United States Court of Appeals
United States Court of Appeals
For the First Circuit
For the First Circuit
No. 96-1877
UNUM CORPORATION AND UNUM LIFE
INSURANCE COMPANY OF AMERICA,
Plaintiff-Appellant,
v.
UNITED STATES OF AMERICA,
Defendant-Appellee.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MAINE
[Hon. Gene F. Carter, U.S. District Judge]
Before
Torruella, Chief Judge,
Aldrich, Senior Circuit Judge,
and Lynch, Circuit Judge.
William J. Kayatta, Jr., with whom Jared S. des Rosiers,
Pierce Atwood, Barbara H. Furey, Barry W. Larman, and UNUM
Corporation and UNUM Life Insurance Company of America were
on brief for appellant.
Edward T. Perelmuter, Tax Division, Department of
Justice, with whom Loretta C. Argrett, Assistant Attorney
General, and David I. Pincus, Tax Division, Department of
Justice, were on brief for appellee.
December 2, 1997
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LYNCH, Circuit Judge. The need to raise capital
LYNCH, Circuit Judge.
and to compete in increasingly diversified financial markets
has led a number of American mutual life insurance companies
to convert to being stock companies. This process, known as
"demutualization," often involves a conversion of the mutual
policyholders' ownership interest in the old company into
ownership interest in the form of stock in the new company.
This appeal raises important questions about the
proper tax treatment of one form of demutualization: whether
stock and cash distributed to policyholders in exchange for
their mutual ownership interests as part of a statutory
demutualization constitute "policyholder dividends" under
808 of the Internal Revenue Code. If so, the insurer may
take a deduction for "policyholder dividends" under
805(a)(3). Whether the "policyholder dividends" deduction
is available has great financial consequences for the company
and for the public fisc. This question involves
consideration of the scope of the "policyholder dividend"
under 808, as well as the broader relationship between the
general corporate tax provisions of the Code (contained in
Subchapter C) and the Code's insurance tax provisions
(contained in Subchapter L).
In this case, UNUM Corp. ("UNUM"), the demutualized
successor to Union Mutual Life Insurance Co. ("Union
Mutual"), seeks a tax refund based on a "policyholder
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dividends" deduction of over $652 million. This sum, which
UNUM was required to distribute to its policyholders by state
law, represents the value of Union Mutual's accumulated
surplus. See Me. Rev. Stat. Ann. tit. 24-A, 3477 (West
1996).
UNUM's principal argument is that the cash and
stock distributed during the demutualization constitute
"policyholder dividends" under the plain language of 808(b)
and thus are deductible under 805. UNUM further argues
that, beyond the statute's plain language, the legislative
history and public policy behind the Code's treatment of life
insurance companies support this result.
The IRS argues that general corporate tax
provisions apply to insurance companies in the absence of
specific provisions to the contrary in the Code's insurance
tax section, and that, under those corporate tax provisions,
UNUM is not entitled to any deduction for its reorganization.
The IRS argues that nothing in 808 or its legislative
history indicates that Congress envisioned 808 as
encompassing capital transactions such as UNUM's
demutualization. Rather, placed in proper context, 808 is
not relevant to the value-for-value exchanges for which UNUM
seeks a deduction.
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The district court entered judgment for the
government in UNUM's suit for a refund. We affirm the
judgment of the district court.
I
I
This appeal involves only questions of law; we
exercise de novo review. Alexander v. Internal Revenue
Service, 72 F.3d 938, 941 (1st Cir. 1995). The parties have
agreed on the facts.
A. Background
Demutualization has become increasingly common in
the insurance industry. More than 200 mutual life insurance
companies have demutualized since 1930. See S. Preston
Ricardo, The Deductibility of Policyholder Dividends: UNUM
Corp. v. United States, 50 Tax Law. 265, 265 (1996). Between
1954 and 1981, the number of mutual insurers declined from
171 to 135; during the same time, the number of stock
insurers increased from 661 to 1,823. Edward X. Clinton, The
Rights of Policyholders in an Insurance Demutualization, 41
Drake L. Rev. 657, 659 n. 13 (1992). Today, fewer than 80
mutual insurers have assets of over $100 million. See
William B. Dunham, Jr., et al., Introduction, in
Demutualization of Life Insurers, 648 PLI/Comm 9, 16 (1993).
These figures suggest that mutual insurers are rapidly
demutualizing, and that new insurance companies prefer the
stock form at the outset.
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State legislatures have facilitated this
demutualization process by passing statutes permitting such
conversions. Presently, at least forty-one states have
specific statutes that provide for demutualization of mutual
life insurers. Alexander M. Dye, Distributing Consideration
to Policyholders, in Demutualization of Life Insurers, 648
PLI/Comm 75, 78 (1993). Only Hawaii and Idaho expressly
prohibit direct mutual to stock conversion, although they
still permit demutualization through the alternate method of
bulk reinsurance conversion. See Clinton, supra, at 673 n.
116. Every state, including those that lack specific
demutualization statutes, permits at least some form of
demutualization. See id.
There are three usual types of mutual to stock
conversions: a statutory conversion whereby the insurer
directly converts its form of business, merger with a stock
insurer, and bulk reinsurance of the mutual company's
policies. See id. at 660-61. This case only concerns the
first type of conversion: a statutory conversion, in which a
mutual company alters its organizational form to become a
stock insurer by redistributing all the mutual policyholder's
ownership interest in the mutual insurer into shares of stock
in a new stock corporation. "This type of reorganization may
properly be regarded as a reorganization of the company
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because the policyholders are exchanging membership in the
mutual for shares in the new corporation." Id. at 660.
By demutualizing, mutual insurers can obtain
certain advantages available to stock insurers. Stock
corporations are better able to raise capital because they
may sell stock on the equity markets. See id. at 666-671.
Stock companies can more easily diversify their operations by
creating upstream holding companies which can own
subsidiaries engaged in other businesses. See id. at 671-72.
They can also create incentives for superior management
performance through stock option plans. See id. at 672-74.
Mutual insurers can only raise capital by retaining earnings
or charging excess premiums, and are generally subject to
comprehensive regulation by state authorities. These
limitations can hinder their ability to grow and diversify.
See id. at 666.
Much is at stake in this process. Mutual insurance
companies have historically lagged behind stock insurers in
growth of assets and capital. Demutualization and subsequent
stock sales may improve a mutual insurer's capital position
and competitive standing with other insurers and financial
institutions. Mutual insurers naturally want to contend in
the increasingly competitive and deregulated financial
services markets. Many mutual insurers regard
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demutualization as an important step toward bolstering their
financial strength and flexibility.
B. Facts
Union Mutual, based in Maine, was organized as a
mutual insurance company in 1848. Union Mutual's business
was selling various types of insurance and annuity products.
As a mutual company, Union Mutual had no stock and was owned
by its participating policyholders.1 Policyholders
contributed to Union Mutual's surplus by paying premiums that
exceeded the actuarial cost of their policy coverage.
In 1984, Union Mutual's management decided to
reorganize the company as a stock insurer. The management
decided that the company would gain four principal business
advantages from this conversion: an increased ability to
1. Mutual life insurance companies do not raise money by
issuing capital stock, but rather by charging policyholders a
"redundant premium" that exceeds the amount actuarially
anticipated to pay the policy's benefits and expenses. The
excess portions of these premiums are accumulated, retained,
and invested as "surplus".
