*1038 Under reinsurance agreements with another insurance company the petitioner on May 19, 1932, reinsured a large number of the company's policies in consideration of the payment to it of the unearned premiums on the policies in the amount of $1,002,582.01. Shortly thereafter the insurance company, pursuant to the agreements entered into, turned over to the petitioner assets of the value of $1,002,582.01. During 1932, in a court proceeding brought by creditors of the transferor company, the petitioner was directed by court order to segregate the assets and hold them intact until further order of the court. In 1936 the court finally decreed that the transfer of the assets to the petitioner was null and void because made at a time when the transferor was insolvent and ordered the petitioner to surrender the assets, together with accumulated income, to the liquidator of the transferor company. At the same time the court gave leave to the petitioner to file proof of claim with the liquidator for the net unearned premiums in the amount of $1,002,582.01. An appeal was taken by the petitioner to the higher court. While it was pending petitioner entered into an agreement with the liquidator, *1039 which was approved by the court, whereby the petitioner was permitted to retain $501,180.42 and required to turn over to the liquidator cash and assets in the amount of $838,523.56. The amount so paid to the liquidator was charged off to surplus on petitioner's books of account in 1937. Held, that the transferor company was indebted to the petitioner at the time of the settlement in the amount of $1,002.587.01; held, further, that the petitioner is entitled to deduct from its gross income of 1937 the difference between $1,002,587.01 and $501,180.42, or $501,401.59, ascertained to be worthless and charged off in 1937.
*996 This proceeding is for the redetermination of a deficiency of $91,762.79 in petitioner's income tax for 1937. The only question for our determination is whether petitioner is entitled in 1937 to a bad debt deduction on account of its claim against another insurance company, the New Jersey Fidelity & Plate Glass Insurance Co., from which it acquired certain assets in 1932 in consideration for the reinsurance*1040 of certain policies of the latter company, when by court order petitioner was forced in 1937 to give up a portion of the assets for the benefit of the creditors of the transferor company.
FINDINGS OF FACT.
The petitioner is a New Jersey corporation, with its principal office in Newark. It filed its income tax return for 1937 with the collector of internal revenue at Newark.
*997 The petitioner is engaged in writing casualty insurance. During 1937 it was qualified as an insurance company, other than a life or mutual company, under the Revenue Act of 1936.
On May 19, 1932, the petitioner entered into two reinsurance agreements with the New Jersey Fidelity & Plate Glass Insurance Co., hereinafter sometimes referred to as New Jersey, by which it reinsured all of the policies of New Jersey in force in the United States for certain lines of insurance.
In such undertakings New Jersey agreed to pay to petitioner, with reference to the business reinsured in all states except Washington, Oregon, and California:
* * * the full legal unearned premium reserves on the said policy liability assumed by "COMMERCIAL" on the basis of the so-called New Jersey Standard (meaning*1041 on the basis required by the laws of the State of New Jersey relating to Unearned Premium Reserve), as of twelve o'clock midnight, May 19, 1932, less a commission or allowance by "COMMERCIAL" to "NEW JERSEY" of thirty-five per cent (35%) of the said unearned premium reserves. The "NEW JERSEY" guarantees the correctness of the said unearned premium reserves.
As to the business reinsured in Washington, Oregon, and California, the consideration was the reinsurance reserves upon such policies in those states, less 40 percent of the reserve.
The net aggregate amount to be paid to the petitioner as the premium and consideration for all the policy liability ceded to and assumed by petitioner under both contracts was $1,002,582.01. This amount represented the net unearned premiums on the policies assumed pursuant to the said agreements, amounting to $1,436,018.28, less commissions ceded of $433,436.27.
Pursuant to the provisions of the agreements of May 19, 1932, New Jersey transferred to the petitioner certain securities with an agreed value of $1,002,582.01, which securities were actually delivered by New Jersey to the petitioner on or prior to May 29, 1932.
Under the agreements*1042 of May 19, 1932, the petitioner assumed and became liable on all the outstanding insurance policies of New Jersey which were thereby ceded to it. Such reinsurance continued in full force and effect until the expiration of the policies thereby reinsured, which liability was fully discharged on or prior to December 31, 1935.
On or about May 28, 1932, the Commissioner of Banking and Insurance of the State of New Jersey, as liquidator, took charge of the affairs of New Jersey, pursuant to the laws of the State of New Jersey (P.L. 1931, p. 599), and undertook the liquidation of its business.
On July 5, 1932, certain creditors of New Jersey brought suit in the Court of Chancery of the State of New Jersey against that company and the commissioner of banking and insurance, and the petitioner, *998 to have the conveyance of the securities to petitioner by New Jersey set aside on the grounds that New Jersey was insolvent at the time of the conveyance and that the conveyance was in violation of the statutes of the State of New Jersey (§ 64 of the General Corporation Law of New Jersey, now R.S. 14:4-2).
