The Commissioner determined deficiencies in income tax as follows:
Year Deficiency
1957 _$6,192.54
1958 _ 3,741.49
1959 _ 4,555.51
1960 _ 1,341.77
1961_ 5,617.21
1962 _ 10,257. 76
The issue for decision is whether the Commissioner erred in disallowing for each year a deduction of $35,000 as interest paid on indebtedness within section 822(c) (5).
FINDINGS OF FACT
The petitioner was incorporated under the laws of Rhode Island. It maintains its books and files its returns on a calendar year basis. Its returns for the years here involved were filed with the district director of internal revenue at Providence, R.I.
The petitioner writes fire and other insurance, not including life, and has qualified to transact business as a mutual insurance company in 30 States of the United States and Puerto Rico.
It established and maintains a guaranty fund of $500,000 in order to qualify and do business in the various States and to write policies without contingent liability or contingent premium which would render its policyholders liable to assessment under its charter. Many mutual insurance companies maintain a similar fund.
Insurance authorities of the States require this kind of a fund to be designated as surplus on the insurer’s annual statements. An insurance company, in order to do business in a State, must have surplus in regard to policyholders in an amount related to the kind and amount of insurance to be written. It may be in the form of accumulated surplus or a guaranty fund. Losses to policyholders and expenses of the company are payable before payments on the guaranty fund.
The petitioner had issued and outstanding during the tax years, 500 guaranty fund certificates, each in the principal amount of $1,000. From 235 to 293 of those certificates were held during the tax years by owners who were neither policyholders nor directors of the petitioner. $35,000, or 7 percent, was paid as interest on the guaranty fund certificates in each tax year, was deducted on the return as interest under section 822(c) (5) and was disallowed by the Commissioner in determining the deficiency for each year. The payments were made despite losses in 2 years.
The certificate holders and the policy owners each had the right to elect 6 of the 12 directors of the petitioner. All of the directors were policy owners during the tax years.
Interest of not more than 10 percent or less than 7 percent was payable on the certificates if sufficient net profits or unused or unabsorbed premiums were left after payment of expenses and losses and provision for a reserve for reinsurances.
The guaranty fund could be used to pay losses if the corporation had exhausted its assets, including members’ liability but exclusive of uncollected premiums.
The certificates had no fixed maturity date or retirement sinking fund. The company had the obligation to pay only the principal amount and the option to retire all outstanding certificates in whole at $1,000 each or in part at any time or from time to time, if it had a sufficient surplus remaining thereafter.
A certificate could be sold, assigned, or transferred under certain stated limiting circumstances and conditions.
All stipulated facts are incorporated herein by this reference.
The payment of $35,000 in each tax year to the holders of the guaranty fund certificates were payments of interest and as such were deductible by the petitioner for Federal income tax purposes.
OPINION
Murdock, Judge:This taxpayer, like at least 135 other mutual companies, was required by law to have available reserve funds in order to do business in 30 States of the United States and Puerto Rico. It had to borrow money for that purpose. The usual methods, such as bank and other secured loans, were not available to it and it attracted lenders, in part, by offering 7-percent interest. It thus obtained the use of $500,000 and for the use of that borrowed money it agreed to pay and paid interest amounting to $35,000 every year thereafter, including 2 years in which it operated at a loss. The maximum which the lenders could receive on each guaranty fund certificate was $1,000 of principal and annual interest of 7 percent. No tax benefit or avoidance scheme was involved. There is no reason to disregard the form of the transactions and there is no difference between the form and the substance of those transactions.
