*220 Decision will be entered under Rule 50.
1. In 1940 the petitioner acquired title to certain parcels of real estate through foreclosure proceedings but without making any bid therefor. In no case was the value of the parcel of real estate acquired equal to the petitioner's loan on the property, plus accrued interest, although in some cases the value was in excess of the principal of the loan. Petitioner concedes that it received taxable income to the extent of such excess. Held, that the petitioner, making its return on the cash basis, did not derive taxable income from the foreclosure proceedings beyond the amount conceded.
2. During 1940 the petitioner paid $ 16,255.28 representing guaranteed interest on supplementary contracts not involving life contingencies in cases where such contracts were issued pursuant to options selected by the insured. Held, that such payments are legal deductions from gross income as interest paid upon indebtedness.
*811 The petitioner asks for a redetermination of a deficiency in income tax for the calendar year*221 1940 in the amount of $ 10,344.29. The questions in issue are:
(1) Whether the respondent erred in including in the gross income of the petitioner $ 124,446.56 representing accrued interest on mortgage loans realized through the acquisition of mortgaged property by foreclosure proceedings.
(2) Whether the petitioner is entitled to deduct from gross income $ 16,255.28 representing guaranteed interest paid by the petitioner on *812 supplementary contracts not involving life contingencies in those cases where such contracts were issued pursuant to options selected by the insured.
(3) In the event it is held that the deduction under issue (2) is not allowable, whether the petitioner is entitled to a deduction in the amount of $ 16,395 in respect of 3 3/4 percent of the mean of the reserves held at the beginning and end of the calendar year 1940 under supplementary contracts not involving life contingencies in those cases where such contracts were issued pursuant to options selected by the insured.
Some of the issues raised by the petition have been abandoned and by mutual concessions the deficiency in income tax has been reduced.
FINDINGS OF FACT.
The petitioner is a life insurance*222 company organized and existing under the laws of the Dominion of Canada, with its principal office at Toronto, Ontario, Canada. Its return for the calendar year 1940 was filed with the collector of internal revenue for the district of Michigan.
Petitioner transacts its business in several cities of the United States as well as in Canada and elsewhere. More than 50 percent of its total reserve funds have been held for fulfillment of its life insurance and annuity contracts. At all times material to this proceeding the petitioner was a foreign life insurance company within the meaning of sections 201, 202, and 203 of the Internal Revenue Code.
Petitioner maintains its accounts and files its income tax returns on the cash receipts and disbursements basis.
During 1940 the petitioner acquired through proceedings to foreclose mortgages owned by petitioner and in default a large number of parcels of real estate situated in the Canadian provinces of Ontario, Manitoba, Saskatchewan, Alberta, and British Columbia. The amount of accrued interest on said mortgages at the time of such foreclosures aggregated $ 146,760.44. In those foreclosure cases where the value of the property acquired*223 at the time of foreclosure was greater than the principal of the mortgage debt then due petitioner, the amount of such accrued mortgage loan interest in excess of the principal of the mortgage debt aggregated $ 22,313.88, which amount petitioner concedes to represent realized taxable income for 1940.
The $ 124,446.56 balance of the above mentioned $ 146,760.44 accrued mortgage loan interest represents the sum of:
(a) The entire amount of accrued interest in those foreclosure cases where the value of the property acquired at the time of foreclosure was less than the then principal of the mortgage debt, and
(b) The amount of accrued interest in excess of the difference between the value of the property and the principal of the mortgage debt *813 in those foreclosure cases where the value of the property acquired at time of foreclosure was greater than the principal of the mortgage debt then due petitioner.
No part of the said sum of $ 124,446.56 represents interest received in cash by the petitioner during 1940. In respect of the mortgage loans upon which such interest accrued, petitioner received nothing of value which would be applied toward the mortgagor's indebtedness other*224 than the properties acquired upon foreclosure of the mortgage.
Petitioner's title to such real estate was in each instance acquired by way of statutory foreclosure proceedings carried out as hereinafter described and in no instance by petitioner bidding in or becoming a purchaser thereof at an auction or other sale.
