Document: 52 L.Ed.2d 4 97 S.Ct. 1440 430 U.S. 725 UNITED STATES, Petitioner,v.CONSUMER LIFE INSURANCE COMPANY. FIRST RAILROAD & BANKING COMPANY OF GEORGIA, Petitioner, v. STATES. PENN SECURITY Nos. 75-1221, 75-1260 and 75-1285. Argued Dec. 6, 1976. Decided April 26, 1977. Syllabus Under § 801(a) of the Internal Revenue Code 1954, an insurance company is considered a life for federal tax purposes if its reserves constitute more than 50% "total reserves," as that term defined in 801(c). Qualifying companies are accorded preferential treatment. The question here how unearned premium accident health (nonlife) policies should be allocated between primary insurer reinsurer applying test. reserve basic casualty business important component reserves" under 801(c)(2). taxpayers contend by virtue certain reinsurance agreements ("treaties") they have maintained nonlife below level. These treaties were two types: (1) Treaty I, whereby taxpayer served reinsurer, "other party" was or ceding company; (2) II, ceded portion to party," reinsurer. Both types provided other party would hold dollars derived from until such time premiums "earned," i. e., attributable protection during policy already elapsed. also set up on books corresponding reserve, relieving requirement, even though assumed all substantial risks. In each case, reported their affairs annually this way both Service appropriate state departments. Despite authorities' acceptance these annual statements, Government argues must attributed parties taxpayers, with result fail test thus disqualified treatment, primarily because, Government's view, 801 embodies rule "insurance follow risk." Held : 1. valid and, contrary argument, not sham transactions without economic substance. Pp. 736-739. 2. Since neither held nor reserves, since treatment accord customary practice policed regulatory authorities, 801(c)(2) does permit attribution treaties. 739-750. (a) language suggest Congress intended "reserves risk" govern determinations 801. 740-741. (b) Nor legislative history furnish support interpretation. 742-745. (c) Section 820 Code, prescribing modified coinsurance contracts, affords unmistakable indication did intend embody rule. 745-750. 3. required 801(c)(3), counting total "all law." There no statutory law cases maintain contested especially departments affected States consistently accepted reports showing claim be. 750-752. No. 524 F.2d 1167, 207 Ct.Cl. 638, 75-1285, 1155, 594, affirmed; 75-1260, 5 Cir., 514 675, reversed remanded. 1 Stuart A. Smith, Washington, D. C., United States. 2 John B. Jones, Jr., Penn Security Life Insurance Company. 3 James R. Harper, Atlanta, Ga., First Railroad Banking Company Georgia. E. Michael Masinter, Consumer Mr. Justice POWELL delivered opinion Court. 6 decision (A&H) purposes. We granted certiorari three resolve conflict Circuits Court Claims. 425 990, 96 2200, 48 814 (1976). 7 * An IRC 801(a), 26 U.S.C. 801(a),1 qualifying treatment.2 A close line will ordinarily achieve savings it can increase decrease so come within definition. 8 risks A&H dispute over computation reserves. treaties, use commonly industry do effect, meet test, accordingly qualify treatment.3 9 Specifically 801(c).4 type involved generally written two- three-year term. policyholders typically pay full advance, wholly "unearned" when initially receives it. See Rev. Rul. 61-167, 1961-2 Cum. Bull. 130, 132. insurer's liability discharged one several ways: granting future promising claims; reinsuring risk solvent reinsurer; returning pro rata event cancellation. Each method discharging may cost money. establishes side accounts device help assure assets necessary responsibilities. O. Dickerson, Health 604-605 (3d ed. 1968) (hereafter Dickerson). Standard accounting field, made mandatory calls equal gross premium.5 simplified example useful: policyholder takes out premium, paid $360. At first $360 unearned, record amount end month, thirty-sixth has elapsed, $10 become "earned."6 reduced $350. Another reduction permitted at second on. II 10 issue forms.7 form, "ceding company," part taxpayer. being earned is, had requirement. fashion statements authorities criticism. acceptance, parties, identified above, taxpayers,8 thereby disqualifying 11 Ins. Co. 1957 Southern Discount Corp. operating successful consumer finance business. Its borrowers, means assuring payment obligations death disability, purchased obtained loans. This known credit usually coextensive coverage loan. commencement coverage, loan running years. Prohibited Georgia itself, sales agent American Bankers Co., receiving return sizable commission services. 