COMMISSIONER v. FIRST SECURITY BANK OF UTAH
Legal provision: Internal Revenue Code
Argument of Ernest J. Brown
Chief Justice Warren E. Burger: Number 305, Commissioner of Internal Revenue against First Security Bank.
Mr. Brown you may proceed whenever you are ready.
Mr. Ernest J. Brown: Mr. Chief Justice and may it please the Court.
This case, on certiorari to the Tenth Circuit.
brings to the Court for the first time since it was enacted as part of the Revenue Act of 1928, what is now Section 482 of the Internal Revenue Code.
That provision is as follows.
In any case of two or more organizations, trades or businesses owned or controlled directly or indirectly by the same entities, the Secretary Office delegates, the Commissioner as I phrase it, to distribute a portion or allocate gross income, deductions, credits or allowances between or among such organizations, trades or businesses if he determines that such distribution, apportionment or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organizations, trades or businesses.
This provision of course expresses the judgment that autonomous business units will exercise self interest and bargaining power which will cause income and outlays to reflect the performance or function and the acquisition of benefits in accordance with the values of the market.
But on the other hand, when we have units under common control, a host of factors which may or may not include tax considerations, may distort this picture and cause considerable divergence between income, expenditures on the one hand and performance or function or the acquisition of benefits on the other.
So that the regulations have always provided since -- as they provide now since 1934 that the authority given account is not solely or even necessarily primarily to cases of improper accounting or fraudulent, colorable or sham transactions or a device designed to evade or avoid taxes, but the authority extends to any case in which by inadvertence or design, taxable income, in whole or in part of the controlled tax payer is other than it would have been had the taxpayer in the conduct vist to ask, been an uncontrolled taxpayer, dealing at arm's length with another uncontrolled taxpayer.
To bring performance or function and taxable income into life to create what some Courts have referred as economic reality, the Commissioner may and often has found it necessary to analyze pricing, charges, of their services, distribution of receipts or the bearing of burdens of expenditures.
In this case, the Commissioner found it necessary to allocate to the taxpayer banks a substantial part, some 40% of the premium income received by a -- like insurance company under common control for the years 1954 through 1959.
His allocation was upheld by the Tax Court, relying on its previous review decision in Local Finance Corporation, a decision which thereafter had been affirmed by the Seventh Circuit Court of Appeals.
In the Local Finance Corporation decision, the Tax Court had reviewed extensive and reference was made in this case in the Tax Court to those findings, had reviewed extensively the nature and customs of the business of credit insurance which is much involved here.
The Tenth Circuit Court of Appeals, however, reversed the Tax Court, disagreeing with the Seventh Circuit in Local Finance.
Because of this conflict and because the significance of Section 482 increases as business aggregates grow not only larger, but more varied in their nature, we have more and more cases where a business aggregate includes corporations that are subject to methods of taxation other than the normal, barring the corporations, Western Hemisphere Trade Corporations and life insurance companies as in this case.
For those reasons, the Government sought certiorari which this Court granted.
The facts giving rise to the controversy are as follows.
The taxpayers are two national banks; First Security Bank of Utah and First Security Bank of Idaho.
They are holding on subsidiaries of First Security Corporation, a publicly owned Holding company, which owns a number of other corporations as well, including First Security Company or Management Company which I would refer as Management Company to avoid confusion, Smith and Sons, an insurance agency and beginning in 1954, First Security Life, an insurance company incorporated in that year which is a -- that one is prime activist in this case.
We should go back to 1948 at the opposite.
Beginning then and since that time, the banks have offered to their borrowers, Credit Life Insurance.
This is diminishing term, Life insurance under which in case of the death of the borrower, his death will be paid to the creditor.
The Premium charged throughout en banc all here are concerned was $1.00, per hundred per year.
This has been the usual and standard right in the industry.
This premium, though apparently it sounds small, permits generous commissions to be paid to the person who sells the insurance.
It has been customary in the industry to pay commissions in the neighborhood of 50% of the premiums.
Justice Potter Stewart: Is that on each year's premium?
Mr. Ernest J. Brown: Yes, Your Honor.
They are often paid in advance.
This is usually measured by the time of the death.
If the death is said to be repaid in three years, then a single premium will be collected at the outset to cover the three-year death.
So that the --
Justice Potter Stewart: And the commission approximates 50% of all the premiums over the period?
Mr. Ernest J. Brown: 50% of the premium, yes.
It is possible and in many cases it happens that a Credit Life Insurance Company will issue a policy directly to the borrower and he will be the policy holder in holding.
However, in these cases or in this case as demonstrated by the exhibits in the record, the banks followed another procedure.
They took out group life insurance policies, beginning 1948 or each bank took out a group life insurance policy, covering the lives of their borrowers who qualify.
In 1948, this was with the Credit Life Insurance Company of Ohio.
In 1953, this was changed to another group policy with the American Banker's Life Insurance Company of Florida.
So that the procedure that was followed was when a borrower came to the bank, his loan was approved.
