COMMISSIONER OF INTERNAL REVENUE v. FIRST SECURITY BANK OF UTAH, N. A., ET AL.
No. 70-305
Supreme Court of the United States
Argued January 10, 1972—Decided March 21, 1972
405 U.S. 394
Stephen H. Anderson argued the cause for respondents. With him on the brief was S. J. Quinney.
Ernest Getz filed a brief for Bud Kouts Chevrolet Co. et al. as amici curiae urging affirmance.
MR. JUSTICE POWELL delivered the opinion of the Court.
This case presents for review a determination by the Commissioner of Internal Revenue (Commissioner), pursuant to
Until 1954, any borrower who elected to purchase this insurance was referred by the Banks to two independent insurance companies. The premium rate charged was $1 per $100 of coverage per year, the rate commonly charged in the industry. The Insurance Commissioners of the States involved—Utah, Idaho, and Texas—accepted this rate. The Banks followed a routine procedure in making this insurance available to customers. The lending officer would explain the function and availability of credit insurance. If the customer desired the coverage, the necessary form was completed, a certificate of insurance was delivered, and the premium was collected or added to the customer‘s loan. The Banks then forwarded the completed forms and premiums to Management Company, which maintained records of the
It was the custom in the insurance business (although not invariably followed), regardless of the cost of incidental paperwork, to pay a “sales commission“—ranging from 40% to 55% of net premiums collected—to a party who originated or generated the business. But the Banks had been advised by counsel that they could not lawfully conduct the business of an insurance agency or receive income resulting from their customers’ purchase of credit life insurance. Neither the Banks nor any of their officers were licensed to sell insurance, and there is no question here of unlawfully acting as unlicensed agents. The Banks received no commissions or other income on or with respect to the credit insurance generated by them. During the period from 1948 to 1954 commissions were paid by the independent companies writing the insurance directly, to Smith, one of the wholly owned subsidiaries of Holding Company. These commissions were reported as taxable income, not by Smith, but by Management Company which had rendered the services above described. During this period (1948-1954), the Commissioner did not attempt to allocate the commissions to the Banks.2
Security Life was not a paper corporation. It commenced business in 1954 with an initial capital of $25,000,
Security Life reported the entire amount of reinsurance premiums, 85% of the premiums charged, in its income for the years 1955-1959. Because the income of life insurance companies then was subject to a lower effective tax rate than that of ordinary corporations, the total tax liability for Holding Company and its subsidiaries was less than it would have been had Security Life paid a part of the premium to the Banks or Management Company as sales commissions.6 Pursuant to his
The parties agree that
“The purpose of section 482 is to place a controlled taxpayer on a tax parity with an uncontrolled taxpayer, by determining according to the standard of an uncontrolled taxpayer, the true taxable income from the property and business of a controlled taxpayer. . . . The standard to be applied in every case is that of an uncontrolled taxpayer dealing at arm‘s length with another uncontrolled taxpayer.”10
The question we must answer is whether there was a shifting or distorting of the Banks’ true net income
We note at the outset that the Banks could never have received a share of these premiums. National banks are authorized to act as insurance agents when located in places having a population not exceeding 5,000 inhabitants,
The penalties for violation of the banking laws include possible forfeiture of a bank‘s franchise and personal liability of directors. The Tax Court found that the Banks, upon advice of counsel, “held the belief that it would be contrary to Federal banking law . . . to receive income resulting from their customers’ purchase of credit insurance” and, pursuant to this belief, “the two Banks have never received or attempted to receive commissions or reinsurance premiums resulting from their customers’ purchase of credit insurance.”15
Petitioner does not contest this finding by the Tax Court or the holding in this respect of the Court of Appeals below. Accordingly, we assume for purposes of this decision that the Banks were prohibited from receiving insurance-related income, although this prohibition did not apply to non-bank subsidiaries of Holding Company.16