On August 4, 1932, the Court of Chancery issued an order directing petitioner*1043 to segregate and set aside the assets in question, together with all income derived therefrom, pending further order of the court. On February 13, 1935, the court promulgated its opinion in the case. It held that the transfer of the assets by New Jersey to the petitioner was made at a time when the New Jersey company was insolvent and was known to be insolvent by both the transferor and the petitioner; that petitioner was not a bona fide purchaser of the assets for a valuable consideration; that the transfer was in violation of the statutes of the State of New Jersey, and therefore null and void as to the creditors of New Jersey. The concluding paragraph of its opinion states:
The transfer will be set aside and the securities ordered delivered to the Commissioner of Banking and Insurance [the liquidator]. Commercial may present its claim for the unearned premiums and will be subrogated to the rights of the policyholders reinsured by it.
The court entered its decree in the case on February 11, 1935. It decreed that petitioner should account to a special master appointed by the court for all of the transferred assets and the accumulated income thereon and that the master*1044 deliver such assets to the commissioner of banking and insurance for the benefit of the creditors of New Jersey. It was further decreed:
IT IS FURTHER ORDERED, ADJUDGED and DECREED, that the defendant, Commercial Casualty Insurance Company, be and it hereby is, subrogated to the rights of the policyholders reinsured by it and that it is hereby granted leave to file a proof of claim in the amount of One million two thousand five hundred eighty-two dollars and one cent ($1,002,582.01) with the Commissioner of Banking and Insurance of the State of New Jersey or his successor in office for the net unearned premiums as of May 19, 1932, on the policies reinsured by it, said net unearned premium for the purpose of said claim being the unearned premiums of said policies reinsured by the defendant Commercial Casualty Insurance Company less the percentage thereof allowed to the New Jersey Fidelity and Plate Glass Insurance Company as a commission by the terms and provisions of the said reinsurance agreements dated May 19, 1932, copies of which are annexed to the bill of complaint filed herein. * * *
An appeal was taken to the Court of Error and Appeals of the state by the petitioner, wherein*1045 it was contended that the petitioner was not aware of the insolvency of New Jersey at the time the reinsurance agreements were entered into and that the Court of Chancery was in error in applying section 64 of the General Corporation Law of New Jersey rather than the section of the law applicable to insurance companies. Thereafter, on February 27, 1937, while this appeal *999 was pending, a settlement agreement was entered into between the petitioner and the liquidator of New Jersey, subject to approval by the court, whereby the petitioner was permitted to retain from the assets in question (1) $7,680.42 representing the aggregate amount that it had expended for taxes and insurance on properties covered by mortgages on certain of the assets which were not to be retained by the petitioner; (2) the further amount of $18,500 for services and expenses incident to handling and servicing assets to the date of the settlement agreement; and (3) the further amount of $475,000, half in cash, and half in bonds and mortgages. The total amount of the fund in the hands of the petitioner at the time of the settlement agreement was $1,339,703.98. The amounts which the petitioner was permitted*1046 to retain totaled $501,180.42. The balance of the assets, $838,523.56, was to be turned over to the liquidator and the petitioner was to be released from any further liability in the matter.
The agreement further provided that:
8. Commercial Casualty Insurance Company shall, upon consummation of the settlement, release the right under said decrees to file a claim against the assets of New Jersey Fidelity & Plate Glass Insurance Company and will discontinue and consent to the dismissal of its said pending appeals.
The settlement agreement was consummated in 1937 and during that year petitioner transferred to the liquidator cash and securities in the aggregate amount of $838,523.56. This amount was charged off to surplus on petitioner's books of account in 1937.
The parties have stipulated:
18. Petitioner, on its 1937 income tax return, claimed a deduction of $773,523.56 on account of the foregoing facts, the item being set forth by it as follows:
| Losses on New Jersey Fidelity and Plate Glass Insurance Company Settlement | $838,523.56 |
| Less: Amount received by release under reinsurance agreement | 65,000.00 |
| $773,523.56 |
19. In the annual statement*1047 which accompanied the petitioner's return for the calendar year 1937, petitioner, under Schedule 3 "Disbursements" on page 3, line 55, set forth the following:
| New Jersey Fidelity and Plate Glass Insurance Company - Settlement | $838,523.56 |
And, in said annual statement, petitioner, on line 71, page 9 of the Underwriting and Investment Exhibit, set forth the following as a charge to surplus:
| New Jersey Fidelity and Plate Glass Insurance Company - Settlement | $838,523.56 |
20. The company recovered, during the calendar year 1937, the sum of $43,560.00 of agents' balances previously charged off and shown in its annual convention statement, page 8 of its Underwriting and Investment Exhibit, line 24.