The loan officer, we are told made available, informed him or offered, the record of course does not repeat the conversations, but hard selling and the soft selling and then this interest in selling, both sides were interested and we do not suggest that it makes a difference whether this was pressed or not.
In any event, Credit Life Insurance was offered or made available to the borrower, as necessary, it was explained to him, ultimately it is desired.
If he was interested, he was given by the bank an application form to fill out.
There are copies in the record, they are relatively simple.
The qualifications are, minute, you have to be under 65 and yes, some other minor matters, but this is a sample form, the borrower interested filled it out.
It was then examined by a bank employee and if satisfactory, the premium was collected or added to the amount of his loan.
The bank employee then made out and delivered to the borrower a certificate of insurance and there are copies of those in the record.
Well, they are numbered exhibits and I assume that they can be accepted.
It is another very simple document.
It is important I think that at this time the insurance was effective.
If the borrower had been killed in traffic on the way home from the bank, he was insured.
His loan would be paid off.
The insurance companies which issued these group policies to the banks received the commissions, well, I should go back a step.
When the bank had issued this certificate to the borrower, it turned over the premium and the papers involved to the Management Company which made appropriate records and then forwarded the premium and the appropriate records to the insurance company.
The insurance company, both Credit Life of Ohio and American Bankers of Florida remitted generous commissions varying from -- between 1948 and 1954, from 40 to 55 % of the premiums involved.
These were paid to Smith and Sons, the insurance agent subsidiary though it had nothing to do at all with either selling or perfecting the insurance that had been done by the bank and their employees.
Oddly enough and for reasons which an Executive Vice President of Treasury of the Management Company testified, he could not recall.
These commissions were not included in the taxable income of the insurance agency or of the bank, but of the Management Company and the testimony as I say just a blank, the Vice President of the Treasury said I just cannot remember why it was done that way.
In any event this was the procedure that went on from 1948, until 1954.
Late in 1953 the American National Insurance Company of Texas approached the holding company with a new plan, a slight variant on the O.
It had noticed --
Justice Harry A. Blackmun: Mr. Brown, could I just ask one detail.
Mr. Ernest J. Brown: Certainly Your Honor.
Justice Harry A. Blackmun: What was the difference in tax rate by the inclusion of those premiums in the Management Company's returns as distinguished from the insurance company?
Was this not to be advantage of those --
Mr. Ernest J. Brown: Well, there was no insurance company at that time Your Honor.
The insurance company is formed and comes into being in 1954.
Justice Harry A. Blackmun: But in any event it was reported by the Management Company at then corporate rates, I take it.
Did the Government lose by this?
Mr. Ernest J. Brown: Your Honor, these were all the same rates.
As you know there is very little graduation in corporate rates.
The banks, the Management Company and the insurance agency, none as a loss corporation in that way so that -- I suppose except for a purist, it made no great difference.
There was no revenue difference necessary that might have been.
I cannot say because I have not the returns before me that for all those six years the -- all of the corporations possibly involved were in the roughly 50% bracket rather than in the roughly 22% bracket.
But we will accept these were prosperous corporations and I think it is highly probable that it may be.
If the management --
Unknown Speaker: (Voice Overlap)
Mr. Ernest J. Brown: If the Management Company was in a lower bracket to we are making no point of it as you suggest.
These as opposed to an insurance company or corporations which are taxed all in the same manner, regular purposes.
Justice Byron R. White: But you will tell us plainly why the Government in his own (Inaudible)?
Mr. Ernest J. Brown: Yes, well, I can tell you that.
Now the Management Company had no function at all.
It just copied and made copies and forwarded to the --
Justice Byron R. White: (Inaudible)
Mr. Ernest J. Brown: No.
That is not correct, Justice White.
The employees of the bank were the ones who filled out.
The -- who supervised --
Justice Byron R. White: Then they send it to the management Company?
Mr. Ernest J. Brown: For transmission, for making their own records and transmitting to the insurance company.
Justice Byron R. White: I know, but is not the Management Company handled the bookkeeping (Inaudible)
Mr. Ernest J. Brown: It made records, Your Honor.
It was an accounting company but all of the contact with the costumers, the filling out of applications, delivery of the certificate was by bank employees with the company.
Now, there is no alternative allocation to the Management Company.
That is not before the Court of course in this case and in case that should be remanded.
I would be embarrassed if I stood and then cut the ground from under the Commissioner, but to the best of my knowledge I have not considered the Management Company and it seems to have been largely a transmittal tower, keeping its zone.
They didn't have Xerox machines, but if they ran these through the Xerox machine and sent them on, where I suppose the function would then perform.
In any event, in 1953, the American National Company came in with a new plan.
It proposed that it'd be the prime underwriter on the Credit Life Insurance.
However, that the holding company form a subsidiary and that that subsidiary re-insure all these risks, American National had noted that financial institutions were forming their own subsidiary or affiliate insurance companies and the record indicates it were not the key part of business, it could.
