*1526 Deductions - Insurance Companies - Net policy Reserves. Petitioner, a life insurance company doing business in Germany, Austria and elsewhere, and computing and maintaining its policy reserves required by the laws of those two foreign countries in their respective currencies had for the taxable year 1920 a net addition of 1,830,253 marks required by the laws of Germany in its German reserve and a net decrease of 6,250,887 kronen in the reserve upon its Austrian business required by the laws of that country. On its business other than German and Austrian it had a net addition required by law of $36,235,398. Held, that the total net addition to petitioner's reserve funds required by law for such year and allowable as a deduction under section 234 of the Revenue Act of 1918 is the combination of these three figures, the net addition in the German reserve and the reduction in the Austrian reserve to be converted, for purposes of combination, on the basis of the exchange value of the German mark and the Austrian krone at the end of that year.
*1217 This proceeding is for the redetermination of a deficiency of $3,469,122.40 for the calendar year 1920. The sole issue is the correct amount of petitioner's net addition to reserve funds required by law to be made within that taxable year and allowable as a deduction under section 234 of the Revenue Act of 1918, petitioner having deducted $35,420,821 as such addition and respondent having reduced this amount to $729,597 and increased net income by the amount disallowed, or $34,691,224.
FINDINGS OF FACT.
Petitioner, the New York Life Insurance Company, is a New York corporation which has been engaged in the mutual life insurance business on the participating level premium plan since 1845. For many years prior to 1913 and until August 1, 1914, it was also engaged in such insurance business in Germany and Austria and since the latter date it has written no new business in those European countries, but has continued the fulfillment of its existing policy contracts therein.
*1218 In 1921 and 1922 petitioner reinsured all of its Austrian and German*1528 business. With respect to all of the policies at any time issued by it in Germany and Austria, all of the premiums thereon and all of the benefits payable thereunder were respectively payable exclusively in and were actually paid in German marks in Germany and Austrian kronen in Austria and in no other currency and in no other place whatsoever.
Petitioner invested in Germany and Austria its excess of receipts over disbursements and never transferred to the United States such excess. It kept at its offices in Germany and Austria, respectively, complete records of its transactions in those countries, which records were kept solely in the respective currencies of Germany and Austria. These German and Austrian offices made regular reports in German marks and Austrian kronen of their business to the home office in New York.
During the time that petitioner did business in Germany and in Austria and continuing throughout the year 1920, it received and disbursed in Germany and in Austria, respectively, varying amounts of marks and kronen, such receipts and disbursements being reported to the home office in New York and there entered upon its records expressed in terms of United States*1529 currency at the rate of 23.8 cents per German mark and 20 cents per Austrian krone. The par rates of exchange for this currency were 23.8 cents per German mark and 20.26 cents per Austrian krone. As of the close of each calendar year petitioner's German and Austrian offices, respectively, sent to the home office in New York a detailed statement of all of petitioner's assets and policy reserves in Germany and Austria, all of which were in German marks and Austrian kronen.
The market rates of exchange on New York for German marks and Austrian kronen on December 31 of 1915 to 1920, inclusive, expressed in cents, were as follows:
| Year | Cents per mark | Cents per krone |
| 1915 | 19.03 | 12.95 |
| 1916 | 18.31 | 11.86 |
| 1917 | 20.015 | 10.56 |
| 1918 | 12.845 | 6.188 |
| 1919 | 2.15 | .61 |
| 1920 | 1.38 | .25 |
The average market rate for the year 1920 was 1.63 cents for the German mark and 0.47 cents for the Austrian krone.
On March 15, 1921, petitioner filed its tax return for 1920 and paid the tax thereon shown to be due in the sum of $621,658.64. On March 30, 1928, respondent mailed petitioner the deficiency notice advising it of the determination of an additional tax deficiency for*1530 *1219 1920 of $4,290,164.26. Of this deficiency petitioner consented to the assessment and collection of $749,499.16 and this was duly satisfied by credit against certain overassessments against petitioner for other years. By the answer filed herein, respondent admits an additional credit due, further reducing the deficiency by $71,542.70 and leaving in controversy $3,469,122.40 of the original deficiency determined. The period for assessment and collection of such deficiency as may in fact exist has not expired, having been extended by consents in writing executed by both parties to the controversy as provided for by the taxing statute.
