Court Opinion

ID: 9426756
Source: CourtListenerOpinion
Date Created: 2023-08-02 23:18:51.623917+00
Date Added: 2024-06-11T17:23:02.949275
License: Public Domain

Mr. Justice White,
with whom Mr. Justice Marshall joins, dissenting.
The Court today makes it possible for insurance companies doing almost no life insurance business to qualify for major tax advantages Congress meant to give only to companies doing mostly life insurance business. I cannot join in the creation of this truckhole in the law of insurance taxation.
I
Congress has chosen to give life insurance companies extremely favorable federal income tax treatment. The reason for this preferential tax treatment is the nature of life insurance risks. They are long-term risks that increase over the period of coverage and that will ultimately require the payment of a claim. Companies that assume life insurance risks therefore must accumulate substantial reserve funds to meet future claims; these reserve funds are invested, and a large portion of the investment income is then added to the funds already accumulated. In recognition of the special *754characteristics of life insurance risks, Congress has allowed a substantial portion of life insurance company income to escape taxation.1
Other types of insurance, such as the accident and health (A&H) coverage provided by the taxpayers in these cases, do not involve the assumption of long-term risks that inevitably will require the payment of benefits at some point in the relatively distant future. Consequently, Congress has provided for taxation of such nonlife insurance companies in much the same manner as any other corporation. See Internal Revenue Code of 1954, §§ 831, 832, 26 U. S. C. §§ 831, 832. Many companies mix nonlife insurance business with their life insurance business, and Congress has decided to tax such “mixed” enterprises according to whether the majority of the company’s business is life or nonlife:
“[I]f this accident and health business was more than 50 per cent of their business, as measured by their reserves, it could not be treated as a life insurance company. On the other hand, if their accident and health insurance were incidental and represented less than 50 per cent of their business we treated them as a life insurance company.” Hearings on H. R. 8245 before the Senate Committee on Finance, 67th Cong., 1st Sess., 85 (1921) (testimony of Dr. T. S. Adams, Tax Adviser to the Treasury Department), also quoted ante, at 743.
*755In order to measure the proportion of life insurance business done by an insurance company, Congress used the fraction of total insurance reserves consisting of life insurance reserves, as defined by § 801. The purpose of this reserve-ratio test is, of course, to determine whether a majority of an insurance company’s business is life insurance.2
More than 50% of the business of the taxpayer insurance companies for the taxable years in question here was nonlife rather than life insurance business, as measured by the reserves accumulated to cover all life and nonlife risks assumed by the taxpayers.3 The taxpayers sought to obtain preferential treatment as life insurance companies under § 801 by arranging with other companies to hold the necessary reserves for the taxpayers. I agree with the majority that these arrangements had economic substance in that the companies holding the reserves performed two additional *756functions for the taxpayers: a clearinghouse function, collecting premiums and paying out claims, and a financing function, lending the difference between the reserves established for the policy and the premiums, less selling expenses, received from the policyholder. See ante, at 737-738, and n. 16; Economy Finance Corp. v. United States, 501 F. 2d 466, 477-478 (CA7 1974), cert. denied, 420 U. S. 947, rehearing denied, 421 U. S. 922 (1975), motion for leave to file second petition for rehearing pending, No. 74-701. But I cannot agree that these arrangements enable the taxpayers to qualify for tax savings Congress intended to give only to insurance companies whose predominant business is the assumption of insurance risks.
II
The majority holds that the taxpayers may obtain these tax savings despite the predominantly nonlife character of their insurance business, “[s]ince the taxpayers neither held the unearned [A&H] premium dollars nor set up the corresponding unearned premium reserves, and since that treatment was in accord with customary practice as policed by the state regulatory authorities . . . .” Ante, at 750. This rule would permit an A&H insurance company to qualify for preferential treatment as a life insurance company by selling a few life policies and then arranging, by means similar to those employed here, for a third party to hold the A&H premiums and the corresponding reserves. Under the majority’s rule, these reserves held by the third party to cover risks assumed by the A&H company would not be attributed to that company; its total reserves for purposes of § 801 would consist almost entirely of whatever life insurance reserves it held; and the company would satisfy the reserve-ratio test.4 I *757cannot believe that Congress intended to allow an insurance company to shelter its nonlife insurance income from taxation merely by assuming an incidental amount of life insurance risks and engaging another company to hold its reserves through arrangements with the requisite economic substance and state regulatory approval to satisfy the standard, announced by the majority today.