So, it suggested that for 8 (b), it would supply accounting services, some record keeping, the insurance company record keeping, actuarial services.
The staff like of an insurance company, but this would be for 8 (b), and then it would re-insure all this risks with this subsidiary to be formed so that the risk was then shifted.
Chief Justice Warren E. Burger: And who is doing all this paperwork?
Mr. Ernest J. Brown: Well, I suppose the lawyers did the drafting of the documents, Your Honor but --
Chief Justice Warren E. Burger: Well, but the reinsurance, the blanket reinsurance policy does not take care of all the paperwork, does it?
Mr. Ernest J. Brown: No, no, no.
The -- well, we are told by the record that this was in fact done by most of the -- by American National.
The findings are that other than the payment of loses, that bank charges and taxes that the newly formed reinsurance company had little in the way of expenses.
Indeed the findings of the Tax Court which set out the expenses had showed a very minute figure there.
So it was, I think I do not exaggerate if I say it was largely passive.
It had investment problems of course, but it had substantial funds.
Justice William O. Douglas: Is the controller taken any position on this, is that it?
Mr. Ernest J. Brown: The Comptroller has come, we are coming Justice Douglas to the question of the authority of banks to participate.
The Comptroller has taken the position that a bank may as an incident to its lending function, handle insurance and the Court of Appeals for the Fifth Circuit in the Saxon case which is cited in both briefs held that this was improper and invalidated the ruling of the Comptroller and enjoined the banks from participating in the selling of insurance.
Justice Byron R. White: Well, the statute forbids (Inaudible) being in an insurance business?
Mr. Ernest J. Brown: No Your Honor, this is very peculiar.
The statute; we have no statute at all that does anything.
There is this 1916 statute which says that national banks in a small town may be insurance agents.
Now the Comptroller says, well that is general business.
He does not care that the banks can be on the general, but that they can assist their lending functions.
The taxpayers and perhaps properly, I do not think we have to ask the Court for a decision on that banking question, the taxpayers read that statute or part of that statute because this is one of the curious aspects as though it said banks in small towns and only banks in small towns, they do the following things.
They have been stressed the thing, the Section that says, banks may receive commissions.
They do not mention the fact that the statute also says that banks may collect premiums and sell insurance in that generally.
The banks in this case fairly effectuated the insurance.
However, this was put into operation.
Security life was formed with a capital of 25,000, paid in surplus of 12,500; 37,500 in net worth.
At the end of the year, it was re-insuring risks of over 6 million.
At the end of 1959, it was re-insuring risks of over 41 million.
Chief Justice Warren E. Burger: I think we will pick up after lunch with that.
Mr. Brown you may continue.
You have nine minutes of total remaining time.
Mr. Ernest J. Brown: Your Honors as I was pointing out, beginning in 1954 the banks remitted premiums to American National.
It kept some 13.5 % of those premiums for its fees.
The remaining 86.5 were remitted to Security Life.
This business was very profitable for Security Life with a net worth of $37,500.00 at the outset in 1954.
By the end of 1959 it had a net worth of $850,000.00 and it paid a $389,000.00 dividend so in five years with a capitalization on original net worth of $37,500.00, it had profits after reserves and after expenses of a $1,200,000.00.
The Commissioner allocated 40% of the premiums then to the banks on the theory that the banks had performed the services which resulted in the insurance.
They had effectuated the insurance and that the market demonstrated that commissions of a minimum 40% were allocable.
On these facts it would be very difficult even to, I think to raise a substantial question, but the facts -- (Voice Overlap)
Chief Justice Warren E. Burger: Could they have -- could the bank have lawfully have charged and received and kept a 40% commission at that time?
Mr. Ernest J. Brown: Well, that is the next question Mr. Chief Justice.
The taxpayers make the point that and they have repeated frequently in their briefs that the banks could not receive these commissions.
And as I was pointing out in answer to Justice Douglas’ question, Justice White suggested, this is considerably more complicated than that.
The only statute is when it permits banks in small towns to engage in general insurance agents.
The Comptroller of the Currency believes and has ruled that this type of transaction is perfectly proper for banks.
However, the Fifth Circuit has enjoined banks from participating in just this type of transaction.
It is interesting that the Fifth Circuit and there is a substantial question of standing as the suit was brought by insurance agents, the Fifth Circuit ruled, surveying a fairly lengthy statutory history and more of what Congress had failed to do than what it had done that there was an inhibition on the banks and that this was to protect insurance agencies to avoid competition by banks with insurance agents.
Well, I think it is clear that what the banks did here ousted an insurance agents of a substantial business.
It is not our point either to exonerate or indict the banks for what they did, but only to describe what they did.
So even if you take the statute as I suggested earlier that authorizes small town banks to act as agents to sell insurance, to collect premiums and then to receive commissions, it seems to me a peculiarly narrow reading to focus only on the receiving commissions.
The banks effectuated this insurance and it is not for me to say whether they were insurance --
Justice Byron R. White: Well, let us assume that -- let us assume the statute does forbid the banks from collecting premiums.
