Court Opinion

ID: 4590388
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:03:31.773461+00
Date Added: 2024-06-11T07:59:24.653454
License: Public Domain

MASSACHUSETTS PROTECTIVE ASSOCIATION, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Massachusetts Protective Ass'n v. CommissionerDocket No. 19803.United States Board of Tax Appeals18 B.T.A. 810; 1930 BTA LEXIS 2590; January 14, 1930, Promulgated *2590  1.  The petitioner is an insurance company taxable under section 246 of the Revenue Act of 1921.  During the year 1922 it received $125,000 in settlement of a suit brought by it in a prior year against another insurance company.  Held that such amount is not includable in gross income under the provisions of the statute.  2.  Held, further, that a percentage of the policy fees paid to the petitioner during the taxable year and permanently retained by it comprised a part of its taxable income of that year.  F. H. Nash, Esq., for the petitioner.  Philip M. Clark, Esq., for the respondent.  SMITH *810  The respondent has determined a deficiency for the calendar year 1922 in the amount of $6,206.34.  The petitioner objects to such part of the deficiency as results from the inclusion in net taxable income of an item of $125,000 representing an amount received in the year 1922 in settlement of a suit brought by it against another corporation, and an item of $13,842.61 representing the amount of net gain from policy fees received uring the taxable year.  FINDINGS OF FACT.  The petitioner is a Massachusetts corporation with its principal*2591  office at Worcester.  During the year 1922 and for many prior years it was engaged in the business of accident and health insurance.  Its business was conducted widely over the United States.  It sold insurance policies only to members of the Masonic fraternity.  For the calendar year 1922 the petitioner filed an annual statement with the Superintendent of Insurance of the Commonwealth of Massachusetts, as required by law, which contains the following data: Underwriting exhibitPREMIUMS1.  Total premiums per item 20, p. 2$4,285,082.392.  Add unpaid return and reinsurance premiums Dec. 31, 1921, per item 4 of last year's exhibit03.  Total4,285,082.394.  Deduct unpaid return and reinsurance premiums Dec. 31, 1922, per items 39 and 40, p. 505.  Balance4,285,082.396.  Add unearned premiums Dec. 31, 1921, per item 8 of last year's exhibit, and item 40, p. 5, last year's statement$1,084,413.717.  Total5,369,496.108.  Deduct unearned premiums Dec. 31, 1922, per item 28, p. 51,087.076.669.  Premiums earned during 1922$4,282,419.44UNDERWRITING PROFIT AND LOSS ITEMS10.  Gain from - 11.  Policy fees per item 21, p. 2$476,911.3912.  Inspections per item 22, p. 2013.  Agent's balance previously charged off, per item 38, p. 2014.  Other underwriting income per income exhibit, p. 2(a)0Total476,911.3915.  Loss from - 16.  Policy fees retained by agents, per item 23, p. 3463,068.7817.  Agents' balances charged off, per item 55, p. 34,165.3718.  Other underwriting disbursements, per disbursement exhibit, p. 3, other than losses and expenses, per items 24 and 33 of this exhibit(a)0Total467,234.15(b) Gain from items 10 to 189,677.2419.  Bills receivable and premiums in course of collection not admitted Dec. 31, 1921, per item 20 of last year's exhibit$18,308.0420.  Bills receivable and premiums in course of collection not admitted Dec. 31, 1922, per items 46 and 50, p. 428,408.3521.  (b) Loss from items 19 and 2010,100.3122.  (b) Loss from underwriting profit and loss items423.0723.  Underwriting income earned during 19224,281,996.37*2592 *811  In the "Disbursements" schedule of the statement appears an item "Policy fees retained by agents $463,068.78." The statement also contains in the "Income"schedule, page 2, line 33, and in the "Miscellaneous Exhibit" page 9, line 75, an item "Judgment in suit against Nat'l.  Protective Assn. Et al. $125,000.00." The amount of $125,000 was received by the petitioner in the year 1922 in settlement of a suit brought by it against the National Protective *812  Association, a Massachusetts corporation, and its officers.  The National Protective Association, hereinafter sometimes referred to as the defendant company, had been organized in the latter part of the year 1917 by some of the petitioner's officers and agents, who were at that time in its employ, to engage in business in direct competition with the petitioner.  The petitioner's suit was based upon alleged losses resulting from the wrongful acts of the defendant company.  The court appointed a master in chancery, who submitted a report recommending that damages be allowed the petitioner in the amount of $193,359.75.  The award recommended by the master in chancery was based upon an estimate of the damages suffered*2593  by the petitioner from losses as follows: 1.  1,164 policies on old policyholders who were caused by the defendant company to leave the petitioner$14,969.002.  4,558 quarterly premiums on policies of old policyholders4,785.903.  Policy fees paid out by the petitioner for renewing 1,096 lapsed policies4,866.244.  575 new policies that would have been written by 18 of the petitioner's agents in 1918 but for their services on behalf of the defendant company16,726.505.  12,222 new policies that would have been written over a period of 3 years by 23 agents who were induced to leave petitioner's employ116,113.116.  Services of old agents hired by the defendant company and expense of hiring new agents11,500.007.  A portion of the salaries paid to officers from Aug. 1, 1917, to Feb. 28, 1918, who rendered services to the defendant company during that period24,400.00Total193,360.75The amount of $125,000 received by the petitioner in settlement of the suit did not specifically include any of the amounts making up the total of the award recommended in the report of the master in chancery, but was an arbitrary amount agreed upon by the parties. *2594  In the course of the petitioner's business the term "policy fees" was used to designate the initial payment made by insured persons upon new policies to cover the period from the effective date of the policy to the due date of the first or next succeeding quarterly premium.  