*1049 1. The petitioner, an insurance company other than a life or mutual, reinsured a portion of each risk assumed, and received from the reinsurer so-called flat commissions based upon the net premiums of the insurance ceded to it and an additional amount, designated as "contingent commissions", based upon the net results of the reinsurance. Held, that the amounts are taxable income, being reimbursement for commissions paid by the petitioner to its agents on the reinsurance or an offset against premiums on the reinsurance.
2. Commissions received by the petitioner for acting as broker in the writing of policies of insurance of a kind not underwritten by it, held not to constitute taxable income within the meaning of section 204 of the Revenue Act of 1928.
3. The petitioner is taxable under section 204 of the Revenue Act of 1928 as an insurance company.
*1079 The respondent determined a deficiency of $9.08 in income tax against the petitioner for the year 1928. The errors alleged by the petitioner are*1050 the inclusion in taxable income of the amounts of $9,647.52 and $490.22 alleged to represent commissions and brokerage received from reinsurance of risks with the Royal Insurance Co., Ltd., and the amount of $2,909.59 alleged to be commissions and brokerage received for writing insurance contracts for other companies. An alternative issue raised by the respondent is whether the petitioner is taxable as an insurance company. The stipulation of facts entered into by the parties is by reference made a part of our findings of fact.
FINDINGS OF FACT.
The petitioner was organized under the corporation laws of the District of Columbia in 1919, to underwrite fire, plate glass, mirror, *1080 and automobile theft insurance. In 1928 its charter was amended so as to include authority to underwrite insurance on buildings against loss or damage by windstorm, cyclone, or tornado.
The petitioner in 1926 entered into a written agreement with the Royal Insurance Co., Ltd., for the reinsurance of fire and tornado risks underwritten by the former. Articles 2, 3, 4, 8, and 9 of the agreement, as modified in 1928, read as follows:
ARTICLE 2
The National Capital agrees, and by these*1051 presents does obligate itself to reinsure with the Royal its first surplus, and the Royal agrees, and does obligate itself to receive from the National Capital its first surplus, the liability of the Royal to attach simultaneously with that of the National Capital, provided however that the National Capital shall give prompt advices by telephone, telegram or written notice to the Royal or its representative in the City of Washington, D.C., where the amount of liability ceded to the Royal on any one risk is in excess of $15,000 on a building or $5,000 on contents. It is further understood and agreed that the National Capital shall retain a share of the liability for its own account on each risk on which reinsurance is ceded to the Royal.
ARTICLE 3
It is further understood and agreed that all entries, binders or advices of reinsurance ceded by the National Capital to the Royal shall be subject to the same warranties, conditions, specifications and rates of premium as the original insurance, losses and loss expenses shall be payable pro rata, in the same manner and on the same terms and conditions as paid by the National Capital, and the Royal shall be given immediate notice of*1052 the occurrence of all losses, including an estimate, where possible, of the amount of the probable damage. In the event that an estimate of the amount of probable damage cannot be determined at the time of reporting a loss, this information should be advised at the earliest possible moment thereafter.
ARTICLE 4
All settlements of losses agreed to by the National Capital shall be accepted by the Royal and upon being furnished with proper proofs of loss the claim shall be paid by the Royal, pro rata, at the same time and in the same manner as the National Capital has paid under its policy contract so reinsured. It is provided, however, that the Royal shall have the right, if its interest as reinsurer is in excess of that of the National Capital, to participate in any adjustment, if it so elects to do, and that no legal expenses shall be incurred by the National Capital, a proportion of which would be properly chargeable to the Royal, without due notice to, and consent of, the Royal; and the Royal, in such case, reserves the right not to participate in such legal expenses, if it so choose.
ARTICLE 8
The "Royal" shall allow to the "National Capital" a flat Commission from May 1, 1926 of*1053 30% on the net premiums received by the "Royal" from the "National Capital" i.e. gross premiums less return premiums and cancellations, such commission to cover all expenses, except taxes, Local Board expenses, *1081 losses and loss expenses and from and including December 9th, 1927 the flat commission on the foregoing basis is 30% on Fire business and 35% on Tornado business.