You make your argument in spite of that.
Mr. Ernest J. Brown: Yes sir.
Justice Byron R. White: Yes.
Mr. Ernest J. Brown: And that is what -- on any ground whether, it seems to me that this is correct.
Justice Byron R. White: Do you come to the same result on both Section 61 and 482 in that respect?
Mr. Ernest J. Brown: No Your Honor, I think not.
I think under -- if we had been involved in the years before 1954, we would have.
As Judge Friendly pointed out, 1961, this Court's decision in Lucas and Earl, Chicago and Joliet Railroad, is as he said, a blunt instrument.
Usually that is an all or nothing.
Now, we would not claim that all the payments to the life insurance company were income to the banks because the life insurance company did perform the function of re-insuring these writs.
It was a minimum capital, but it did that.
So here, 482 provides for allocation as it often requires analysis of prices, of services.
1961 is the blunter instrument.
Judge Friendly’s opinion in the Ruben (ph) case which is cited makes a point of that.
So we would -- I do not know, I shouldn't say that it's universal, that no Court has ever analyzed a transaction and said part of the income was uncommon to Lucas and Earl, but 482 is the more flexible, and more surgical instrument and it seems appropriate here that that should be.
It presumes that their will be no receipts.
It does not ask the bank to receive the money, but it says the bank is taxable as though it had.
That has been true since Lucas and Earl.
So that I do not think that makes any difference and I would like to demonstrate this.
I think two simple cases would demonstrate that even if this prohibition on receipt were verbatim in the statute as indeed it was in Local Finance, the Indiana statute was there quite explicit, but two simple cases.
The first let us take a public office or a purchasing agent and let us make it federal since it is a federal statute, and some point it is made of that.
He is prohibited by a statute, we will say, from receiving any funds or moneys from any person with whom he deals, a person deals with his office customarily and would like more business than he has been to get, approaches him and offers him a substantial sum of money.
He says, I cannot take it, the law prohibits it and then he remarks, I have a son in college, he could certainly use some extra money, he is always complaining that he does not have enough.
The visitor thinks he understands what has been said and promptly they also check to the son in college who inquires it is proven, and is told to keep it.
Now, I assume that it would be no question, that is income to the father.
Let us bring it a step closer to this case, in fact I would say almost identical with this case.
Instead of the son in college, the purchasing officer says, no I cannot take your money and the conversation goes on and then he indicates he had inherited an orchard a few years back and he had incorporated it, his Farms Incorporated and they sell the produce.
The visitor at a little polite in direction says he is interested in inquiring apples and peaches and says I will pay you, I will pay farms incorporated a price which is obviously far above the market.
The price is accepted, Farms Incorporated receives the money.
I think there could be no question that though the statute prohibits the officer from receiving these funds that 482 would allow the commissioner to allocate that money to him.
The Fifth Circuit has had no difficulty where purchasing officers who in such oblique fashion had funds paid to them (Inaudible).
So that seems to this case.
I cannot believe the statute is more.
We are not concern with the legality or illegality of the banks whether they skirted the edge of collegiality makes no difference.
They performed a valuable economic function.
The commissioner and the Tax Court reviewing him decided that it was highly appropriate that the market value of this function be allocated to the banks.
I would like to reserve if I may any such remaining times I have Mr. Chief Justice.
Chief Justice Warren E. Burger: Very well Mr. Brown.
Argument of Stephen H. Anderson
Mr. Stephen H. Anderson: Mr. Chief Justice and may it please the Court.
The question as far as these national banks in Salt Lake City, Utah and Boise, Idaho are concerned is whether or not the Commissioner of Internal Revenue purporting to use the authority of Section 482 of the Internal Revenue Code can allocate to them insurance related income which the banks neither received nor could lawfully receive those resulting in a tax where this is no income and could never be any income and will never be any income not withstanding any outcome of this case.
The Commissioner’s position in this case is wrong for a number of reasons.
It is wrong, so wrong that commentators across the country have uniformly criticized it.
Referring to this specific case, we have cited two of those articles in our brief.
One is currently a review of an address given at the Chicago Tax Institute, it is Mr. O'lean's (ph) article, cited on page 9 of our brief.
It attempts to overturn all applicable persons in the area with the sole exception, the sole aberration of Local Finance and I might add to the Court, and I am sure the Court has probably already picked this up from the briefs that both Courts below in this case were in favor of the taxpayers position.
Judge Fay who was in the courtroom the day I understand, Judge Fay after hearing our case dissented in Local Finance and then seeing that -- feeling that he was bound by Local Finance ruled against the taxpayer in the Tax Court.
In addition Your Honors, and I understand this is correct that the Comptroller of the Currency has made his opposition to the Internal Revenue Services position known.
I am informed that that is correct and a copy of the letter which he has sent to the Solicitor General’s Office has been made available to these member national banks.
