Smith v. Commissioner

*58 This is an appeal from the determination of a deficiency in income and profits taxes for the*2677 years 1917, 1918, and 1919 in the aggregate sum of $5,598.19. The questions presented for consideration are:

1. Whether the respondent erred in disallowing certain "premium discounts" as a deduction in the computation of net income for the years under consideration.

2. Whether the respondent erred in his treatment of the certificates of profit received by petitioner on certain marine insurance policies.

FINDINGS OF FACT.

Petitioner is an individual engaged in the insurance brokerage business at 51 Maiden Lane, New York, N.Y.

During the years 1917, 1918, and 1919 marine insurance, then commonly known as "Marine War Risk Insurance" was not only expensive but difficult to obtain in the United States. The Atlantic Mutual Insurance Co. (hereafter referred to as Atlantic), as the name implies, was a "mutual" company, engaged in selling marine and inland transportation insurance. That company sold the so-called marine war risk insurance during the years in question, but its rates therefor were exceedingly high. Petitioner's clients who were in need of marine insurance protection were willing to purchase from the Atlantic but were unwilling to pay the premium rates then*2678 prevailing. Petitioner had a number of clients, some of whom he had done business with for a number of years prior to the taxable years, and being confronted with the necessity for satisfying the needs of his clients in respect to marine war risk insurance, the petitioner pursued two distinct courses, viz, he took out blanket policies of marine insurance from the Atlantic in his own name "on account of whom it may concern" for an estimated amount of insurance with an estimated premium and sold parts of the insurance to his clients in the amounts desired; he also purchased marine insurance for and in the name of his clients, William E. Peck & Co., Inc., and the Bull Insular Line. In each instance the petitioner paid the Atlantic its regular premium and in turn charged his clients a rate averaging from 35 to 37 per cent off the amount so paid.

In computing his net income for the years here under consideration the petitioner deducted as a loss the difference between the premiums paid by him to the Atlantic, and the amounts paid to him by his clients. These amounts, termed by the petitioner "premium discounts," were $24,980, $22,236.26, and $18,901.06 for the years 1917, 1918, and*2679 1919, respectively.

In consideration of the reduced rate of premium allowed by the petitioner to his clients, it was agreed, in those cases where insurance was issued in the name of the client instead of in the name of the petitioner, that the annual dividends should be formally assigned to *59 the petitioner. In accordance with this understanding and agreement the petitioner's clients executed writings assigning and transferring their dividend rights to the petitioner.

It was the custom of the trustees of the Atlantic, in each year, after losses and expenses had been determined, to issue to its policyholders on or after the first Tuesday in May "certificates of profit," redeemable in cash, at the option of the company, in six years, subject to reduction or cancellation if necessitated by extraordinary losses or expenses. These certificates of profit represented a certain percentage of the "earned premiums" for the preceding year, which in 1917, 1918, and 1919, amounted to 40 and 45 per cent. The amounts of earned premiums on the policies here under consideration for the years 1917, 1918, and 1919 were:

*2680 The amounts of certificates of profit credited by the Atlantic to the account of the petitioner, representing dividends declared by the trustees of that company based on earned premiums for the year preceding the declaration, were:

These certificates of profit were reported as dividends received by the petitioner during the years in question.

Although the certificates of profit were redeemable at face value in six years, during the World War they were redeemed in less time than that.

After certificates of profit were issued, they had a market value, which before the War was at a premium of from $3 to $5 on each $100 certificate. During the War, however, the best prices obtainable were from $90 to $95 for each $100 certificate.

The respondent in computing the petitioner's taxes for the years 1917, 1918, and 1919 held that the excess amounts paid for premiums over the amounts received should be treated as an investment*2681 and that the certificates of profit, in the nature of "scrip dividends" received in the succeeding year, to the extent that they were in excess of the premium discounts in the preceding year, should be treated as income subject to surtax. Therefore, petitioner's income was increased *60 for 1917, 1918, and 1919 by $24,980, $22,236.26, and $18,901.06, respectively. The respondent also excluded the scrip dividends from income for 1917 and 1918 and included the difference between $22,236.26 and $31,834.50, or $9,598.24, as income subject to surtax in 1919.

