*764 1. Where the evidence shows that petitioner's principal business during the taxable year 1934 was that of writing title insurance and that more than one-half of its gross income was from that source, held, petitioner was an insurance company subject to the tax imposed by section 204, Revenue Act of 1934, as the term "insurance company" is used in section 701(c)(2), and is therefore exempt from the excess profits tax imposed by section 702(a) of the same Act.
2. During the taxable year 1934, pursuant to a resolution of its board of directors, petitioner transferred from an account carried on its books as "Reserve for Unearned Premiums" $40,000 to its undivided profits account. $35,674.69 of this "Reserve for Unearned Premiums" had been legally deducted by petitioner in determining its net income for prior years. Held, that $35,674.69 of the $40,000 thus released to petitioner's general uses, for reasons stated in the opinion, constituted gross income to petitioner during the taxable year under section 204(b)(1)(C) of the Revenue Act of 1934.
3. Held, the remainder of the $40,000 thus released was not income to petitioner in 1934. It had not been legally deducted*765 by petitioner in prior years and should have gone back into income in the year when illegally deducted as an addition to reserves. The Commissioner has not established any estoppel which would require this amount to go into petitioner's income in 1934.
*1023 The respondent for the calendar year 1934 determined a deficiency in income tax of $6,273.64 and a deficiency in excess profits tax of $612.95. Petitioner contests the entire deficiency in excess profits tax and $5,500 of the deficiency in income tax. It concedes there is a deficiency in income tax of $773.64, due to an adjustment which petitioner does not contest.
The issues involved are (1) whether the respondent properly included in petitioner's taxable income for the year 1934 an amount of $40,000 which petitioner transferred from its "Premium Reserve Account" to its "Undivided Profits Account" pursuant to a resolution adopted at a special meeting of its board of directors on July 5, 1934; and (2) whether petitioner is an "insurance company" as that term is used in section 701(c)(2) of the*766 Revenue Act of 1934, and therefore, exempt from the excess profits tax imposed by section 702(a) of the same act. Relative to the first issue the respondent has affirmatively alleged that petitioner is estopped to deny that the amount of $40,000 is taxable income for the year 1934.
FINDINGS OF FACT.
Petitioner is a corporation, duly organized and existing under and by virtue of the laws of the State of Texas, having been organized in the year 1906. Its office and principal place of business is in Dallas, Texas.
At the close of the year 1912 petitioner set up on its books an account captioned "Premium Reserve Account" and at that time it credited to this account the amount of $15,500.75. During each of the years 1913 to 1929, inclusive, it increased the credit balance of this *1024 account from $15,500.75 to $149,829.88 by means of a series of debits and credits in amounts respectively as follows:
| Year | Debit | Credit | Balance on December 31 |
| 1912 | $15,500.75 | ||
| 1913 | $1,205.07 | $6,633.24 | 20,928.92 |
| 1914 | 2,514.51 | 10,269.30 | 28,683.71 |
| 1915 | 3,405.66 | 6,114.68 | 31,392.73 |
| 1916 | 3,294.46 | 8,255.36 | 36,353.63 |
| 1917 | 4,451.28 | 8,590.59 | 40,492.94 |
| 1918 | 3,696.29 | 6,243.54 | 43,040.19 |
| 1919 | 1,784.21 | 5,357.31 | 46,613.29 |
| 1920 | 3,362.22 | 9,350.53 | 52,601.60 |
| 1921 | $2,622.99 | $11,026.71 | $61,005.32 |
| 1922 | 3,308.03 | 14,752.09 | 72,449.38 |
| 1923 | 3,518.10 | 17,098.81 | 86,030.09 |
| 1924 | 7,337.11 | 18,836.82 | 97,529.80 |
| 1925 | 5,866.90 | 20,556.18 | 112,219.08 |
| 1926 | 6,234.77 | 21,506.37 | 127,490.68 |
| 1927 | 11,116.26 | 19,967.73 | 136,342.15 |
| 1928 | 9,805.35 | 19,029.00 | 145,565.80 |
| 1929 | 5,124.52 | 9,388.60 | 149,829.88 |
*767 At all times prior to August 12, 1929, petitioner operated under the provisions of the Texas insurance law designated as article 4971 of "Chapter Sixteen, Surety and Trust Companies" of "Title 78, Insurance" of the Revised Civil Statutes of Texas of 1925, the pertinent parts of which are set out in the margin. 1 Effective August 12, 1929, the Texas law was amended so as to place all title insurance companies, including petitioner, under the rules and regulations provided in article 1302a, of "Chapter One, Purposes" of "Title 32, Corporations - Private" of the Revised Civil Statutes of 1925, as amended, the pertinent parts of which are set out in the margin. 2
*768 *1025 During the years 1930 to 1935, inclusive, petitioner made no further credits to its premium reserve account. During the year 1931 petitioner transferred $9,829.88 from its premium reserve account to its surplus account, thus leaving its premium reserve account with a credit balance on December 31, 1931, of $140,000. The effect of the transfer of this $9,829.88 is not here in question.