During the calendar year 1920, and for many years prior thereto, the insurance laws of Germany and of Austria were, in provisions pertinent to the question here involved, substantially similar. Each of those countries required petitioner to revalue its policies at the close of each year on the net premium basis and to maintain a reserve in the amount of such valuation invested in securities of those countries and of specified classes. By the laws of those countries the method of computing this valuation was the same and was also similar*1531 to the method used under the laws of New York State, in all cases the same table of mortality being used with interest at the same rate, the reserve in Germany on German business being expressed in marks and in Austria on Austrian business in kronen. The petitioner complied with these provisions of the German and Austrian laws.
The New York Life had life insurance in force in Germany and in Austria, respectively, which it had issued in those countries, subject to, and in accordance with, the laws of those respective countries applicable to life insurance companies therein, of the number of policies, of the face amounts, and with the policy reserve thereon, as required by the respective laws of Germany and Austria, as follows:
| GERMANY | |||
| Date | Number of policies | Face amount of insurance in German marks | Policy reserve in German marks |
| Dec. 31, 1919 | 14,587 | 281,108,975 | 120,592,954 |
| Dec. 31, 1920 | 14,024 | 270,884,181 | 122,423,207 |
| Decrease | 563 | 10,224,794 | 1 1,830,253 |
| AUSTRIA | |||
| Date | Number of policies | Face amount of insurance in Austrian Kronen | Policy reserve in Austrian kronen |
| Dec. 31, 1919 | 10,245 | 136,497,879 | 71,115,670 |
| Dec. 31, 1920 | 9,351 | 124,126,106 | 64,864,783 |
| Decrease | 894 | 12,371,773 | 6,250,887 |
*1532 *1220 The New York Life, as required by German law, carried all the foregoing policy reserve on German policies into the reserve value fund in Germany, and it was invested in German state and municipal securities, real estate in Germany, policy loans on German policies and cash on deposit in German banks; all of which securities were deposited and held by Konigliche Seehandlung at Berlin in the "German Premium Reserve Fund" of the New York Life - all as required by German law.
The New York Life, as required by Austrian law, carried all the foregoing policy reserve on Austrian policies into the Austrian balance sheet, and it was invested in Austrian state, municipal and railway securities, in policy loans on Austrian policies, and in cash on deposit in Austrian banks; all of which securities were deposited in the custody of, and held by, the Imperial and Royal Post Savings Bank at Vienna - all as required by Austrian law.
The New York Life's outstanding insurance in force (excluding German and Austrian policies) with the policy reserve thereon (less reserve on reinsurances of $50,650 for 1919 and $96,391 for 1920), was as follows:
| Date | Policies | Face of insurance | Policy reserve 1 |
| Dec. 31, 1919 | 1,431,362 | $3,033,716,574 | $712,337,006 |
| Dec. 31, 1920 | 1,581,660 | 3,521,272,025 | 748,572,404 |
| Increase | 150,298 | 487,555,451 | 36,235,398 |
*1534 The New York Life had, in addition to the policy reserve required by law, a contingency reserve for the additional protection of its policy obligations, which by law it was permitted to maintain, and *1221 which was shown on line 38, page 5, of the annual statements to the Superintendent of Insurance of the State of New York for 1919 and 1920, expressed in United States currency as follows:
| Dec. 31, 1919 | $41,493,640.91 |
| Dec. 31, 1920 | 47,262,456.96 |
The New York Life's ledger assets, expressed in terms of United States currency, as of December 31, 1919 and 1920, respectively, were as follows:
| Date | Excluding | Including | Including | Including |