In a letter of the Comptroller of the Currency asked the Solicitor General to make his views known to this Court that the Comptroller opposed the Internal Revenue Service position.
I am not sure that that point was adequately made.
I might request that it would be helpful for the Court to have a copy of the Comptroller’s views attached to the record for a review.
Justice Harry A. Blackmun: Mr. Anderson, this -- in these remarks you have made, are you attacking the implementation of Section 484 or the Section itself?
Mr. Stephen H. Anderson: The implementation.
Justice Harry A. Blackmun: You are not questioning the integrity of it as a tool in the tax structure?
Mr. Stephen H. Anderson: No Your Honor.
The errors which we --
Justice Harry A. Blackmun: But what would be position if an officer of the bank had received or had embezzled income and instead of keeping it himself had placed it in the bank, would -- and the bank in some way will be responsible for it.
Would the bank be taxable on that embezzled income?
Mr. Stephen H. Anderson: You say the employee embezzled the income?
Justice Harry A. Blackmun: Yes.
Mr. Stephen H. Anderson: No.
We would say that the bank would not be taxable, the employee would.
That is the James case cited at page 29 and 30 of the Government’s brief and that is a 180 degrees we submit from the present situation.
There in that case, the illegal income was actually received.
In this case illegal income was not received because it will be illegal to take it.
Justice Harry A. Blackmun: Well, the distinction you draw then is only in the fact of receipt --
Mr. Stephen H. Anderson: That is correct.
Justice Harry A. Blackmun: -- not the illegality?
Mr. Stephen H. Anderson: Well, it is correct.
The fact of receipt is the controlling distinction.
The illegality in this case goes further to buttress other points that we would make.
On the example you gave, it is the fact of receipt, that is correct.
We submit that the errors in the Government’s position and there are a number of them and I will go through at least three main errors in the Government’s position.
All find themselves bottomed on one main circumstance which we do not think has been adequately represented to the Court.
For nearly a quarter of a century, these banks have made credit life, health and accident insurance available to their borrowers and we might add that their contacts with this insurance was so small that it caused the banks for the activity of all their branches and all of their personnel less than $2,000.00 a year per bank to process the insurance characterized by both Courts below as negligible.
Justice Harry A. Blackmun: Well then at that point let me ask you this?
Mr. Stephen H. Anderson: Yes.
Justice Harry A. Blackmun: If you should lose by chance on this argument, are you also attacking the allocation itself, percentage wise?
Mr. Stephen H. Anderson: We surely are, Your Honor.
Justice Harry A. Blackmun: Alright.
Chief Justice Warren E. Burger: Now what was the relationship between the $2,000.00 figure you have just mentioned and whatever percentage override was charged by the bank for handling the service charge, how much do that amount to?
Mr. Stephen H. Anderson: Your Honor, that is one of the main points of our case.
The banks charged nothing.
The banks received a substantial benefit just by having insurance available on the premises.
As a matter of fact, the record shows that over one-half million dollars in bank loans were paid off by the discharge of this insurance on people who died, who and the banks charged -- the banks received their benefit in that fashion.
Chief Justice Warren E. Burger: Well, was there not some service charge that the bank received just before the paperwork?
Mr. Stephen H. Anderson: No, Your Honor.
The banks paperwork was de minimis, both --
Chief Justice Warren E. Burger: What was the 11 or 11.5% figure that --
Mr. Stephen H. Anderson: That was the amount that was charged by American National Insurance Company for servicing the insurance for -- well, if I can the diagram this way.
Here would be the banks, here is their holding company, here is the Sister Life Insurance Company, Security Life until 1959.
American National was an independent, unrelated insurer up here.
The insurance went from American National through a group policy in the banks to the borrower and the obligation was between the borrower and American National.
Then American National re-insured the risk, $41,000,000.00 worth by 1959, re-insured the risk down to Security Life and did all of the actuarial work for Security Life and charged 11 cents, actually it is 15 cents, charged Security Life that much and then remitted the Security Life the balance.
Justice Byron R. White: I have -- except to the fact that Security Life was a Sister Corporation, I suppose that Security Life would have had to pay out to somebody a commission?
Mr. Stephen H. Anderson: That is another main point of our case, no.
The amicus brief in this case; first let -- may I make two -- just two points on that.
The amicus brief in this case sets up the situation which we arguendo tried to point out in our brief and that is that the commissioner has had a basic underlying fallacy on his reason, in his reasoning.
He says that in an unrelated, uncontrolled situation a commission would be paid.
In the amicus situation for many, many years the automobile dealers in Michigan made available credit life, health and accident insurance in connection with GMAC Financing and they took no commissions nor did any related entity or person take any commissions.
But GMAC kept 100% of the premiums paid.
The reason for that being that it was against the law for the automobile dealers in Michigan to receive the commission.
That is point number one.
Justice Byron R. White: Well, that may be so but a family corporation (Inaudible) insurance independently, make sure that there was somebody in this family that would take commission, the Smith agents which then gave it to the Management Company?