During the taxable year 1934, pursuant to a resolution adopted at a special meeting of its board of directors on July 5, 1934, the material parts of which are set out in the margin, 3 petitioner transferred by book entry from its premium reserve account to its undivided profits account the amount of $40,000. The amount so transferred was a part of the excess over the reserve required by the 1929 law, and was a part of the premium reserve account existing on the books of petitioner at the close of 1929 and is the $40,000 item by reason of which the respondent has determined the deficiency in income tax here in controversy. Petitioner's premium reserve account had a credit balance of $140,000 at the beginning of 1934 and a credit balance of $100,000 at the close of 1934.
*769 All of the funds with which the premium reserve account was at any time credited were earned by petitioner prior to 1930, and in the various income tax returns made by petitioner for the years 1913 to 1929, inclusive, petitioner claimed and was allowed a deduction from its gross income of the amount of the net increase in such premium reserve account for each such year. Petitioner's income tax returns for each such previous year disclosed the earnings of petitioner and the claimed deduction by reason of the crediting of part of such annual income to the premium reserve account.
During the taxable year involved petitioner was engaged in the title insurance business.
On April 15, 1935, pursuant to an extension of time for filing return granted by the collector of internal revenue on March 15, 1935, petitioner filed with the collector a corporation income and excess profits tax return, form 1120, for the calendar year 1934, and reported items of gross income and expenses, as follows:
| INCOME | |
| Interest received | $14,513.57 |
| Premium - insurance and bonds | 57,906.88 |
| Legal fees | 1,007.95 |
| Abstract fees | 15,530.75 |
| Recoveries accounts receivable | 70.70 |
| Miscellaneous | 272.65 |
| 89,302.50 |
*770 *1026 There then followed items of deduction aggregating $60,169.97, which are not set out in detail because they are not in controversy. The deduction of this $60,169.97 from the gross income of $89,302.50 reported by petitioner left a net income of $29,132.53 reported in petitioner's return.
The respondent determined that petitioner's corrected net income for the taxable year 1934 was $74,758.99 or $45,626.46 more than petitioner had reported. This increase of $45,626.46 was composed of two items - (1) the $40,000 which petitioner transferred from its premium reserve account to its undivided profits account, and (2) the disallowance of a loss $5,626.46 on the sale of assets. Petitioner does not question the correctness of the disallowance of the loss, but does question the correctness of the respondent's determination that the transfer of the $40,000 from the one account to the other constitutes taxable income.
Petitioner in its return also reported nontaxable interest on obligations of the United States in the amount of $2,916.39 and dividends deductible under section 23(p) of the Revenue Act of 1934 in the amount of $339.48. Included in the deduction for taxes*771 of $4,404.20 was an item for Federal capital stock tax of $500.