ARTICLE 9
In addition to the commission provided for in Section Eight (8) there shall be paid by the "Royal" to the "National Capital" contingent commissions of 5% on the net results of the Fire business and 5% on the net results of Tornado business (each to be treated separately) ceded under this contract for each contingent year, meaning reinsurances, to be computed as follows:
By deducting from the gross premiums ceded to the "Royal":
1. Cancellations and return premiums.
2. Commissions.
3. The amount of losses and loss expenses incurred.
4. Local Board and all other expenses and taxes.
It is understood that any contingent commission paid shall not be treated as an expense in computing the contingent commission of any subsequent contingent year; also, that at the expiration*1054 of a contingent year, the "Royal" will make up the contingent account and, on request will remit (all premiums for the contingent period being paid to the "Royal" and not otherwise) the amount found to be due, if anything, or may request the "National Capital" to charge the same in their next monthly account current.
In the event of the termination of this contract with less than a years time having transpired since the previous accounting, no accounting shall be made nor any contingent allowances granted until a full twelve months period shall have elapsed since the last previous accounting, and all losses incurred during the full period shall be charged against the account, subject to the condition of this contract.
The gross premiums on policies of insurance underwritten by the petitioner in 1928, less cancellations and return premiums of $8,594.06, amounted to $97,005.62. The petitioner included the total of $105,599.68 of these figures in its original income tax return for 1928 as gross premiums written on insurance.
The gross premiums, less cancellations and return premiums, on the portions of the policies reinsured with the Royal Insurance Co., Ltd., during 1928 amounted*1055 to $31,922.06, which amount the petitioner deducted in its original return in determining premium earnings of $57,104.07 on insurance contracts. In making settlement with the Royal Insurance Co., Ltd., for the premiums of $31,922.06 charged the petitioner on the reinsurance, the petitioner deducted therefrom the amount of $9,647.52 for "flat commission" payable to it under the provisions of article 8 of the reinsurance contract, and paid the balance of $22,274.54 in cash. The amount withheld as "flat commission" was credited in petitioner's books to an account designated "Commissions on Insurance."
The petitioner received the sum of $490.22 in 1928 from the Royal Insurance Co., Ltd., pursuant to the terms of article 9 of the reinsurance contract.
*1082 During 1928 the petitioner held a license issued by the Superintendent of Insurance of the District of Columbia to act as a general insurance broker. The petitioner received requests from clients, agents, and brokers to effect, and in 1928 did effect, insurance on risks which it was not authorized to assume. The petitioner received a commission of 20 percent on such insurance. In cases where the insurance was obtained*1056 through an agent or broker, 75 percent of the commission was paid to the agent or broker, as the case might be. During 1928 the petitioner received the net sum of $2,909.59 for acting as broker between insurance companies and insurance agents in effecting policies of insurance with other insurance companies.
The amounts of $9,647.52, $490.22, and $2,909.59, received by the petitioner under the circumstances stated above, were reported by the petitioner in its original return for 1928 as "Commissions and brokerage received during the year 1928 on policies placed." It also reported the receipt of $428.75 as commissions on real estate loans, and net investment income of $16,057.40.
The petitioner claimed, as part of its ordinary and necessary expenses, the sum of $23,749.84 for "Agents' compensation, including brokerage."
The petitioner filed a statement of its condition and affairs for 1928 with the Superintendent of Insurance of the District of Columbia on a form adopted by the National Convention of Insurance Commissioners for stock fire and marine insurance companies. In 1930 the Superintendent of Insurance of the District of Columbia issued instructions that "commissions*1057 on outside agency or brokerage business or commissions received on reinsurance ceded" should not be reported in the premium underwriting exhibit of the gain and loss exhibit of the annual statement blanks for stock fire insurance companies, or as a part of underwriting income, but should be reported in the miscellaneous exhibit of the gain and loss exhibit "as income from other sources."
The Superintendent of Insurance of the District of Columbia makes an examination of the affairs of the petitioner about every three years to determine whether it is conducting its activities according to the laws of the District of Columbia applicable to insurance companies.
OPINION.
