Petitions for Review from the United States Board of Tax Appeals.
Before BIGGS, CLARK, and BUFFINGTON, Circuit Judges.
The income tax repercussions of insurance carried by corporations on the lives of their officers have turned upon the distinction between two simple classes of cases. The first is where the corporation receives the proceeds of such insurance as beneficiary named in the policy. The amounts so received are not taxable to it, they being within the statutory exclusion from gross income of "amounts received under a life insurance contract", Revenue Act of 1934, sec. 22(b)(1), 26 U.S.C.A. Int. Rev. Acts, page 670, and see United States v. Supplee-Biddle Hardware Co., 265 U.S. 189, 44 S. Ct. 546, 68 L. Ed. 970. The second, as might be expected, deals with next step - transference of the insurance proceeds from the corporationbeneficiary to its stockholders. Now the stockholders do not receive those proceeds "under a contract of insurance". The contract goes no further than to create a legal relationship between the insurer, the insured officer, and the beneficiary corporation. The amounts received by the stockholders fall rather into the broad category of dividends. They have accordingly been taxed to the stockholders, despite their physical segregation from the corporate assets coupled with a corporate undertaking (by appropriate resolutions passed prior to the insured officer's death) to pay them over to the stockholders when received, Cummings v. Commissioner, 1 Cir., 73 F.2d 477; May v. Commissioner, 20 B.T.A. 282.
The cases at bar fall into this second class. They present, as do the Cummings and May cases, the segregation of insurance proceeds in accordance with a preconceived and legally implemented plan of distributing them pro rate among stockholders. There is, however, an important difference in method. The procedure employed goes beyond the mere adoption of resolutions and opening of special bank accounts. Here, the Golden-Anderson Valve Specialty Company, an absolute owner and beneficiary of eleven unmatured policies on the life of its president, Charles B. Golden, entered into a contract with a trust company. The contract was labeled "Agreement for the Distribution of Insurance". Under it, the policies were delivered and made payable to the trust company by the corporation: the trust company engaged to collect their proceeds when the occasion arose and distribute them to the holders of stock in the corporation at that time. This contract has been fulfilled. Our problem is to determine the consequences of that fulfillment. Are the amounts received by the stockholders from the trust company exempt insurance monies or taxable dividends? Or, further, are they in the nature of both?
We are unable to detect any substantial flaw in the appellant stockholders' argument that their receipts from the trust company are amounts received under a life insurance contract. Without going into details or technicalities, it seems plain from the record that the trust company was duly named beneficiary of all eleven policies. The issuing insurance companies were all notified, and the change of beneficiary was in one way or another endorsed by them on the face of each policy. That the change was effective is further buttressed (pragmatically speaking) by the fact that collections seem to have been made on the policies by the trust company without any difficulty whatsoever. The trust company was, therefore, included in the legal relationships created by the eleven life insurance contracts. It received the insurance proceeds directly under those contracts. If it acted as trustee for the stockholders, the latter likewise received them under those contracts "in trust" within the scope of long standing regulations particularizing the insurance exemption, Regulations 86, Art. 22(b)(1)-1. Again without going into details or technicalities, we think it clear that the agreement between the Valve Company and the trust company set up (despite certain reservations of rights in the policies to the corporation) a valid unfunded insurance trust.*fn1 The formal transfer of monies from the insurance company to the stockholders via the trust company occurred, therefore, in the maner contemplated by the exemption regulations.
The qualification inherent in our use of the adjective "formal" proceeds from a conviction that the stockholders' receipts at bar must also be classified as dividends. These are broadly defined in the statute:
"(a) Definition of Dividend. The term 'dividend' when used in this title * * * means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913.
"(b) Source of Distributions. For the purposes of this Act every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits." Revenue Act of 1934, Sec. 115, 26 U.S.C.A. Int. Rev. Acts, page 703.
At the time distributions were made to the stockholders by the trust company, the Valve Company had in its treasury an amount of orthodox undistributed earnings and profits accumulated since February 28, 1913, which exceeded the amount of the distributions. That being so, the conclusive presumption of section (b) above removes the nice question of whether life insurance proceeds are "earnings and profits" from the case. It is comforting, however, to note that an acute investigator of the subject has emerged with an affirmative answer.*fn2 The distributions at bar are, therefore, dividends, if they were "by" the Valve Company to its stockholders. We think they were.
A corporation cannot, and does not, make a gift of its assets to shareholders. It may, however, transfer surplus assets to them in the form of dividends. The case at bar unquestionably instances a transfer of surplus assets to stockholders. The eleven policies certainly constituted corporate assets before the distribution agreement with the trust company. Even after the agreement the Valve Company continued to deplete its coffers by paying premiums to keep some of the policies alive.Yet ensuant upon Mr. Golden's death, the corporation had nothing, the stockholders everything. A dividend transfer, actively engineered by the corporation (which acquired the policies, and entered into the distribution agreement), occurred somewhere along the line. The only difficulty is in fixing the exact point.
If the transfer occurred immediately upon on the execution of the distribution agreement, the dividend would be measured by the then cash surrender value of the policies, and not, as the Commissioner has done at bar, by the amount of their proceeds. Our view of the matter, however, is that the transfer did not so occur. Practically speaking, the stockholders could receive no cash until the policy proceeds were collected. Technically speaking, they received but little else until then. The agreement called for distribution to (or, if one prefers, the policies were held intrust for) only those persons who held stock when the proceeds were collected. We have spoken, moreover, of certain policy rights reserved by the Valve Company in the distribution agreement. These, we think, constituted a retention of incidents of ownership sufficient to delay the occurrence of a transfer, as that concept has been developed in the surely analogous fields of estate and gift taxation,*fn3 until those incidents were extinguished at Mr. Golden's death. That being so, the Commissioner's measure is the correct one.
We are confronted, then, with the unusual spectacle of two provisions of the same enactment in direct collision with each other. Both speak in specific terms, 1 Paul and Mertens, Law of Federal Income Taxation, sec. 3.10; yet one imposes tax, the other exempts from tax. If there is any force whatever in the hornbook rule that exemptions should be narrowly construed against the taxpayer, 1 Paul and Mertens, Law of Federal Income Taxation, sec. 3.30, the exemption should and must give way. Furthermore, it is to be borne in mind that the eleven policies indemnified the Valve Company against the loss occasioned by the cessation of Mr. Golden's services. That loss is essentially one of future earnings and profits - earnings and profits which could only be transferred to stockholders as taxable dividends, see Magill, Taxable Income, above cited, p. 338.
One minor question remains. Mr. Golden, the insured president of the Valve company, held, as might be expected, a large portion of its stock. Did his insurance dividend accrue to him individually in the period before his death, or to his estate in the period after his death? The Board's allocation of the dividend to the later period is, we think, plainly correct. "All events creating the liability"*fn4 for that dividend had assuredly not occurred prior to Mr. Golden's death, or even - to split a metaphysical hair - up to and including the moment of his death. For one thing, payment of the dividend was conditional upon payment of the policy proceeds. For another, that payment was in turn ...