In its accounting records petitioner did not treat the accrued but uncollected mortgage loan interest as income. Petitioner maintained a ledger account in respect of each mortgage loan showing debits and credits to the principal indebtedness and, in separate columns, the debits and credits to interest. Upon foreclosure of a mortgage such account was closed out and a new asset account opened to record transactions in respect of the real estate acquired by the foreclosure proceeding. In this real estate account the cost of the property was shown as either the balance due on the principal of the mortgage indebtedness or a lesser amount in cases where the value of the property was less. No portion of the accrued interest was capitalized or carried forward to the real estate account.
Petitioner's loans were not evidenced by promissory notes, its only claim against the mortgagor*225 being that based on the obligation contained in the mortgage. The petitioner maintained a policy of not instituting foreclosure proceedings until it had exhausted all efforts to collect from or settle with the mortgagor.
When possible, in order to avoid the cost of foreclosure proceedings and to save time, petitioner obtained voluntary deeds from the mortgagors in lieu of foreclosure. In those cases where voluntary conveyances were so obtained, respondent has determined the amount of realized interest by reference to the value of the properties.
Under the foreclosure proceedings here involved the petitioner received the mortgaged property in satisfaction of the mortgage indebtedness and thereafter had no legal claim against the mortgagor.
In the provinces of Canada mortgages on real estate are within the legislative jurisdiction of the province. In all the Canadian provinces other than Quebec the law is based upon the law of England, but each province has from time to time enacted statutes affecting the enforcement of the mortgagee's right to foreclose. The English mortgage is a conveyance of land with a provision for defeasance on payment of the mortgage debt. It also contains*226 a covenant to pay the mortgage money *814 and confers on the mortgagee power to take possession of the premises and lease or sell the same should the mortgagor make default.
There are generally two systems of land registration in Canada -- the old system, which requires registration of documents only, leaving them subject to scrutiny by subsequent purchasers, and the land titles system, commonly known as the Torrens system of land registration, which calls for examination by a public official in the land titles office, who issues a certificate of ownership upon which a purchaser or mortgagee may rely without further inquiry. Even where both systems are in vogue in one province, the steps leading up to the final order of foreclosure are practically the same.
In the Canadian Provinces of Ontario, Manitoba, Saskatchewan, Alberta, and British Columbia a mortgagee may foreclose a mortgage, and so become the absolute owner of the premises, in substantially the following manner:
(a) A writ is issued by the court, or, in the Province of Manitoba, an application is made to the land titles officer, claiming foreclosure. If no defense is entered within a prescribed time, or after any *227 defense has been disposed of, an order nisi is made, setting a date some months in the future (usually six months) before which the mortgagor or subsequent encumbrancer, e. g., second mortgagee or execution creditor, must pay the mortgage debt or be foreclosed. If payment is not made by the date set, the mortgagee obtains an order of court or of the land titles officer, as the case may be, declaring that the mortgagor is foreclosed, and thereafter the mortgagee may deal with the property as an absolute owner and does not have to account to anyone should he sell the property for more than his claim. Where the mortgage is in the English form there is no actual judicial conveyance or vesting order, the effect of the final order being to make absolute the conveyance contained in the mortgage and to extinguish the right to redeem the property, until then enjoyed by the mortgagor and subsequent encumbrancers. Where the mortgage is in form of a charge on land, under the Torrens system, the final order does not operate as a conveyance to the mortgagee, and in consequence after the final order of foreclosure has been issued an application must be made by the mortgagee to the proper official*228 to be registered as the absolute owner.
(b) In the Provinces of Ontario, British Columbia, and Saskatchewan, the mortgagor, on being served with the writ, has the option of requiring an auction sale of the land as hereinafter explained. If he does not exercise this right within a prescribed time, the foreclosure proceedings continue as outlined above. In none of the foreclosure cases involved in this proceeding was any such sale held.
(c) In the Province of Alberta the land must be put up for sale in such manner, after such advertisement, and at such price as to the court seems proper. If no sale results therefrom, the mortgagee *815 applies to the court for foreclosure and the court may either order the land to be again offered for sale or may make a final order of foreclosure vesting title to the land in the mortgagee.
(d) In the Province of Manitoba a formal auction sale must take place in every instance, and no order for foreclosure issues unless the sale proves abortive as hereinafter explained.
(e) Whenever a sale is required in any of the above cases, the property is advertised and a reserve bid is set by the court. If anyone makes a bid in excess of the reserve bid*229 the sale is carried out. If no bids or insufficient bids are received, the sale is abortive and the mortgagee may then proceed to obtain final order of foreclosure. The mortgagee is not permitted to bid and may not buy in at such a sale, without special leave of court.