12 With view participating underwriter simply profitable business, formed here, owned subsidiary incorporated Arizona, State lowest capital requirements companies. Although Life's low precluded serving law, nonetheless reinsure admitted 13 therefore negotiated Bankers. company. 100% originating Southern, agreeing reimburse losses incurred. equivalent 871/2% received Bankers.9 But mode differed policies. respect policies, month remitted stated percentage collected prior month. however, remainder basis balance period. 14 Again might prove helpful. Assume buys January policy, paying date policy. On February 1, obligated represents premium; there further payments reinsurance. reinsurance, remit only $10, been It same March February, 36 months. 15 I either terminate agreement upon 30 days' notice. termination prospective; continue terms expiration executed. "runoff provision." 16 Because dollars, express provision value premiums. Meantime Life, holding established business.10 Annual filed Arizona reflected challenge disapproval. 17 By 1962 accumulated sufficient surplus insurer. terminated, began placing directly Life. then which issued Life.11 Ultimately retained lion's share risk, but earned. rather complicated contractual provisions, receive initially. 18 Roughly described, follows: received. immediately returned sum meant cover initial expenses. Then, quarter, "experience refunds" based claims experience. If claims, refund 47% (and naturally always were), less sums claims. apparent never retain 3% quarter. Only exceeded encroached, recoup reducing experience later quarters. Actual approached 19 Again, premiums, books. took against them take exception.12 20 taxable years 1958 through 1960, 1964, here. For those computed ratio shown authorities. According figures, qualified Commissioner determined, latter favorable deficiency assessed brought suit refund. Claims, disagreeing trial judge, B 21 relevant entity case petitioner agreement,13 company, another Railroad.14 carried approved 1961-1964. Consequently excluded income consolidated return, pursuant 1504(b)(2) Code. determined status exclusion deficiency. sued prevailed District Court, Appeals Fifth Circuit reversed, relying heavily Economy Finance States, 501 466 (CA7 1974), cert. denied, 420 947, 95 1328, 43 425, rehearing 421 922, 1590, 790 (1975), motion leave file petition pending, 74-701. C 22 Missouri corporation, like separate agreements, reinsured unrelated insurers question, 1963-1965. contain runoff present conceded particular similar respects After deficiencies Commissioner, judge Claims ruled III 23 commences argument suggesting substance recognized See, e. g., Gregory Helvering, 293 465, 470, 55 266, 268, 79 L.Ed. 596 (1935); Knetsch 364 361, 81 132, 128 (1960). think accurate characterization. 24 who entered into after arm's-length negotiation gave large recourse just doing favor delayed invest kept resulting investment income. mere "paymasters," contends, indemnity relieve responsibility policyholders. Had insolvent, still claims.15 25 most claimed W. Hammond, Accounting Fire Casualty 86 (2d 1965); Dickerson 563-564. heavy burden taxpayer's caused computing commissions expenses coverage. drain surplus, able expand broader statistical base loss predictions.16 Through associated itself experienced field. Moreover, shielded period catastrophic losses. Even eventually recapture any deep losses, benefit spread months courts passed found expressly nontax purposes.17 Tax considerations well good deal specific "major motive" reduce taxes vitiate otherwise transaction. Cumberland Pub. Serv. 338 451, 455, 70 280, 282, 94 251 (1950).18 IV Whether transactions, attribute because finds Brief 34. assertion, forms heart following reasoning. provides convenient determining whether qualifies Reserves, actuarial standards, represent liabilities. often carelessly referred "reserve funds," available assets; sheet. standard mathematically in, conceptually distinct cash asset. much indisputably sound. 27 continues: liability, advance indicator final finally responsible bears ultimate having cases, argues, risk. merely paymasters negligible 28 assume treaties.19 And broadest sense are, course, Cf. Helvering Le Gierse, 312 531, 539, 61 646, 649, 85 996 (1941). before us, position sustainable matter abstract logic.20 Rather 29 suggestion plain section case. nn. 4, supra. anything, obstacle accepting position. word "risk" occur. used phrase "unearned premiums" reserve." that, taken context, regarded referring account asset represented dollars. agree reference truncated suggests mechanical application concept. words, Congress' place themselves. so, mechanically contend, necessarily sparse furnishes better early Acts, taxed corporations. underwriting included income, although special deduction additions Act 1918, 234(a)(10), 40 Stat. 1079. 