Court Opinion

ID: 9376491
Source: CourtListenerOpinion
Date Created: 2023-03-02 20:01:15.291994+00
Date Added: 2024-06-11T17:17:07.255012
License: Public Domain

United States Tax Court

                                T.C. Memo. 2023-27

                  COMMONWEALTH UNDERWRITING &
                      ANNUITY SERVICES, INC.,
                            Petitioner

                                           v.

               COMMISSIONER OF INTERNAL REVENUE,
                           Respondent

                                      —————

Docket No. 8228-18X.                                           Filed March 2, 2023.

                                      —————

Kenneth Rubinstein, for petitioner.

Rosemary Y. Oluwo, for respondent.

            MEMORANDUM FINDINGS OF FACT AND OPINION

       CARLUZZO, Chief Special Trial Judge: Respondent determined
that petitioner does not qualify for exemption from federal tax under
section 501(a) 1 because, contrary to petitioner’s claim, it is not an
organization described in section 501(c)(15). Petitioner challenges that
determination in this declaratory judgment proceeding. See § 7428(a). 2
The disposition of an action for declaratory judgment involving the
initial qualification or classification of an exempt organization will

        1Unless otherwise indicated, statutory references are to the Internal Revenue
Code, Title 26 U.S.C., in effect at all relevant times, and Rule references are to the Tax
Court Rules of Practice and Procedure.
        2 Section 7428(a)(1)(E) provides the Court with jurisdiction to make a
declaration in a case of actual controversy involving a determination by the Secretary
with respect to the initial qualification or continuing qualification of an organization
as an organization described in section 501(c)(15) which is exempt from tax under
section 501(a).

                                  Served 03/02/23
                                    2

[*2] ordinarily be made on the basis of the administrative record. Rule
217(a). The case has been submitted without trial; the administrative
record, admitted into evidence by stipulation, is the only evidence
offered by the parties and is the source of the factual summary that
follows. See Rules 122, 217(b)(1) and (2). Petitioner’s principal place of
business was in Belize City, Belize, when the Petition was filed.

       Petitioner bears the burden of proving that respondent’s
determination is incorrect. See Rule 142(a); Partners in Charity, Inc. v.
Commissioner, 141 T.C. 151, 162 (2013); Calhoun Acad. v.
Commissioner, 94 T.C. 284, 295 (1990). For the following reasons, we
find that petitioner has failed to do so.

                          FINDINGS OF FACT

      On January 17, 2013, petitioner was organized by a
“Memorandum of Association and Articles of Association”
(memorandum of association) in Belize, which shows petitioner’s sole
shareholder to be its only flesh and blood officer. Nothing in the record
suggests that petitioner adopted bylaws.

       According to the memorandum of association, petitioner was
organized to engage in any act or activity that is not prohibited under
any law then in force in Belize, including, but not limited to carrying “on
the business of an investment company.” The general business
objectives listed in petitioner’s memorandum of association do not
include the marketing, issuance, or maintenance of commercial annuity
contracts.

       During the relevant time, petitioner sold annuity contracts to
individuals in consideration for purchase payments. The parties dispute
the characterization of the purchase payments for federal income tax
purposes. Upon receipt, purchase payments were transferred to a
segregated trust account administered by an independent trustee
neither related nor subordinate to petitioner. The segregated trust
account was further divided among various subaccounts invested in
separate investment funds. The trustee of the segregated trust account
was responsible for the annuity contracts’ assets, investments, and
distributions of funds as necessary pursuant to the terms of the annuity
contracts. According to the annuity contracts, the assets held in the
segregated trust accounts and subaccounts are the “property” of
petitioner rather than of the clients that provided the purchase
payments.
                                          3

[*3] The annuity contracts provide that “prior to [the] annuitization
[date] the Primary Beneficiary may select” an annuity payment option
“available under the contract,” including a life annuity, a joint and
survivor annuity, or “an Annuity Payment Option not set forth in the
Contract, but which is acceptable to” petitioner. Further, the annuity
contracts specify that petitioner will “make payments under an annuity
option [no] less frequently than annually.” The annuity contracts also
provide for an initial variable account charge payment to petitioner from
the purchase payments “designed to compensate . . . [petitioner] for
assuming the mortality risks and expense risks under this Contract and
to reimburse . . . [petitioner] for expenses incurred in the issuance of the
Contract,” as well as an annual maintenance charge payment to
petitioner deducted from the variable account “designed to compensate
. . . [petitioner] for assuming ongoing mortality risks and expense risks
under this Contract and to reimburse . . . [petitioner] for expenses
incurred in the annual administration of the Contract.” Pursuant to the
annuity contracts, each investment fund is assessed investment
management fees by the fund’s investment adviser “for managing the
Fund and selecting its portfolio of securities.”

       Pursuant to the annuity contracts, the value of each segregated
trust account depends on the performance of the investment options
chosen. The amount of each annuity payment, likewise, depends on the
performance of the investment options chosen and is not guaranteed for
that reason.

       The annuity contracts provide a death benefit provision which
states that “the Death Benefit that will be paid under this Contract to
the Beneficiary upon the death of the Annuitant will be the total of all
Purchase Payments received by . . . [petitioner] prior to the date of the
Annuitant’s death, less all annuity payments and other payments
previously made by . . . [petitioner] and less any applicable [contingent
deferred sales charge].”

      Petitioner received $82,621,231 and $2,131,442 in purchase
payments in 2013 and 2014, respectively, as consideration for the sale
of the annuity contracts. According to respondent, the purchase
payments constitute premiums; according to petitioner, the purchase
payments “arguably” are premiums, but not premium income. 3

      3   The distinction has not been explained. See § 832(b).
                                        4

[*4] Petitioner also received $150,000 4 and $194,782 in maintenance
fees in 2013 and 2014, respectively. According to petitioner, and without
explaining why or how, only the maintenance fees constitute premiums.