| German mark | German and | German and | German and | |
| and Austrian | Austrian | Austrian | Austrian | |
| kronen assets | assets | assets | assets ex- | |
| held in | expressed | expressed | pressed in | |
| Germany and | in U.S. | in U.S. | U.S. currency | |
| Austria | currency at | currency | at the average | |
| 23.8 cents | at 5 | market rate | ||
| per mark | cents per | for the | ||
| and 2 | mark and | calendar year | ||
| cents per | 2 cents | 1920 at 1.63 | ||
| krone | per | cents per | ||
| krone | mark and | |||
| 0.47 cents | ||||
| per krone | ||||
| Dec. 31, 1920 | $931,173,624 | $976,831,197 | $939,328,504 | $933,938,251 |
| Dec. 31, 1919 | 890,000,018 | 936,509,949 | 898,291,873 | 892,801,028 |
| Difference | 41,173,606 | 40,321,248 | 41,036,631 | 41,137,223 |
| Date | Including German and | Including German and |
| Austrian assets expressed | Austrian assets expressed | |
| in U.S. currency at the | in U.S. currency at Dec. 31, | |
| market rate current at Dec. | 1920, at 1.38 cents per | |
| 31, 1919 at 2.15 cents per | mark and 0.25 cents per | |
| mark and 0.61 cents per | krone | |
| krone | ||
| Dec. 31, 1920 | $934,699,696 | $933,460,476 |
| Dec. 31, 1919 | 893,573,629 | 892,310,951 |
| Difference | 41,137,223 | 41,149,525 |
The New York Life's German and Austrian assets as of December 31, 1919, and December 31, 1920, respectively, consisted of (1) policy loans on German and Austrian policies, (2) the company's building in Berlin, (3) cash in Austrian and German banks, and (4) the following securities which were absolutely identical in both years except as to a small amount in a few items shown in italics:
| GERMAN SECURITIES | ||
| Description of security | Par value Dec. 31, 1919 | Par value Dec. 31, 1920 |
| Government bonds | ||
| Marks | Marks | |
| German Imperial 3s | 3,723,500 | 3,723,500 |
| German Imperial 3 1/2s | 5,066,900 | 5,066,900 |
| German Imperial 4s | 1,056,500 | 1,056,500 |
| German State (Loan of 1915) 5s | 1,090,000 | 1,090,000 |
| German Imperials 5s | 6,825,700 | 6,825,700 |
| German War Loans 5s | 8,601,000 | 8,601,000 |
| German Treasury Notes 4 1/2s | 3,500,000 | 3,400,000 |
| Prussian Cons. 3s | 7,759,700 | 7,759,700 |
| Prussian Cons. 3 1/2s | 10,417,300 | 10,417,300 |
| Prussian Cons. 3 3/4s | 10,000.000 | 10,000.000 |
| Prussian Cons. 4s | 3,000,000 | 3,000,000 |
| Wurtemburg State 3 1/2s | 174,300 | 173,100 |
| Municipal bonds | ||
| Augsburg 4s (Loan of 1907) | 964,500 | 964,500 |
| Barmen 4s (Loan of 1907) | 1,400,000 | 1,400,000 |
| Berlin 4s (Loan of 1904) | 1,938,600 | 1,938,600 |
| Bremen State 3 1/2s (Loan of 1899) | 500,000 | 500,000 |
| Cologne 4s (Loan of 1912) | 8,000,000 | 8,000,000 |
| Crefeld 4s (Loan of 1907) | 1,219,000 | 1,219,000 |
| Danzig 4s (Loan of 1904) | 3,555,000 | 3,450,000 |
| Dortmund 4s (Loan of 1907) | 3,859,500 | 3,859,500 |
| Dusseldorf 4s (Loan of 1908) | 1,141,000 | 1,141,000 |
| Frankfort 4s | 7,216,900 | 7,099,000 |
| Mannheim 4 1/2s (Loan of 1914) | 9,924,000 | 9,824,000 |
| Nuremburg 4s (Loan of 1912) | 5,000,000 | 5,000,000 |
| AUSTRIAN SECURITIES | ||
| Description of security | Par value Dec. 31, 1919 | Par value Dec. 31, 1920 |
| Government bonds | ||
| Kronen | Kronen | |
| Austrian War Loans 5 1/2s (1915-1918) | 20,000,000 | 20,000.000 |
| Austrian Insurance Loan 4.36 | 4,968,917.80 | 4,968,917.80 |
| Austrian Rentes 4s | 38,078,800 | 42,401,814.77 |
| Railroad bonds | ||
| Empress Elizabeth R.R. (Loan of 1856) 5 3/4s | 118,800 | 124,740 |
| Empress Elizabeth R.R. (Loan of 1869) 5 1/4s | 40,000 | 40,000 |
| Empress Elizabeth R.R. (Loan of 1873) 5s | 238,400 | 238,400 |
| United So. Austrian Lombard & Central Italian R.R. (Loan of 1869) 5s | 665,600 | 790,195.07 |
*1222 By the charter and by-laws of the New York Life in effect in 1920, the office committee of the company was given power to regulate the general conduct of the company's business.