It is, of course, well established that income assigned before it is received is nonetheless taxable to the assignor. But the assignment-of-income doctrine assumes
“[O]ne vested with the right to receive income [does] not escape the tax by any kind of anticipatory arrangement, however skillfully devised, by which he procures payment of it to another, since, by the exercise of his power to command the income, he enjoys the benefit of the income on which the tax is laid.”17
One of the Commissioner‘s regulations for the implementation of
“The interests controlling a group of controlled taxpayers are assumed to have complete power to cause each controlled taxpayer so to conduct its affairs that its transactions and accounting records truly reflect the taxable income from the property and business of each of the controlled taxpayers.”18
This regulation is consistent with the control concept heretofore approved by this Court, although in a different context. The regulation, as applied to the facts in this case, contemplates that Holding Company—the controlling interest—must have “complete power” to shift income among its subsidiaries. It is only where this power exists, and has been exercised in such a way that the “true taxable income” of a subsidiary has been
Apart from the inequity of attributing to the Banks taxable income that they have not received and may not lawfully receive, neither the statute nor our prior decisions require such a result. We are not faced with a situation such as existed in those cases, urged by the Commissioner, in which we held the proceeds of criminal activities to be taxable.19 Those cases concerned situations in which the taxpayer had actually received funds. Moreover, the illegality involved was the act that gave rise to the income. Here the originating and referring of the insurance, a practice widely followed, is acknowledged to be legal. Only the receipt of insurance commissions or premiums thereon by national banks is not. Had the Banks ignored the banking laws, thereby risking the loss of their charters and subjecting their officers to personal liability,20 the illegal-income cases would be relevant. But the Banks from the inception of their use of credit life insurance in 1948 were careful never to place themselves in that position. We think that fairness requires the tax to fall on the party that actually receives the premiums rather than on the party that cannot.21
It is argued, finally, that the “services” rendered by the Banks in making credit insurance available to customers “would have been compensated had the corpora-
We conclude that the premium income received by Security Life could not be attributable to the Banks. Holding Company did not utilize its control over the Banks and Security Life to distort their true net incomes. The Commissioner‘s exercise of his
Affirmed.
MR. JUSTICE MARSHALL, dissenting.
The facts of this case illustrate the natural affinity that lending institutions and insurance companies have for each other. Congress depends on the ability of the Commissioner of Internal Revenue to utilize
Section 482 provides:
“In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary or his delegate may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.”
First enacted as § 45 of the Revenue Act of 1928, 45 Stat. 806, the statute was intended to prevent the avoidance of tax liability through fictions and “to deny the power to shift income . . . arbitrarily among controlled corporations, and to place such corporations rather on a parity with uncontrolled concerns.” Central Cuba Sugar Co. v. Commissioner, 198 F. 2d 214, 216 (CA2 1952). See H. R. Rep. No. 2, 70th Cong., 1st Sess., 16-17; S. Rep. No. 960, 70th Cong., 1st Sess., 24-25. It is intended to serve the same purpose in the present Code.
It is well-established law that in analyzing a transaction under
Applying that test to this case, the following facts are relevant. Before 1954, an independent insurance company paid respondents commissions ranging from 40% to 45% for their services in offering insurance to borrowers designed to discharge their debts in the event that they died or became disabled during the term of their loans. After 1954, respondents offered borrowers policies issued by a different insurance company. At this time the holding company that controlled respondents created a new subsidiary to reinsure the borrowers who purchased policies. By paying off the independent insurance company with 15% of the proceeds of the policies, the subsidiary assumed the insurance risks and garnered the remaining 85% of the proceeds. No commission was paid to respondents by either the independent company or the insurance subsidiary.