In his deficiency notice respondent has disallowed a deduction claimed in petitioner's 1940 return in the amount of $ 16,255.28 representing interest paid by the petitioner during 1940 at guaranteed rates under contracts supplementary to life insurance policies issued by petitioner in those cases where such supplementary contracts were entered into pursuant to the election by the insured, during his lifetime, of one of the optional methods of settlement provided in such policy, other than a method of settlement involving a life contingency.
During and prior to the year 1940 petitioner issued life insurance policies providing that the insured or the beneficiary should have the right to select one of four methods of settlement in respect of the proceeds of the policy at maturity. The provisions relating to "Option I -- Limited Instalments," are as follows:
OPTIONAL METHODS OF SETTLEMENT
While this Policy is in force*230 the Insured, with the assent of any assignee and absolute beneficiary and with the right of revocation, by notifying the Company in writing, may elect to have the proceeds of this Policy when it becomes a claim, paid in instalments according to one of the Options, I, II or III, in lieu of a payment in one sum, or in like manner may leave the proceeds on accumulation with the Company in accordance with Option IV. Such election or revocation shall become operative only when endorsed upon the Policy at the Head Office of the Company. No such election having been made by the Insured, the beneficiary entitled to the proceeds of this Policy with the consent of the assignee, if any, may, when the Policy becomes payable, exercise such right of election. If the Insured shall so direct in writing no instalments under Option I, II or III shall be commuted, transferred or encumbered during the lifetime of the beneficiary. If no beneficiary survives the Insured, the instalments guaranteed under the option chosen may be commuted upon an interest basis of 3 1/2 percent., compounded annually and paid in one sum.
Option I -- Limited Instalments. A limited number of instalments, each for an amount*231 (for each $ 1,000.00 of net proceeds), corresponding to the number of instalments showing in the table following.
* * * * *816
| Monthly Instalments for each $ 1,000 of Net Proceeds | ||
| Option I | ||
| Limited Instalments | ||
| No. of monthly | Amount of each | |
| instalments | Monthly Instalment | |
| 60 | 18.13 | |
| 120 | 9.84 | |
| 180 | 7.10 | |
| 240 | 5.76 | |
| 300 | 4.97 | |
| 360 | 4.45 | |
| 420 | 4.09 | |
| 480 | 3.83 | |
| 540 | 3.64 |
* * * *
Such surplus from interest as ascertained by the Company, according to its regulations for the time being, will be applied to increase instalments payable after the first year, under Option I or II or the interest payments guaranteed under Option IV.
Instalments will be paid monthly, quarterly, semi-annually or annually. The equivalent of twelve monthly instalments of 10.00 each will be four quarterly instalments of 29.91, or two semi-annual instalments of 59.57, or one annual instalment of 118.13. The figures in the tables above are on the basis of monthly instalments and net proceeds of 1,000.00 and will apply pro rata to other amounts. The net proceeds must be sufficient to purchase either an instalment in Canadian currency of 10.00 Dollars when*232 paid monthly, 15.00 Dollars when paid quarterly, 25.00 Dollars when paid semi-annually or 50.00 Dollars when paid annually, or their equivalent at the par rate of exchange in the currency in which this Policy is written, otherwise an instalment option is not available. The first instalment under any option chosen shall be payable immediately upon approval of the claim by the Company. Under Options II and III the age of the beneficiary (satisfactory proof of which must be furnished the Company before the payment of the first instalment) will be taken as at the nearest birthday at the date the first instalment becomes payable.
When this Policy becomes a claim, if an optional method of settlement is chosen, this Policy must be surrendered to the Company, who will deliver to each beneficiary a supplementary contract evidencing his or her rights and benefits under the option selected.
The provisions of a typical "supplementary contract," issued in accordance with the last paragraph of the above quoted policy provisions, in a case where the insured in his lifetime elected Option I, are as follows:
The Manufacturers Life Insurance Company hereby promises to pay to [name of beneficiary] *233 the sum of Forty-Nine Dollars and Twenty Cents ($ 49.20) United States Currency, on the tenth day of November, 1938, and a like amount monthly thereafter on the tenth day of each month in each year until one hundred and twenty (120) such payments in all shall have been made.