31 1921 became persuaded accurately reflect nature enterprise, form policyholders, some bank deposit. Hearings H.R. 8245 Senate Committee Finance, 67th Cong., 1st Sess., 83 (1921) (testimony Dr. T. S. Adams, Adviser Treasury Department). receipts "were true (to company) analogous permanent investment." Oregon Mutual 311 267, 269, 207, 208, 180 (1940). provided, time, alone receipts. 1921, §§ 242-245, 42 261. rationale apply insurance, continued 246-247. 32 built assumption differences called markedly different Strict adherence dictate insuring segregate rules could applied each. possibility chose instead thumb,21 test.22 official explained: 33 "Some mix insurance. practicable disassociate businesses we 50 per cent measured treated hand, incidental company." Hearings, supra, Adams). 34 passage constitutes significant deliberations. 35 succeeding controversy developed enjoyed carrying fair burden. charges stock favored mutuals, vice versa. nagging compute proper tried host formulas ameliorate problems. H. Rep. 34, 86th 2-7 (1959); S.Rep. 291, 3-11 U.S.Code Cong. Admin.News 1959, p. 1575; Alinco 373 336, 345-349, 178 813, 831-837 (1967). throughout significantly changed.23 1959 legislation structure Income 73 112. subject taxation.24 rewriting substantive provisions taxing companies, not, despite occasional change,25 make alterations few references committee shed little light presented here.26 They explicit implicit 37 More anything appears hearings, reports, debates added 820, concerning contracts companies.27 section, designed problem unintelligible thought embodied unvarying 38 conventional contract reinsurance.28 agrees arising covered insurer, overhead. sets proportion obligation customary, reinsured. 39 variation esoteric area As explained Committee, major reinsurers licensed New York, York unlicensed 4245 608 (1959) (statement Henry F. Rood). Denial places undesirable depleted latter's remains unchanged. Few accept wishing offering contract. Obligations shared before, backing consideration right retention, require formula, reinsurer's investments reserve. id., 609; Wightman, Statements Accounts 150-151 (1952); McGill, 435-440 (rev. 1967). legislation, House, contained contracts. twice, once reinsurer.29 double taxation inequitable, House agreed. That shall contracting consent consenting (in share) 820(c)(1), declared "shall reinsured." 820(c)(3). 41 obligations. Thus, mandates escape 820(c)(3), providing elaborate redundancy. 820(a)(2) specifies optional, requiring fact option all. Plainly incompatible risk.30 himself, interpreting implicitly acknowledged Rev.Rul. 70-508, 1970-2 Cum.Bull. 136. Advice requested elected 820. books, bore wanted know count Relying 801(b) Regulations implementing it, could. dictated precisely opposite result. D impose Instead, rely practices, leaving, makes evident, broad discretion negotiate own terms. open door widespread abuse. "Congress aware extensive, continuing supervision states. obvious subjecting scrutiny agencies additional safeguard overreaching companies." Benefit Revenue, 488 1101, 1108 (CA3 1973), 419 882, 148, 122 (1974). Lamana-Panno-Fallo Industrial 127 56, 58-59 (CA5 1942); F.2d, 345, Ct.Cl., 831. Prudential Benjamin, 328 408, 429-433, 66 1142, 1154-1157, 90 1342 (1946); 1011 (McCarran-Ferguson Act). presenting members drafted bill careful underscore primacy regulation, reserves.31 44 us accordance standards,32 while third court address issue. three, department change reserves.33 treaties.34 V 45 801(c)(2), n. suggests, 46 Our attention drawn statute requires Instead returns main theme asserts, essence, general doctrine risk.35 find difficult infer relied indications contrary. compelling. be.36 consistent construction "by agency charged enforcement entitled great deference courts." NLRB Boeing 412 67, 75, 93 1952, 1957, 752 (1973). Trafficante Metropolitan 409 205, 210, S.Ct., 364, 367, 415 (1972); Udall Tallman, 380 16-18, 792, 801-802, 616 (1965); Skidmore Swift 323 134, 139-140, 65 161, 164, 89 124 (1944). administered officials,37 least where, reason construe differently. meaning disputed reserves.38 VI 47 reasons stated, taxpayers. judgments 75-1221 75-1285 affirmed. judgment remanded proceedings opinion. ordered. 49 WHITE, whom MARSHALL joins, dissenting. today possible almost advantages give mostly cannot join creation truckhole taxation. 51 chosen extremely long-term ultimately claim. Companies accumulate funds invested, accumulated. recognition characteristics risks, allowed taxation.1 Other involve inevitably benefits point relatively distant future. Consequently, manner corporation. 