A mutual insurer's accumulated surplus is the excess of
assets over liabilities. Such an excess results from the
accumulation of redundant premiums and investment earnings
over the life of the company. Surplus generally belongs to
the mutual insurer's members in proportion to their
contributions, and is generally returned to policyholders
through policyholder dividends.
Mutual insurers are thus owned by their policyholders.
Policyholders in mutual companies are denominated "members"
of the company; their ownership rights in the company are
their "membership interests". Members of mutual insurance
companies have many of the same rights as stockholders in
corporations, including the right to vote and the right to
residual surplus upon liquidation.
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raise capital, greater flexibility to diversify into new
markets, an increased accountability for company performance
by management, and an enhanced ability to attract and retain
key personnel.
Under Maine law, Union Mutual was not permitted to
implement its conversion plan until the plan was approved by
the Maine Superintendent of Insurance. See Me. Rev. Stat.
Ann. tit. 24-A, 3477 (West 1996). Maine law imposes
several conditions that a demutualization plan must satisfy
in order to receive approval by the Superintendent. These
include, inter alia, (1) that the company pay policyholders a
"fair and equitable" amount for their ownership interests in
the company, (2) that the "equity share" of each policyholder
be determined under a fair and reasonable formula based upon
the insurer's entire surplus as stated in a financial
statement filed with the Superintendent, (3) that the
conversion plan give each member of the demutualizing insurer
a preemptive right to acquire his or her proportionate part
of the proposed capital stock of the new stock company, (4)
that the plan provide for payment to each member of his or
her entire equity share in the insurer, with the payment to
be made in cash or stock of the stock company, and (5) that
policyholders entitled to receive stock or cash include all
policyholders within three years prior to the date the plan
was submitted for approval to the Superintendent. See id.
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On December 14, 1984, Union Mutual submitted a plan
of recapitalization and conversion to the Superintendent.
Union Mutual amended the plan several times in response to
rulings by the Superintendent. On July 11, 1986, Union
Mutual submitted its fourth and final amended plan, which was
approved by the Superintendent on August 8, 1986.
The approved plan of conversion may be generally
described as follows. A holding company was formed to own
all the stock of the new stock company. Those who were
"eligible policyholders"2 transferred their "membership
interests" in Union Mutual to the holding company in exchange
for stock in the holding company. "Membership interests"
were defined in the conversion plan as:
[A]ll the rights or interests of each
policy and contract holder of Union
Mutual including, but not limited to, any
right to vote, any rights which may exist
with regard to the surplus of Union
Mutual not apportioned by the Board for
policyholder dividends, and any rights in
liquidation or reorganization of Union
Mutual, but shall not include any other
right expressly conferred by a
policyholder's insurance policy or
contract.
2. "Eligible policyholders" were generally defined in the
conversion plan as all Union Mutual policyholders during the
three years prior to December 31, 1984.
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Eligible policyholders who qualified as "cash
option eligible policyholders"3 could elect to exchange their
membership interests for cash instead of stock. The holding
company, after obtaining 100% of the membership interests in
Union Mutual, exchanged the membership interests for 100% of
the shares of the newly formed stock insurer. The holding
company sold stock not issued to policyholders to insiders
and the general public. At the conclusion of the Plan, UNUM
Life Insurance Co. ("UNUM Life"), the new stock company, was
a wholly owned subsidiary of UNUM, the holding company. UNUM
was in turn owned by former Union Mutual policyholders,
insiders, and members of the general public.
The approved plan included an actuarial formula for
calculating the consideration to be paid to each policyholder
in exchange for his or her membership interest in Union
Mutual. This figure, denominated each policyholder's "equity
share" in Union Mutual, was defined as "the dollar amount of
that part of Union Mutual's Adjusted Surplus attributable to"
the particular policyholder. Each policyholder's "equity
share" comprised two components: a "minimum equity share"
and the individual's "contribution to statutory surplus". On
December 31, 1985, the day Union Mutual presented its
consolidated balance sheet for final review by the
3. "Cash option eligible policyholders" were generally
defined in the conversion plan as policyholders with equity
of less than $2,500 in Union Mutual.
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Superintendent, Union Mutual's adjusted surplus was
$652,050,097.4 Based on that figure, Union Mutual's
management determined that each policyholder should receive a
per capita amount of $612.25 as the "minimum equity share".
The "contribution to statutory surplus" varied by individual
policyholder. The formula for computing a policyholder's
"equity share" that is referred to in the plan of conversion
reveals this two-component scheme.
The plan of conversion also provided for creation
of an accounting mechanism known as a Participation Fund
Account ("PFA"). The PFA created the functional equivalent
of a closed block5 and was allocated assets which, together
4. Surplus can be measured by either statutory accounting
principles or generally accepted accounting principles
("GAAP"). The difference between the two methods is
primarily one of timing: the costs of selling policies are
fully charged when incurred under statutory accounting
principles, but are amortized over the expected life of the
policies under GAAP. UNUM's accumulated surplus of
$652,050,097 was calculated under GAAP.
In UNUM's demutualization plan, "surplus" was defined as
"the amount of the surplus of Union Mutual as shown by its
financial statement as of the Computation Record Date
(December 31, 1985) filed with the Superintendent, as may be
confirmed or adjusted in the event of an examination by the
Superintendent, including all voluntary reserves but without
taking into account the value of nonadmitted assets or of
insurance business in force."
5. Some states protect the policyholders by requiring that a
mutual insurer establish a "closed block" of business as a
condition of demutualization. See N.Y. Ins. Laws. 7312
(West 1997); 40 Pa. Cons. Stat. Ann. 915-A (West 1997).
Such statutes generally require the mutual insurer's policies
and contracts in force at the time of the reorganization be
placed by the reorganized insurer into a "closed block" into
which the insurer must allocate assets that, together with
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with premiums from the participating policies, were
actuarially sufficient to pay policy claims and policyholder
dividends. Under the conversion plan, the amount of the
assets in the PFA could not be distributed to stockholders of
the demutualized insurer. As with a closed block, it had to
be invested and used for the exclusive benefit of the
policyholders. The PFA was designed with the aim that Union
Mutual's policyholders would continue to receive policyholder
dividends after the demutualization at the same level as
before, even though policyholders and stockholders would have
competing claims on the earning and profits of the company.
The PFA thus was meant to assure policyholders that their
reasonable expectations about the investment value of their
policies would continue to be met.
The creation of the PFA was an important
consideration in the Superintendent's decision to approve the
demutualization plan. In his Final Decision and Order, the
Superintendent discussed the PFA at some length, observing
that Union Mutual policyholders had bought their policies
revenue, are sufficient to pay policy claims and policyholder
dividends. Thereafter, the insurer may not distribute any
earnings or proceeds developed within that block to
stockholders. The closed block must be operated for the
exclusive benefit of the included policies and contracts,
distributions being for policyholder dividend purposes only.
See id.; Dye, supra at 115-116.
A PFA may be required as a condition of demutualization
in states which do not require a closed block. The Maine
demutualization statute does not require a closed block. See
Me. Rev. Stat. Ann. tit. 24-A, 3477 (West 1996).
