertinent parts of the act of 1916, referred to, follow: 'Title I-- Income Tax.

'Part II-- On Corporations.

'Sec 10. That there shall be levied, assessed, collected, and paid annually upon the total net income received in the preceding calendar year from all...