*2327 1. The petitioner is entitled to a deduction for each of the years 1923 to 1926, inclusive, of 4 per cent of the mean of the reserve funds required by law and held at the beginning and end of each taxable year, undiminished by the amount of exempt interest received. National Life Insurance Co. v. United States,277 U.S. 508">277 U.S. 508.
2. Reserves maintained by a mutual life insurance company on account of dividends declared upon participating policies and left with the company to accumulate are not "reserve funds required by law" within the meaning of the revenue acts.
3. Reserves maintained for premiums paid in advance are not "reserve funds required by law" within the meaning of the revenue acts.
*766 The respondent has asserted deficiencies in income taxes as follows:
| 1922 | $494.49 |
| 1823 | 588.21 |
| 1924 | 749.81 |
| 1925 | 830.41 |
| 1926 | 1,026.33 |
Error is alleged on the part of the respondent in diminishing the deduction of 4 per cent of the mean of the reserve funds required deduction*2328 of 4 per cent of the mean of the reserve funds required by law and held at the beginning and end of each of the taxable received; in disallowing as a reserve fund required by law amounts set up and held at the beginning and end of each of the years 1922 to 1926, inclusive, on account of dividends declared and left with the company to accumulate; and in disallowing as a reserve fund required by law an amount set up and held at the beginning and end of each of the years 1922 to 1926, inclusive, for premiums paid in advance.
FINDINGS OF FACT.
The petitioner is a corporation organized and existing under the laws of Ohio, with its principal place of business at Columbus.
It is a mutual life insurance company issuing policies upon the level premium plan. During the taxable years it issued several types or classes of policies, including an ordinary whole life policy and a 10-year renewable term policy. The ordinary whole life policy contains the following provisions:
RESERVE BASIS. - The reserve on this policy shall be computed according to the American Experience Table of Mortality and 3 1/2% interest, the first year's insurance being term insurance purchased by the whole or*2329 part of the premium to be received during the first policy year.
* * *
DIVIDENDS. - At the end of the first policy year, if the second annual premium is paid in cash, and at the end of each subsequent policy year, the Company *767 will annually determine, and account for the portion of the divisible surplus accruing on this policy. Dividends thus credited, at the option of the Insured, may be:
First. Withdrawn in cash or applied toward the payment of any premium or premiums; or
Second. Applied to the purchase of paid-up participating life insurance additions to the policy payable at the death of the Insured; or
Third. Left to accumulate to the credit of the policy with interest at not less than 3 1/2% per annum and payable at the death of the Insured, but withdrawable at any time.
Unless the insured shall have elected otherwise within thirty-one days after any dividend is due, the same shall be applied to the purchase of paid-up additions to the policy which, if the insurance has not been extended or continued for a reduced amount of paid-up insurance in accordance with the nonforfeiture provisions and if the security of any indebtedness under the*2330 policy shall not be thereby impaired, may be surrendered at any time on written request of the insured for their then reserve value, not less than the original dividends.
PAID-UP OPTION. - Upon written request and surrender of this policy, any existing paid-up additions hereto and any dividend accumulations standing to the credit of the policy will be used to convert this policy into a paid-up participating life insurance policy, for its face amount, payable as provided in this policy, when the cash value of this policy as stated in the "Table of Guarantees," together with the cash value of such paid-up additions and dividend accumulations, equal the net single premium at the attained age of the Insured for such amount of insurance according to the American Experience Table of Mortality and 3 1/2% interest. Any indebtedness against this policy will continue as an indebtedness and lien against the paid-up policy.
The 10-year renewable term policy provides in part as follows:
CONVERSION OF POLICY. - At the option of the Insured this policy may be changed on any anniversary thereof without medical re-examination for a policy of the same amount upon any life or endowment plan, *2331 without disability benefits, then issued by the Company. The Insured shall have the option of receiving a policy bearing the same date and age of issue as this policy by the payment of the difference between the premiums required under the two contracts with interest at 6% compounded annually from their respective due dates to the date of change, provided, however, that the amount to be paid to secure such change shall in no case be less than the difference in reserves for the respective policies according to the American Experience Table of Mortality with 3 1/2% interest; or, the Insured may elect to receive a new policy at the Company's rate for the attained age of the Insured, in which case the entire reserve and dividend accumulations on this policy shall be applied to the purchase of an annuity to be applied in the uniform reduction of the premium on the new policy.
The Insured may elect to receive a policy containing disability benefits upon furnishing evidence of such health as would, in the judgment of the Company's Medical Director, warrant the granting of such benefits.
DIVIDEND AND RENEWAL PROVISIONS. - At the end of the second and of each subsequent policy year the*2332 Company will annually determine and account for the portion of the divisible surplus accruing on this policy which may thereafter be used by the Insured in accordance with the following provision:
At the expiration of each ten year period from the date of issue of this policy, the premiums due hereon will be adjusted as shown in the "Table of Renewal *768 Rates," on the first page hereof, for the then attained age of the Insured; but any surplus accumulation hereunder will at that time be applied as an annuity towards reducing each annual premium for the new term as the same becomes due; such new premium shall not however be less than that charged during the preceding term and if the surplus accumulated hereunder be more than sufficient to continue the new premium upon that basis the excess shall be used in the reduction of premiums called for under succeeding terms; but when the Insured attains the age of 60 years (nearest birthday) this policy, if then in force, will become without any action on the part of the Insured a whole life continuous premium policy without participating in surplus and the premium payments required thereafter will be $63.00 per $1,000 of insurance*2333 which will remain the rate without change for the remainder of the life of the Insured.