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with an understanding that policy costs would be continually
adjusted through dividends reflecting Union Mutual's actual
experience. The Superintendent also noted that, when
purchasing their policies, policyholders based their dividend
expectations on dividend illustrations shown to them by Union
Mutual that were in turn based on the dividends the company
had been paying pursuant to the dividend scales current at
the time of purchase. The Superintendent concluded:
Even though these "illustrations" were
not guarantees that dividends would be
paid, Union Mutual, in practice,
typically paid dividends in accordance
with these scales. Based upon these
illustrations and upon actual practice,
policyholders expect that they will
continue to receive these dividends as
long as their policies are in force.
Therefore, I find it appropriate that the
Plan, by creating a mechanism such as the
PFA, supports these expectations of
future dividends.
That the PFA would maintain these expectations was, according
to the Superintendent, critical to the acceptability of the
conversion plan.
Union Mutual implemented its plan of conversion on
November 14, 1986. To the 105,098 Eligible Policyholders who
selected the Cash Option, Union Mutual distributed
$129,129,082. To the remaining 58,561 Eligible
Policyholders, Union Mutual distributed 20,489,072 shares of
UNUM stock. This stock was assessed as having a fair market
value of $25.20 per share, making the total value of the UNUM
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stock distributed under the Plan equal to $522,471,336.
Union Mutual also distributed an additional $609,396 in cash
to compensate policyholders for the value of fractional
shares created by the conversion formula. In total, Union
Mutual distributed $652,209,814 to the Eligible Policyholders
during the demutualization.
Prior to the demutualization, on October 12, 1984,
Union Mutual's tax counsel had asked the IRS for a private
letter ruling on the tax treatment of the conversion.
Contrary to the position taken by UNUM now, Union Mutual then
sought to convince the IRS that the stock distributed to
policyholders in exchange for their membership interests in
Union Mutual would constitute tax free exchanges under 351
of the Code. UNUM also sought to persuade the IRS that the
exchange of the membership interests received by the holding
company for common stock of the new stock company would
constitute a tax free recapitalization under 368(a)(1)(E).
In support of these positions, Union Mutual made a
submission to the IRS on March 25, 1985 stating that "the
equity interest of Union Mutual's policyholders resemble the
rights of stockholders in a corporation and have substantial
value." The submission further stated that the Supreme
Court, in Helvering v. Southwest Consolidated Group, 315 U.S.
194 (1942), had characterized a recapitalization as a
"reshuffling of a capital structure within the framework of
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an existing corporation," Id. at 202, and argued that "[t]he
exchange of evidences of ownership interest in Union Mutual
argues for the exchange being treated as a recapitalization"
under the Supreme Court's characterization. Id. (emphasis in
original).
Union Mutual made another submission to the IRS on
November 8, 1985, discussing whether the exchange of the
membership interests for cash or stock would be treated as
nondeductible redemptions of stock under 302 or as
deductible "policyholder dividends" under 808 and 805,
although UNUM did not specifically ask for a letter ruling on
that subject at that time.
On December 16, 1986, the IRS issued its private
letter ruling to Union Mutual regarding the proper tax
treatment of the demutualization. See Priv. Ltr. Rul. 87-11-
121 (December 16, 1996). The letter ruling stated that the
exchange between the policyholders and UNUM of the
policyholders' membership interests in Union Mutual for UNUM
stock was a tax-free exchange under 351. See id. The
ruling also stated that the exchange between UNUM and UNUM
Life, the stock insurer that would succeed Union Mutual, of
the Union Mutual membership interests for UNUM Life voting
common stock was a tax free recapitalization under
368(a)(1)(E). See id. The ruling further stated that the
cash distributed to policyholders in exchange for their
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membership interests constituted value-for-value transfers
and were, accordingly, properly characterized as
nondeductible redemptions under 302, not deductible
"policyholder dividends" under 808 and 805. See id.6
The IRS viewed the stock-for-membership interest exchanges,
in contrast, as non-recognition exchanges subject to 351
(no gain or loss recognized to policyholders), 354 (no gain
or loss recognized to holding company on exchange of
membership interests to converted company for stock, and
1032 (no gain or loss recognized to either holding company or
converted company on receipt of property for stock).
On its 1986 consolidated federal income tax return,
UNUM did not claim a "policyholder dividend" deduction for
the cash and stock distributed to policyholders during the
demutualization. UNUM had entered into an agreement with the
IRS extending the time period within which the IRS could
audit the 1986 return, after which UNUM would be given an
6. The IRS has not always held this view regarding the tax
treatment of distributions from surplus made during a
demutualization. In 1983, the IRS issued a non-binding
technical advice memorandum addressing the demutualization of
a mutual casualty insurer through merger with a stock
insurer. Tech. Adv. Mem. 8409003 (Nov. 4, 1983). In this
memorandum, the IRS took the view now advanced by UNUM that
cash distributions paid out of surplus to policyholders
during the demutualization were policyholder dividends under
then 822(e)(2) and 822(c)(11). In 1989, the IRS withdrew
this memorandum without comment. Tech. Adv. Mem. 9010003
(Nov. 13, 1989). Because such memoranda are nonbinding, we
do not base our conclusions upon them. We nonetheless
recognize that the IRS has not consistently maintained the
positions it presently advances in this appeal.
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additional six months within which to decide whether to amend
the return to claim a refund. The IRS audit, which ended in
1991, concluded that UNUM had properly characterized the cash
distributions as nondeductible stock redemptions under 302
and the stock distributions as made pursuant to
nonrecognition exchanges of its stock for property. UNUM
thereafter changed its view of the proper tax treatment of
the transaction by timely amending its 1986 return to claim
the cash ($129,738,478), then the value of the stock
($522,471,336), as deductible policyholder dividends under
808 and 805. UNUM sought a refund in excess of $77
million. The IRS denied these claimed deductions.
In 1993, UNUM filed suit in the district court,
seeking deductions and a refund of the $77 million. The
district court ruled in favor of the government, holding that
the cash and stock distributions could not be construed as
"policyholder dividends" under 808. UNUM appeals.
II
II
UNUM makes a colorable but ultimately unpersuasive
argument that this appeal involves only the narrow task of
interpreting 808 and 805 of the Code. UNUM would have at
least a plausible argument that it was entitled to a
"policyholder dividend" deduction if those two sections were
the only potentially relevant Code sections to this case.
But we must construe the Code as a whole. The Supreme Court
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admonished in Helvering v. N.Y. Trust Co., 292 U.S. 455
(1934), that "the expounding of a statutory provision
strictly according to the letter without regard to other
parts of the Act and legislative history [may] often defeat
the object intended to be accomplished." Id. at 464.
Therefore, courts must
not look merely to a particular clause in
which general words may be used, but . .
. take in connection with it the whole
statute (or statutes on the same subject)
and the objects and policy of the law, as
indicated by its various provisions, and
give to it such a construction as will
carry into execution the will of the
Legislature, as thus ascertained,
according to its true intent and meaning.
Id. (citation and internal quotations omitted).
We conclude that 808 and 805 do not govern this
case. UNUM's demutualization constitutes a capital
transaction and is accordingly subject to the general
corporate tax rules under Subchapter C which govern such
transactions. These rules clearly bar any deduction for
amounts distributed during a capital transaction.
