Trans City Life Ins. Co. v. Comm'r of Internal Revenue
| Decision Date | 30 April 1996 |
| Docket Number | No. 23678-93,16934-94.,23678-93 |
| Citation | 106 T.C. No. 15,106 T.C. 274 |
| Parties | TRANS CITY LIFE INSURANCE COMPANY, an Arizona Corporation, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
James E. Brophy III, Phoenix, AZ, and Mark V. Scheehle, Scottsdale, AZ, for petitioner.1
Avery Cousins III, Jacksonville, FL, Susan E. Seabrook, Phoenix, AZ, Lana Eckhardt, Dallas, TX, and Nancy S. Vozar, Washington, DC, for respondent.
P is an insurance company authorized to sell disability and life insurance within the State of Arizona. P's primary and predominant business activity is writing credit life and disability insurance policies. During the subject years, P and G, an unrelated entity, entered into two retrocession (reinsurance) agreements for valid and substantial business reasons. Under the terms of each agreement, G retroceded its position on reinsurance to P, and P agreed to pay G a $1 million ceding commission. The agreements helped P qualify as a life insurance company under sec. 816, I.R.C., which, in turn, allowed P to claim the small life insurance company deduction under sec. 806, I.R.C. Relying on sec. 845(b), I.R.C., R disregarded both of these agreements because, she alleged, the agreements did not transfer to P risks proportionate to the benefits that P derived from the small life insurance company deductions under sec. 806, I.R.C.
Held: R may rely on sec. 845(b), I.R.C., prior to the issuance of regulations. Held, further: R committed an abuse of discretion in determining that the agreements had “a significant tax avoidance effect” under sec. 845(b), I.R.C., with respect to P. Held, further: P may amortize each ceding commission over the life of the underlying agreement.
Trans City Life Insurance Company, an Arizona corporation, petitioned the Court to redetermine respondent's determinations for its 1989 through 1992 taxable years. Respondent determined deficiencies of $603,356, $510,716, $382,508, and $297,928 in petitioner's 1989, 1990, 1991, and 1992 Federal income taxes, respectively. Respondent's determination for 1989 was reflected in a notice of deficiency issued to petitioner on September 15, 1993 (the 1993 Notice). Respondent's determinations for 1990, 1991, and 1992 were reflected in a second notice of deficiency issued to petitioner on September 12, 1994 (the 1994 Notice).
In her amendments to answers (Amendments), respondent asserted that petitioner was not entitled to amortize ceding commissions payable under two reinsurance agreements with The Guardian Life Insurance Company of America (Guardian). Respondent asserted in her Amendments that the 1989 through 1992 deficiencies were $672,210, $553,533, $437,584, and $354,246, respectively.
We must decide:
1. Whether respondent may rely upon section 845(b), prior to the issuance of regulations. We hold she may.
2. Whether the two reinsurance agreements at issue had “significant tax avoidance [effects]” under section 845(b), with respect to petitioner. We hold they did not.2
3. Whether petitioner may amortize the ceding commissions payable under the reinsurance agreements over the life of the agreements. We hold it may.
Unless otherwise indicated, section references are to the Internal Revenue Code in effect for the taxable years in issue. Rule references are to the Tax Court Rules of Practice and Procedure. Dollar amounts are rounded to the nearest dollar. The 50-percent ratio described in section 816(a) is referred to as the Life Ratio.3
1. General Factsa. Petitioner
At all relevant times, petitioner was an Arizona corporation with its principal offices located in Scottsdale, Arizona. It was an “insurance company” for purposes of section 816(a), and it was authorized by the State of Arizona Department of Insurance to sell disability and life insurance within the State of Arizona. Its primary and predominant business activity was writing credit life and disability insurance policies covering individuals who financed vehicles purchased from automobile dealers. During the subject years, it wrote direct credit policies that generated the following amounts of premiums from life and disability insurance:
+----------------------------------------+
¦Year¦Life insurance¦Disability insurance¦
+----+--------------+--------------------¦
¦1989¦$3,227,739 ¦$2,570,868 ¦
+----+--------------+--------------------¦
¦1990¦2,626,873 ¦1,971,888 ¦
+----+--------------+--------------------¦
¦1991¦2,590,894 ¦1,807,293 ¦
+----+--------------+--------------------¦
¦1992¦3,189,966 ¦2,079,715 ¦
+----------------------------------------+
b. Notices of Deficiency
Petitioner's 1989 through 1992 Forms 1120L, U.S. Life Insurance Company Income Tax Return, reported small life insurance company deductions (see section 806) of $1,770,350, $1,792,007, $1,361,574 and $1,109,638, respectively. Respondent disallowed these deductions. According to the 1993 Notice:
Your reinsurance agreement with Guardian Life Insurance Company of America has a significant tax avoidance effect with respect to the Trans City Life Insurance Company. Pursuant to Internal Revenue Code section 845 an adjustment is made to reserves to eliminate the avoidance effect by treating the reinsurance agreement as terminated on December 31, 1989 and reinstating the agreement on January 1, 1990.
By eliminating the avoidance effect of this agreement you do not meet the requirements of a life insurance company as specified in Internal Revenue Code section 816 because the reserves necessary to meet the definition of a life insurance company do not comprise more than 50 percent of your total reserves.
Therefore, it is determined that the amount of $1,770,350.00, claimed on your return as a small life insurance company deduction for the taxable year ended December 31, 1989, is not allowed.
Accordingly, income is increased in the amount of $1,770,350.00 for the taxable year ended December 31, 1989.
The 1994 Notice is virtually identical to the 1993 Notice, and it states the same reason for respondent's adjustments to the years referenced therein. Neither the 1993 Notice nor the 1994 Notice disregarded the income that petitioner earned under the reinsurance agreements.
2. Reinsurance in Generala. Overview
Reinsurance is an agreement between an initial insurer (the ceding company) and a second insurer (the reinsurer), under which the ceding company passes to the reinsurer some or all of the risks that the ceding company assumes through the direct underwriting of insurance policies. Generally, the ceding company and the reinsurer share profits from the reinsured policies, and the reinsurer agrees to reimburse the ceding company for some of the claims that the ceding company pays on those policies. A reinsurer may...
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