SEAWELL: The major question is whether the amounts of $9,647.52 and $490.22 received by the petitioner from the Royal Insurance Co., Ltd., under the provisions of the reinsurance contract, and the sum of $2,909.59 received for acting as broker in the writing of policies of insurance for other companies, constitute taxable income *1083 to the petitioner. No claim is being made by either party that the several amounts have any relation to investment income or gain from the sale or other disposition of property. *1058 They differ only as to whether the amounts are taxable as underwriting income. The petitioner claims that the amounts represent commissions earned in its business. We think there is a clear distinction between the amounts received under the reinsurance contract and the fees earned for writing insurance for other companies, and shall first dispose of the former items.
Section 204(b) of the Revenue Act of 1928 provides that the gross income of an insurance company, such as the petitioner, means "the combined gross amount earned during the taxable year, from investment income and from underwriting income as provided in this subsection, computed on the basis of the underwriting and investment exhibit of the annual statement approved by the National Convention of Insurance Commissioners, and (B) gain during the taxable year from the sale or other disposition of property." "Underwriting income", as used in the section, means the "premiums earned on insurance contracts during the taxable year less losses incurred and expenses incurred." Subsection (4). Subsection (5) defines the phrase "Premiums earned on insurance contracts during the taxable year", used in subsection (4), to mean*1059 an amount computed as follows, so far as the definition is material here:
From the amount of gross premiums written on insurance contracts during the taxable year, deduct return premiums and premiums paid for reinsurance. * * *
The answer is not controlled by the manner in which the amounts were labeled in the reinsurance contract or set up in petitioner's books and the annual statement approved by the National Convention of Insurance Commissioners. ; ; ; affd., .
In the case of ; , the court, in speaking generally of reinsurance agreements, said:
The commission of the agent is taken from the original premium, and the reinsuring company takes its share of the premium subject to such deduction.
Nothing of record here establishes that the parties to the reinsurance contract before us intended a different result. The insurance reinsured*1060 with the Royal Insurance Co., Ltd., was subject to the same terms and rates of premium as the original policies, and losses and loss expenses paid by the petitioner were assumed by the reinsurer on a pro rata basis. All losses were to be adjusted by the *1084 petitioner alone, except that the Royal Insurance Co., Ltd., reserved the right to participate in the settlement of claims in which its interest exceeded that of the petitioner.
Article 8 of the reinsurance contract provided for a "flat commission" on net premiums received by the Royal Insurance Co., Ltd., from the petitioner, "such commission to cover all expenses, except taxes, Local Board expenses, losses and loss expenses." Article 9 provided for an additional so-called commission based upon the "net results" of the insurance reinsured, computed in the manner set forth in the reinsurance contract. The petitioner was under a contractual obligation to reinsure a portion of its surplus risks with the Royal Insurance Co., Ltd., and had the parties to the contract intended that flat commissions, using the term as it is generally understood, should be paid for the mere performance of such a duty, we think clearer language*1061 would have been employed. Commissions paid by the petitioner to its agents, and brokers, for services performed in effecting the insurance reinsured with the Royal Insurance Co., Ltd., was an expense of the petitioner.
The amounts paid by the Royal Insurance Co., Ltd., to the petitioner, pursuant to articles 8 and 9 of the reinsurance contract, as "commissions" reimbursed the petitioner for such expenses. The petitioner, however, treated the payments as though they were commissions earned on the reinsurance contracts, instead of, as it should, reimbursement for expenses incurred in connection with the reinsured insurance. We think, and so hold, the amounts should be treated as reimbursement for expenses incurred in connection with the insurance in question.
We think the petitioner's claim should be denied for other reasons. Section 204(a)(5) of the Revenue Act of 1928 specifically provides that in the computation of premiums earned on insurance contracts during the taxable year there shall be deducted from gross premiums on insurance contracts within the same year, "return premiums and premiums paid for reinsurance." The petitioner asks us to allow as premiums on reinsurance, *1062 the gross premiums, less cancellation and return premiums, on the insurance reinsured with the Royal Insurance Co., Ltd., and relieve it of tax on the so-called commissions received.