Petitioner's balance sheets as of the beginning and end of the taxable year, as reported on its return, are as follows:
| Dec. 31, 1933 | Dec. 31, 1934 | |
| ASSETS: | ||
| Cash | $8,904.83 | $18,497.18 |
| Notes receivable and mortgages | 49,741.43 | 3,737.50 |
| Accounts receivable | 2,955.15 | 3,399.25 |
| Investments in Government obligations | 108,761.06 | 78,991.50 |
| Stocks of domestic corporations | 7,822.78 | |
| Real estate | 11,554.10 | |
| All other investments or loans, real estate | 160,912.24 | 241,539.60 |
| Accrued interest | 1,560.52 | 2,560.48 |
| Furniture and fixtures | 3,606.37 | 3,163.82 |
| Abstract plant | 75,000.00 | 75,000.00 |
| Library | 1,300.00 | 1,000.00 |
| 424,295.70 | 435,712.11 | |
| LIABILITIES & CAPITAL: | ||
| Funds in escrow | $1,094.07 | $5,077.91 |
| Accrued expenses | 343.14 | 2.00 |
| Reserve for depreciation | 2,763.66 | 2,474.58 |
| Reserve for contingencies | 600.00 | 600.00 |
| Reserve for taxes | 2,960.20 | 10,500.00 |
| Reserve unearned premium | 140,000.00 | 100,000.00 |
| Capital stock | 200,000.00 | 200,000.00 |
| Surplus | 30,000.00 | 30,000.00 |
| Undivided profits | 46,534.63 | 87,057.62 |
| 424,295.70 | 435,712.11 |
*1027 OPINION.
BLACK: We shall consider*772 the issues, stated elsewhere, in the inverse order.
Was petitioner exempt from the excess profits tax imposed by section 702 of the Revenue Act of 1934? This section provides in part that:
(a) There is hereby imposed upon the net income of every corporation, for each income-tax taxable year ending after the close of the first year in respect of which it is taxable udner section 701, an excess-profits tax * * *. [Tialics supplied.]
Section 701 imposes a capital stock tax upon certain corporations and under subdivision (c)(2) thereof, it provides that taxes thus imposed shall not apply "to any insurance company subject to the tax imposed by section 201, 204, or 207." Petitioner contends that it is an "insurance company" subject to the tax imposed by section 204. The material provisions of section 204 are set out in the margin. 4
*773 The parties have stipulated that "during the taxable year involved, petitioner was engaged in the title insurance business." On cross-examination of petitioner's witness, F. D. Price, it was brought out that petitioner also engaged in business other than the title insurance business. A corporation may be organized under the insurance laws of a state, be subject to supervision by the insurance officers of the state, and actually do a certain amount of insurance business, and yet fail to classify as an "insurance company" as that term is used in the Federal tax statutes. ; ; . It is the character of the business actually done in the tax year that determines whether the corporation is taxable as an insurance company. If insurance is its principal business, it is taxable as an insurance company. *1028 *774 . If, therefore, petitioner's title insurance business is its principal business, it is an insurance company taxable under section 204.
The character of petitioner's business actually done during the taxable year was testified to by F. D. Price, the auditor having supervision and control of petitioner's records, as follows:
Q Will you state what the records show as to the gross income for the Dallas Title and Guaranty Company in the year 1934?
A The gross income, according to the records, of the Dallas Title and Guaranty, was $92,558.37.
Q Mr. Price, have you figured what percentage of that income is derived from premiums on title policies and investments on title company holdings?
A Approximately 60% is underwriting income, and approximately 20% is insurance investment income, thereby making a grand total of approximately 80% of the gross income derived from the insurance business.
Petitioner also introduced in evidence its income tax return, in which it had reported taxable gross income of $89,302.50 and nontaxable gross income of $3,255.87, or a total of $92,558.37. The break-down of these*775 figures into separate items is shown in our findings of fact. We think these facts, together with the stipulation that "during the taxable year involved petitioner was engaged in the title insurance business", establishes that petitioner was engaged in the insurance business, other than "life or mutual." We, therefore, hold that petitioner is an insurance company subject to the tax imposed by section 204, and that it is not subject to the excess profits tax imposed by section 702.
Is petitioner taxable on the $40,000, or any part thereof, transferred from the premium reserve account to the undivided profits account during the taxable year 1934?
Petitioner contends (1) that the $40,000 had been on hand as an asset since prior to 1930 and as such was not taxable gain in 1934; (2) that the transaction does not fall within the defined items of income contained in section 204 of the Revenue Act of 1934; (3) that all of the reserve fund of $149,829.88 on hand at the close of 1929 was legally taxable in the years in which it was earned prior to 1930, and consequently was not taxable in 1934; and (4) that the fact that no income tax was paid on the $149,829.88 in the years in which*776 it was earned furnishes no authority for subjecting any part of the fund to income tax in 1934, prior to which year the entire fund was a part of petitioner's capital assets.