A. Structural Overview
Because this case involves the interplay between
two Subchapters of the Code, we describe them in general
terms. Subchapter C is a broadly applicable section of the
Code which contains many of the Code's general corporate tax
provisions. It applies to all corporations, including mutual
and stock insurance companies. See 7701(a)(3) ("When used
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in this title, . . . [t]he term 'corporation' includes . . .
insurance companies."); 7701(a)(8) ("the term 'shareholder'
includes a member in an . . . insurance company.").
Subchapter C governs corporate capital transactions
and the taxation of all corporate distributions and
adjustments, including the organization, operation,
liquidation, and reorganization of all corporate enterprises
and their distributions to shareholders and associates. See
301-85. Many general rules in Subchapter C as well as
additional rules in other sections of the Code contain
language that, by their literal terms, bar the deduction UNUM
seeks. Sections 162, 311, 354, and 1032 apply with
particular force. We explain these sections and discuss why
they apply later.
Subchapter L, in contrast, is a highly focused
section of the Code which specifically governs certain
aspects of the taxation of life insurance companies. See
801-818. Subchapter L enacts a special scheme of
determining the gross income, deductions, and taxable income
of life insurance companies, whether of the stock or mutual
variety. It accommodates the unique manner by which life
insurance companies raise and distribute capital. One
purpose behind this parallel system of income calculation is
to determine more accurately the taxable income of life
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insurance companies than general tax rules otherwise would
permit.
While Subchapter L applies specifically to life
insurance companies, the existence of Subchapter L does not
exempt insurance companies from the application of the rest
of the Code. Subchapter L at times specifically displaces
otherwise applicable rules. For example, life insurance
company taxable income is defined in 801 as "life insurance
gross income" reduced by "life insurance deductions".
801(b). "Life insurance gross income" is specifically
defined in 803, not the generally applicable definition of
gross income provided in 61. And "life insurance
deductions" are specifically governed by 804 and 805,
even though 804 and 805 incorporate many of the general
rules about deductions by reference. But Subchapter L does
not alter general tax rules governing subjects not within its
ambit. Specifically, Subchapter L does not exempt insurance
companies from the general corporate tax rules of Subchapter
C "[e]xcept to the extent that [Subchapter L makes] specific
provisions." S. Rep. No. 291, 86th Cong., 1st Sess. 39
(1959), reprinted in 1959-2 C.B. 770, 798.
The Supreme Court addressed the relationship
between Subchapter C and Subchapter L in Colonial American
Life Ins. Co. v. Commissioner, 491 U.S. 244 (1989). Colonial
American involved the question of whether "ceding
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commissions" paid by a reinsurance company to a direct
insurer under an indemnity reinsurance contract could be
deducted in the year in which they were paid, or whether they
had to be capitalized over the estimated life of the
underlying policies. See id. at 246-47. The taxpayer argued
that the ceding commissions were analogous to certain agents'
commissions deductible under 809 and should be similarly
deductible. See id. at 249-50. The IRS responded that the
ceding commissions were more properly characterized as a type
of capital expenditure and should, as is usual for such
expenditures, be amortized over their useful life under
263. See id. at 252-53. The Court ruled against the
taxpayer, holding that 809 did not expressly provide for
the requested deduction and that 263 should apply in the
absence of a specific provision to the contrary. See id. at
260. The taxpayer's argument, the Court stated,
at most proves only that Congress decided
to carve out an exception for agents'
commissions, notwithstanding their
arguable character as capital
expenditures. We would not take it upon
ourselves to extend that exception to
other capital expenditures,
notwithstanding firmly established tax
principles requiring capitalization,
where Congress has not provided for the
extension.
Id. at 252.
Under the rule of Colonial American, general
corporate tax provisions of Subchapter C apply to insurance
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companies unless Subchapter L makes a specific provision to
the contrary. The question that this case poses, therefore,
is whether the cash and stock distributions made by UNUM
during its conversion are made specifically deductible by
808 and 805 of Subchapter L, notwithstanding the fact
that they are clearly not deductible under 162, 311,
354, 1032 and other relevant provisions of the Code.
B. UNUM's burden of proof
It is a now "familiar rule" that an income tax
deduction "'is a matter of legislative grace and that the
burden of clearly showing the right to the claimed deduction
is on the taxpayer.'" INDOPCO, Inc. v. Commissioner, 503
U.S. 79, 84 (1992) (quoting Interstate Transit Lines v.
Commissioner, 319 U.S. 590, 593 (1943)). Deductions must
therefore be "strictly construed" and allowed "'only as there
is clear provision therefor.'" Id. (quoting New Colonial Ice
Co. v. Helvering, 292 U.S. 435, 440 (1934)). Subchapter L
has been subject to narrow construction because its
provisions "give life insurance companies tax benefits over
other taxpayers." National Life & Accident Ins. Co. v.
United States, 385 F.2d 832, 833 (6th Cir. 1967). Thus it is
UNUM's burden to demonstrate that the cash and stock
distributed during the demutualization constitute deductible
"policyholder dividends" under 808.
C. Analysis of UNUM's arguments
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UNUM's principal argument is that the cash and
stock distributions constitute "policyholder dividends" under
the plain meaning of 808, 808(b)(1) in particular, and
are therefore deductible under 805(a)(3). Bolstering this
position are two overlapping contentions: (1) the
legislative history and public policy underlying the Code's
scheme of life insurance taxation demonstrate that Congress
intended the term "policyholder dividend" to include the
distributions made during UNUM's demutualization; and (2)
because "policyholder dividends" are broader than classic
corporate dividends, "policyholder dividends" need not
possess the essential characteristics of a dividend -- i.e.,
they are not subject to the constraints which limit the
classic definition of dividends. We reject both arguments.
There is no dispute that 805(a)(3) allows life
insurance companies to deduct "policyholder dividends" from
income. Section 805(a)(3) expressly states: "there shall be
allowed the following deductions: . . . --The deduction for
policyholder dividends. . . ." 805(a)(3). The real
question, rather, is whether the definition of "policyholder
dividend" in 808 encompasses the cash and stock distributed
during UNUM's demutualization.
In this regard, UNUM's principal argument is that
the plain meaning of 808 entitles it to deduct the amounts
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distributed during the demutualization.7 We believe that, in
order to make this claim successfully, UNUM must demonstrate
that the distributions satisfy both 808(a) and 808(b).
Section 808(a) provides that:
[F]or purposes of this part, the term
"policyholder dividend" means any
dividend or similar distribution to
policyholders in their capacity as such.
808(a). Under 808(b)(1), upon which UNUM hinges the main
body of its argument, a "policyholder dividend" may include:
any amount paid or credited (including as
an increase in benefits) where the amount
is not fixed in the contract but depends
on the experience of the company or the
discretion of the management.
808(b).
UNUM asserts that the distributions easily satisfy
808(a), which, UNUM claims, merely emphasizes the broad
scope of "policyholder dividends." The source of UNUM's
authority for this claim is unclear. UNUM seems to rely
7. Section 808(a) and (b) provide in full:
(a) Policyholder dividend defined.--for purposes of this
part, the term "policyholder dividend" means any dividend or
similar distribution to policyholders in their capacity as
such.
(b) Certain amounts included.--For purposes of this
part, the term "policyholder dividend" includes--
(1) any amount paid or credited (including as an
increase in benefits) where the amount is not fixed
in the contract but depends on the experience of
the company or the discretion of the management.