By the rules and regulations in effect during 1920-1921 governing the conduct of the New York Life's business, and approved by the board of directors, it was provided that no change should be made "in the method of calculating reserves * * * except upon the advice of Vice-President Rufus W. Weeks or of two of the Company's Actuaries and the approval*1537 of the Office Committee [and that] no new account shall be opened in the Home Office Ledger without authorization from the Office Committee [Rules 4, 12 (a)]."
During the calendar year 1920 (1) neither Vice President Weeks nor any of the actuaries of the New York Life recommended that any change in reserve basis be made by the company; (2) the office committee of the company did not approve making any change in the reserve basis; (3) the office committee did not authorize the opening of any new account or accounts in the home office ledger nor were any new accounts opened in the New York Life's home office ledger at any time between June 25, 1919, and January 5, 1921.
During the calendar year 1920 no entries were made, or authorized to be made, by the New York Life upon any of its records, books or papers in respect to any calculation or expression of any of its assets, receipts, disbursements or policy reserves in Germany and Austria, or for the purpose of expressing them or any of them, in United States currency, at any rate other than the uniform rates that had been used for all time prior to January 1, 1921.
In accordance with section 84 of the New York Insurance Law, *1538 the Superintendent of Insurance of the State of New York (hereafter called Superintendent of Insurance) made annual valuations as of December 31, of each year of the policy reserve, on the net premium basis, of all the New York Life's outstanding policies.
*1223 Between January 1 and March 1 of each calendar year from 1907 to 1921, both inclusive, the New York Life filed with the Superintendent of Insurance an annual report with respect to its business as of December 31 of the preceding calendar year, on the forms for such reports adopted for use by the Insurance Commissioners, known as the "Convention Edition." In each of such annual reports for the years 1907 to 1919, both inclusive, all items relating to German and Austrian business were expressed in terms of United States currency at the rate of 23.8 cents per German mark and 20 cents or 20.3 cents per Austrian krone.
In February, 1920, the New York Life filed as aforesaid its annual report for 1919; and as of December 31, 1919, reported its ledger assets as $936,509,948.90, which included all of its German assets and Austrian assets expressed in terms of United States currency at the rate of 23.8 cents per German*1539 mark and 20.3 cents per Austrian krone.
On or about January 5, 1921, the New York Life proposed to the New York Superintendent of Insurance that (after he should have completed his computation of the net value of all the New York Life's outstanding policies), in order to express German mark policy reserve and Austrian krone policy reserve in terms of United States currency, he should use the rates of 5 cents for the German mark and 2 cents for the Austrian krone, instead of 23.8 cents per German mark and 20 cents per Austrian krone as had been used up to that time.
The Superintendent of Insurance agreed to this adjustment, but he said that the same lower rates must be used as to the German mark assets and the Austrian krone assets of the company; so that both the assets and the policy reserves (so far as they were represented by German marks and Austrian kronen) would be expressed in United States currency at the new rates. The New York Life's assets and policy reserves (in so far as they consisted of German marks and Austrian kronen) were then expressed in United States currency at the new rates.
That adjustment did not represent any transfer of funds to or from*1540 the United States, Germany or Austria; nor the conversion of any assets into money; nor any change in the actual financial condition of the New York Life, one way or the other. The New York Life had exactly the same liabilities in marks and kronen for its German and Austrian business as it had before; and it had exactly the same assts to cover those liabilities as it had before. The entries in the 1920 report were merely explanatory entries accomplishing *1224 but one purpose, namely, to express for convenience, in terms of United States currency the New York Life's German and Austrian business (both assets and liabilities) at rates more nearly corresponding to the current market rates of exchange than had theretofore been used by it.