The tax advantage of the post-1954 structure derived from the fact that the Life Insurance Company Tax Act for 1955, 70 Stat. 36, as amended by the Life Insurance Company Income Tax Act of 1959, 73 Stat. 112, as amended,
The Commissioner‘s analysis of this case is not overly complex: He saw that respondents performed essentially the same services and generated the same income after 1954 that they did before, and he concluded that
The respondents make, in essence, two arguments in their attempt to rebut the Commissioner‘s position. First, they urge that they never received any funds as a result of offering the policies to borrowers, and that it is therefore unfair to tax them on any portion of said proceeds. If
We need not look far to find that this entire complicated economic structure—established, designed, administered, and amendable by the holding company—had the right to the proceeds. Pursuant to
The Court apparently concedes that if respondents’ only argument against taxation were that they have
Having implicitly rejected the argument that mere nonreceipt of money is sufficient to avoid taxation, the Court proceeds to accept respondents’ second argument that in this case the taxpayer is legally barred from ever receiving money, and in this circumstance he cannot be taxed on it. Respondents find a legal bar to receipt of the proceeds at issue here in
“In addition to the powers now vested by law in national banking associations organized under the laws of the United States any such association located and doing business in any place the population of which does not exceed five thousand inhabitants, as shown by the last preceding decennial census, may, under such rules and regulations as may be prescribed by the Comptroller of the Currency, act as the agent for any fire, life, or other insurance company authorized by the authorities of the State in which such bank is located to do business in said State, by soliciting and selling insurance and collecting premiums on policies issued by such company; and may receive for services so rendered such fees or commissions as may be agreed upon between the said association and the insurance company for which it may act as agent; and may also act as the broker or agent for others in making or procuring loans on real estate located within one hundred miles of the place in which said bank may be located, receiving for such services a reasonable fee or commission: Provided, however, That no such bank shall in any case guarantee
either the principal or interest of any such loans or assume or guarantee the payment of any premium on insurance policies issued through its agency by its principal: And provided further, That the bank shall not guarantee the truth of any statement made by an assured in filing his application for insurance.”
This statute by inference and the regulations of the Comptroller of the Currency,
But the crucial fact in this case is that under their own theory respondents have already violated the federal statute and regulations by soliciting insurance premiums. Title
“It seems desirable from the standpoint of public policy and banking efficiency that this authority should be limited to banks in small communities. This additional income will strengthen them and increase their ability to make a fair return to their shareholders, while the new business is not likely to
assume such proportions as to distract the officers of the bank from the principal business of banking. Furthermore in many small places the amount of insurance policies written . . . is not sufficient to take up the entire time of an insurance broker, and the bank is not therefore likely to trespass upon outside business naturally belonging to others.
“I think it would be unwise and therefore undesirable to confer this privilege generally upon banks in large cities where the legitimate business of banking affords ample scope for the energies of trained and expert bankers. I think it would be unfortunate if any movement should be made in the direction of placing the banks of the country in the category of department stores. . . .” Letter of June 8, 1916, to Senate, 53 Cong. Rec. 11001.
There is nothing in the history of the provision to indicate that Congress was more concerned with banks’ actually receiving money than with their performing the activities that generated the money. In fact, the history that is available indicates that it is the activities themselves that Congress wished to stop. Banks in large communities were simply not permitted to do anything that insurance agents might do, i. e., they were not permitted to solicit insurance.
Under respondents’ theory of the case, the legal violation is thus a fait accompli and the respondents are taxable as if there had been no illegality.1 See, e. g., United
the Commissioner could properly determine that the statute was violated by the acts of solicitation, and, as the Court recognizes, since “the illegality involved was the act which gave rise to the income,” this Court‘s prior decisions permit the Commissioner to tax the income of the lawbreakers.
If, however, the Court is attempting to distinguish sub silentio between “originating and referring” and “soliciting” and is concluding that only the latter is illegal, then there is nothing in the statute or regulations that would make illegal the receipt of income generated by the former. Hence, the Commissioner could reject the respondents’ second argument that it would violate federal banking laws to include the proceeds in their income.
Whichever approach the Court selects, the statute requires consistency-i. e., the statute requires that the activities that produce income be illegal before the receipt of the income is deemed to violate the law.
I agree with the Court that deference must be paid to the expertise of the Comptroller, but in proposing that
Senator Owen, who shepherded the 1916 legislation through the Senate, noted at one point that
What is critical to a correct disposition of this case, in my view, is that if respondents’ activities are not illegal, there is no reason that receipt of the income generated from them should be illegal. It should be pointed out that the theory that receipt of said income would be illegal was first proffered by respondents’ counsel. This theory is certainly self-serving in the sense that it provides what the Court regards as the dispositive factor in this case without hindering the activities of the holding company in any way.
The Court suggests that the Commissioner has never relied on the
The reasoning of the majority runs along these lines: if A violates the law-by attempted embezzlement or by illegally soliciting insurance sales, for example-but he receives no money and has no “legal right” to receive any money, then he cannot be taxed as if the money had been received; but, if A actually embezzles money or receives insurance premiums in violation of the law, A can be taxed even though he may have transferred the money without any personal gain to a third party from whom he has no right of recovery.