The decided cases strongly tend to support the allowance of the deductions claimed herein. No two cases in this general field have facts exactly alike (cf. Proctor Shop, Inc., 30 B.T.A. 721, affd. 82 F. 2d 792) but every important fact in this case was also present and considered in one or more of the decided cases. In three of them, the lenders could elect directors. In several the source of the interest payments was like that in this case. The cases cited below support the conclusion that the $500,000 evidenced by the guaranty fund certificates represented borrowed money and the $35,000 paid annually as “interest” was deductible as interest paid for the use of and forbearance in regard to borrowed money. See, for example, Commissioner V. National Grange Mutual Liability Co., 80 F. 2d 316, affirming 31 B.T.A. 666; Holyoke Mutual Fire Insurance Co., 28 T.C. 112; Property Owners Mutual Insurance Co., 28 T.C. 1007; Citizens Fund Mutual Fire Insurance Co., 28 T.C. 1017; Benjamin Franklin Life Assurance Co., 46 B.T.A. 616.
The Commissioner argued in the National Grange case “that the guaranty fund was in fact preferred stock, the so-called interest thereon was a dividend [and] the payment of this dividend was not an expense.” The Board there held that the guaranty fund units were not preferred stock giving the holders an interest in the corporation, but an obligation on which interest was accrued and paid and the payment of that interest was clearly an expense. That case was reviewed by the Board without dissent and was affirmed on the Commissioner’s appeal. The U.S. Court of Appeals for the First Circuit held that the funds secured by the “guaranty fund certificates” were “borrowed money,” although, “The requirements of the situation compelled them to put the company’s obligation to the lenders into a tenuous and unusual form.” That court held “Payments for the use of this money were therefore interest.” The payments in the present case were also interest paid for the use of borrowed money.
The Court in the Holyoke Mutual case, referring to the right of the guaranty holders to elect some directors, said, “Their function is analogous in some respects to creditors’ representatives in other situations who participate in management of a business to protect the creditors’ interest.”1 The Court also said in that case, “The guaranty capital is not equivalent to common stock, for the shareholders [in the guaranty fund] are not entitled to participate in the profits beyond the payments fixed by law. These have been said to be in the nature of interest. Commonwealth v. Berkshire Life Insurance Co., 98 Mass. 25 (1867).” The same is true in the present case.
The taxpayer in Benjamin Franklin Life Assurance Co., supra, was organized as a mutual company under the laws of California. It obtained the funds required by the insurance commissioner of that State by issuing certificates of indebtedness to the lender of the funds. The certificate there fixed 5 percent as the interest rate and provided that the principal and interest would be payable only out of the surplus remaining after providing for all reserves and other liabilities. The funds obtained were described as a “liability” in “its return to the insurance commissioner.” The Court held that the sums paid by the petitioner as interest on the funds covered by the certificates were deductible by it as “interest paid * * * on its indebtedness” within the meaning of section 203(a) (8) of the Revenue Act of 1934. The question of whether the payments here were interest is not different from the one there decided and it too should be decided for the petitioner. The fact that the cited case involved a mutual life insurance company and the present case involves a mutual “other than life” does not justify a different result here.
We distinguished Policyholder’s National Life Insurance Co., 37 B.T.A. 60, in the FramMin case and added, “More in point is our decision in Manhattan Mutual Life Insurance Co., 37 B.T.A. 1041.” The same reasoning applies here.
The Commissioner here contends that the guaranty fund certificates did not represent a genuine debtor-creditor relationship. He does not argue that they were like common or preferred stock or that they represented an equity interest in the company. He does not say what he thinks they were. They did not represent an equity interest. The cases relied upon by the Commissioner are distinguishable on their facts. Cf. Manhattan Mutual Life Insurance Co., supra.
Each case must be decided on its own facts. Proctor Shop, Inc., supra. Here the debt evidenced by each certificate is in a fixed amount, it represents borrowed money required by law, the interest rate is fixed, the certificates can be transferred, they can be retired in whole or part by the debtor under stated circumstances, the interest has been paid every year, including two loss years, and, considering all of the proven facts, the $35,000 payments in the tax years are deductible as interest on indebtedness within the meaning of section 822(c) (5). Cf. Commissioner v. National Grange Mutual Liability Co., and Benjamin Franklin Life Assurance Co., supra.
Reviewed by the Court.
Decisions will be entered under Bule 50.
The certificate holders also had voting rights in the Property Owners and Citizens Fund cases.