The investments in Germany of the New York Life were in marks; and they were in excess of the policy reserves in marks. The investments in Austria were in kronen; and they were in excess of the policy reserve in kronen. There was no change whatever in the New York Life's assets.
The New York Life's obligation to its German and Austrian policyholders was not diminished. The New York Life's German and Austrian policies were still being*1541 valued on the specified table of mortality and rate of interest (American Table of Mortality and 3% interest). The net value of German and Austrian policies remained the same. There was no change in reserve basis; there was no release of reserve to the free assets of the company. There was only a change in the rates of expressing German and Austrian reserves and assets in terms of United States currency. This change was voluntarily made by the company; it was not required by law.
The Insurance Department of the State of New York has never issued or ever had rules or regulations governing the expression, in terms of United States currency, of the net value of German and Austrian policies or German and Austrian assets.
In 1921 when the New York Life adopted rates of 5 cents for the German mark and 2 cents for the Austrian krone for expressing its German and Austrian policy reserves and assets in terms of United States currency other life insurance companies reporting to the Superintendent of Insurance of the State of New York used other rates for expressing German and Austrian reserves and assets in terms of United States currency.
On January 13, 1920, and January 10, 1921, respectively, *1542 the Superintendent of Insurance signed and delivered to the New York Life certificates of his aforesaid annual valuations, as of December 31, 1919 and 1920, respectively.
All German and Austrian policy reserves were included in such annual valuations by expressing them in terms of United States currency for the calendar year 1919 and all prior years, at the rate of 23.8 cents for the German mark and 20 cents for the Austrian krone.
On January 5, 1921, the office committee authorized the opening of a new account entitled "Foreign Exchange due to Change in Standards." On January 19, 1921, the treasurer submitted to the office committee a memorandum of the journal entries which had been made in this new account, as follows:
| JOURNAL ENTRY | ||
| 12,484 | $2,951,840.56 | Reducing German Policy Loans to rate |
| of exchange of .05 per Mark. | ||
| 12,484 | 1,073,844.43 | reducing Austrian Policy Loans to |
| rate of exchange of .02 per Kronen. | ||
| 12,487 | 27,143,411.37 | reducing German and Austrian Bonds |
| to rate of exchange of .05 per Mark | ||
| and .02 per Kronen. | ||
| 12,520 | 49,973.83 | placing German and Austrian Ledger |
| Balances exchange of .02 per Kronen | ||
| and .05 per Mark | ||
| Paris Acct | 6,283,623.25 | placing German and Austrian Bank |
| Balances exchanges of .02 per kronen | ||
| and .05 per Mark. | ||
| 37,502,693.44 |
*1543 *1225 In February, 1921, the New York Life made its annual report to the Superintendent of Insurance with respect to its business as of December 31, 1920, on the "Convention Edition" form.
The New York Life reported in such 1920 report its ledger assets as of December 31, 1920, at $939,328,504.04, in which were included all of its German assets and Austrian assets, expressed in terms of United States currency at the rate of 5 cents for the German mark and 2 cents for the Austrian krone.
The computations resulting in the item of $790,778,475 included all the German and Austrian business; and such computations as to German and Austrian business were expressed in terms of United States currency at the rate of 23.8 cents per German mark and 20 cents per Austrian krone.
Item designated "6 1/2. Adjustment arising from the adoption of a lower standard for conversion of Foreign Currencies, $34,691,224.00," and item designated "43 1/2. Adjustment arising from the adoption of a lower standard for conversion of Foreign Currencies, $37,502,693.44," arise from the adoption of rates of 5 cents per German mark and 2 cents per Austrian krone, for expressing German and Austrian*1544 reserves and German and Austrian assets respectively in terms of United States currency.
As of December 31, 1919, the New York Life had reported its assets at $936,509,948.90.