*1000 21. Petitioner, after entering into the reinsurance agreement referred to in paragraph 2 of this stipulation and during May, 1932, reinsured one-half of the risks which it had assumed under the above contracts with Metropolitan Casualty Insurance Company of New York, which was an affiliate of the petitioner, and transferred to the latter certain of the securities referred to in Paragraph 8 hereinabove mentioned.
22. On February 26, 1936, a*1048 contract was entered into between petitioner and Metropolitan Casualty Insurance Company of New York, with whom petitioner had reinsured one-half of the risks taken over by it from New Jersey, as stated above, and New Jersey Investment Company, a copy of which contract is attached hereto, made a part hereof and marked Exhibit I.
23. Petitioner received payment of $65,000.00 from Metropolitan Casualty Insurance Company of New York under this contract, marked Exhibit I, in the year 1936. Said amount of $65,000.00 was not included in its federal income tax return for 1936, but was included in its federal income tax return for 1937 as set forth in Paragraph 18 of this stipulation.
24. The said deduction claimed by petitioner in the sum of $773,523.56 has been disallowed by the Commissioner.
In the final liquidation of New Jersey, policyholder creditors received 49.22632 percent of their claims and nonpolicyholder creditors 41.15232 percent.
OPINION.
SMITH: This proceeding presents two questions: First, whether the New Jersey company was indebted to the petitioner in 1937 in the amount of $1,002,582.01, and, second, whether the portion of that amount which proved to be*1049 uncollectible in 1937 is legally deductible from the petitioner's gross income of 1937.
It is the contention of the respondent in this proceeding that the New Jersey company was not indebted to the petitioner in 1937 in any amount whatever. His contention is that the consideration for the reinsurance agreements entered into on March 19, 1932, was the transfer to the petitioner by the New Jersey company of assets of a value of $1,002,582.01, and that when the New Jersey company made the transfer of those assets within a few days after the dates of the agreements the debt was settled.
We do not think that this contention can stand in the light of the decree of the Court of Chancery of New Jersey entered against the petitioner on February 11, 1936. In that proceeding the petitioner and the other defendants contended that the unearned premiums on the policies reinsured by the petitioner were held in trust for reinsurance and that the fund was appropriately devoted to effecting the reinsurance in discharge of the trust. This contention of the defendants was not sustained by the court. It held that the transfer was not made for a valuable consideration within the meaning of the*1050 New Jersey statute; that it was made at a time when the New Jersey company was insolvent; and that therefore the transfer was null and *1001 void as to the creditors of New Jersey. The court did not hold, however, that New Jersey was not indebted to the petitioner in any amount whatever. The petitioner had serviced the policies which had been reinsured by it and presumably had paid out large amounts in settlement of claims arising out of the policies. the court held that petitioner was entitled to file a claim against the liquidator for the net amount of the unearned premiums on the policies of $1,002,582.01. It further held that the petitioner was subrogated to the rights of the policyholders reinsured. We think this is tantamount to recognizing that the New Jersey company was indebted to the petitioner in the amount of the unearned premiums on the policies. There is no basis for the claim of fraud on the part of the petitioner as a result of entering into the agreements of May 19, 1932. All that the court determined was that, since the New Jersey company was insolvent at the time the transfer of the assets was made to the petitioner in the month of May 1932, that transfer*1051 was null and void as to the other creditors. This left the petitioner a creditor of the New Jersey company in the amount of $1,002,582.01.
In this connection it should be noted that the petitioner was permitted to make proof of claim against the New Jersey company as a policyholder creditor in the exact amount of the unearned premiums on the policies reinsured, which is the amount that the New Jersey company agreed to pay under the reinsurance agreements of May 19, 1932. It was not required to limit its claim to the amount that it had actually paid out in servicing the policies. It was not a general creditor of the insolvent corporation.
The next question is whether this indebtedness was "in the nature of agency balances and bills receivable", within the meaning of section 204(c)(6) of the Revenue Act of 1936.
Insurance companies are taxed under the Revenue Act of 1936 differently from other companies. They are required to include in gross income the amount earned during the taxable year from investments and from underwriting, gain from the sale or other disposition of property, and certain other items. Insurance companies, other than life or mutual, in which class the*1052 petitioner falls, are permitted to deduct from gross income under section 204(c)(6) "Bad debts in the nature of agency balances and bills receivable ascertained to be worthless and charged off within the taxable year." In the course of the business of an insurance company transacting business in different states premiums on policies written are ordinarily collected by the insurance company's agents. Receipt by the agent is receipt by the principal. The company is chargeable with the gain derived through receipts by the agent. Where the premiums which have *1002 been collected by the agent can not be collected by the company from the agent, the insurance company is permitted to deduct from its gross income as a bad debt the amount owed to it by the agent.