(2) excess interest,
(3) premium adjustments, and
(4) experience-rated refunds.
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24
principally on Republic Nat'l Life Ins. Co. v. United States,
594 F.2d 530 (5th Cir. 1979), in which the court stated that
"policyholder dividends" have an "expansive definition" and
"include more than just classic dividends." Id. at 532.
UNUM seems also to rely on Treas. Reg. 1.811-2(a) (1997),
which tracks the language of 808(a), as further evidence of
the broad scope of the "policyholder dividend." Because
"policyholder dividends" are "expansive", UNUM argues, they
necessarily encompass the amounts distributed during the
demutualization. We are not persuaded by these arguments,
which attempt to sweep the language of 808(a) under the
table. Rather, we think that 808(a) presents a major
obstacle, which UNUM fails to overcome.
UNUM argues that the real test is whether the
distributions satisfy 808(b). UNUM focuses its attention
on the text of 808(b)(1), arguing: (1) Nothing in the
insurance contracts between UNUM and its policyholders
addressed the amounts due to the policyholders in a
demutualization; therefore the amounts were "not fixed in the
contract"; (2) The cash was distributed out of Union Mutual's
accumulated surplus, which represents the fruits of the
company's considerable business success since its founding;
therefore the amounts "depend[ed] on the experience of the
company"; (3) Union Mutual's management, though subject to
the supervision of the Maine Superintendent of Insurance and
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25
obligated to present "fair and equitable" terms to the
policyholder, decided the amounts within that range which
would be paid to policyholders in exchange for their equity
interests; therefore, the amounts were based "on the
discretion of management." The combination of these
circumstances, UNUM argues, satisfies the elements of
808(b)(1), and thus the distributions are "policyholder
dividends" deductible under 805(a)(3), regardless of the
general corporate tax provisions contained in Subchapter C.
While we recognize that UNUM's argument is
plausible, we nonetheless find it unpersuasive. As we
explain later, 808(b) describes categories of distributions
that may constitute policyholder dividends provided that the
definition of 808(a) is met. But UNUM has failed to
satisfy us that the term "policyholder dividend" under
808(a) includes value-for-value exchanges that occur during
a corporate reorganization such as this. UNUM's argument
ultimately suffers from a fundamental defect: it assumes that
Congress wished to ignore the context in which the cash and
stock distributions took place. We later explain why UNUM's
arguments that the distributions fit within 808(a) fail.
We first set the stage as to why Subchapter C applies.
D. Application of Subchapter C
In a paradigmatic recapitalization, the corporation
is not allowed a deduction for distributions made in the
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26
course of the transaction. See Woodward v. Commissioner, 397
U.S. 572, 579 n.8 (1970) ("[W]herever a capital asset is
transferred to a new owner in exchange for value either
agreed upon or determined by law to be a fair quid pro quo,
the payment itself is a capital expenditure . . ."); United
States v. Houston Pipeline Co., 37 F.3d 224, 226 (5th Cir.
1994) ("Stock redemptions, as a general rule, are
characterized as capital transactions, and the purchase price
of a stock redemption is not deductible.") (footnotes
omitted); Jim Walter Corp. v. United States, 498 F.2d 631
(5th Cir. 1974) (corporation's purchase of outstanding
warrants in connection with issuance of stock and bonds
treated as a capital transaction); Frederick Weisman Co. v.
Commissioner, 97 T.C. 563, 572 (1991) (collecting cases).
Here, Union Mutual purchased its policyholders'
equity interests and transferred them to UNUM. UNUM in turn
exchanged the policyholders' membership interests in Union
Mutual for stock in UNUM or cash. UNUM was financially in no
worse a position after "paying out" $522 million worth of
stock to implement the demutualization than it was before the
transaction occurred. What changed was the form of
ownership, precisely the topic which capital transactions
typically involve.8 As for the $130 million distributed in
8. UNUM acknowledged that its demutualization was a capital
transaction subject to general corporate tax law when it
submitted its May 22, 1985 request to the IRS for a private
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27
cash to redeem certain policyholders' interests, UNUM was
left poorer. But the Code disallows deductions for such
distributions made in redemption. See 311(a).
We find that, because UNUM's demutualization is a
capital transaction, it is subject to the general corporate
tax provisions of Subchapter C unless UNUM carries its burden
of showing an exception. These provisions clearly prohibit a
company from deducting cash or the value of stock distributed
to its policyholders in redemption of their equity interests
in the company.
Applying Subchapter C, the Code would clearly
disallow UNUM from taking a deduction on the cash distributed
during the demutualization. Section 311 provides that a
corporation that purchases shares of its stock from a
letter ruling regarding whether the conversion would be
entitled to tax-free treatment under 351 and
368(a)(1)(E). The IRS treated the demutualization as a
capital transaction in its response, see Priv. Ltr. Rul. 87-
11-121 (Dec. 16, 1986), in which it confirmed that the
transaction would be nontaxable under those sections and
further stated that the cash distributions would be treated
as nondeductible redemptions under 302 and the stock
distributions would be treated as non-recognition exchanges
under 1032. We do not view this as precluding UNUM from
changing its position, but that UNUM thought it necessary to
ask the IRS for a letter ruling on the general corporate tax
implications of its demutualization reflects UNUM's awareness
that its restructuring was subject to Subchapter C.
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shareholder ordinarily may not receive a deduction for that
purpose.9 Section 311(a) states:
no gain or loss shall be recognized to a
corporation on the distribution, with
respect to its stock, of its stock (or
rights to acquire its stock), or
property.
311(a). Congress reinforced the strength of this rule by
enacting 162(l) (now 162(k)) after the Fifth Circuit
recognized a narrow exception in Five Star Manufacturing Co.
v. Commissioner, 355 F.2d 724 (5th Cir. 1966) (deduction
allowed when expenditures made to save the corporation from
dire and threatening circumstances). Section 162(k)(1)
unreservedly prohibits corporations from taking deductions
for distributions made in the course of reacquiring its
stock:
Except as provided in paragraph 2, no
deduction otherwise allowable shall be
allowed under this chapter for any amount
paid or incurred by a corporation in
connection with the reacquisition of its
stock . . . .10
9. The Code treats the membership interests held by Union
Mutual's policyholders as "stock". See 7701(a)(7) ("the
term 'stock' includes shares in an . . . insurance company").
The Code also treated Union Mutual's policyholders as
stockholders in a corporation. See 7701(a)(8) ("the term
'shareholder' includes a member in an . . . insurance
company.").
10. Cf. I.R.C. 317(b), providing that "[f]or purposes of
this part, stock shall be treated as redeemed by a
corporation if the corporation acquires its stock from a
shareholder in exchange for property, whether or not the
stock so acquired is cancelled, retired, or held as treasury
stock."
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29
162(k)(1). The reference to "this chapter" is to Chapter
One of the Code (I.R.C. 1-1399), which includes both the
general corporate tax provisions in Subchapter C and the
insurance tax provisions in Subchapter L. While 162(k)(2)
does contain some exceptions to the general rule,11 none of
these apply to insurance companies. By its literal terms,
therefore, 162 forecloses any deduction for the cash
distributed by UNUM.12
11. Section 162(k)(2) provides that:
(2) Exceptions.--Paragraph (1) shall not apply to--
(A) Certain deductions.--Any--
(i) deduction allowable under section 162
(relating to interest)
(ii) deduction for amounts which are
properly allocable to indebtedness and
amortized over the term of such
indebtedness, or
(iii) deduction for dividends paid
(within the meaning of section 561)
(B) Stock of certain regulated investment
companies.--Any amount paid or incurred in
connection with the redemption of any stock in
a regulated investment company which issues
only stock which is redeemable upon the demand
of the shareholder.