A year later, as of December 31, 1920, the New York Life began its report of its assets with the $936,509,948.90 balance with which it had started the calendar year 1920; and it then next reported and added thereto and subtracted therefrom its 1920 income and disbursements:
| (a) Income received during 1920, as | $193,790,133.12 |
| (b) Disbursements during 1920 at | 153,468,884.54 |
| Excess of income over disbursements | 40,321,248.58 |
*1226 This $40,321,248.58 balance, when added to the $936,509,948.90 assets with which the year began, made the assets at the end of 1920, $976,831,197.48, but the New York Life then modified the "Convention Edition" form for 1920 by inserting in the disbursements a special line in handwriting, page 3, line 43 1/2 as follows:
| 43 1/2. Adjustment arising from the adoption of a lower standard for conversion of Foreign Currencies | $37,502,693.44 |
This item is not a disbursement but is necessary because in 1920 the Company adopted a*1545 lower standard for conversion of certain foreign currencies resulting in a decrease in dollars in its Foreign Assets and correspondingly in its Foreign Liabilities.
The inclusion of this bookkeeping item among the actual disbursements automatically caused the $976,831,197.48 assets on hand at the end of 1920, expressed in United States currency, to appear as $939,328,504.04.
Tne New York Life reported on the "Convention Edition" form of the Annual Report, page 5, its policy reserves as of December 31, 1920.
| Total lines 1 to 5 | $790,778,475 |
| Line 6 on Reinsurances | 96,391 |
Such $790,778,475 policy reserve included:
(a) German mark policy reserve representing New York Life's policy reserve in its German policies, and
(b) Austrian kronen policy reserve representing the New York Life's policy reserve on its Austrian policies.
both expressed in United States currency at the old conversion rates of 23.8 cents for the German mark and 20 cents for the Austrian krone.
The New York Life then modified the "Convention Edition" form for 1920 by inserting a special line in handwriting, page 5, line 6 1/2, as follows:
| 6 1/2 - Adjustment arising from the adoption of a lower standard for conversion of Foreign Currencies | $34,691,224 |
| The New York Life contends that the "net addition required by law to be made within the taxable year to reserve funds" for 1920, under the 1918 Revenue Act, section 234(a)(10)(a) was | 1 $35,420,821 |
| The Commissioner of Internal Revenue, in determining the tax deficiency for 1920 (of which $3,469,122.40 is the amount now in controversy) allowed as a deduction under said section 234(a)(10)(a) as the "net addition, etc.," for 1920 | 729,597 |
| Difference | 34,691,224 |
*1227 This difference in the "net addition, etc.," as respectively claimed by the New York Life, and as allowed by the Commissioner, is the exact amount shown on line 6 1/2, page 5, of the New York Life's annual report for 1920, as follows:
| 6 1/2 - Adjustment arising from the adoption of a lower standard for conversion of Foreign Currencies | $34,691,224 |
OPINION.
TRAMMELL: Briefly stated, the facts upon which the issue here presented is raised are that petitioner for the year 1920 and for many years prior thereto was engaged in the life insurance business in Germany, Austria and elsewhere. Its risks under policies written in these two foreign countries were expressed in and payable in the currency of the respective country and its policy reserves on such business, required by the laws of each country, were maintained in their respective currencies and invested in such countries.
For many years prior to 1920 the rate of exchange on German marks and Austrian kronen*1547 varied but slightly. Petitioner had consistently, during those years in making its report to the Superintendent of Insurance of New York State, converted its German and Austrian reserves, including the additions thereto for the current year required by the laws of these countries, at the standard rate of exchange to state them in American currency for purposes of combining them with similar totals in respect to their other than German and Austrian business.
After the close of the World War the exchange values of the German mark and the Austrian krone depreciated largely and shortly after the close of the calendar year 1920 petitioner proposed to the Superintendent of Insurance of New York that in making its annual report for that year it convert the change in these two foreign reserves for the purposes of the report on the basis of 5 cents for the German mark and 2 cents for the Austrian krone. This proposal was agreed to on condition that petitioner should also report its German and Austrian assets, representing the investments of its reserves in those countries, converted at the same rate in order that the public and its policyholders might be fully advised. This was done, *1548 the regular or "Convention Edition" form of report being amended to interline a reduction in asset value by such conversion equivalent to $37,502,693.44.