This period was either for a full quarterly period or less.  The policy fee was usually paid to the agent who had secured the policy and retained by him, or forwarded to the petitioner and later remitted to the agent.  Generally all of the policy fees went to the agents as a part of their compensation.  During the year 1922 the petitioner made a practice of requiring its agents in certain States to pay in to it 25 per cent of all policy fees collected, which it would withhold until the insured had paid the second premium on his policy.  This plan was adopted as a means *813  of getting the agents to follow up their sales more closely and of reducing the number of lapsed policies.  Where the second premium on a policy was never paid by the insured the petitioner retained, permanently, the 25 per cent of such policy fee.  During the taxable year 1922 the petitioner received $476,911.39 of such policy fees*2595  and repaid $463,068.78 to the agents on the policies upon which the second premiums were paid.  The respondent has included in petitioner's net income the amount of $13,842.61 representing the difference between the total amount of the policy fees received by it, as shown on the annual statement referred to above, and the amount of policy fees repaid to the agents.  OPINION.  SMITH: The petitioner is taxable under section 246 of the Revenue Act of 1921, which reads as follows: (a) That, in lieu of the taxes imposed by sections 230 and 1000, there shall be levied, collected and paid for the calendar year 1922, and for each taxable year thereafter, upon the net income of every insurance company (other than a life or mutual insurance company) a tax as follows: (1) In the case of such a domestic insurance company the same percentage of its net income as is imposed upon other corporations by section 230; (2) In the case of such a foreign insurance company the same percentage of its net income from sources within the United States as is imposed upon the net income of other corporations by section 230.  (b) In the case of an insurance company subject to the tax imposed by this*2596  section - (1) The term "gross income" means the combined gross amount, earned during the taxable year, from investment income and from underwriting income as provided in this subdivision, computed on the basis of the underwriting and investment exhibit of the annual statement approved by the National Convention of Insurance Commissioners; (2) The term "net income" means the gross income as defined in paragraph (1) of this subdivision less the deductions allowed by section 247; (3) The term "investment income" means the gross amount of income earned during the taxable year from interest, dividends and rents, computed as follows: To all interest, dividends and rents received during the taxable year, add interest, dividends and rents due and accrued at the end of the taxable year, and deduct all interest, dividends and rents due and accrued at the end of the preceding taxable year; (4) The term "underwriting income" means the premiums earned on insurance contracts during the taxable year less losses incurred and expenses incurred; (5) The term "premiums earned on insurance contracts during the taxable year" means an amount computed as follows: From the amount of gross premiums*2597  written on insurance contracts during the taxable year, deduct return premiums and premiums paid for reinsurance.  To the result so obtained add unearned premiums on outstanding business at the end of the preceding taxable year and deduct unearned premiums on outstanding business at the end of the taxable year; *814  (6) The term "losses incurred" means losses incurred during the taxable year on insurance contracts, computed as follows: To losses paid during the taxable year, add salvage and reinsurance recoverable outstanding at the end of the preceding taxable year, and deduct salvage and reinsurance recoverable outstanding at the end of the taxable year.  To the result so obtained add all unpaid losses outstanding at the end of the taxable year and deduct unpaid losses outstanding at the end of the preceding taxable year; (7) The term "expenses incurred" means all expenses shown on the annual statement approved by the National Convention of Insurance Commissioners, and shall be computed as follows: To all expenses paid during the taxable year add expenses unpaid at the end of the taxable year and deduct expenses unpaid at the end of the preceding taxable year.  For*2598  the purpose of computing the net income subject to the tax imposed by this section there shall be deducted from expenses incurred as defined in this paragraph all expenses incurred which are not allowed as deductions by section 247.  The petitioner contends that the respondent has erroneously included in its net income the amount of $125,000 received by it in settlement of its suit against the National Protective Association, and the amount of $13,842.61 representing the net gain from policy fees received during the taxable year.  It contends that a strict interpretation of the statute above quoted, particularly with reference to the computation of gross income, excludes therefrom both of the amounts in question.  With respect to the $125,000 item we think that the petitioner's contention must be sustained.  This amount is neither investment income nor underwriting income as these terms are defined in the statute.  In his report the master in chancery recommended an award for damages in the amount of $193,359.75, made up of both actual and anticipated losses for several years beginning with the year 1917.  