Petition for Review from a Decision of the United States Board of Tax Appeals.
Before THOMPSON and BIGGS, Circuit Judges, and DICKINSON, District Judge.
This is an appeal from a decision of the Board of Tax Appeals. The petitioner is the Penn Mutual Life Insurance Company, a Pennsylvania corporation, engaged in carrying on the business of a mutual life insurance company, having no capital stock; and its policyholders constitute its members. The controversy here involved relates to alleged federal income tax deficiencies which were found by the Board of Tax Appeals to be in the amount of $38,884.14 for the year 1926, and in the amount of $26,322.55 for the year 1928. The revenue acts under which the taxes against the respondent have been levied, though of different years, are the same in terms so far as the pertinent parts thereof are concerned. We are therefore setting out as a note to this opinion*fn* the pertinent sections of the Revenue Act of 1928 (sections 201-203 [26 U.S.C.A. §§ 201-203 and notes]) and Regulations 74 pertaining thereto.
The questions presented arise by reason of the disallowance by the Board of deductions claimed by the petitioner as interest on indebtedness under paragraph 8 of subsection (a) of section 203 of the statute referred to (26 U.S.C.A. § 203 note). The points in controversy fall conveniently into categories which relate to the policies issued by the petitioner and options thereunder.
As to the Two Policies of Insurance, Known Respectively as "Ordinary Life Trust Certificate or Instalment Policy" and "Ordinary Life Policy."
The first policy, for our consideration, is one designated by the petitioner as an "Ordinary Life Trust Certificate or Instalment Policy," which we will refer to hereafter as the Trust Certificate policy. It provides for payment of the sum of $24,000 in 240 equal monthly instalments, "the first instalment-certain to be paid upon the receipt" of proof of the death of the insured. The policy contains provisions to the effect that the beneficiary may commute the sums due in instalments by a lump sum payment with the permission of the insured, and, if such permission has been given, the total commuted value of the policy will be $18,380.
Section 1 of the policy, which is entitled "Participation -- Dividends of Surplus," provides:
"Annual Dividends. This Policy will participate in surplus while in force by payment of premiums and thereafter if full-paid. Dividends will be determined and accounted for by the Company and will be available upon payment of the second year's premium, and at the end of the second and of each subsequent policy-year.
"Dividends may be used: * * *
"(3) To accumulate to the credit of this Policy at 3 per cent. per annum compound interest, this interest rate to be increased annually by such addition as may be awarded by the Board of Trustees, which accumulation will be payable at the maturity of this Policy or may be withdrawn at any time with interest to the date of withdrawal.
"If no other option is selected, dividends shall be paid in cash."
Section 7 of the policy, which is entitled "Instalments," provides:
"When this Policy becomes a claim it will be payable in 240 Monthly instalments- Certain * * * provided no indebtedness on account of this Policy is outstanding. If there be any indebtedness at maturity on account of this Policy which is not repaid before the first instalment-certain falls due, such indebtedness shall be forthwith deducted from the total commuted value of this Policy and the amount of each instalment-certain payable during the specified period of 20 years shall be thereby reduced in the proportion that the total indebtedness bears to the total commuted value.
"If the beneficiary should die while receiving instalments-certain, the commuted value of the instalments-certain remaining unpaid calculated by the Company on the same basis (3% compound interest) as the instalments are granted, shall be payable to such beneficiary's executors or administrators, unless otherwise provided in this Policy or by proper instrument in writing filed at the Home Office of the Company. The payment, upon the death of such beneficiary, of the remaining instalments-certain shall discharge the Company from all liability under this Policy.
"The instalments-certain after the first year will be increased annually by such addition as may be awarded by the Board of Trustees.
"The commuted value of this Policy is calculated on the basis of annual payment of the instalments. If the instalments are payable in semi-annual, quarterly or monthly portions, the Company will pay with the first instalment of each year an additional amount equal to the saving in interest through payment of the instalments other than annually, which will be the following percentage of the stipulated yearly instalments: if semi-annually 0.73%, if quarterly 1.10%, if monthly 1.34%."
Section 3 provides: "The reserve basis of the following table is the American Experience Table of Mortality with interest at 3 per cent. per annum, according to the net level premium method. In computing the reserve on this policy, the commuted value shall be $1,838.00 for each $120 of yearly income."
The Board found as a fact, and its finding is supported by sufficient evidence, that: "The fixed monthly instalment of $100.00 provided for in the foregoing policy, insofar as actuarial calculation is concerned, includes a partial payment of the original lump sum equivalent; that is, the original lump sum at the time of death or maturity of the policy, and the remainder thereof is the equivalent of a guaranteed rate of 3 per cent."
If this finding be stated in a slightly different fashion, it is that the sum of $24,000 to be paid in 240 equal monthly instalments does in fact represent the $18,300, the "commuted" value of the policy, plus 3 per cent. compounded annually as called for by the policy.
The second type of policy involved herein is designated by the petitioner as an "Ordinary Life Policy." It provides for payment to the beneficiary, upon receipt of proof of death of the insured, of the sum of $100,000. Section 1 of this policy, also entitled "Participation-Dividends of Surplus" is identical in provisions with section 1 of the "Ordinary Life Trust Certificate or Instalment Policy," quoted above. Section 7, entitled "Options for Payment of this Policy as an Income," provides:
"The insured, subject to any designation of beneficiary or assignment of this Policy filed with the Company, as provided in Section 4, may elect in writing that the net proceeds of this Policy at maturity, or any part thereof, or the cash value before maturity, not less than $1,000, shall be payable according to any of the following options. In such written election no beneficiary entitled to the proceeds of this Policy or any part thereof or any instalment of interest or principal to become due thereon shall have the right to commute, withdraw, surrender, encumber, alienate or assign the same upon any terms whatsoever unless by the written permission of the insured.
"The beneficiary entitled to receive the net proceeds when payable may elect in writing to have the net proceeds payable according to any of the following options in event ...