On Petitions for Review of Decisions of the United States Board of Tax Appeals.
Before BIGGS, CLARK, and GOODRICH, Circuit Judges.
Tax liability in this case turns upon the mutual or cooperative character of the petitioners. There are involved tax deficiencies of $167,331.06 for the years 1929 to 1935 inclusive.
The history of the petitioners, Keystone Automobile Casualty Co. and Keystone Automobile Club Fire Co., begins with the organization on March 23, 1925, of the Insurance Exchange of the Keystone Automobile Club. The Club was a cooperative association organized as a non-profit corporation under the laws of Pennsylvania to promote the interest of motorists and to furnish various facilities and services to its members. The Insurance Exchange was organized by the Club with a loan of $25,000 to write automobile casualty and fire insurance.
On May 31, 1928, the Club in order to accommodate members in New Jersey, where an insurance exchange was not permitted to operate, reorganized the Exchange by the incorporation under Pennsylvania law of a casualty insurance company and a fire insurance company, the petitioners in this case. The Club paid into the treasury of the petitioners $450,000, the minimum capital requirements for such companies, for which it received the entire capital stock of the petitioners.*fn1
In November, 1930, the statutory capital of the petitioners was increased from $450,000 to $750,000. The increase was made in order to meet the requirements of the Financial Responsibility Law of the State of New York. The increase was effected by the transfer from the contingent reserve to the capital and surplus accounts of the necessary amounts. A stock dividend of $100,000 was declared by each company and additional shares of stock representing the stock dividends were issued to the Club.
As of December 31, 1935, the capital and surplus of the petitioners amounted to $750,000 and their contingent reserve amounted to $719,301.33 - a total of $1,469,301.33. The present expectation, however, is that upon the liquidation of the petitioners the Club would receive only $450,000.*fn2
The petitioners in the tax years involved insured members of the club and also members of two other automobile clubs, the Delaware Automobile Association and the Pittsburgh Motor Club. On the average they insured 35,121 of the 42,493 members of the Keystone Club and, in addition, 5,171 members of the other clubs. All policyholders were treated alike - they were charged premiums at about 10%, until 1932 and thereafter at about 20% less than those of ordinary stock companies and were refunded 25%, until 1932 and thereafter 10%, of the premiums.
The members of the Keystone Club elected the Club's officers and directors. The persons so chosen elected themselves, by proxy from the Club, officers and directors of the petitioning companies. Policyholders of the other two clubs had no power to vote, although it was provided that they could become members of the Keystone Club upon payment of annual dues.
Under these facts it is necessary to determine whether two provisions of the Revenue Acts dealing with mutual insurance companies are applicable to the petitioners. One provision, § 103(11) of the Revenue Acts of 1928 and 1932 and § 101(11) of the Revenue Act of 1934, 26 U.S.C.A. Int. Rev. Code, § 101(11), exempts: "Farmers' or other mutual hail, cyclone, casualty, or fire insurance companies or associations (including interinsurers and reciprocal underwriters) the income of which is used or held for the purpose of paying losses or expenses;" The other provision, § 208(c)(3) of the Revenue Acts of 1928 and 1932 and § 207(c)(3) of the Revenue Act of 1934, 26 U.S.C.A. Int. Rev. Code, § 207(c)(3), permits deductions as follows: "In the case of mutual insurance companies (including interinsurers and reciprocal underwriters, but not including mutual life or mutual marine insurance companies) requiring their members to make premium deposits to provide for losses and expenses, the amount of premium deposits returned to their policyholders and the amount of premium deposits retained for the payment of losses, expenses, and reinsurance reserves." The court finds it unnecessary to determine whether the petitioners have retained income or premium deposits for the purpose of paying losses or expenses*fn3 because of the conclusion of the court that the petitioners are not mutual insurance companies.
A determination of the mutual or cooperative*fn4 character of an enterprise within the meaning of a statute requires first an analysis of the legislative intent of what is meant by the word "mutual" as disclosed by the statute. Such an analysis, however, fails to disclose any statutory specifications for a mutual organization.*fn5 It becomes necessary, therefore, to determine the normal attributes of a mutual organization.
Counsel for petitioners contend that "the primary and fundamental characteristic of a mutual insurance company is that it be organized and operated exclusively for the purpose of furnishing insurance at cost to its policyholders." This ignores an equally fundamental characteristic of mutual or cooperative organizations - democratic ownership and control.*fn6 In his dissenting opinion in Frost v. Corporation Commission, 1929, 278 U.S. 515, 536, 49 S. Ct. 235, 243, 73 L. Ed. 483, Mr. Justice Brandeis has pointed out that the aim of cooperatives is "economic democracy on lines of liberty, equality and fraternity." The Supreme Court in Penn Mutual Co. v. Lederer, 1920, 252 U.S. 523, 535, 40 S. Ct. 397, 401, 64 L. Ed. 698, has stated: "The ral difference between the two classes of life companies as now conducted lies in the legal right of electing directors and officers. In the stock company stockholders have that right; in the mutual companies the policyholders who are the members of the corporation."
It is true that minor or mere formal departures from the norm do not foreclose the matter. There is no legal litmus test to determine by color reaction the classification of an organization. " * * * it must be the actual nexus of its rights and duties, not its name or form, which decides whether a company falls within one class or the other * * * ." L. Hand, J., in Equitable Life Assur. Society v. Bowers, 2 Cir., 1937, 87 F.2d 687, 690. A substantial departure from a fundamental requirement of a mutual company ...