       On May 12, 2014, petitioner submitted to the IRS a Form 1024,
Application for Recognition of Exemption Under Section 501(a) of the
Internal Revenue Code. The narrative description of petitioner’s
activities included with the Form 1024 states in part that petitioner

       markets and issues commercial annuity contracts to
       individuals worldwide and it administers and maintains
       such contracts. This constitutes 100% of the Company’s
       activities. The activities are carried out by the officers and
       personnel of the Company. The Company does not engage
       in marketing, sales or solicitation of such contracts in the
       United States. The annuity contracts issued by the
       Company do not contain any life insurance component, nor
       do they provide any death benefit, other than the return of
       any unpaid principal remaining under the contract. The
       total gross income of the Company will not exceed US
       $600,000 per annum. All income will be derived from
       annuity contract maintenance fees.

      Respondent issued petitioner a final adverse determination letter
dated January 24, 2018, denying petitioner’s application.          The
determination letter stated in pertinent part:

       This is a final adverse determination that you do not
       qualify for exemption from Federal income tax under
       Internal Revenue Code (the “Code”) section 501(a) as an
       organization described in Code Section 501(c)(15). The
       adverse determination was made for the following
       reason(s): Applicant does not qualify for exemption under
       section 501(c)(15) because Applicant has not established
       that it is an insurance company described in section 816
       (other than life) within the meaning of section 501(c)(15),
       and it does not meet the requirements of section 501(c)(15)
       that its gross receipts not exceed $600,000 and that more

       4 There is some confusion whether the proper figure for 2013 is $150,000 or

$154,392, but this does not affect our conclusion here.
                                           5

[*5]    than 50 percent of its receipts consist of premiums.
        Therefore, your application for exemption is denied.

                                     OPINION

        An organization that is described in section 501(c)(15) can qualify
for exemption from federal income tax under section 501(a) if the
organization: (1) is an insurance company as defined in section 816(a)
(other than a life insurance company) 5 and (2) the organization’s gross
receipts for the taxable year do not exceed $600,000 and more than 50%
of its receipts consist of premiums (financial test). See § 501(c)(15)(A)(i).

       Assuming without finding that petitioner is an insurance
company as defined in section 816(a), we address whether petitioner
satisfies the financial test in section 501(c)(15)(A)(i). 6

       According to respondent, the purchase payments of $82,621,231
and $2,131,442 petitioner received in 2013 and 2014, respectively,
constitute “gross receipts” for purposes of section 501(c)(15)(A), and
because petitioner’s gross receipts for each of those years exceed
$600,000, petitioner fails the financial test in section 501(c)(15)(A)(i)(I)
and is not exempt from tax under section 501(a).

       Petitioner, on the other hand, contends that the purchase
payments it received did not constitute gross income within the meaning
of section 501(c)(15)(A). Specifically, petitioner argues that (1) because
the purchase payments were not “retained, controlled or utilized by”
petitioner, they do not constitute gross receipts, and (2) the purchase
payments “do not comprise premium income,” even if they may be
considered premiums. Petitioner further contends that its only source
of gross receipts during the years in issue was annual maintenance
charges, which did not exceed $600,000 during any year in issue, and

        5Section 816(a) defines an insurance company as any company “more than half
of the business of which during the taxable year is the issuing of insurance or annuity
contracts.”
         6 Relying upon a statement made by respondent’s Appeals officer that the

financial test was “not in issue,” petitioner takes the position that the financial test
should not be taken into account here because the test was not challenged by
respondent during the consideration of its application for exemption. The express text
of the final adverse determination letter demonstrates otherwise. Furthermore,
petitioner does not, and could not, argue that it was precluded or dissuaded from
offering evidence that it complied with the financial tests during administrative
consideration. The evidence was offered and, as noted, apparently taken into account
in the final adverse determination letter.
                                    6

[*6] therefore it satisfies the financial test in section 501(c)(15)(A) and
is a qualifying organization exempt from tax under section 501(a).

       Insurance premiums are includable in an insurance company’s
gross income. See Avrahami v. Commissioner, 149 T.C. 144, 174–75
(2017).     Petitioner acknowledges that the purchase payments
“constituted the funds used to make annuity payments.” This appears
to fit squarely within the definition of a premium. See National
Association of Insurance Commissioners, Statement of Statutory
Accounting No. 51—Life Contracts, para. 5 (explaining that a premium
“shall be recognized as income on the gross basis (amount charged to the
policyholder) when due from policyholders”). Petitioner’s contention
that the purchase payments were not “retained, controlled or utilized
by” petitioner is contradicted by its own annuity contracts, which
provide that the assets held in the segregated trust accounts and
subaccounts “remain the property of” petitioner. Moreover, petitioner
has not provided any authority suggesting that the premiums were not
premium income. Therefore, petitioner has not established that its
gross receipts did not exceed $600,000 during either year in issue,
thereby failing to satisfy the financial test in section 501(c)(15)(A).

       On the other hand, if the purchase payments are not properly
treated as premiums, then petitioner would seem to have no premium
income because petitioner has failed to establish that the maintenance
fees it received should be considered “premiums.” Viewed in that
manner, petitioner fails the prong of the financial test that requires
more than 50% of its gross receipts to consist of premiums. See
§ 501(c)(15)(A)(i)(II).

       It follows that petitioner is not an organization that is described
in section 501(c)(15) and therefore is not exempt from federal tax under
section 501(a).

      To reflect the foregoing,

      Decision will be entered for respondent.