The "dividends paid" deduction under 561 does not
include policyholder dividends, but only includes dividends
as described in 316 "relating to [the] definition of
dividends for purposes of corporate distributions". 562(a).
12. The legislative history of 162 supports the conclusion
that 162(k) forecloses a deduction for UNUM in this case.
The Committee Report suggests that Congress intended 162(l)
(now 162(k)) to be construed broadly to foreclose any
deduction for payments in connection with redemptions, except
for those specifically enumerated in the statute.
The conferees intend that the denial of
deductibility will apply to amounts paid
in connection with a purchase of stock in
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The Code is equally clear that UNUM may not deduct
the value of the stock distributed in exchange for equity
interests. Section 354(a) provides
No gain or loss shall be recognized if
stock or securities in a corporation a
party to a reorganization are, in
pursuance of the plan or reorganization,
exchanged solely for stock or securities
in such corporation or in another
corporation a party to the
reorganization.
354(a). Section 354 thus bars any deduction for the
exchange of UNUM stock for the membership interests of Union
Mutual pursuant to the conversion plan. And 1032(a)
provides
No gain or loss shall be recognized to a
corporation on the receipt of money or
property in exchange for stock (including
treasury stock) of such corporation.
a corporation, whether paid by the
corporation directly or indirectly, e.g.,
by a controlling shareholder, commonly
controlled subsidiary or related party.
The conferees wish to clarify that,
while the phrase "in connection with [a]
redemption" is intended to be construed
broadly, the provision is not intended to
deny a deduction for otherwise deductible
amounts paid in a transaction that has no
nexus with the redemption other than
being proximate in time or arising out of
the same general circumstances.
H.R. Conf. Rep. No. 99-841, 99th Cong., 2d Sess at II-168,
reprinted in 1986 U.S.C.C.A.N. 4075, 4256. In this case,
there is a clearly established nexus in that the payment
"does . . . represent consideration for the [membership
interests] or expense related to [their[ acquisition . . . ."
Id. at 4257.
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31
1032(a). As is the case with 162(k) and 311, these
Code sections do not contain provisions excluding insurance
companies from their scope.
E. Section 808
We find nothing in 808 that specifically
overrides these general rules. Indeed, that 808 does not
even mention these rules suggests that it may have nothing to
do with capital transactions altogether. Congress has been
explicit in those situations when it wished Subchapter L to
modify Subchapter C. See 805(b) (modifying the interest
deduction under 163, the charitable contributions deduction
under 170, the rules for amortizable bond premium under
171, the net operating loss deduction under 172, and the
dividends received deductions under 243-245). Congress
could have done the same with the Code sections that directly
govern UNUM's demutualization. That Congress did not choose
to do so strongly suggest that Congress wanted those sections
to apply with full force.
Our view that Congress did not intend the
demutualization process to be exempted from these general tax
rules is strengthened when we examine 808(a). UNUM
essentially makes a two-step argument regarding 808(a):
(1) any distribution which fits the strict language of
808(b) is a "policyholder dividend" for purposes of 808,
regardless of the language of 808(a); and (2) because the
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transaction here is a "policyholder dividend" under 808,
UNUM is entitled to a deduction under 805(a)(3). We reject
the first prong, so the second collapses accordingly.
UNUM argues that the term "policyholder dividend"
under 808 is not bound by the constraints that usually
characterize dividends, but includes any distribution that
can fit within the language of 808(b)(1): "any amount paid
or credited . . . where the amount is not fixed in the
contract but depends on the experience of the company or the
discretion of the management." We reject this reading of
808.
Basic canons of statutory construction require us
to consider the language of 808(a) in construing 808(b).
See United States Nat'l Bank of Or. v. Indep. Ins. Agents of
America, Inc., 508 U.S. 439, 455 (1993) (Courts must "at a
minimum . . . account for a statute's full text, language as
well as punctuation, structure, and subject matter.").
Section 808(a) states:
For purposes of this part, the term
"policyholder dividend" means any
dividend or similar distribution to
policyholders in their capacity as such.
808(a). This text may be divided into three components.
The "[f]or the purposes of this part" language requires that
the definition of "policyholder dividend" has no force beyond
Part I of Subchapter L, which specifically involves the
taxation of life insurance companies; thus 808 cannot
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govern a transaction basically within the purview of
Subchapter C. The "any dividend or similar distribution"
language requires all "policyholder dividends" to possess the
essential characteristics of a dividend. Finally, the "to
policyholders in their capacity as such" requires that the
dividend-like distributions be based on the contractual
relationship between the policyholder and insurer. We
interpret the language of 808(a) to mean exactly what it
says. Any distribution by an insurer to its policyholders
must accordingly bear the essential characteristics of a
dividend and be based on the contractual relationship between
the policyholder and insurer in order to qualify as a
"policyholder dividend". And if 808(a) is not satisfied,
then 808(b) cannot be satisfied either.
UNUM attempts to circumvent the plain meaning of
808(a) by arguing that the language of 316 specifically
exempts "policyholder dividends" from the constraints that
bind typical corporate dividends. Section 316(a) defines the
term "dividend" as follows.
For the purposes of this subtitle, the
term "dividend" means any distribution of
property made by a corporation to its
shareholders . . . out of its earnings
and profits of the taxable year . . . .
316(a). By its terms, this definition of dividends applies
to Subtitle A, 28 U.S.C. 1-1563, which includes the
portion of the Code governing income taxation. Section
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34
316(b) limits the extent of the application of this
definition: The definition in subsection
(a) shall not apply to the term
'dividend' as used in
Subchapter L in any case where
the reference is to dividends
of insurance companies paid to
policyholders as such.
316(b). UNUM argues that the language of 316(b)
demonstrates that "policyholder dividends" have broader scope
than "dividends" as defined in 316(a), so it would be
erroneous to conclude that policyholder dividends should be
deemed a type of dividend as that term is so defined. It is
true that 316(b) means that a policyholder dividend under
808 is not limited to distributions out of the insurer's
earnings and profits and may include additional amounts from
other sources. But, UNUM's assertion notwithstanding, it
does not follow that because "policyholder dividends" may
include more than classic corporate dividends then
"policyholder dividends" may therefore encompass any
distribution to policyholders regardless of its context or
purpose.13 As Judge Carter appropriately noted,
13. UNUM cites dicta in Republic Nat'l Life Ins. Co. v.
United States, 594 F.2d 530, 532 (5th Cir. 1979), describing
the "policyholder dividend" as "expansive." Because
policyholder dividends are "expansive," UNUM argues,
policyholder dividends can encompass even value-for-value
exchanges that occur during a corporate recapitalization.
This argument misapprehends the meaning of Republic Nat'l
Life. In that case, the court was referring to the fact that
the definition of "policyholder dividend" is expansive
relative to the "classic dividend" definition, adding that
"Congress intended to include more than just classic
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The fact that "policyholder dividend" is,
in certain respects, broader in scope
than "classic dividend" neither implies,
nor even suggests, that Congress intended
"policyholder dividend" to be construed
broadly.