The language of § 801 and its accompanying regulations does not require such a result. Section 801 (a) provides that any insurance company may qualify as a life insurance company “if its life insurance reserves . . . comprise more than 50 percent of its total reserves . . (emphasis added); § 801 (c) (2) includes “unearned premiums” in the definition *758of “total reserves” for purposes of § 801 (a). It is clear that, as required by Treasury Regulations, unearned premium reserves were set up to “cover the cost of carrying the [A&H] insurance risk for the period for which the premiums have been paid in advance,” Treas. Reg. § 1.801-3 (e) (1972), and that these reserves “have been actually held during the taxable year[s]” at issue here. § 1.801-5 (a)(3) (1960). The question is whether the A&H reserves set up to cover risks assumed by each taxpayer are considered to be “its” reserves even though they are in the physical possession and under the nominal control of another company.
The Regulations explicitly answer this question in the affirmative for life insurance reserves:
“[Life insurance] reserves held by the company with respect to the net value of risks reinsured in other solvent companies . . . shall be deducted from the company’s life insurance reserves. For example, if an ordinary life policy with a reserve of $100 is reinsured in another solvent company on a yearly renewable term basis, and the reserve on such yearly renewable term policy is $10, the reinsured company shall include $90 ($100 minus $10) in determining its life insurance reserves.” § 1.801-4 (a) (3) (1972). (Emphasis added.)
Accord, § 1.801-4 (d) (5). Thus, for purposes of the reserve ratio test of § 801, life insurance reserves are attributable to the company assuming the risk under a reinsurance agreement. The same attribution rule should be used in calculating the denominator of the reserve ratio (life plus nonlife reserves) as for the numerator (life reserves); as the majority recognizes, ante, at 748 n. 30, there is no reason not to adopt a consistent approach to allocation of both life and nonlife reserves in determining life insurance company status.
The rule that life and nonlife reserves are attributable to the risk bearer reflects the familiar principles of cases such as Lucas v. Earl, 281 U. S. 111 (1930), where income earned by *759a taxpayer was attributed to him notwithstanding a contractual arrangement under which the income was paid over to a third party. In that case, the salary derived from the taxpayer’s business activity was treated as “his” income even though he did not receive or hold it. Similarly, the reserves applicable to the A&H insurance business of each of the taxpayers here should be treated as “its” reserves. Cf. Commissioner v. Hansen, 360 U. S. 446 (1959).5
III
The majority insists nonetheless that these predominantly nonlife insurance companies be given preferential tax treatment intended only for predominantly life insurance companies. To reach this result, the majority relies, not on the language or legislative history of the § 801 reserve-ratio test, but on § 820 of the Code, which was added nearly 40 years after the reserve-ratio test was adopted and which gives life insurance companies the choice of whether to have reserves *760under certain “modified coinsurance contracts” attributed to the reinsurer who bears the risk or to the reinsured who holds the reserves under the contract. See ante, at 745-748. The majority finds this section at once “redundan [t]” and “incompatible” with the Commissioner's interpretation of § 801. Ante, at 748. What the majority overlooks is that § 820 applies only to companies that have already qualified as life insurance companies by virtue of § 801; it prescribes, not how those companies qualify for life insurance company status, but rather how they are to be taxed once they have qualified for such status—specifically, how they can avoid double taxation on investment income received by the reinsurer but paid over to the reinsured pursuant to the particular type of reinsurance contract defined in § 820 (b). The option to attribute reserves for these contracts either to the reinsurer or the reinsured is given only to life insurance companies which qualify under § 801, see § 820 (b)(1), and is expressly made inapplicable “for purposes of section 801” in determining whether they so qualify, §820 (a)(1).
The majority notes that § 820 (a)(1) denies insurance companies the choice of how to allocate their modified coinsurance contract reserves for purposes of the § 801 reserve-ratio test, but interprets this exception to § 820 to “[mean] that for purposes of § 801 the reserves are invariably treated as held by the ceding company. . . .” Ante, at 748 n. 30. This “explanation” simply assumes the conclusion that the majority is attempting to justify: What the parties to these cases are arguing about is whether for § 801 purposes reserves are invariably attributable to the company holding them rather than to the company bearing the risks that the reserves were set up to cover. Mandatory attribution to the risk bearer under § 801 is just as consistent with the inapplicability of the § 820 option as is mandatory attribution to the holder of those reserves, and is more consistent with the attribution rule prescribed by the Regulations for life insurance reserves. See *761supra, at 758. Moreover, the definition of nonlife reserves under §§ 801 (c) (2) and (3) is explicitly made applicable only “[f]or purposes of [the] subsection [801] (a)” reserve-ratio test. The attribution rule at issue in these cases thus does not apply to the § 820 rules for taxing the income of life insurance companies from modified coinsurance contracts (or to the taxation of any other insurance income). In short, the majority’s conclusion that § 820 “affords an unmistakable indication” of congressional intent with respect to attribution of reserves under § 801, ante, at 749, is refuted by the language of the Code itself.6
For the reasons stated, I respectfully dissent.