Mr. Stephen H. Anderson: Yes.
Yes, you are entirely correct.
Justice Byron R. White: What about the return of 40% or 50% of the premium to the life insurance company, when somebody in their family collects it?
Mr. Stephen H. Anderson: That is the key phrase.
When somebody in their family could collect it and that is correct.
This -- as firmly established -- excuse me.
Justice Byron R. White: Why did the -- how did the Smith Agency handed the money over to the Management Company (Inaudible)
Mr. Stephen H. Anderson: In the original years, 1948 to 1954, the testimony is on the record that the income was so small that it virtually passed notes.
It should have been taken into income by the Smith.
It was taken into income by Management Company and when asked in testimony that the Executive Vice-President said it just escaped notice.
It was a mistake, but as firmly embedded in the tax law as any principle, the commissioner cites here is the principle established by this Court in Moline Properties and National Carbide and in other cases that the taxpayers may structure their affairs anyway they please notwithstanding that the Commissioner of Internal Revenue does not like the structure and you are right Your Honors so long as lawfully some related entity could take this money then the holding company was anxious for the entity to take the money.
But the very bottom fact to this case and I submit the Commissioner has not shown anything to the contrary, the very bottom fact of this case if I had not made any point at all while I am up here is this point that if that thing in Salt Lake City, your invoicing was completely isolated from any other related entity on a desert island or some place doing business and there was no related entity that it would not take these commissions because there is a violation of federal banking law so to do.
The penalties for violation at federal banking law are very severe.
There are laws that corporations and banking franchise had criminal liability on the part of the directors.
Now, this is no closely held tiny little group that served a profit, that people that served a profit by devices or contrivances.
These are national banks publicly owned through holding company.
The Directors of these banks had no personal stake in this.
They were trying to abide by the law.
The law said the banks could not take this income and again I can -- excuse me.
Justice Byron R. White: (Voice Overlap) it wasn't possible, I am not stating that there is anything wrong with it.
it wasn't possible for the intra family insurance company was that take 89% of the premiums or 85% of the premiums and the tax of the insurance company tax revenue.
Mr. Stephen H. Anderson: By all means?
Justice Byron R. White: Was it possible (Inaudible) and without doing that it would have retained 40% (Inaudible)
Mr. Stephen H. Anderson: Yes sir.
Justice Byron R. White: And had the tax law have ever entered to a tax insurance company on this premium?
Mr. Stephen H. Anderson: It has Your Honor.
In 1959, the tax, the income tax, the Life Insurance Tax Act was passed.
The Lower Court, Judge Fay referred to that.
Under that law insurance companies are taxed at exactly the same rate as any other corporation.
The only difference is that because of reserves which must be set up to protect the policy holders, that the timing is slightly different, but the whole corporation labels apply.
The only thing it is different is time.
But I again -- I must emphasize this point.
If I sit down with no point made, it must be this point, but this point it must be this point and that is that these banks would not take commissions illegally, notwithstanding the outcome of this case, notwithstanding anything that would happen, these banks will not take insurance related income.
The record shows that they have been advised by counsel not to take that income.
Our law firm gave that advice.
The advice will be honored and they will not take that income.
The only thing that the commissioner could achieve in this case would be the unheard of result of taxing these banks, exacting a tax out of the treasury of these banks when there is no income that the banks can get their hands on ever.
Thus there will be a tax without income ever.
Justice Harry A. Blackmun: Yes.
But there is (Voice Overlap)
Mr. Stephen H. Anderson: Yes Your Honor?
Justice Harry A. Blackmun: Which the ultimate owners can get their hands on?
Mr. Stephen H. Anderson: Now, that is another good point.
The Government infers in its brief that somehow all of this is mashed together and the income is there to be paid down.
In 1959 Your Honor, the Security Life Insurance Company of Texas was spurned off pursuant to the Bank Holding Company Act of 1956, was spurned off to a new holding company group.
The record shows at page 1 -- at page 51 that after that spin off, the dividend which Mr. Brown referred to was paid up to the new parent.
The record also shows that there was a developing difference in the shareholders of those corporations so that by 1967 they were substantially different.
The Commissioner points out in his reply brief and raises an implication that I am glad is raised because we have not been able to get to the point feeling the record was closed, but he implies in his reply brief that when these two entities were reconsolidated back 1970 that somehow this money came back in, that is not so.
Justice Byron R. White: Well let us assume that the banking laws were then -- so it is perfectly clear that a bank could in connection with (Inaudible) the generating credit life insurance taking commission?
Mr. Stephen H. Anderson: One half of my argument would fall.
Justice Byron R. White: And then let us assume that the bank, these banks continued not to take a commission although in terms of the service it performed they would have been entitled to it.
And they had the income said be to paid by the life insurance, the Family Life Insurance Company then would you have the same argument now before us?
Mr. Stephen H. Anderson: I would have one-half of my argument, one-half would fall in it --
Justice Byron R. White: Would you have it?
Would have it?
