Court Opinion

ID: 4480442
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:14:18.095878+00
Date Added: 2024-06-11T14:53:39.411252
License: Public Domain

Tannenwald, J., dissenting: I hold to the view that the guaranty fund certificates herein did not create that degree of debtor-creditor relationship sufficient to justify the deduction of the $35,000 paid each year as “interest paid or accrued * * * on indebtedness” within the meaning of section 822 (c) (5). The certificates were in form a promise to pay money advanced and the semiannual payments were designated as “interest.” But it is clear that we are not bound thereby in determining the proper treatment of such payments under the Federal income tax laws. See Benjamin Franklin Life Assurance Co., 46 B.T.A. 616, 618 (1942). Many of the terms of the certificates depart from the standards normally considered sufficiently indicative of an indebtedness to justify the deduction of periodic payments in respect thereof as interest. The semiannual payments herein are to be made only if the net profits or unused or unabsorbed premiums (after all expenses and losses and a reserve for reinsurance) are sufficient.1 There is no date, short of liquidation of petitioner, on which the principal is required to be paid and, of course, the certificate holders have no way of compelling liquidation. Retirement of the principal amount of the certificates is entirely at the option of petitioner’s board of directors and then only if the remaining surplus is in a specified amount. Moreover, the certificates are severely limited as to transferability; petitioner has the right to designate another certificate holder or a policyholder to purchase the certificate at an appraised value not only in the event of a proposed sale, 'but also in the event of transfer by death, sale on execution, bankruptcy, or insolvency. Finally, the certificate holders have important voting rights, namely, to elect one-half the board of directors. The cases in this area which might be considered as supporting petitioner’s position are clearly distinguishable. Commissioner v. National Grange Mut. L. Co., 80 F. 2d 316 (C.A. 1, 1935), affirming 31 B.T.A. 666 (1934); Benjamin Franldin Life Assurance Co., supra; Manhattan Mutual Life Insurance Co., 37 B.T.A. 1041 (1938). In none of these cases were the certificate holders entitled to vote.2 Nor is there anything to indicate that there were any restrictions whatever on transferability. In National Grange, the interest was required to be paid if a mathematically specified level of surplus or profits was reached; in Benjamin Franklin, the Court held that the principal as well as the interest was required to be paid as soon as there was sufficient surplus — i.e., at a time prior to liquidation; and in Manhattan Mutual Life, the interest was guaranteed and was payable irrespective of surplus or profits. There is no doubt that, under State law, the guaranty fund was essential to petitioner’s underwriting activities. The parties admit that the certificates were issued in order to meet the legal requirements of the various States in which petitioner properly conducted its insurance 'business. Such being the case, the required semiannual payments of interest quite properly might be considered a normal business expense and, other things being equal, deductible on that basis. But other things are not equal. Petitioner is a member of a special species under the income tax laws. As a mutual insurance company, it has been entitled to special treatment since 1921. See 8 Mertens, Law of Federal Income Taxation sec. 44.01 et seq. (1964 rev.). During the years at issue, its taxability was based on its investment income and it was entitled, under the then applicable provisions of section 822, only to certain itemized deductions of which ordinary and necessary business expenses connected with its underwriting activities was not one. Since January 1, 1963, underwriting income is also included in the tax base and such expenses are now deductible. Sec. 823. Whatever may be the proper conclusion as to the deductibility after that date of the type of payments involved herein as ordinary and necessary business expenses, to attempt to classify the certificates herein as “indebtedness” is like trying to fit a square peg into a round hole.3 Beyond this, I believe that the majority may unintentionally be providing ammunition in respect of issues, involving the characterization of instruments, which may arise in future cases and cannot now readily be foreseen. I would hold that petitioner’s guaranty fund certificates were not “indebtedness” and that consequently the semiannual payments thereon were not “interest paid or accrued.” Compare Pacific Northwest Finance Corporation, 3 T.C. 498 (1944). Having reached this conclusion, it becomes necessary to deal with petitioner’s alternative assertion that, if the certificates are not “indebtedness” and the semiannual payments are not “interest” within the meaning of section 822(c)(5), it necessarily follows that the certificates are stock. From (this, petitioner argues that it is not a mutual insurance company taxable under section 821 and therefore must be taxable under section 831 as an insurance company “other than a mutual insurance company.” 4 Petitioner’s line of reasoning is not as inexorable as petitioner would have us believe. Assuming without deciding that the certificates partake of the nature of preferred stock, petitioner is nevertheless a mutual insurance company within the meaning of section 821. Commissioner v. National Grange Mut. L. Co., supra; Holyoke Mutual Fire Insurance Co., 28 T.C. 112 (1957) ; Property Owners Mutual Insurance Co., 28 T.C. 1007 (1957) ; Citizens Fund Mutual Fire Insurance Co., 28 T.C. 1017 (1957). Raum, Dawson, Hoyt, and Simpson, JJ., agree with this dissent.   On the face of the certificates, it Is not clear whether the “Interest” payments were cumulative.    In Holyoke Mutual Fire Insurance Co., 28 T.C. 112 (1257), Property Owners Mutual Insurance Co., 28 T.C. 1007 (1957), and Citizens Fund Mutual Fire Insurance Co., 28 T.C. 1017 (1957), the certificate holders also had voting rights but the question of deductibility of “interest” was not before the Court.    In view of the fact that the instant case involves taxable years prior to that date, we do not have before us the question of the includability of the payments herein in such category by reason of the fact that the establishment of the guaranty fundi was a prerequisite to the conduct of petitioner’s insurance business in various States.    Interestingly enough, the application of see. 831 to petitioner would appear to produce operating losses with a consequent overpayment of taxes during the taxable years.