The statute contemplates the imposition of a tax on earned premiums, in the determination of the amount of which allowance is made for reinsurance premiums. The net premiums on the insurance reinsured by the petitioner in 1928 with the Royal Insurance Co., Ltd., were $31,922.06, and had that amount been paid without offsets of any kind, the petitioner would be entitled to deduct it from the premiums written on insurance contracts during 1928 in computing the amount of its earned premiums. The whole of the premiums *1085 on reinsurance was not paid. The petitioner deducted the sum of $9,647.52 as "commission" when paying the reinsurance premiums, and in addition thereto received from the Royal Insurance Co., Ltd., the amount of $490.22 as "contingent commissions" on the same reinsurance. These amounts, totaling $10,137.74, we think should be regarded as offsets to, or reductions of, the premiums of $31,922.06 on reinsurance. The remainder of $21,784.32 is all the petitioner is actually out*1063 of pocket for premiums on reinsurance paid during the taxable year and is the only amount it is entitled to deduct as "premiums paid for reinsurance." The reduction of the amount of premiums on reinsurance results in earned premiums, taxable as underwriting income.
The situation respecting the amount of $2,909.59 received for acting as a broker in writing policies of insurance for other companies is different. Section 204 of the statute limits taxable income of insurance companies, such as the petitioner, to investment income, consisting of interest, dividends and rents; underwriting income, defined as earnings on premiums, computed in a prescribed manner, and gain from the sale or other disposition of property. If the amount is taxable to the petitioner it must be brought within one of the three classifications of income. See . It is clear that the amount is not investment income, underwriting income, or gain from the sale or other disposition of property. Accordingly, we hold that the amount does not constitute taxable income to the petitioner.
*1064 The respondent contends, in the alternative, that if we hold, as we have, that all or a substantial part of the amounts in controversy is not taxable, the petitioner is taxable under section 13 of the 1928 Act as an ordinary domestic corporation.
The governing statute contains no definition of "insurance company." The determination of whether a corporation is taxable as an insurance company is controlled by the character of the business actually carried on by it.
The petitioner's business was carried on under a name indicating it to be an insurance company; its charter authorized it to underwrite certain specified forms of insurance; and its activities were examined periodically by the Superintendent of Insurance of the District of Columbia to ascertain whether it was conducting its business pursuant to the laws of the District of Columbia governing insurance companies. It derived substantially all of its income from three sources, namely, investment income, underwriting income, and commissions on policies of insurance written for other insurance companies. For 1928 the petitioner reported net investment income of*1065 $16,057.40 and net underwriting income of $57,104.07, a total of *1086 $73,161.47, the basis for the underwriting income being gross premiums of $105,599.06, exclusive of return premiums and cancellations. Other income reported consisted of $428.75 for commissions on real estate loans and the so-called commissions of $13,047.33 in controversy here. After excluding from the latter sum the amount of $10,137.74, which we have held to be taxable as underwriting income, there remains but $2,909.59, representing commissions for writing insurance for other companies, and the item of $428.75, not actually earned in conducting a strictly insurance business. These amounts are small in comparison with gross premiums and underwriting income. Petitioner's chief source of income was from the conduct of activities generally known as an insurance business. Other activities carried on by it were merely incidental thereto and are not sufficient, in our opinion, to warrant a holding that the petitioner is not an insurance company other than a life or mutual company within the meaning of the act.
To support his view, the respondent cites *1066 , and . Upon reargument the court reversed itself in the former case, following The facts in the other case relied upon are distinguishable. There about 42 percent of the corporation's entire income was derived from the operation of a trustee and bond sale service, which service the court held was, in a large part, a distinct business from the insurance business conducted by it.
One other point remains. In their agreed statement of facts the parties stated that the amount of $5,430.11 included in commissions and brokerage on policies placed is an offset against the amount of $23,749.84 deducted as an expense for compensation paid to agents. As we understand the stipulation, no adjustment need be made on account of the manner in which the amounts were reported. However, if we are in error, the question may be settled under Rule 50.
Reviewed by the Board.
Judgment will be entered under Rule 50.