The respondent's position is that since petitioner has had the benefit of the net increase in the premium reserve account for the years 1913 to 1929, inclusive, as deductions from gross income in years prior to 1930, it should be required to include in its gross income for the taxable year 1934 that part of the reserve which was released during the *1029 taxable year, namely, $40,000. In support of this position, the respondent cites, among other cases, , and , and cases therein cited. The respondent has also affirmatively pleaded that petitioner is estopped to deny that the amount of $40,000 is taxable income to it for the year 1934.
In approaching the contentions thus made by both parties, it will be pertinent, we think, to determine the validity of the deductions taken by petitioner in years prior to 1930 of the net additions to the premium reserve account. *777 Petitioner now says these were all illegal and should have been restored to income in the years when they were taken as deductions. The revenue acts prior to the Revenue Act of 1921, together with the Act of August 5, 1909, all allowed insurance companies to deduct from their gross income "the net addition, if any, required by law to be made within the year to reserve funds * * *." Section 38 second of the Act of August 5, 1909 (36 Stat. 113); section II G. (b) of the Tariff Act of October 3, 1913 (38 Stat. 173); section 12 of the Act of September 8, 1916 (39 Stat. 768); section 234(a)(10), Revenue Act of 1918 (40 Stat. 1079). Section 234(a)(10) of the Revenue Act of 1921 (42 Stat. 256) allowed for the year 1921 a deduction "In the case of insurance companies (other than life insurance companies), in addition to the above (unless otherwise allowed): (A) The net addition required by law to be made within the taxable year to reserve funds * * *." See ; affd., ; certiorari denied, *778 ; and art. 691, Regulations 62. This deduction was not allowable for 1922 and subsequent years.
The Texas law (art. 4971, note 1, supra ) under which the reserve of $149,829.88 was built up required petitioner to have "a fully paid up and safely unimpaired capital of at least" $100,000, and also "good available assets exceeding its liabilities, which liabilities for the purpose of this subdivision shall be taken to be its capital stock, its outstanding debts and a premium reserve at the rate of fifty per cent of the current annual premiums * * *." (Italics supplied.) It is our opinion that, in the absence of any evidence to the contrary, the deductions taken by petitioner in years prior to 1922 of the net additions to the premium reserve account in the total amount of $45,504.57 504.57 were all legal and proper deductions from gross income.
At this point, we think it is appropriate to remark that, while it is stipulated that at the close of 1912 petitioner carried on its books an account designated thereon as "Premium Reserve Account", with a then credit balance of $15,500.75, it was not stipulated that this amount had been deducted in determining*779 the amount of petitioner's *1030 excise tax under the 1909 Act. The stipulation as to deductions is as follows:
In the various income tax returns made by petitioner for the years 1913 to and inclusive of 1929, petitioner claimed and was allowed a deduction from its gross income of the amount of the net increase in such "Premium Reserve Account" for each such year.
Hence we have computed these deductions so taken from 1913 to 1921, both years inclusive, and arrived at the figure of $45,504.57 legal deductions, as stated above.
Beginning with the Revenue Act of 1921, effective January 1, 1922, Congress changed its method of taxing "Insurance Companies Other Than Life Or Mutual." See sections 246 and 247 of the Revenue Acts of 1921, 1924, and 1926 and section 204 of the Revenue Acts of 1928, 1932, and 1934. After the year 1921, Congress no longer allowed as deductions from gross income the net addition required by law to be made within the taxable year to reserve funds. Congress did provide, however, in section 246(b)(1) of the Revenue Acts of 1921, 1924, and 1926 and section 204(b)(1) of the Revenue Act of 1928, that in computing the gross income:
The term "gross*780 income" means the combined gross amount, earned during the taxable year, from investment income and from underwriting income as provided in this subdivision, computed on the basis of the underwriting and investment exhibit of the annual statement approved by the National Convention of Insurance Commissioners.
