*686 A corporate taxpayer in 1932, in accordance with an obligation, paid its agent compensation of $199,715.85, and on the last day of the year made a new contract whereby the compensation was reduced by a computation on a new basis and the agent was to pay the difference, $44,621.24, "as a contribution to the surplus of the company, without liability upon the part of the company, except that said sum is to be paid by the company to the agent with interest thereon at 6 per cent per annum, if, as, and when, any surplus of the company can be so used for such purpose without impairing the solvency of the company." There was ample surplus at all times to make such payment. Held, the entire amount of $199,715.85 is deductible in 1931.
*585 The Commissioner determined a deficiency of $8,750.70 in petitioner's income tax for 1931. The petitioner assails the computation of underwriting losses incurred in 1931, computed under section 204(b)(6) of the Revenue Act of 1928, and the disallowance of a deduction of $44,621.64 as part of the expense of agency*687 services.
FINDINGS OF FACT.
The petitioner is an insurance company, other than life or mutual, incorporated under the laws of California, and does business solely in that state. About 80 percent of its business in 1931 was the writing of workmen's compensation insurance. The remainder was automobile liability, collision, and property damage insurance, and public liability and theft insurance.
1. In its income tax return for 1931 the petitioner took a deduction for underwriting losses incurred of $611,245.39, computed as follows:
| Underwriting loss (losses paid) | $723,049.74 | |
| Unpaid losses end of 1931 | $549,175.65 | |
| Unpaid losses end of 1930 | 660,980.00 | |
| 111,804.35 | ||
| Losses incurred | 611,245.39 |
The amounts for unpaid losses set out above represent estimates of petitioner's claims examiners of the total remaining cose of final adjustment of outstanding policy claims against the petitioner. There is no uniformity of method of the claims examiners of the *586 company, but in making their estimates they take into consideration numerous factors, and, bases upon experience, revise their estimates from time to time during the process of settlement*688 of claims.
In its annual statement for the year ended December 31, 1931, which petitioner was required by law to file with the Insurance Commissioner of California, it showed, under the "Underwriting and Investment Exhibit", "Losses" computed as follows:
| Losses paid (adjusted for salvage and reinsurance) | $723,049.74 |
| Add unpaid losses December 31 of current year | 626,321.15 |
| Total | 1,349,370.89 |
| Deduct unpaid losses December 31 of previous year | 596,532.85 |
| Losses incurred during the year | 752,838.04 |
The difference between the figure for losses incurred shown on the annual statement and that shown on petitioner's return is due to the difference in the amounts shown on each for unpaid losses. For the annual statement, unpaid losses are computed according to state law on a reserve basis, which requires that the company show as its liability for unpaid losses the higher of two amounts: the one computed by a prescribed formula involving principally a percentage of premiums, the other the total of the estimates of the company's claims examiners. The percentage formula gave the higher figure for 1931. The annual statement is that approved by the National Convention*689 of Insurance Commissioners.
2. During 1931 the petitioner was under contract with the Victor Montgomery General Agency, Inc., in accordance with which the latter managed all the affairs of the petitioner, paying all overhead expenses of salaries and rents, in return for a certain percentage of premiums collected on policies written by petitioner. This remuneration was paid monthly to the agency upon the basis of business done each month, and up to December 31, 1931, the agency had received in cash from the petitioner the amounts due. On that date the remaining payment, applicable to December, was made to the agency by the petitioner, the total payments for the year amounting to $199,715.85.
As a result of the depreciation in value of petitioner's investment securities during 1931, it was found upon a preliminary check-up before the end of the year that the company would show a reduction in surplus of more than $100,000 after taking into consideration the year's earnings. While the company would have remained solvent, the management considered that the large reduction in surplus would have been detrimental from a sales standpoint. In order to make a better showing for competitive*690 purposes, a plan was devised whereby the agency paid to the petitioner on December 31, 1931, *587 an amount of $44,621.64 under a written agreement. This agreement provided, after reciting that it was the desire of the parties to conform with the economic conditions caused by the general depression which had made it advisable "to curtail expenses and to adopt all measures to increase the efficient and economic operation of the parties", that the contract between the agency and the petitioner should be adjusted to specified percentages of premiums collected different from the original contract rates. The adjustment was to apply only to business transacted during 1931. The difference between the total due the agency by the petitioner under the original contract and that due under the amended rates was stated to be $44,621.64, which "shall constitute a contribution made by the Agent and accepted by the Company as a contribution to the surplus of the Company, without liability upon the part of the Company, except that said sum is to be paid by the Company to the Agent with interest thereon at six (6%) per cent per annum, if, as, and when, any surplus of the Company can be so*691 used for such purpose without impairing the solvency of the Company." Pursuant to the agreement, the agency paid $44,621.64 by draft to the petitioner on December 31, 1931.
On its annual statement for 1931 filed with the Insurance Commissioner of California, the petitioner showed $155,094.21 as underwriting expenses "unpaid December 31 of current year, as per liabilities exhibit." On its income tax return for 1931, it claimed that amount as an "expense liability unpaid", plus an "added * * * expense for which a note was given" of $44,621.64, making a total of $199,715.85, in computing its deduction for underwriting expense. The agency treated the entire amount of $199,715.85 as income on its books for 1931, and set up the $44,621.64 as an asset.
During 1932 and 1933 petitioner repaid $17,750 periodically in amounts of $1,000 or $1,500. By 1934 or 1935 the full amount of $44,621.64 was repaid to the agency, with interest in full computed and paid on the final installment.
In 1933, at the suggestion of the state insurance examiner, the agreement was amended to provide that the $44,621.64 should be repaid in whole or in part if, as and when such repayment would not reduce the*692 surplus of the petitioner below $165,000.
OPINION.
STERNHAGEN: 1. The petitioner's first contention is that its deduction for losses should be not $611,245.39, as taken by it on its return, but $752,838.04, as shown on its annual statement filed with the California insurance commissioner. This contention for 1931 is controlled by the Revenue Act of 1928 and is precisely the same as that *588 made for 1930 and rejected in . The deduction taken on the return was correct.
2. The petitioner filed an opaque return, and the Commissioner held that the item of $44,621.64 "represents a contingent liability and as such does not constitute an allowable deduction from gross income."
It can not be said that the $44,621.64 represents a contingent liability. By its original contract the petitioner was, throughout 1931, obligated to pay its agent $199,715.85, and this amount it paid. Without more it was clearly deductible. The new agreement of December 31, 1931, did not change this liability or payment. It did, to be sure, purport to reduce the absolute amount and make the $44,621.64 seem*693 to be repaid to petitioner to be paid back later by petitioner only if it could be so paid "without impairing the solvency of the company." But, since the company always had a surplus more than sufficient to withstand the payment, there never was a contingency and the obligation was never impaired and never lapsed. Really its agent, merely to enable the company to keep up appearances, loaned the company $44,621.64 and called it artificially a "contribution to surplus", while retaining a right to demand its repayment with interest, subject only to the possibility that the right would lapse with a vanished surplus. The amendment of 1933 further limiting the agent's right to repayment did not operate retroactively to change the contractual rights in 1931.
The entire $199,715.85 was a proper deduction of 1931, and the Commissioner's disallowance of $44,621.64 was in error.
Judgment will be entered under Rule 50.