In the event of the death of [name of beneficiary] before having received all of the above monthly payments, the commuted value of the remaining *817 payments will be paid in one sum to the Executors, Administrators or Assigns of the said [name of beneficiary].
Surplus from interest as ascertained by the Company will be applied on each anniversary to increase the future payments payable hereunder.
These instalments are in full settlement under Policy No. 709,921, on the life of [name of insured].
In Witness Whereof the said Company has hereunto affixed its Corporate Seal by the hands of its proper Officers at the City of Toronto, Canada, this fifteenth day of November, 1938.
Such contracts are ordinarily referred to as "Supplementary Contracts Not Involving Life Contingencies."
The fixed monthly installment payments for each $ 1,000 of net proceeds, set forth in the table incorporated in option I, quoted*234 above, in so far as actual calculation is concerned, include a partial payment of such net proceeds, and the remainder thereof is the equivalent of interest at a guaranteed rate of 3 1/2 percent per annum.
In his deficiency notice respondent has allowed petitioner a deduction for interest paid during the taxable year on indebtedness in the amount of $ 9,143.60 on account of the interest included in installment payments under option I, in those cases where such options were selected by the beneficiary after the death of the insured.
Respondent has not allowed petitioner any deduction for interest paid in respect of payments made during the taxable year under option I, in those cases where such options were selected by the insured during his lifetime.
That portion of the installment payments made by petitioner in 1940, pursuant to option I, in those cases where such options were selected by the insured in his lifetime, in excess of the portion thereof representing the net proceeds of the insurance amounted to $ 16,255.28.
To provide for the payment of the net proceeds of life policies which had matured and were payable during 1940 and subsequent years, under the supplementary contracts*235 not involving life contingencies, the petitioner carried on its books a liability (which it contends is a reserve liability) called "Present Value of Amounts Not Yet Due on Supplementary Contracts Not Involving Life Contingencies," the amount thereof at the beginning of 1940 being $ 662,068, and the amount thereof at the end of 1940 being $ 704,142. The mean of these amounts is $ 683,105, of which 64 percent, or $ 437,187, was held in respect of supplementary contracts arising from options exercised by the insured during his lifetime, and the balance was held in respect of supplementary contracts arising from options exercised by the beneficiaries after the policies had matured. Three and three-quarters percent of $ 437,187 is $ 16,395. The liability so carried on petitioner's books was an amount which, if maintained with annual interest increments, would exactly equal petitioner's obligations under the supplementary contracts not involving life contingencies. The *818 obligations arising under these option contracts were absolute obligations of the petitioner and were not contingent upon the happening of future events. For the purpose of providing for these obligations, *236 petitioner was required to accumulate and maintain the liability by the statutes of the states in which it was then doing business and by the rulings of state officials made pursuant to authority conferred upon them by such statutes and, as so required, the petitioner at all times held admitted assets sufficient to provide for this and all other reserves and/or liabilities.
Respondent has not allowed petitioner a deduction under section 203 (a) (2) of the Internal Revenue Code in respect of the reserve funds held pursuant to the supplementary contracts not involving life contingencies.
OPINION.
The first question for consideration is whether the petitioner derived taxable income during 1940 in the amount of $ 124,446.56 representing interest on mortgage loans realized through acquisition of the mortgaged property through foreclosure proceedings. This amount is the excess of accrued interest upon the foreclosed properties over the stipulated values of the properties at the time they were acquired through foreclosure proceedings. The Internal Revenue Code in force in 1940 provides in material part as follows:
SEC. 202. GROSS INCOME OF LIFE INSURANCE COMPANIES.
(a) Gross Income Defined.
*237 (1) In General. -- In the case of a life insurance company the term "gross income" means the gross amount of income received during the taxable year from interest, dividends, and rents.
* * * *
SEC. 203. NET INCOME OF LIFE INSURANCE COMPANIES.
(a) General Rule. -- In the case of a life insurance company the term "net income" means the gross income less --
* * * *
(7) Interest. -- All interest paid within the taxable year on its indebtedness, except on indebtedness incurred or continued to purchase or carry obligations (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from taxation under this chapter.