In section 246(b)(4) of the Revenue Acts of 1921, 1924, and 1926 and section 204(b)(4) of the Revenue Act of 1928, Congress provided that the term underwriting income "means the premiums earned on insurance contracts during the taxable year less losses incurred and expenses incurred", and in the following paragraph it provided as follows:
(5) The term "premiums earned on insurance contracts during the taxable year" means an amount computed as follows:
From the amount of gross premiums written on insurance contracts during the taxable year, deduct return premiums and premiums paid for reinsurance. To the result so obtained add unearned premiums on outstanding business at the end of the preceding taxable year and deduct unearned premiums on outstanding business at the end of the taxable year.
Apparently petitioner deducted the net additions to the premium reserve account*781 during the years 1922 to 1929, inclusive, in the total amount of $88,824.56 on the ground that this amount of the premiums collected was "unearned premiums", for in its balance sheets as of December 31, 1933 and 1934, attached to its 1934 return, it reported this reserve as "Reserve Unearned Premium Dec. 31, 1933, $140,000 and Dec. 31, 1934, $100,000."
*1031 It is now settled, however, that premiums paid a title insurance company are earned when paid and constitute gross income when received, and that reserves set up to meet future liabilities under title insurance policies are not deductible from gross income. ; affd., . Cf. ; . It, therefore, was improper for petitioner to deduct on its returns for the years 1922 to 1929, inclusive, the net additions to its premium reserve account during those years in the amount of $88,824.56. If this were the only part of the reserve with which we were dealing, we would sustain*782 petitioner's contention that none of the $40,000 in question could be taxed to petitioner in 1934.
The situation is different, however, as to the additions to the premium reserve account during the years 1913 to 1921, inclusive. As we have already stated, the aggregate of the net additions to reserve in those years was $45,504.57, all of which petitioner deducted on its income tax returns for those years. The Commissioner properly allowed these deductions under the law and regulations which were in force during those years. In 1931 petitioner transferred by book entry from said account designated "Premium Reserve Account" to "Undivided Profits Account" the sum of $9,829.88. Presumably the Commissioner taxed that amount as income of petitioner for that year. He makes no contention to the contrary. This $9,829.88 subtracted from the $45,504.57 which the Commissioner had legally allowed as deductions in years from 1913 to 1921, inclusive, leaves $35,674.69. If, in a later year, any part of this legal reserve for which deductions have been properly allowed in prior years is released to the general uses of the petitioner and thus increases petitioner's free assets, to that extent*783 the reserve should be treated as income in the year in which it became so available. ; art. 240, Regulations 33 (Revised); art. 548, Regulations 45 (1920 Edition).
We think such a release as is referred to above took place during the taxable year 1934. On July 5 of that year, petitioner called a special meeting of its board of directors to consider the recommendation of its executive officers that $40,000 be transferred from the premium reserve account to the undivided profits account. After considerable discussion of the matter, a resolution was adopted whereby petitioner's officers were directed to make the transfer. We think this transfer of $40,000 amounted to a release of petitioner's legal reserve to that extent and was income to petitioner in 1934 to the extent of $35,674.69, upon authority of , and . Cf. *784 ; ; ; affd., ; certiorari denied, . We do not think the change in the Texas law (art. 1302a, note 2, supra ) which became effective on August 12, 1929, compels a different holding from that we have just made, in view of the fact that petitioner took no steps to release the amount in question until the taxable year 1934. Cf. , and cases therein cited, and .
Our holding above disposes of all of petitioner's contentions except the second, namely, that the transaction does not fall within the defined items of income contained in section 204 of the Revenue Act of 1934. In support of this contention, petitioner relies principally upon . That case involved section 204(b)(1) of the Revenue Act of 1928, which contained a restricted definition of gross income of insurance companies*785 other than life or mutual. This definition of gross income was enlarged by section 204(b)(1) of the Revenue Acts of 1932 and 1934 to include "and (C) all other items constituting gross income under section 22." See note 4, supra. For the reasons already given, we hold that $35,674.69 of the $40,000 in question should be included in petitioner's gross income under section 204(b)(1)(C) of the Revenue Act of 1934.