OPINION.

MORRIS: Petitioner alleges error on the part of the respondent in disallowing as a deduction in the computation of his taxes for the years 1917, 1918, and 1919 the amounts of $24,980, $22,236.26, and $18,901.06, respectively, representing premium discounts sustained by petitioner in the marine insurance transactions hereinbefore discussed, and, further, in deducting from dividends received from the Atlantic the sums of $24,980, and $22,236.26 and holding that said amounts were not dividends but were a return of capital invested. While the petitioner contends that the figure of $24,980 above referred to is excessive*2682 to the extent of $2,440.40, no satisfactory explanation has been advanced which would warrant our making any change. It is true the petitioner's witness, an expert accountant, testified as to what the books contained, but he has not shown us by his testimony why the book figures should be changed.

For reasons which will be made apparent by this opinion, these marine policies purchased by petitioner from the Atlantic must be separated into two classes: (1) policies purchased in the name of the petitioner and resold by him to his clients, and (2) policies purchased by the petitioner for and in the name of his clients.

With respect to the policies of insurance purchased by the petitioner from the Atlantic in his name for resale to his clients we confess that we can see no difference between such purchases and sales and the ordinary purchases and sales of any other assets or commodities. By purchasing this insurance in his own name the petitioner thereby became a policy holder of the Atlantic and as such, enjoyed all of the rights and privileges appertaining thereto, which included voting. He purchased this insurance for the express purpose of reselling it and it is clear to us*2683 that he must have regarded the amount of the premium collected from his clients plus what he would receive from the Atlantic by way of certificates of profit as the sale price. Therefore the insurance premiums paid by the petitioner upon policies issued to himself represented the cost of such insurance purchased for resale and upon such resale the profit derived or the loss sustained is the difference between the premiums paid by petitioner to the Atlantic and the amounts received from clients plus the certificates of profit from the Atlantic. Said profit or loss should be reported in the year in which the certificates of profit are received. As the certificates had a market value of 90 to 95 per cent during the taxable years in question, the amount of *61 the profit or loss should be determined by including the certificates at 95 per cent of their face value if the petitioner's books are kept on the cash receipts and disbursements basis, or at their face value if his accounts are on the accrual basis.

The circumstances surrounding the insurance purchased by petitioner for William E. Peck & Co., Inc., and the Bull Insular Line are, we believe, entirely different. In these*2684 cases the petitioner was not in the relation of principal and client, as in those cases where he purchased insurance in his own name for resale, but was acting in his usual capacity as insurance agent negotiating insurance for and in the name of his client. As such agent or broker, he procured the policies for those two companies.

With respect to the peculiar arrangement for the payment of premiums on those policies, it might safely be said that the petitioner acted the same as any other insurance agent might have acted under the same or similar circumstances. Petitioner was confronted with the necessity of satisfying the needs of his clients, and for failure to do so, might have found himself losing some or all of the other business brought to him by his clients, and being so circumstanced, he in effect said: "I will arrange the insurance which you want and will pay the premium demanded by the Atlantic and I will look to you for reimbursement in part and to the dividends declared by the Atlantic for the remainder." This indeed, as the petitioner admits, was a wise course to pursue even though he might have sustained a loss on the transaction. The amounts of premiums so advanced*2685 by the petitioner were advancements with the expectation of being reimbursed by his clients through the receipt of certificates of profit, and when such certificates of profit were declared and either assigned to or issued directly to the petitioner, although they might be dividend income in the hands of William E. Peck & Co., Inc., and the Bull Insular Line, they lost their identity as such when they were received by the petitioner, and were then nothing more than reimbursement of monies advanced by an agent for the account of his client. To the extent that an amount received by petitioner was more or less than the amount advanced by him, he realized a profit or sustained a deductible loss which profit or loss should be included in the computation of net income for the year in which the certificates of profit were received by the petitioner. In the computation of said profit or loss the certificates of profit should be included at 95 per cent of their face value if the petitioner's accounts are on the cash basis or at their face value, if on the accrual basis.

Reviewed by the Board.

Judgment will be entered on 15 days' notice, under Rule 50.

TRUSSELL dissents.