UNUM Corp. v. United States, 929 F. Supp. 15, 20 n.6 (D.
Maine 1996). Indeed, the term "policyholder dividend" is
still a defined category. That it possesses a broader scope
than the term "dividend" as defined in 316(a) suggests only
that policyholder dividends are different from ordinary
corporate dividends, not that they are fundamentally unlike
them.
F. The distributions are not dividends
This analysis suggests that the lengthy debate as
to whether and how policyholder dividends are like or unlike
corporate dividends is largely beside the point. All
dividends, whether policyholder dividends or corporate
dividends, share certain essential characteristics. The
focus should be on whether the stock and cash distributions
bear the essential characteristics which qualify them as a
dividend of any stripe. We find that the cash and stock
distributions at issue in this case simply are not
"policyholder dividends" as that term is defined, because
they are fundamentally not dividends or distributions similar
to dividends as 808(a) requires. Because they do not meet
dividends" within policyholder dividends. Id.
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36
the definition of 808(a), 808(b) is superfluous.
Moreover, because the distributions do not meet the
definition of 808(a), they are still subject to the general
corporate tax rules of Subchapter C, under which they may not
be deducted.14
The economics of the demutualization compel this
conclusion. A dividend, even a policyholder dividend, is a
unilateral distribution by a company to its owners (who, in
the case of mutual life insurance companies, also happen to
be customers). No matter how large, a dividend still leaves
intact the owner's equity interest in the company. But the
cash and stock distributions for which UNUM seeks a deduction
were not unilateral distributions by a company to its owners.
Both were made in exchange for policyholders' membership
interests in the former mutual company. Those who received
cash had their equity interests extinguished, transactions
amounting to classic redemptions. Those who received stock
had their equity converted from one form to another,
transactions which were classic non-recognition exchanges.
14. While the holding in this case would be the same whether
or not there was a PFA, the existence of the PFA is added
evidence that the economic reality of this transaction is
that the conversion of mutual membership interests to stock
is not a policyholder dividend. The PFA, a crucial element
in the decision of the Maine Insurance Commissioner to
approve this transaction, is an accounting mechanism which
recognizes (in the common sense of the word) that
policyholder dividend expectations may be segregated from
other ownership interests and the two are not equivalent.
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37
No authority exists supporting the proposition that the term
"dividend" encompasses such transactions.
UNUM nevertheless argues that the distributions
should still be characterized as "policyholder dividends"
because, removed from context, they can plausibly be
shoehorned into the text of 808(b)(1). Judge Carter deftly
explained the fallacy of UNUM's argument as follows:
The fact that Congress intended life
insurers to be able to deduct any
dividend-like distribution to
policyholders to the extent of its
capital-like component neither implies,
nor even gives rise to the inference,
that Congress also intended life insurers
to be able to deduct any distribution at
all to policyholder that contains a
capital-like component to the extent of
that component.
UNUM Corp. v. United States, 929 F. Supp. at 24 n.15.
UNUM's argument clouds the reason why 316
distinguishes policyholder from regular corporate dividends.
Policyholder dividends typically include a capital component
in addition to earnings and Congress wished to provide a
deduction for that component. See 805(a)(3); 809
(limiting the extent of the deduction). But the fact that
"policyholder dividends" may include additional components
does not change the fact that they must still essentially
constitute dividends as 808(a) expressly requires. The
acknowledgement reflected in 316(b) that policyholder
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dividends are more expansive than classic dividends does not
alter this conclusion.
As the district court observed, UNUM's
bootstrapping argument ignores other sources of authority on
what constitutes a "dividend." In Hellmich v. Hellman, 276
U.S. 233 (1928), the Supreme Court described a dividend as
the recurrent return upon stock paid to
stock holders by a going corporation in
the ordinary course of business, which
does not reduce their stock holdings and
leaves them in a position to enjoy future
returns upon the same stock.
Id. at 237. Similarly, the Supreme Court in United States v.
Davis, 397 U.S. 301 (1970), described a "dividend" as a
distribution whose
effect is to transfer the property from
the company to its shareholder without a
change in the relative interest or rights
of the stockholders.
Id. at 313 (emphasis added). A distribution is "not
essentially equivalent to a dividend" if it "result[s] in a
meaningful reduction of the shareholder's proportional
interest in the corporation." Id. In light of this
authority, we do not view distributions of stock or cash by a
mutual insurer in consideration for the same value of
ownership interest in a mutual company to be a dividend under
any definition of the term, including a "policyholder
dividend" under 808.
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39
The cash distribution is not a dividend or similar
to a dividend precisely because it did reduce (to zero) the
ownership interest of those policyholders who received cash
and left them in no position to enjoy future returns, except
as policyholders. Cf. Hellmich, 276 U.S. at 237. It was
thus akin to a nondeductible distribution in redemption. In
contrast, the stock distribution was not a dividend or
similar to a dividend because it was not in the nature of a
"recurrent return upon stock paid to stockholders by a going
corporation in the ordinary course of business." Id.
Rather, it effected a conversion of one form of equity to
another through a classic non-recognition exchange.
G. Other reasons
The fact that UNUM's demutualization occurred
through a holding company suggests additional reasons why
UNUM is also not, for other reasons, entitled to a
"policyholder dividend" deduction. First, UNUM, which
distributed its stock to policyholders in exchange for their
membership interests in Union Mutual, is not a "life
insurance company" as defined in 816(a); the tax
consequences of the stock distributions are accordingly
subject to general corporation tax provisions in Subchapter
C, which disallow the deduction. See 354(a); 1032(a).
Second, the term "amount paid" in 808(b)(1) requires
distributions out of the company's surplus, whereas the stock
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40
distribution came from the holding company. Union Mutual did
not actually "pay" anything in making that exchange. It is
true that UNUM is the sole owner of a life insurance company,
but having structured the demutualization as it did, UNUM
must "accept the consequences of [its] choice." See
Commissioner v. National Alfalfa Dehydrating & Milling Co.,
417 U.S. 134, 149 (1974).15
Even so, our decision does not rely on the fact
that UNUM structured its demutualization through a holding
company. Sections 354(a) and 1032(a) would apply to the
demutualization regardless of its form, even if Union Mutual
distributed stock in the new stock company in direct exchange
for the membership interests of its policyholders.
UNUM's best argument may be the analogy it draws
between a mutual insurance company liquidation and
demutualization. When a mutual insurance company is
liquidated, its assets are distributed to the policyholders
and those distributions may be called dividends. This
reorganization, the company says, is functionally equivalent
15. The one aspect of the demutualization involving the
stock of a life insurance company was the transaction between
the new stock life insurer, UNUM Life, and the holding
company, UNUM, in which the stock company exchanged 100% of
its shares for 100% of the membership interest in Union
Mutual. A transaction between two corporations can not come
within the rubric of 808, which involves distributions to
"policyholders in their capacity as such." Instead, it
constitutes a recapitalization under 368(a)(1)(E), as the
IRS confirmed, in response to UNUM's request, in Priv. Ltr.
Rul. 87-11-121.