Mr. Stephen H. Anderson: The half --
Justice Byron R. White: (Voice Overlap) the receipt?
Mr. Stephen H. Anderson: Then we would get into the earnings.
The amount of allocations, the right of taxpayer to structure their affairs as they chose and all of that would have to be examined.
The first half of my argument is that we do not even have to get to that in this case because as I will point out in a minute under Section 61, this Court has long held that the taxpayers will not be taxed unless there is an income, that is what it is called, an income tax.
In -- well excuse me Your Honor, have I finished answering your question.
Unknown Speaker: (Inaudible)
Mr. Stephen H. Anderson: Alright.
Unknown Speaker: I know you (Inaudible)
Mr. Stephen H. Anderson: I just wanted to say this that it has been always been the law, always without any deviation.
There is not one authority the commissioner has cited to this Court, not one.
It has always been the law that tax is not exacted unless there has been an actual receipt of money or the right to receive money.
In Harrison versus Schaffner, Lucas versus Earl, Corliss versus Bowers, Commissioner versus Glenshaw Glass and a host of other cases decided by this Court that principle is as deeply embedded in the tax fabric of this country as any there is.
There has never been a case contrary to that.
In Corliss versus Bowers this Court said this.
It said, income is that over which a man has an unfettered command, that he is free to enjoy at his own option.
In Commissioner versus Glenshaw Glass this Court described income as that which is clearly realized over which a man has complete dominion.
None of those concepts are present in this case.
I submit that complete dominion, the right to enjoy at his own option, unfettered command clearly realized are nowhere in this case because of the national banking laws, the banks could not take the income.
They had no unfettered command.
They had no complete dominion and foremost they had no option.
They had no option whether or not to take the income.
At the very heart of our tax laws, I submit to the Court, at the very root of it, tax has always followed the existence in the taxpayer of alternatives, of options.
Justice Harry A. Blackmun: I suppose that is not true, I mean, the state tax side, is it?
Mr. Stephen H. Anderson: In the state tax side I would --
Justice Harry A. Blackmun: Estate, federal estate tax side, where we have includable in the gross statement many things that are no longer owned by the decedent at his death.
Not a good (Voice Overlap)
Mr. Stephen H. Anderson: I am a morman.
I do not know what options a person would have after death.
I -- maybe he is exercising the supernatural, I do not whether I got your point Your Honor, but I --
Justice Harry A. Blackmun: Well, (Voice Overlap) certain types of trust that are included there.
We have gifts in contemplation of death which are included, none of which are owned at the time of death and yet are taxable for federal estate tax purposes?
Mr. Stephen H. Anderson: Yes.
The rule would apply, Your Honor.
The point is well made that at the time of death the way the estate tax law operates is that, I think it is Section, what, 2036; the way that the estate tax operates is that a man must have had the right at his death to exercise ownership and control and a whole host of cases have developed out of that concept that at the man’s death he had the right to exercise dominion over the property.
Justice Harry A. Blackmun: (Inaudible) if you are right of getting the contemplation of that.
My memory is hazy, but let me -- aren't there some old cases about gifts or future bonds, coupons that ought to be due in the future?
Mr. Stephen H. Anderson: Yes Your Honor, Lucas versus -- Helvering versus Horst.
Justice Harry A. Blackmun: And certainly there is no right at the time of those coupons be mature to receive?
Mr. Stephen H. Anderson: The critical distinction and we cite Helvering versus Horst in the brief and we would cite the contemplation of death is that at some point the taxpayer had the -- he had dominion, he had the right to exercise dominion.
That is the same with the con -- gift in contemplation of death.
At some point in time Your Honor, the taxpayer either had the right to exercise dominion or in fact exercised dominion over the money.
Now, that is different, 180 degrees different from our case.
In our case there has been no right.
There has been no dominion, there has been no exercise of dominion and can be no exercise of dominion at any time.
That is the critical distinction.
That is why the Government’s position is in direct collision with precepts undeviatingly perpetuated by this Court.
It is in direct cohesion with those precepts.
Without the citation of authority, rather it overturns all applicable precedent which we have cited and discussed in our brief.
Now, this is a tax case.
Taxes are complicated things.
They themselves adhere to and follow a statute.
In this case it is Section 482.
We submit the error of the Commissioner’s position as Mr. Justice Blackmun pointed out is in the implementation of the Commissioner’s position on the statute.
There are two controlling factors under Section 482.
The Government has made known a number of things.
It has talked about money and controlled entities and such, but it has not gone to the statute.
The statute says that it will operate where a controlling entity, in this case the holding company, has the power arbitrarily to tamper with the income, understate the income of one of these controlled entities and when the holding company comes in and tampers with the income of this entity in favor of this entity, but it arbitrarily shifts the income then the Commissioner may come in and examine that situation.
We do not have that here.
It's stated in terms of this case the holding company would have to have the right to affect the banks to take the insurance income, but no such right exists because the banks would not operate in violation of law.