I would agree with this analysis in most cases. Where I differ from the Court is in which category to place this transaction. To pretend that respondents have not received any money and have no right to any money is to ignore the thrust of
theory of the case expressed in this opinion. On the contrary, the Commissioner argued in his brief (p. 13) as follows:
“The Commissioner‘s allocation does not force respondents to violate the federal banking law. It was they, not the Commissioner, who chose to solicit and sell credit life insurance at a rate set at a sufficiently high level to permit the payment of commissions. If their activities did not violate the banking law, the Commissioner‘s allocation will not, of itself, constitute a violation on their part. And, surely, the payment of taxes would not be an illegal act.”
Both sides dealt with this point in oral argument. Tr. of Oral Arg. 14-18, 30, 40.
This is the nub of the case. What is there in the legislative history or the purpose of
If respondents had actually received the proceeds and transferred them to the insurance subsidiary, they would still be free to make essentially the same argument that they make in this case, i. e., they could argue that federal law prohibited them from receiving the money; that they violated federal law, but had no right to keep the money; and that they should not be taxed on receipt of funds which they could not legally keep.
To be consistent with the assignment-of-income cases, Helvering v. Horst, supra, and Lucas v. Earl, supra, and the line of cases that includes Rutkin v. United States, supra, and James v. United States, supra, the Court would have to reject this argument. Yet, I maintain that this is just what the taxpayer is arguing here. The Commissioner has determined that in reality the respondents have earned income, and he has taxed it under
In my view, the Commissioner has done exactly what
MR. JUSTICE BLACKMUN, with whom MR. JUSTICE WHITE joins, dissenting.
As I read the Court‘s opinion, I gain the impression that it chooses to link legality with taxability or, to put it better oppositely, that it ties illegality to receive with inability to tax. I find in the
1. Section 4821 surely contemplates taxation of income without formal receipt of that income. That, indeed, is the scope and purport of the statute. It is directed at income distortion by a controlling interest among two or more of the controlled entities. I, therefore, am not convinced that the fact the income in question here did not flow through the Banks at any time-because it was deemed proscribed by the 1916 Act (if the pertinent portion thereof, 39 Stat. 753, is still in effect, a proposition which may not be free from doubt),2 and because the
2. Section 482 has a double purpose and a double target. It authorizes the Secretary or his delegate, that is, the Commissioner, to allocate whenever he determines it necessary so to do in order (a) “to prevent evasion of taxes” or (b) “clearly to reflect the income of any” of the controlled entities. The use of the statute, therefore, is not restricted to the intentional tax evasion. No evasion of tax, in the criminal sense, by these Banks is specifically suggested or at issue here. And I do not subscribe to my Brother MARSHALL‘S intimation that what the Banks were doing was otherwise illegal. The second alternative of the statute, however, is directed at something other than tax evasion or illegality. It is concerned with the proper reflection of income (or deductions, credits, or allowances) so as to place the controlled taxpayer on a tax parity with the uncontrolled taxpayer. It is designed to produce for tax purposes, and to recognize, economic realities and to have the tax consequences follow those realities and not some structured nonreality. This is the aspect of the statute with which the Commissioner and these respondents are here concerned. Thus, legality and illegality seem to me to be beside the point.
3. From this it follows that the Court‘s repetitive emphasis on the missing
4. The purpose of the controlling interest in structuring the several entities it controls is apparent and can-
5. What, then, happened? The chronology is revealing:
(a) Initially, that is, until 1954, the Banks solicited the insurance, charged the premium, and forwarded it to Management Company. The latter in turn sent it on to the then-favored independent insurance carrier. That carrier paid the recognized sales commission to Smith, Management Company‘s wholly owned insurance agency.5
(b) In 1954 the American National-Security Life arrangement appeared on the scene. This was prompted by the blossoming of the credit insurance business as a profitable undertaking. Obviously, it was a matter of concern to established and independent insurance companies when they came to realize that lending institutions were in a position to form their own insurance affiliates
(c) The Life Insurance Company Tax Act for 1955 was enacted, 70 Stat. 36, followed by the Life Insurance Company Income Tax Act of 1959, 73 Stat. 112. These statutes served to accord preferential tax treatment-as compared to ordinary corporations-to life insurance companies. See United States v. Atlas Life Ins. Co., 381 U. S. 233 (1965). This happily coincided, of course, with Security Life‘s development.
