1. The legal reserve of a mutual life insurance company,
consisting of premiums paid by the members, and earnings upon
premiums invested, is "invested capital," within the war excess
profits tax
Page 272 U. S. 614
provision of the Revenue Act of 1917, which (§ 207(a)) define
invested capital, in the case of a corporation or partnership,
as
"(1) Actual cash paid in, (2) the actual cash value of tangible
property paid in other than cash, for stock or shares of such
corporation or partnership . . . and (3) paid in or earned surplus
and undivided profits used or employed in the business,"
etc. P.
272 U. S.
617.
2. A legal reserve so constituted, and used for the double
purpose of security and investment, is not a liability, though
carried as such on the books, but is assets of the company. P.
272 U. S.
618.
3. Until the maturity of a policy, the policy holder is simply a
member of the corporation, with a relation to it analogous to that
of a stockholder to a joint stock company: upon the maturity of the
policy, he becomes a creditor with an enforceable right. P.
272 U. S.
618.
4. Assuming that, in § 207(a), supra, the words "actual cash
paid in" are qualified by the clause "for stock or shares in such
corporation or partnership," the premiums paid by the policy
holders of a mutual life insurance company are cash paid for
"shares" in the corporation. P.
272 U. S.
619.
3 F.2d 1020 affirmed.
Certiorari (268 U.S. 686) to a judgment of the circuit court of
appeals which affirmed a judgment of the District Court (295 F.
881) against Duffy, Collector of Internal Revenue, in an action by
the Insurance Company to recover the amount of an additional income
tax assessment, which had been paid by the Company under
protest.
MR. JUSTICE SUTHERLAND delivered the opinion of the Court.
This case arises under the Revenue Act of 1917, c. 63, 40 Stat.
300, 302-306, imposing upon every corporation,
Page 272 U. S. 615
partnership and individual a war excess profits tax. The
pertinent provisions of the Act are as follows:
"Sec. 201. That, in addition to the taxes under existing law and
under this Act, there shall be levied, assessed, collected, and
paid for each taxable year upon the income of every corporation,
partnership, or individual, a tax (hereinafter in this title
referred to as the tax) equal to the following percentages of the
net income:"
"Twenty percentum of the amount of the net income in excess of
the deduction (determined as hereinafter provided) and not in
excess of fifteen percentum of the invested capital for the taxable
year. . . ."
"Sec. 203. That, for the purposes of this title, the deduction
shall be as follows, except as otherwise in this title provided
--"
"(a) In the case of a domestic corporation, the sum of (1) an
amount equal to the same percentage of the invested capital for the
taxable year which the average amount of the annual net income of
the trade or business during the prewar period was of the invested
capital for the prewar period (but not less than seven or more than
nine percentum of the invested capital for the taxable year), and
(2) $3,000. . . ."
"Sec. 207. That, as used in this title, the term 'invested
capital' for any year means the average invested capital for the
year, as defined and limited in this title, averaged monthly."
"As used in this title 'invested capital' does not include
stocks, bonds (other than obligations of the United States), or
other assets, the income from which is not subject to the tax
imposed by this title nor money or other property borrowed, and
means, subject to the above limitations:"
"(a) In the case of a corporation or partnership: (1) actual
cash paid in, (2) the actual cash value of tangible
Page 272 U. S. 616
property paid in other than cash, for stock or shares in such
corporation or partnership at the time of such payment (but in case
such tangible property was paid in prior to January first, nineteen
hundred and fourteen, the actual cash value of such property as of
January first, nineteen hundred and fourteen, but in no case to
exceed the par value of the original stock or shares specifically
issued therefor), and (3) paid in or earned surplus and undivided
profits used or employed in the business, exclusive of undivided
profits earned during the taxable year. . . ."
By § 200, it is provided that the term "corporation" includes
joint-stock companies or associations and insurance companies, and
we assume that this includes nonstock mutual insurance companies as
well as those having capital stock
Respondent is a mutual company having no capital stock, and its
policyholders constitute its members. Its business has always been
conducted upon the "level premium plan," under which the estimated
annual cost of the insurance is averaged and the maximum annual
contribution of each member is uniform throughout the life of the
policy. The annual contributions during the early years of the
policy are in excess of the natural premiums, and such excess
premiums, augmented by interest thereon, are held as a reserve to
maintain the insurance in the later years. These contributions (or
premiums), together with the increment derived from their
investment, constitute the sole assets of the company. A more
complete statement of the plan will be found in the opinion of the
district court in this case, 295 F. 881, and cases cited in that
opinion at p. 883.
The company is required by state laws, as a condition of
continuing business, to maintain its assets at a sum not less than
the amount of the "legal reserve" required by such laws. For the
year 1917, the legal reserve amounted
Page 272 U. S. 617
to something over $186,000,000. In addition to the legal
reserve, the company maintained a second or "contingent reserve" as
a margin of safety to meet contingencies. The two reserves are not
segregated in any way or separately identified or invested. The
funds therein, constituting the company's entire assets, are
invested in its office building and in government bonds and other
securities. The income resulting from the investments is returned
for federal taxation and is taxed. For the year 1917, the sum of
the two reserves was returned by the company as invested capital
for that taxable year. The net income shown for the year was
$1,808,339.33, upon which the company paid an income tax of
$108,500.36, but no excess profits tax. The Commissioner of
Internal Revenue amended the returns and, thereupon, levied an
additional assessment against the company amounting to $83,779.70.