One of the principal items, amounting to $116,113.11, represents the net*2599  worth of new policies which would have been written over a period of three years by 23 of petitioner's agents had not these agents been induced to leave the petitioner and to enter the services of the National Protective Association.  Another item of $16,726.50 represents new policies that would have been written by other agents in 1918 but for their services on behalf of the National Protective Association over the same period.  A third item of $24,400 represents a part of the salaries paid by the petitioner from August 1, 1917, to February 28, 1918, to officers who were giving a part of their time to the National Protective Association.  If the $125,000 item is includable in gross income it must be either "investment income" or "underwriting income." Both of these are carefully defined in the statute.  It did not consist of "interest, dividends and rents." It therefore was not "investment income." The statute defines *815  "underwriting income" as meaning "premiums earned on insurance contracts during the taxable year less losses incurred and expenses paid." We think that it can not fairly be contended that any part of the amount consisted of premiums earned on insurance contracts. *2600  The payment was made in compromise of a suit for damages.  Moreover, the amount of $125,000 actually received by the petitioner in 1922 is not the amount of damages recommended in the report of the master in chancery, but is a compromise amount agreed upon by the parties in settlement of the suit.  The statute makes no provision for the inclusion in gross income of such an amount, and in determining the petitioner's taxable income we can not go outside of the statute.  It was well within the rights of Congress to say what part of their gains the petitioner and other like insurance companies should be taxed upon, or from what sources their taxable income should be derived.  It has said that only the earnings from investments and the earnings from premiums on insurance contracts should be taxed.  We may presume that Congress was aware in drafting the law that a taxpayer, such as the petitioner, might receive income, in the general sense of the term, from other sources than those named.  It is clear, however, that only the income from the specific sources named was intended to be taxed.  Any doubt upon the matter must be resolved in favor of the taxpayer.  As to the item representing*2601  the net amount of policy fees received by the petitioner during the taxable year 1922, the same test must be applied; that is, whether such amount is a gain through investment income or underwriting income as these terms are defined in the statute.  The term "policy fees" was used by the petitioner to designate the initial amount paid by an applicant on an insurance policy.  It covered the cost of the policy to the insured for the period between the effective date of the policy and the due date of the first or next succeeding quarterly premium.  The policy fees were usually collected by the agents and retained by them as a part of their compensation.  Under the general custom followed by the petitioner and other like insurance companies all of the policy fees collected were either retained by the agents or repaid to them, so that there was no balance left with the company and no gain to the company from this source.  During the year under consideration, however, the petitioner required certain of its agents to pay in to it 25 per cent of each policy fee collected, which it held until the second premium had been paid by the policyholder.  Where the second premium was never paid the*2602  petitioner retained permanently the 25 per cent of the policy fee.  The amount of the policy fees so collected by the petitioner during the year 1922 was $476,911.39 and the amount of such fees repaid to the agents was $463,068.78.  The difference between *816  these amounts, $13,842.61, is the amount which the respondent has included in the petitioner's net income.  It seems to us that in determining the amount of the petitioner's gross income for the year under consideration no distinction can be made between the so-called policy fees and the regular quarterly premiums.  They were both amounts paid by an insured person for the protection afforded him by his policy.  The fact that the petitioner designated the initial payments as policy fees and treated them for administrative purposes in a different manner from the payments thereafter made did not alter their character.  They were, nevertheless, we think, "premiums written on insurance contracts during the taxable year" and, therefore, includable in gross income.  While the amount of policy fees received by the petitioner during the taxable year is not included in the amount of gross premiums shown in the underwriting and*2603  investment exhibit, we do not think that this fact alone differentiates the amount from premiums or excludes it from gross income for tax purposes.  The provision of the statute that the gross income be computed on the basis of the underwriting and investment exhibit of the annual statement approved by the National Convention of Insurance Commissioners does not intend to restrict gross income to the actual setup appearing in the statement, but rather contemplates the use of the statement as a guide and the acceptance of the figures and statements therein contained as correct, unless proven to be in error.  The underwriting and investment exhibit shows in the profit and loss schedule policy fees received by the petitioner or its agents during the taxable year 1922 in the amount of $476,911.39.  This amount should be included in gross income.  The amount of such gross income as was retained by or repaid to the agents as compensation is deductible along with the other ordinary and necessary expenses of the business, as provided in section 247(a)(1) of the statute.  Reviewed by the Board.  Judgment will be entered under Rule 50.