6. Only the Banks were the responsible force behind the premium income. No one else was. Certainly American National was not. Certainly Security Life was not. Smith was out of the picture. And if it can be said that Management Company or Holding Company contributed a part, they did so only secondarily. It was the participating bank that explained to the borrower the function and availability of the insurance; that gave the customer the application form; that examined the application; that prepared the certificate of insurance; that collected the premium or added it to the loan; and that sent the form and the premium to Management Company. It was the participating bank that thus
7. It is no answer to say that generation of income does not necessarily lead to taxation of the generator; here the earnings themselves stayed within the corporate structure dominated by Holding Company, and did not pass elsewhere with consequent tax impact elsewhere. I do not so easily differentiate, as does the Court, ante, at 401 n. 11, between referral outside the affiliated structure and referral conveniently within that structure to a re-insurance company that could be taxed on the premium income (unreduced by commissions) at advantageous tax rates.
8. That the selling effort of the Banks seems comparatively minimal and that the processing cost seems comparatively negligible are, I believe, beside the point and quite irrelevant. No one else devoted effort or incurred cost of any significance whatsoever. Taxability has never depended on approximating expenses to receipts; in fact, the less the cost, the greater the net income and the greater the tax burden.
9. Neither is it an answer to say that before the organization of Security Life the Banks did not receive income from credit insurance premiums and that, therefore, the emergence of Security Life did not change the situation so far as the Banks were concerned. For me, it very much changed the situation, for the controlled structure took over the insurance business and the premiums thenceforth were nestled within that structure.
11. In the area of federal estate taxation an obvious parallel is found in the many instances of includability in the decedent‘s gross estate of property not owned or possessed by the decedent at his death. The Code itself provides for the inclusion of transfers theretofore effec-
12. This demonstrates for me that there have been and are many examples of taxation of income without that “complete dominion” over it that the Court now finds so necessary. The quotation, cited by the Court, from Mr. Justice Holmes’ opinion in Corliss v. Bowers, 281 U. S. 376, 378 (1930), consists of language used to support the taxation of income; it is not language, as the Court would make it out to be, that supported the nontaxation of income. The Justice‘s posture-and the Court‘s-in that case surely looks as much, and perhaps more, to includability here than it does to excludability.13
13. The Court shrinks from extending the possibility of taxation-without-receipt to the situation where the taxpayer is “prohibited from receiving” the income by another statute. It states that no decision of the Court has as yet gone that far. It is equally true that no decision of the Court has refrained from going that far.
14. The Court‘s reluctance is reminiscent of the “claim of right” doctrine, which found expression in the unfortunate and short-lived (15 years) decision in Commissioner v. Wilcox, 327 U. S. 404 (1946), to the effect that embezzled income was not taxable to the embezzler. Wilcox, of course, stood in sharp contrast to Rutkin v. United States, 343 U. S. 130 (1952), where money obtained by extortion was held to be taxable income to the extortioner; it was overruled, at last, in James v. United States, 366 U. S. 213 (1961). In Wilcox, as here, the Court wrestled with the concept and imaginary barrier of illegality, was impressed by it, and, as in this case, concluded that illegality and taxability did not mix and could not be linked. That doctrine encountered resistance in Rutkin and in James, and was rightly rendered an aberration by those later decisions.
In conclusion, I note that the Court of Appeals remanded Management Company‘s case to the Tax Court for consideration of the
And so it is. The result of today‘s decision may not be too important, for it affects only a few taxpayers. It seems to me, however, that it effectively dulls one edge of what has been a sharp two-edged tool fashioned and bestowed by the Congress upon the Internal Revenue Service for the effective enforcement of our federal tax laws.
Notes
“But taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed-the actual benefit for which the tax is paid....” 281 U. S., at 377-378.
In another case Mr. Justice Holmes said:“There is no doubt that the statute could tax salaries to those who earned them and provide that the tax could not be escaped by anticipatory arrangements and contracts however skillfully devised to prevent the salary when paid from vesting even for a second in the man who earned it....” Lucas v. Earl, 281 U. S. 111, 114-115 (1930).