831, 832, 832. Many decided "mixed" enterprises according majority company's nonlife: 53 "(I)f Department), quoted ante, 743. 54 order measure done fraction consisting purpose reserve-ratio determine insurance.2 taxpayers.3 sought obtain arranging arrangements performed functions taxpayers: clearinghouse function, collecting financing lending difference selling expenses, policyholder. 737-738, 16; 466, 477-478 enable whose predominant 56 holds predominantly character "(s)ince . ." Ante, 750. arranging, employed majority's rule, consist entirely whatever held; satisfy test.4 believe allow shelter assuming engaging requisite approval announced today. 57 accompanying regulations "if comprise percent (emphasis added); includes definition 801(a). clear Regulations, "cover advance," Treas. Reg. 1.801-3(e) (1972), "have actually year(s)" 1.801-5(a)(3) "its" physical possession nominal control 58 explicitly answer affirmative reserves: 59 "(Life insurance) net deducted example, ordinary $100 yearly renewable basis, include $90 ($100 minus $10) reserves." 1.801-4(a)(3) (1972). (Emphasis added.) 60 Accord, 1.801-4(d)(5). 801, agreement. calculating denominator (life plus reserves) numerator reserves); recognizes, 748, 30, adopt approach allocation status. bearer reflects familiar principles Lucas Earl, 281 111, 241, 74 731 (1930), where him notwithstanding arrangement party. salary activity "his" he Similarly, applicable Hansen, 360 446, 1270, 1360 (1959).5 62 insists given To reach result, relies, nearly adopted gives choice "modified contracts" 745-748. "redundan(t)" "incompatible" Commissioner's interpretation 748. What overlooks applies 801; prescribes, status, specifically, avoid 820(b). see 820(b)(1), inapplicable "for 801" qualify, 820(a)(1). 63 notes 820(a)(1) denies allocate interprets exception "(mean) invariably 1452 30. "explanation" assumes conclusion attempting justify: arguing about bearing cover. Mandatory inapplicability holder prescribed 758. (3) "(f)or (the) subsection (801) (a)" (or income). short, "affords indication" congressional intent 749, refuted itself.6 64 respectfully dissent. provides: "(a) defined. "For subtitle, 'life company' engaged issuing annuity (either separately combined insurance), noncancellable "(1) (as (b)), "(2) unpaid (whether ascertained), life, health, "comprise (c))." seen, statement text somewhat oversimplified. Reserves ratio. 345-355, 831-847 none involves ignore factor. Statutory citations, unless indicated, 1954. year receipt, stockholders. scheme described Atlas 381 233, 1379, 358 (1965), Jefferson 408 842, 844-846 (CA4), 396 828, 77, 78 (1969). Stock Most mutual 821, implicated 638 (1975); 594 (1975). Government. 675 earlier effect 801(c) part: "(c) Total (a), 'total reserves' "(3) "Life 801(b). (1960) (defining premiums), 69-270, 1969-1 185: Utah Home 763 (CA10), 290 679, 103, 586 (1933); 20, infra. Massachusetts Protective Assn. 114 304 (CA1 1940); Monarch 314 1940). figure straight-line Some sum-of-the-digits Rule 78, detail Pet. Cert. 34a-36a (Findings Fact 10, 11). methods material treaty, obligating Such only; remain unaware 269 482, Indeed, former sections except corporations controlled interests. invokes occasion attempted efforts higher Bank Utah, 405 394, 92 1085, 318 (1972) (§ 482); 340-345, 822-830 269). increased 901/2%. tabular reinsured; liability. addition reviewing forms, conduct regular triennial examinations pooling National Association Commissioners (NAIC). thorough review agreements. NAIC, Examiners Handbook A30-A35 rev. 1970, 2d printing 1974). While examined 1963, 1960 1963. detail, maintenance course four examinations. 1172, 647. details differ seek relationship. 8, relation Superior 462 945 (CA4 1972) (credit reserve). Surplus illustrated example: issues one-year $120, $60 issuance. sheet $120 beginning shows $60. results surplus. elapses, one-twelfth becomes "earned" released level, writing new number old expire, drain, expected range; release match imposed expanding, surplus-drain problem. 606; 764; Reinsurance provide amelioration. above reinsures half treaty simpler II. establish immediate ceded; remits $30, retaining $30. drains $30 twice many depletion 97a-98a, 100a, 105a 18, 19, 25, 37); Railroad, 14a-15a (District finding Appeals, 677). relies asserted analogy (1959). dealing accrual accounting, inapposite. world unto itself. Brown 291 193, 201, 356, 360, (1934); Great Commonwealth 491 109 Mechanical yield sound conceive changes harder surely victory short-lived. Brown, 563, 580, 1162, 1171, 75 (1965) (Harlan, J., concurring). clear, event, traditional logic consists parts, expense portion, "loading," commissions, administrative profit, portion. latter, "morbidity" element, estimate what now responsibilities arise; fixed. Nearly out, connected paid, liabilities strictly needed Nevertheless, uniformly premium. stand footing mortality tables rates interest. loading element. comport viewpoint regulators yields simplicity computation. Establishing larger tends conservative operation availability refunds Mayerson, Ensuring Solvency Property Liability Companies, Insurance, Social Policy 146, 171-172 (S. Kimball Denenberg eds. 1969); 604-606; 764. adhered completely underlying differently too reading Security, 608. 