The petitioner contends that as a result of the reinsurance agreements entered into by it on May 19, 1932, it was entitled to receive from the New Jersey company the net unearned premiums contracted for in the amount of $1,002,582.01; that by reason of the decree of the Court of Chancery on February 11, 1936, the amount owed to it by the New Jersey company was never paid in full and that it is entitled to deduct as a debt*1053 ascertained to be worthless and charged off in 1937 the amount which it was unable to collect. It claims that the uncollectible amount was of the nature of "agency balances." We think that the petitioner's contention upon this point must be sustained. There is no question but that the portion of the $1,002,582.01 owed to it by New Jersey, which was not collected in 1937, was ascertained to be worthless during 1937 and the charge-off of that amount to surplus constituted a proper charge-off thereof.
In its income tax return for 1937 the petitioner claimed the deduction from gross income of $773,523.56. That amount was arrived at by deducting from the $838,523.56, which it paid over to the liquidator, $65,000 which was received from Metropolitan Casualty Insurance Co. The petitioner now admits that it is not entitled to deduct as a bad debt any amount in excess of $527,582.01, which is arrived at in the following manner:
| Net due from New Jersey May 1932 for re-insurance premium | $1,002,582.01 |
| Paid, April 2, 1937, on final settlement in New Jersey liquidation proceedings | 475,000.00 |
| Balance charged off April 1937 | $527,582.01 |
It is to be observed, however, that*1054 the debt which was owed to the petitioner by New Jersey in 1937 was $1,002,582.01. The fund constituting the transferred assets, plus income thereon at the date of settlement, was in the amount of $1,339,703.98. Of this fund the petitioner was permitted to retain $501,180.42. This amount was made up of $7,680.42 which the petitioner had advanced for taxes and insurance premiums in connection with the segregated assets and $18,500 for the petitioner's services and expenses incident to the handling and servicing of the segregated assets, plus $475,000. The petitioner contends that the first two items are not to be taken into account in determining the amount of the bad debt. We think that they should be. Presumably, the petitioner obtained the benefit of the deduction from gross income in years prior to the taxable year of $7,680.42 paid as taxes, and of $18,500 in cash paid for services and *1003 expenses. Since the petitioner has already obtained the benefit of the deduction of those amounts there is no occasion for allowing them as a bad debt deduction.
In our opinion the only amount of the bad debt which the petitioner is permitted to deduct is the difference between*1055 $1,002,582.01, constituting the debt owed to it by New Jersey, and $501,180.42, which it was permitted to retain under the settlement agreement. We accordingly hold that the bad debt deduction is respect of the item in question is in the amount of $501,401.59 and no more.
The findings of fact, paragraphs 18 to 23, inclusive, were stipulated by the petitioner upon the insistence of the respondent. The petitioner argues that they are not germane to the question as to the correct amount of the debt ascertained to be worthless and charged off in 1937. Its contention is that the Metropolitan Casualty Insurance Co. of New York made a profit upon underwriting and that as a result of the settlement agreement between the petitioner and that. company the petitioner received $65,000 as its share of the profits. This profit was included in petitioner's Federal income tax return for 1937. The petitioner contends that the receipt of this income had nothing whatever to do with the debt ascertained to be worthless and charged off by the petitioner in 1937.
The only argument which the respondent makes in his brief with respect to the $65,000 is that it shows that the petitioner considered*1056 the entire amount of its loss upon the New Jersey transaction as a loss rather than as a bad debt. We are of the opinion that the $65,000 item is not germane to the question of the amount of the debt ascertained to be worthless and charged off in 1937.
After deduction of the bad debt of $501,401.59, petitioner had a remaining loss of over $200,000, the assets which it was required to surrender to the court amounting to $838,523.56. The respondent concedes that petitioner is entitled to a loss deduction of $43,560, stating in his brief:
* * * The respondent now concedes that petitioner is entitled to a deduction in the amount of $43,560.00 of the loss claimed. A deduction of this amount is allowable under section 204(c)(10) of the Revenue Act of 1936 for the reason that it now appears that petitioner had taxable miscellaneous income taxable under section 204(b)(1)(C) in the form of the recovery of agency balances previously charged off in the amount of $43,560.00. In short, this amount is deductible even though it did not represent a bad debt in the nature of an agency balance or bill receivable because of section 204(c)(10).
Reviewed by the Board.
Decision will be*1057 entered under Rule 50.
MURDOCK and MELLOTT dissent.