The Revenue Act of 1918 provides in section 234(a)(10):
SEC. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions * * *.
* * *
*1228 (10) In the case of insurance companies, in addition to the above: (a) The net addition required by law to be made within the taxable year to reserve funds * * *.
It is admitted that petitioner for the calendar year 1920, on its business other than in Germany and Austria, had an enormous increase of $487,555,451 in new insurance, on the basis of which its existing reserve was required by law to be increased $36,235,398. It is also admitted that in respect to its German business for that year the existing reserve was required by the laws of Germany to be increased by 1,830,253 marks, and in respect to its Austrian business the Austrian law required at the close of such year a reserve of 6,250,887 kronen less than the existing reserve.
Petitioner contends that the net addition to its total reserve*1549 funds for that year which it is entitled to deduct in arriving at net taxable income is the combination of those three figures, or $36,235,398, plus 1,830,253 marks, minus $6,250,887 kronen, the two latter amounts to be converted for purposes of combination upon some accepted basis of value for exchange, either the standard rate, the average rate for the year, the rate at the beginning or at the close of the year, or the arbitrary rate proposed by it and accepted by the Superintendent of Insurance of New York State of five cents for the German mark and two cents for the Austrian krone.
Respondent's contention is, and it is upon this theory that the deficiency herein has been computed, that the figures entered upon the Convention Edition form of report must be accepted literally and that when the assets representing investments of the German and Austrian reserves are expressed in American dollars at the low rate of exchange there is effected a corresponding reduction in these reserves; that instead of combining the changes in the three reserves the net change must be computed by combining the totals of the three reserves as of the beginning and close of the taxable year and*1550 the difference between such totals is the net addition or decrease, as the case may be. Following this theory respondent has taken the total of petitioner's German and Austrian reserves at the beginning of the year, built up by the additions from year to year and converted at the standard rate of exchange, and such totals at the close of the year converted at the depreciated rate of five cents for the mark and two cents for the krone, the result giving a decrease in these two foreign reserves, on the dollar basis, of more than $35,000,000, this decrease wiping out all except $729,597 of the net addition of $36,235,398 required by law on account of other business. He contends that this latter sum is the net addition allowable to petitioner as a deduction for the taxable year.
*1229 This theory of respondent treats the net policy reserve of a life insurance company on the participating level premium plan as in the nature of a reserve of assets increasing or diminishing with the rise and fall of the market. It has been overlooked that this reserve is not the assets in which it may happen to be invested, but merely a calculated amount subject to exact mathematical computation. *1551 It is the net value of outstanding policies calculated upon a given table of mortality, with interest at a certain adopted rate. The reserve so calculated may be ten millions of dollars or marks or kronen and invested in securities of the same market value. Such securities may in the course of the year lose half of their market value, but this condition does not reduce the reserve in amount. The assets are merely security for the reserve, but the amount of the reserve is determined exactly by the mathematical calculation of the life value of outstanding policies and is increased or decreased only by a change in amounts and/or life expectancies of such policies.
The purpose of the above quoted section of the taxing statute is to permit a taxpayer engaged in the business of petitioner to except from taxable income that portion of its gross receipts from premiums which it receives under obligation created by law to immediately set aside with proper guaranties of maintained value to meet the policies as they mature. It is apparent that respondent's method of computing the amount of the net addition to petitioner's reserve for the calendar year 1920 denies it the privilege accorded*1552 by the Act, the admitted facts showing that of its total premium receipts some $35,000,000 was required to be set aside for purposes of the reserve and for that year there was released to the general funds of the company, due to decrease in reserve, only the amount of 6,250,887 kronen on its Austrian business, while respondent's computation allows a deduction for that year on account of addition to reserve of only $729,597.