242 Act, 261, provided: "That title (including fulfillment centum funds." 1942 add specifying elements appear 1942, 163, 867, amending 201(b) 1939. note addition, elaborate. glimmer 2333, 77th (1942); 1631, 145 (1942). 2, During hearings witnesses legislators expressed concern so-called specialty particularly reaping excessive g. Subcommittee Taxation Ways Means, 85th 242-244, 330, 422-434 (1958); 84-85 proposed deny altering 330; 85. No addressed clearly led 1098, 84th 3-7 (1955); 1571, 3-8 (1956). 22-23 41-44 "s Optional general. Treatment Secretary his delegate, ) treated, (other 801), Consent "Paragraph consent, delegate prescribe "(A) paragraph contract, "(B) subsection. "Such given, rescinded delegate. "(b) Definition 'modified contract' (hereinafter 'the reinsurer') indemnify reinsured') reinsured, retains ownership "(4) incurred, Federal imposed, Special rules. "Under (a)(1) extent improper reinsured) reinsured: assets. "The Coinsurance carries substantially field property Steffen, Reinsurance, 1035 (D. Gregg 1964); Huebner, K. Black, Cline, 95-100 1976). taxed. weakened unable elect 136, unpersuasive. derives "reserve" 739-740. ways computed, germane reasoning Either none. 105 Rec. 2569, 2576-2577 (remarks Reps. Mills Simpson, chairman ranking minority member, respectively, Taxation). 108a (Finding 47); 16a (finding Court; finding). 1170-1172, 643-647; Court), noted disapproval 677 8; 1157, 599. 48a 29). current bases determination criteria arguably relative importance 483 (Stevens, dissenting). We, written. Furthermore, contends "would wide ramifications prepared visit absent guidance direction." U.S., 575, 1168. necessary, Ariz.Rev.Stat.Ann. 20-506 (1975) "every force." 20-104, " 'Insurer' every person making insurance." 20-103 defines "insurance" "a undertakes summarizing concludes: aspect statutes establishment liable coverage." 69-70. read sweeping conclusion. introduced testimony officials indicated omission taxpayers' "unwittingly" unfamiliar after-the-fact single outweigh formal, rendered names commissioners opportunity review. formal withstood audits. 12, seem determinative: "(T)he 'reserves law' State, Territory, Columbia promulgated exercise power conferred statute, beneficiaries." Treas.Reg. 1.801-5(b) added). 1.801-5(a) (indicating "must claimed"). deemed controlling McCoach North America, 244 585, 709, 1333 (1917) followed Boston 197, 97, 232 (1925); Edwards, 271 109, 436, 859 (1926); Inter-Mountain 294 686, 572, 1227 (1935). Those mandated "required law" technical Rather, various skeletal Acts necessitated restrictive view. McCoach, 589, 711. 948, 950-952 (CA8), 317 655, 51, 87 527 questions arise recent enactments. "life 801(b), originated replaced problematic concept McCoach. Occidental 385 4-7 (CA9 calculated three-stage process outlined intricate calculations narrowing Clark, Financial Intermediaries, 84 Yale L.J. 1603, 1637-1664 deferring 728 estimated 70% 75% 1642-1643, 152. 236-237, 247-249, 1381-1382, 1387-1388, (1965). purpose, "primary activity" determines status: 'insurance underwritten name, charter powers, subjection laws authorized intends carry on, Code." 1.801-3(a)(1) "the risks" 740. concede 645 1160, 1975). evidently hopes prevent "widespread abuse" type, But, observed, goal regulation protect treasury avoidance sure aside 645. why, long care them. hope taking advantage loophole created undermined 801(c)(3) (state) "(t)he be." 751. (Footnote omitted.) failure inclusion uncontradicted officials' unfamiliarity purporting shift non-risk-bearing 751 36. shifting allocations sufficiently novel, complex, disguised detection officials, avoidance. accrual-basis automobile dealers sold customer installment nonpayment customers. loss, purchase price dealers, amounts nonpayment. accrued established, vested belonged respective contingent 463, 1280. policies; balance, dealer bearers distinguishes Hansen fiat, stating "(l)ife itself." 739 18. hardly attempts Ruling 820(a), 802. define income" 802, 802(b), 804(a) (1), 805(a) (c), decide ruling definition, seeking him, qualified.

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