The petitioner makes its income tax returns upon a cash receipts and disbursements basis. Ordinarily a taxpayer on such basis is required to include in gross income only income received in cash or in property which is the equivalent of cash. The petitioner did not in 1940 receive the $ 124,446.56 accrued interest in question here in cash. Neither did it receive any property which was the equivalent of cash in respect of such $ 124,446.56. The respondent contends, *238 nevertheless, that, since the petitioner acquired the parcels of property here in question by *819 foreclosure proceedings, it is taxable upon the accrued interest of $ 124,446.56 under the principle of Helvering v. Midland Mutual Life Insurance Co., 300 U.S. 216">300 U.S. 216. It was there held that where an insurance company bid in property sold on foreclosure for the amount of the principal and interest the interest was subject to income tax though the bids were made without regard to actual value and the properties were of less value than the amount of the principal. It is his contention that the price fixed by the court or official having jurisdiction in the foreclosure proceedings, which presumably was in every case as much as the principal and accrued interest due the mortgagee, was the equivalent of a bid for the property made by the mortgagee of the amount of its claim.
In those provinces where the court fixed the amount at which the property might be acquired the amount is referred to as a "reserve bid." The respondent submits:
* * * In the instant case, respondent contends that the reserve bid being the petitioner's bid, it was the only bidder*239 and by virtue of the fact that there were no other bidders, the property was conveyed to it. * * *
We do not think that the evidence supports the contention of the respondent. The evidence is conclusive that in no case did the petitioner make any bid for the mortgaged property; also, that the petitioner did not know the price which was fixed by the court or other official having jurisdiction in the premises.
The value of the properties at the date of acquisition by the petitioner is stipulated. Such values are $ 124,446.56 less than the petitioner's claim against the mortgagors, which claim consists of the principal of the debt, other amounts which may have been advanced by the petitioner for the payment of taxes, etc., and accrued interest.
In our opinion Helvering v. Midland Mutual Life Insurance Co., supra, is not controlling in this case. That case was decided upon the fact that the insurance company to protect its claim against the mortgagor made a bid for the property at public sale of the full amount of its claim against the mortgagor. In the instant case the petitioner made no bid for the property. There is no evidence to show that it*240 would have been willing to pay for the property any more than its stipulated value. Since the petitioner did not receive the accrued interest here in question in the form of cash or of property which was the equivalent of cash, it is not taxable thereon. Cf. Nichols v. Commissioner (C. C. A., 6th Cir.), 141 Fed. (2d) 870.
The second question is whether the petitioner is entitled to deduct interest paid in the amount of $ 16,255.28 representing guaranteed interest paid pursuant to supplementary contracts not involving life contingencies in those cases in which such contracts were issued pursuant to options selected by the insured. In making this contention the respondent relies upon Penn Mutual Life Insurance Co. v. Commissioner*820 (C. C. A., 3d Cir.), 92 Fed. (2d) 962, 967. The issue there was identical with that presented here. Likewise the same issue was before the court in Equitable Life Assurance Society of the United States v. Helvering (C. C. A., 2d Cir.), 137 Fed. (2d) 623, reversing 44 B. T. A. 293. That court disagreed with the Third*241 Circuit and held that it was immaterial whether the option was exercised by the beneficiary or by the insured. The reasoning of the court was that upon the death of the insured the insurance company was required to pay interest upon an indebtedness and that when it paid that interest it was immaterial whether the option had been exercised by the beneficiary or the insured. The insurance company obtained a writ of certiorari from the Supreme Court to review another question involved in the case. The respondent made no application for a writ of certiorari. Therefore in its decision in the case, Equitable Life Assurance Society of the United States v. Commissioner, 321 U.S. 560">321 U.S. 560, the Supreme Court did not pass upon the question now under consideration. The petitioner points out, however, that the respondent has in Regulations 103, section 19.203 (a) (7)-1, provided:
Sec. 19.203 (a) (7)-1. Interest. -- * * *
If a life insurance company pays interest on the proceeds of life insurance policies left with it pursuant to the provisions of supplementary contracts, not involving life contingencies, or similar contracts, the interest so paid shall *242 be allowed as a deduction from gross income, * * *
It would seem therefore that the respondent has accepted as correct the opinion of the Second Circuit in Equitable Life Assurance Society of the United States v. Commissioner, supra, so far as it relates to the question here presented.
We think it is quite immaterial whether the option was selected by the beneficiary or the insured. The amount upon which interest was paid was an indebtedness of the insurance company just as much in the one case as in the other.
Decision will be entered under Rule 50.