 Life insurance company taxable income is calculated by a complicated three-stage process outlined in Jefferson Standard Life Ins. Co. v. United States, 408 F. 2d 842, 844-846 (CA4), cert. denied, 396 U. S. 828 (1969). The end result of these intricate calculations is a substantial narrowing of the tax base of such companies. See Clark, The Federal Income Taxation of Financial Intermediaries, 84 Yale L. J. 1603, 1637-1664 (1975). In addition to deferring taxation on 50% of underwriting income, ante, at 728 n. 2, life insurance companies are not taxed on an estimated 70% to 75% of their net investment income. Clark, supra, at 1642-1643, and n. 152. See United States v. Atlas Life Ins. Co., 381 U. S. 233, 236-237, 247-249 (1965).

 In order to qualify under § 801 as a “life insurance company,” the taxpayer first must qualify as an “insurance company.” For this purpose, as well as for qualifying as a “life insurance company,” the “primary and predominant business activity” of the company determines its tax status:
“The term ‘insurance company’ means a company whose primary and predominant business activity during the taxable year is the issuing of insurance or annuity contracts or the reinsuring of risks underwritten by insurance companies. Thus, though its name, charter powers, and subjection to State insurance laws are. significant in determining the business which a company is authorized and intends to carry on, it is the character of the business actually done in the taxable year which determines whether a company is taxable as an insurance company under the Internal Revenue Code.” Treas. Reg. § 1.801-3 (a) (1) (1972). (Emphasis added.)

 The majority assumes that “the taxpayers did take on all substantial risks” under the arrangements by which the A&H reserves in relation to these risks were held by other companies. Ante, at 740. The taxpayers concede and the courts below found that if these A&H reserves are attributable to the taxpayers, they do not qualify as life insurance companies under the reserve-ratio test. 207 Ct. Cl. 638, 645, 524 F. 2d 1167, 1171 (1975); 207 Ct. Cl. 594, 604-605, 524 F. 2d 1155, 1160 (1975); 514 F. 2d 675 (CA5 1975).

 The majority evidently hopes that state regulatory authorities will prevent “widespread abuse” of this type, ante, at 749, by requiring a company assuming insurance risks to hold the corresponding reserves. But, as the Court of Claims below in No. 75-1221 observed, the goal of *757state insurance regulation is not to protect the federal treasury from tax avoidance by insurance companies doing predominantly nonlife business, but rather to protect policyholders by making sure that funds are set aside out of premium receipts for payment of claims. 207 Ct. Cl., at 645, 524 F. 2d, at 1171. The majority suggests no reason why, as long as the insurer has made some arrangement for the establishment of reserves, the state regulatory authorities will care who holds them.
The majority’s hope that the States will prevent insurance companies from taking advantage of the loophole it has created is further undermined by its holding that the A&H reserves involved in these cases were not attributable to the taxpayers under § 801 (c) (3) as “other insurance reserves required by [state] law.” Ante, at 750-752. The majority reasons that the taxpayers were not required by state law to maintain these A&H reserves because “[t]he insurance departments of the affected States consistently accepted annual reports showing reserves held as the taxpayers claim they should be.” Ante at 751. (Footnote omitted.) The majority relies on this failure of state regulatory authorities to require inclusion of the A&H reserves in the taxpayers’ annual statements, despite uncontradicted testimony of state insurance officials that the reason for this failure was the state officials’ unfamiliarity with these particular arrangements purporting to shift reserves to non-risk-bearing companies. Ante, at 751 n. 36. Thus, if a company’s arrangements for shifting reserve allocations are sufficiently novel, complex, or well disguised in its annual statements to escape detection by state insurance officials, state regulation will not help at all to close the door to widespread federal income tax avoidance.

 In Hansen, accrual-basis automobile dealers had sold customer installment obligations to finance companies, who required the dealers to reimburse them for losses arising from nonpayment by the customers. To cover this risk of loss, the dealers retained a portion of the purchase price of the obligations as a reserve. The funds in these reserve accounts were ultimately paid over to the dealers, less amounts applied to cover the losses from nonpayment. The Court held that these reserve accounts were income that accrued to the dealers when the accounts were established, because at that time the reserve funds “were vested in and belonged to the respective dealers, subject only to their . . . contingent liabilities to the finance companies.” 360 U. S., at 463. Similarly, the taxpayers in these cases allowed other parties to retain the purchase price of A&H insurance policies and to apply part of those funds to the payment of taxpayers’ contingent liabilities under the A&H policies; the balance, as in Hansen, was remitted to the taxpayers. These reserves, like the dealer reserves held by the finance companies in Hansen, should be attributed to the risk bearers for tax purposes.
The majority distinguishes Hansen by fiat, stating only that "[l]ife insurance accounting is a world unto itself.” Ante, at 739 n. 18. This is hardly a reason to ignore accepted principles of federal income taxation.

 The majority attempts to find support for its position in a Revenue Ruling requested by the parties to a modified coinsurance contract under § 820 (b). Rev. Rul. 70-508, 1970-2 Cum. Bull. 136. As permitted by § 820 (a), the parties chose to attribute to the reinsured company the reserves on the portion of the risks reinsured with the other company. The reinsured company was assumed to be a life insurance company for purposes of § 801; the question was how its reserves should be calculated for purposes of the tax on life insurance companies imposed under § 802. See Rev. Rul. 70-508, supra. Because the definition of life insurance company reserves in § 801 (b) is used to define “life insurance company taxable income” under § 802, see §§ 802 (b), 804 (a) (1), 805 (a) and (c), the Commissioner had to decide whether the reserves in question were within the § 801 (b) definition for purposes of calculating the tax imposed under § 802. In ruling that the reserves did come within this definition, the Commissioner did not decide how reserves should be attributed for companies seeking to qualify for fife insurance company status. That issue was not before him, because the companies had already qualified.