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41
to such a liquidation because Union Mutual no longer exists
on completion of the demutualization. There are two
responses. The first is that the analogy does not work. The
very nature of a demutualization fundamentally distinguishes
it from a liquidation in that the insurer is still in
business after the conversion is complete. In the present
case, the policyholders continue to be provided insurance,
albeit through a different form of company and under a
different name. Indeed, ensuring that Union Mutual would
continue to meet its policyholders' reasonable expectations
on the investment value of their policies was the very
purpose of the PFA, which calculated the amount of assets
necessary to pay policy claims, provide policyholder
dividends, and satisfy whatever other benefits accrued to
policyholders under their insurance contracts. Notably, the
Maine Insurance Commissioner gave his blessing to the
transaction only on being assured there was sufficient
capital preserved, together with premiums, to cover the
insured risks in the future. This does not happen in the
usual liquidation and, indeed, demonstrates that UNUM's
demutualization cannot properly be so characterized.
Secondly, even if the analogy were apt in general,
we have little reason to think Congress intended that final
distributions of all assets to be within the definition of
"policyholder dividends" under 808(a). Congress could
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42
easily have provided for this deduction by enacting specific
language to that effect. Had Congress wanted to provide
insurance companies with a "policyholder dividend" deduction
for any distribution to policyholders not fixed in the
contract, it could simply have defined "policyholder
dividend" as referring to "any distribution." It would not
have limited the definition to "dividends or similar
distributions" and then left it to the insurance industry to
discover massive deductions in the shadows of the statute.
Although we think the plain meaning of 808 works
against, and not for, UNUM, and mindful of the usual rule
that resort to legislative history is inappropriate in such
circumstances, we do briefly explain UNUM's policy and
legislative history argument. Our primary purpose in so
doing is to determine whether there is a clearly expressed
legislative intention which would cause us to question
application of the usual rule. INS v. Cardoza-Fonseca, 480
U.S. 421, 432 n.12 (1987). A secondary reason is to note
that UNUM's policy arguments are not implausible; they simply
do not carry UNUM's burden of showing clearly that Congress
intended such a deduction.
In support of its statutory argument, UNUM offers
an extended account of the legislative history and public
policy behind the Code's scheme of life insurance company
taxation. UNUM argues that Congress specifically created the
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43
"policyholder dividend" deduction to equalize the tax
treatment of mutual insurers relative to stock insurers.
Under general tax rules, stock companies are not taxed on
capital raised by selling stock, but may not deduct amounts
paid to redeem that stock. (No tax, no deduction) At the
same time, mutual insurers must pay income tax on capital
raised by charging redundant premiums; but, absent the
policyholder dividend deduction, they may not deduct amounts
paid to return capital to policyholders, which typically
occur through policyholder dividends. (Tax, but no
corresponding deduction) By creating the policyholder
dividend deduction in 805(a)(3), UNUM explains, Congress
intended to create symmetry in the taxation of mutual
insurers and thus provide equal tax treatment for both mutual
and stock insurers.
UNUM emphasizes the expansiveness of "policyholder
dividends" by contrasting them with a "return premium".
Return premiums are refunds that occur when a policy is
cancelled, where the amount of the refund generally
represents that portion of paid premiums not applied to the
purchase of coverage up to the time of cancellation. Robert
A. Keeton & Alan I. Widiss, Insurance Law: A Guide to
Fundamental Principles, Legal Doctrines, & Commercial
Practices 5.11(d)(2) (1988). UNUM explains that these
amounts are "fixed in the contract" in that they are based on
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the terms of the contract. "Policyholder dividends" are, in
contrast, any amounts not fixed in the contract, i.e., any
distributions from surplus (that depend on the experience of
the company or the discretion of management) that are not
return premiums.
Under Subchapter L, UNUM explains, Congress divided
amounts returned to policyholders into the categories of
"return premiums" and "policyholder dividend". Return
premiums are deductible, because they contain a return of
premiums. Policyholder dividends are also deductible,
because, like return premiums, they are in part returns of
capital. Policyholder dividends are only deductible in part,
however, because they can also contain earnings from the
investment of the premiums which are nondeductible under
general tax law.
To account for this, UNUM argues, Congress created
an expansive definition of "policyholder dividend" in 808
and enacted 809 to control the extent of the deduction,
since the expansive language does not admit limitation. UNUM
claims that 809 is the sole mechanism by which policyholder
dividends should be limited, not through judicial
construction of the scope of the definition of "policyholder
dividend" under 808. Policyholder dividends should be, in
effect, any distribution that a mutual insurer makes to
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policyholders out of surplus for any reason, and only the
terms of 809 limit the reach of the deduction.
UNUM argues that the facts that Congress created
the policyholder dividend deduction to achieve a tax symmetry
and that Congress accordingly defined "policyholder dividend"
to possess broad scope necessarily compels the conclusion
that "policyholder dividends" must even include distributions
to policyholders that are fundamentally not dividends. We
believe this conclusion is unsupported by the text or
policies underlying the statute. UNUM's analysis of the
legislative history and public policy underlying the
insurance tax provisions of the Code suffers from the same
flaw that undermines its statutory argument. Nothing UNUM
cites supports the proposition that Congress intended the
term "policyholder dividends" to encompass value-for-value
exchanges occurring during a corporate reorganization.
UNUM's argument fails not because its relies on erroneous
facts, but rather because those facts simply do not support
the conclusions UNUM wishes to draw.
In the end, the mere fact that "policyholder
dividends" are not "fixed" by the terms of an insurance
contract does not mean that they include any distribution
that a mutual insurer makes to its policyholders in any
capacity. Under 808(a), in order for a distribution to
qualify as a "policyholder dividend", the distribution must
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occur to policyholders "in their capacity as such" -- i.e.,
in their capacity as policyholders, not owners. The
distribution must also fundamentally be a "dividend or
similar distribution." For the reasons explained in the
balance of the opinion, we believe that the cash and stock
distributions made by UNUM were not dividends. Rather, the
cash distribution constituted a nondeductible distribution in
redemption, while the stock distribution was part of a non-
recognition exchange.
III
III
In Colonial American, the Supreme Court faced a
case similar to this one. As here, the taxpayer made a
colorable argument that Subsection L provided for tax
treatment that general tax law otherwise prohibited.
Similarly, the IRS responded that the basic policies and
structure of the Code defeated the taxpayer's argument. The
Supreme Court, explaining its decision in favor of the IRS,
stated:
It cannot be denied that the language on
which petitioner relies, taken in
isolation, could be read to authorize the
tax treatment it seeks. . . . But when
the statutory and regulatory language is
parsed more carefully, petitioner's
position becomes dubious, and when the
language is read against the background
of the statutory structure, it becomes
untenable.
Colonial American, 491 U.S. at 257. We believe the same to
be true in this case. To accept UNUM's arguments "we would
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have to conclude that Congress subsumed a major deduction
within the fine details of its definition" of the
policyholder dividend. Id. at 260. We do not believe that
Congress intended to conceal in 808 a deduction of this
magnitude.
INDOPCO requires a taxpayer to carry the burden of
proof that it is entitled to a claimed deduction. Despite
UNUM's arguments, we do not believe that 808 and 805 apply
to value-for-value exchanges as occurred in this insurance
company demutualization.
We affirm the judgment of the district court.
Costs to appellees.
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Unum, Corporation v. United States
Court: Court of Appeals for the First Circuit
Date filed: 1997-12-01
Citations: 130 F.3d 501
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