This was accomplished, so far as necessary to be now considered, by
deducting from the amount of invested capital as returned the sum
of $186,258,796, being the exact amount of the legal reserve, and
reducing the company's invested capital for the year to the sum of
$14,719,043.76. It is agreed that, if, instead of this latter sum,
the company's invested capital had been computed at any sum in
excess of $25,500,000, no war excess profits tax would have been
due.
The company paid the amount of the additional assessment under
protest and brought this action to recover it. The collector moved
to strike out the complaint as insufficient in law. It was
stipulated that the decision on the motion should be a final
disposition of the controversy. The district court denied the
motion and rendered judgment for the full amount with interest. 295
F. 881. The judgment was affirmed by the circuit court of appeals.
3 F.2d 1020.
The question for determination is whether the funds constituting
the legal reserve, or sufficient thereof to make
Page 272 U. S. 618
up as much as $25,500,000 when added to the amount allowed by
the commissioner, is invested capital within the meaning of §
207(a) of the Revenue Act. The contention of the collector is that,
under subdivisions (1) and (2), § 207(a), invested capital must be
either cash or tangible property paid in for stock or shares of the
corporation, and inasmuch as the company has no capital represented
by stock or shares, its legal reserve is not invested capital
within the meaning of those subdivisions; that the legal reserve is
not surplus or undivided profits within the meaning of subdivision
(3) because it is no more than the equivalent of the obligations of
the company at the time under its policies of insurance. It is
contented that the legal reserve represents a present existing
liability, and stress is put upon the fact that it is carried by
the company on the liability side of its ledger.
It appears from the complaint that the company has been in
business since the year 1845. During that time, the amount of its
assets has increased, year by year, from about $20,000 in 1846 to
over $200,000,000 in 1917, divided between the legal reserve and
the contingent reserve, as already stated. The legal reserve
includes $70,000,000 premiums theretofore paid and $116,000,000
earnings upon investments. The legal reserve therefore constitutes
assets of a very permanent character. Originally consisting of the
contributions of members only, the earnings now make up
considerably more than one-half of the whole. The contributions
were made for, and have been used to serve, the double purpose of
protection and of investment. These assets, thus constituted, have
never represented indebtedness any more than the capital of a stock
corporation subscribed by its stockholders represents indebtedness.
Until the maturity of a policy, the policyholder is simply a member
of the corporation, with no present enforceable right against the
assets. Upon the
Page 272 U. S. 619
maturity of the policy, he becomes a creditor, with an
enforceable right. Then, for the first time, there is an
indebtedness.
See Mayer v. Attorney General, 31 N.J.Eq.
815, 820-822. In the meantime, each member bears a relation to the
mutual company analogous to that which a stockholder bears to the
joint-stock company in which he holds stock. In either case, the
title to the assets is in the corporation, and not in the members
or stockholders.
True, the amount of the reserve is carried on the books as a
liability, but only as the capital stock of a stock corporation is
carried on its books as a liability. In both instances, in is a
form of bookkeeping to balance assets, which in the one case is
contributed by the members, and in the other by the stockholders.
If § 207(a) subdivisions (1) and (2) had defined invested capital
as "actual cash paid in," without more, it probably would not be
doubted that the part of the legal reserve derived from premiums
would be included. The doubt results from the use of the additional
words "for stock or shares in such corporation or partnership." The
collector says these words qualify the phrase "(1) actual cash paid
in" as well as the phrase which they immediately follow, "(2) the
actual cash value of tangible property paid in." For present
purposes, we shall assume this to be so, although there is a
plausible argument on the other side to the contrary, and consider
the case accordingly. The mutual company is not a stock company,
and the word "stock" may be put aside as having no application to
it. It is clear that, since the word "stock" does not describe
interests in partnerships, included expressly along with
corporations in the same paragraph, the word "shares" must be held
to do so. And if that word is broad enough to include partnership
interests, it it broad enough to include the interests held by
members in nonstock corporations.
Page 272 U. S. 620
To hold the contrary would be to so limit the application of
subdivisions (1) and (2) of § 207(a) as altogether to exclude
therefrom those corporations which have no capital stock. We cannot
suppose that Congress intended such a result, but must conclude
that it used the word "stock" as appropriate in the case of stock
corporations and the word "shares" as appropriate in the case of
partnerships and nonstock corporations. Such an interpretation does
no violence to the ordinary meaning of the word, for while it is
entirely proper to speak of "stock" as "shares" it is equally
proper to designate the several interests in a common fund as
"shares." To the extent of $70,000,000, the legal reserve consisted
of "actual cash paid in" by the members. These payments were
intended for investment, and were invested, to increase the
resources of the company, and thereby reduce the cost of the
insurance, and it requires no stretch of the realities to say that,
within the meaning of subdivisions (1) and (2), § 207(a), the fund
which they created is invested capital. This is enough to relieve
the company from the payment of any war excess profits tax, and it
is unnecessary to inquire whether the remaining $116,000,000 is to
be regarded as earned surplus under subdivision (3).
Judgment affirmed.