For the reasons we have already stated, the remainder of the $40,000 in question would not be taxable income to petitioner in 1934, unless it is so by some principle of estoppel. The Commissioner has specially pleaded estoppel, but we do not think he has proved any facts which establish it. It is true that the facts show that from 1922 to 1929, inclusive, the petitioner claimed and was improperly allowed deductions for additions to reserves in those taxable years amounting to $88,824.56. There were no misrepresentations of fact connected with these deductions. Petitioner did actually set up these reserves on its books, as required by the laws of the State of Texas, but it was not legally entitled to take deductions therefor and the Commissioner should not have allowed*786 these deductions. However, a misunderstanding of the law by both parties does not establish estoppel. Cf. . , and cases there cited. On the issue of estoppel we hold in favor of the petitioner.
Reviewed by the Board.
Decision will be entered under Rule 50.
Footnotes
1. ART. 4971. [4930] Requirements to be complied with.
Such company to be qualified to so act as surety or guarantor, must comply with the requirements of every law of this state applicable to such company doing business therein; must be authorized under the laws of the State where incorporated, and under its charter, to become surety upon such bond, undertaking, obligation, recognizance or guarantee; must have a fully paid up and safely unimpaired capital of at least one hundred thousand dollars; must have good available assets exceeding its liabilities, which liabilities for the purpose of this subdivision shall be taken to be its capital stock, its outstanding debts and a premium reserve at the rate of fifty per cent of the current annual premiums on each outstanding bond, undertaking, recognizance and obligation of like character in force; must file with the Commissioner, a certified copy of its certificate of incorporation, a written application to be authorized to do business under this subdivision and also, with such application, and in each year thereafter, a statement verified under oath made up to December 31, preceding, stating the amount of its paid up cash capital particularizing each item of investment, the amount of premiums upon existing bonds, undertakings, recognizances and obligations of like character in force upon which it is surety; the amount of liability for unearned portion thereof estimated at the rate of fifty per cent of the current annual premiums on each such bond, undertaking, recognizance and obligation in force, stating also the amount of its outstanding debts of all kinds, and such further facts as may be by the laws of this State required of such company in transacting business therein. ↩
2. ART. 1302a. Corporations for owning abstract plants, insuring titles, lending money and dealing in securities, and acting as trustees, etc.; regulation by Insurance Commissioners.
* * *
SEC. 10. Every company doing a title insurance business under the provisions of this Act shall set aside annually as a reserve 5% of its gross premiums so collected before any dividends are paid, the totals of such reserve shall never be required to exceed a total reserve of $100,000.00. Such reserve must be maintained separately and apart from the capital of the company, and shall be invested in such securities as are admissible for investment by life insurance companies under the Laws of this State. Funds accumulated under this provision shall never be used for the payment of any obligation other than those connected with the title insurance, and, in the event of the insolvency of a company, the fund, hereby provided shall be used to protect title insurance policy holders even though there be no accrued title insurance claims and even though there be unpaid obligations of other sorts. ↩
3. Pursuant to notice, a special meeting of the Board of Directors of the DALLAS TITLE AND GUARANTY COMPANY was held * * *.
* * *
The President stated that the meeting was called for the purpose of considering the recommendation of the Executive Officers that the sum of $40,000.00 be transferred from the Premium Reserve Account to the Undivided Profit Account, and asked Judge L. C. McBride to explain that such transfer could be legally made, which he did. The President further stated that, in the opinion of the Executive Officers, it was to the best interest of the Company that such transfer be made.
After considerable discussion of the matter, J. D. Gillespie moved that the following Resolution be adopted, which motion was seconded by M. E. Lott, and carried unanimously:
"RESOLVED That the Officers of the Dallas Title and Guaranty Company be and they are hereby directed to transfer from the Premium Reserve Account to the Undivided Profit Account the sum $40,000.00 of the $140,000.00 in the Premium Reserve Account of said Company." ↩
4. SEC. 204. INSURANCE COMPANIES OTHER THAN LIFE OR MUTUAL.
* * *
(b) DEFINITION OF INCOME, ETC. - In the case of an insurance company subject to the tax imposed by this section -
(1) GROSS INCOME. - "Gross income" means the sum of (A) 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, and (C) all other items constituting gross income under section 22;
* * *
(3) INVESTMENT INCOME. - "Investment income" means the gross amount of income earned during the taxable year, from investment income and from underwriting income as
* * *
(4) UNDERWRITING INCOME. - "Underwriting income" means the premiums earned on insurance contracts during the taxable year less losses incurred and expenses incurred; ↩