NON-FORFEITURE PROVISIONS
SURRENDER VALUES TO AGE 60. - When premiums for three years under this policy have been paid, should default occur in the payment of any subsequent premium, the Insured may elect to receive in cash the reserve and surplus accumulations for entire years or a paid-up non-participating whole life policy for such an amount as said reserve and accumulations will purchase at the attained age of the Insured, used as a net single premium according to the American Experience Table of Mortality and 3 1/2 per cent interest; provided, in either case this policy be surrendered and the selection of benefits made and applied for upon forms to be furnished by the Company, within sixty days from the time when the defaulted premium became due; in event no selection is made within the above period of sixty days, this policy will be binding upon the Company as a paid-up non-participating whole life policy for such a reduced amount as the reserve and accumulations, used as above provided, will purchase.
* * *
On its annual statement for each of the years, the petitioner set up reserves*2334 as follows:
| Dividends left with the company to accumulate at interest and interest thereon | ||
| Year | Beginning of year | End of year |
| 1922 | $74,191.73 | $87,760.00 |
| 1923 | 87,760.00 | 104,143.26 |
| 1924 | 104,143.26 | 122,609.11 |
| 1925 | 122,609.11 | 149,713.91 |
| 1926 | 149,713.91 | 189,306.86 |
| Accumulated dividends on 10-year renewable term policies to be applied inreduction of premiums | ||
| Beginning of year | End of year | |
| 1922 | $12,388.46 | $15,995.00 |
| 1923 | 15,995.00 | 18,501.29 |
| 1924 | 18,501.29 | 21,608.74 |
| 1925 | 21,608.74 | 26,995.18 |
| 1926 | 26,995.18 | 28,234.89 |
*769
| Gross premiums paid in advance, | ||
| including surrender so applied | ||
| less discount, if any | ||
| Beginning of | End of year | |
| year | ||
| 1922 | $ 3,740.58 | $ 3,718.06 |
| 1923 | 3,718.06 | 5,021.05 |
| 1924 | 5,021.05 | 5,501.88 |
| 1925 | 5,501.88 | 5,734.90 |
| 1926 | 5,734.90 | 10,545.45 |
The above reserve for gross premiums paid in advance was set up to provide for the petitioner's liability where policyholders paid premiums which were not yet due, often for several years in advance. In such cases petitioner granted a discount of 3 1/2 per cent from the respective due dates*2335 to the date of payment. The advance payments were subject to withdrawal on demand at their then present value. If the policy was permitted to lapse the advance payments were returned to him at their then present value.
OPINION.
LANSDON: With respect to the first allegation, the respondent concedes error in so far as his determination is inconsistent with the decision of the Supreme Court in . The petitioner is entitled to a deduction for each of the years 1923 to 1926, inclusive, of 4 per cent of the mean of reserve funds required by law and held at the beginning and end of the taxable year undiminished by the amount of tax-exempt interest received.
The remaining question to be determined is whether reserves for dividends left with the company to accumulate at interest and for discounted premiums paid in advance are "reserve funds required by law" within the meaning of section 245(a)(2) of the Revenue Acts, which provide:
(a) That in the case of a life insurance company the term "net income" means the gross income less -
* * *
(2) An amount equal to the excess, if any, over the deduction*2336 specified in paragraph (1) of this subdivision, of 4 per centum of the mean of the reserve funds required by law and held at the beginning and end of the taxable year, * * *
Petitioner maintained reserves for dividends left to accumulate at interest. The amounts accumulated upon ordinary whole life policies were subject to withdrawal by the policyholder on demand, while those accumulated upon the 10-year renewable term policies were available only at the end of the term and were to be applied in reduction of renewal premiums. There is no provision as to payment in case the policy is lapsed.
*770 Frequently, policyholders desired to pay premiums which were not yet due, in which case, petitioner granted a discount from the due date to the date of payment of 3 1/2 per cent, compounded annually. Such funds were subject to withdrawal at any time by the policyholder at their present value. On its annual statement for each of the taxable years petitioner set up reserves for the gross premiums paid in advance.
We think the reserves for dividends left to accumulate at interest and for premiums paid in advance are liabilities of petitioner which do not come within the accepted*2337 definition of "reserve funds required by law." ; ; ; ; .
The Circuit Court of Appeals for the Second Circuit has recently held, in , that reserves for dividends to policyholders held by a mutual life insurance company represent part of the net worth of the company and that they were subject to the capital-stock tax for the years when such taxes were levied against mutual life insurance companies. Bearing on the question whether dividends are policy obligations. the court states:
* * * While it is true that each policy provides for the declaration of those profits in the form of dividends, it is rather as a charter, - also a contract, - provides for the declaration of dividends to shareholders in a stock company. The policy holders are therefore at once associates in the business of life insurance, *2338 as to which they are investors, and creditors of the group as a whole, ().
The petitioner relies upon our decision in , and The facts of such cases are different from those presented here. There, guaranteed premium reduction coupons were attached to the policies which entitled the policyholder to a credit of a definite amount on a fixed future date, and we held that they were policy obligations and that the reserves maintained on account thereof were "reserve funds required by law." In the instant case no obligation arises until the dividend is declared and credited to the policyholder, when it becomes a liability.
Reviewed by the Board.
Decision will be entered under Rule 50.