The fallacy of respondent's theory in computation is apparent when we consider the result reached. It is admitted that petitioner's reserve on other than German and Austrian business had a net addition for the taxable year of more than $36,000,000; that its German reserve was required to be increased by nearly 2,000,000 marks and that the only decrease was one of 6,250,887 kronen in its Austrian reserve. A method of computation that determines in the face of these admitted changes (and these are the only changes in the amounts of the three reserves) a net increase in total reserves of only $729,597 is manifestly erroneous.
To value petitioner's total German and Austrian reserves computed, invested and maintained in German marks and Austrian *1230 *1553 kronen, on the basis of 23.8 cents for the German mark and 20 cents for the Austrian krone as of the beginning of the taxable year, and then to revalue these reserves on the basis of 5 cents for the mark and 2 cents for the krone as of the close of that year, on the basis of a depreciated exchange value of these currencies, is to incease or decrease on the basis of fluctuations of exchange values reserves which are in no sense affected by such changes, but, as heretofore pointed out, are merely mathematically calculated totals arrived at by the use of three factors - total face value of policies, their life expectancies on the basis of a mortality table, and a fixed interest rate, the result being identically the same whethe calculated and expressed in marks, kronen or dollars. It is true that the reserve is spoken of as the net value of outstanding policies, but this value is one computed on a fixed and unvarying basis. By the method used by respondent the net increase or decrease in the reserve is determined upon an asset valuation basis, whereas the taxing statute is concerned merely with the net computed increase in amount - the added number of dollars, marks or kronen required*1554 by law to be set aside, and the only reason that the value of exchange on German marks or Austrian kronen must be considered at all is the necessity to reduce these increases or decreases in foreign reserves to dollars in order to combine them with the additions or decreases in reserves computed and maintained in dollars for purposes of determining a tax which must be computed in the latter currency. It would need no more to demonstrate the respondent's error than the noting of the fact that by this method petitioner is shown to have some $35,000,000 additional income by reason of a loss in this amount in market value of its foreign assets as expressed in terms of American currency.
We hold that petitioner is entitled to deduct, as its net addition required by law to be made to its reserve funds in arriving at the net taxable income for the calendar year 1920, $36,235,398, plus $1,830,253 German marks, and minus 6,250,887 Austrian kronen, the two latter amounts to be converted into dollars for the purpose of combination and computation of the tax at the prevailing exchange rates, as of December 31, 1920, of 1.38 cents for the mark and 0.25 cents for the krone. This will give*1555 a net addition to reserve fund required by law of $36,245,028.
Reviewed by the Board.
Judgment will be entered under Rule 50.
ARUNDELL concurs in the result only.
Footnotes
1. Increase. ↩
1. The policy reserve (less $50,650 for 1919 and $96,391 for 1920 for policy reserve on reinsurances), expressed in United States currency, on all of the New York Life's outstanding policies as of December 31, 1919 and 1920 respectively, was as follows:
(a) (b) (c) (d) Date Including Including Including German and German and German and Austrian Austrian Austrian policy policy policy reserves reserves reserves expressed expressed expressed Excluding in U.S. in U.S. in currency German and currency at currency at at the average Austrian 23.8 cents 5 cents per market rate policy per mark and mark and at current at reserve at 20 cents 2 cents per Dec. 31, 1919 per krone krone at 2.15 cents per mark and at 0.61 cents per krone Dec. 31, 1920 $748,572,404 $790,682,084 $755,990,860 $750,872,766 Dec. 31, 1919 712,337,006 755,261,263 719,788,967 714,636,915 Difference 36,235,398 35,420,821 36,201,893 36,235,851 ↩
Date Including German and Including German and Austrian assets Austrian assets expressed in U.S. expressed in U.S. currency at the market currency at Dec. 31, rate current at Dec. 1920, at 1.38 cents 31, 1919, ar 2.15 cents per mark and 0.25 per mark and 0.61 cents cents per krone per krone Dec. 31, 1920 $934,699,696 $933,460,476 Dec. 31, 1919 893,573,629 892,310,951 Difference 41,126,067 41,149,525 1. For brevity and clarity, the above tabulation excludes $1,929,001.97 "net addition, etc." to certain other legal reserves admitted by both the New York Life and the Commissioner. ↩