The very fundamental premise upon which Section 482 operates is absent in this case.
There is no control element which can arbitrarily shift income.
The Government’s position dies at the very threshold.
The second horn upon which Section 482 operates is in Subsection C of Section -- of Regulation Section 1.482 – 1 (c) and it is in the Government’s brief in the appendix and that states the frontiers of the Commissioner’s authority.
The very frontiers of his authority are stated in that Regulation.
The Regulation says something like this.
The authority of the Commissioner to allocate, to take an action under this Section, and then in effect goes on to say as limited to those situations and this was the key phrase, those situations where the income of the taxpayer would have been different in an uncontrolled situation from that in a controlled situation, Now, if the income or the taxpayer is no different in an uncontrolled situation, how can the Commissioner exercise authority in a controlled situation?
That test was applied by the Court of Appeals in this case and not repudiated by the Commissioner in this case.
It applies to this case and the answer to it as found by both Courts below is that these national banks in an uncontrolled situation would not receive the type of income which the Commissioner tries to allocate to them.
I -- excuse me sir.
Justice Harry A. Blackmun: Mr. Anderson, tell me once again your posture with respect to the Seventh Circuit case of Local Finance, do you feel it is wrong or do you feel it is distinguishable?
Mr. Stephen H. Anderson: Both Your Honor, but since this Court granted certiorari I did not develop any argument on the differences.
In Local Finance for instance, all the finance company officers were licensed insurance agents.
When they made a loan as licensed insurance agents they want ahead and sold insurance.
They also solicited it very heavily.
95% of the borrowers in Local Finance took insurance whereas in our case as little as 13% of the mortgage loan customers took insurance.
The time and effort, the amount of time it cost Local Finance to handle the insurance was much greater and so on, but all of the cases with the sole aberration of Local Finance if it does apply in some way, all of the cases are against the Commissioner.
May I call the Court’s attention to three rules of law.
One is the Short (ph) case, the only applicable present in this area when this taxpayers were trying to fix their affairs.
We cited in our brief and discussed it.
In that case because of OPA Price Regulations, it manufactured, it could not raise prices to its wholly controlled wholesale.
The Commissioner came in and tried to allocate income back and the Tax Court said, we will not tax a taxpayer who neither had the right to receive the income nor received the income.
That is precisely on the point of this case.
The Commissioner himself has recognized this.
In two -- in the current wage price freeze that President Nixon embarked upon last fall the Commissioner in technical information release 1106, issued to the public said that where the public because of strictures of the law under this current wage price freeze, more corporations did not give out dividends and accumulated earnings so that there might be otherwise a violation of Section 531 of the Code that the Commissioner would not come in and exact a penalty tax because the taxpayer was prevented by law from doing something, from distributing the money out.
Commissioner himself has taken the position that he must follow the tendency of the law in other areas.
The tax law does not operate in a vacuum.
Congress did not pass the banking law and the tax law to operate independently of one another, but rather to operate in a harmonious cooperative whole.
The tag if -- if a rule is going to be established affecting all of the regulated industries of banking and insurance industries, Congress should do it, so that taxpayers could do it prospectively and not be penalized.
Justice Byron R. White: What if the allocation has been (Inaudible), same answer?
Mr. Stephen H. Anderson: No, Your Honor.
Then I would be back to the other half of our case.
I might add that the Commissioner has -- well, I will not add that.
There is no income.
May it please the Court, there is no income from which they discharge this tax.
That income flowed out in the 1959 reorganization, it is gone.
It will never come back.
There will never be any income from which to discharge the tax the Commissioner seeks to exact here, never.
These taxpayers were in the position of this kind of a dilemma.
Either one; they pay the tax where there is no income, ad infinitum thus affecting the financial soundness of these national banks as opposed now by the Comptroller of the Currency in this Court or two; take the income, violate federal banking law and risk forfeiture of their charter and criminal liabilities on the part of the Directors or three; give up insurance altogether.
Now, we submit the taxing law has never been that unreasonable.
Chief Justice Warren E. Burger: There is another alternative, is there not perhaps?
I'll put it this way.
Is there anything illegal about their not charging any commission at all and just charging their costumers the net, roughly one-half of the premium and thereby getting all the banking business in that town by cutting the total costs of the borrower?
Mr. Stephen H. Anderson: Well, Your Honor, the banks cannot set the rates.
As a matter of fact the independent insurance companies would be very jealous of a situation where one bank on this quarter was charging one rate and another bank in this charge it was charge -- quarter was charging another because it would draw all of its costumers into chaos.
The testimony in the record is that the banks had nothing to do with the rates, but assuming arguendo that they did upon the answer just to take it further, assuming arguendo that they did, the testimony in this record is un-contradicted as if there is no such thing as a set part of a premium rate which is commission.
So the banks would be out of troubled waters.
The Commissioner could always come in.
A rate could be so low that an independent insurance company out here could be losing money.
They could still chose to pay a commission.
So the banks would always exist in jeopardy of the Commissioners caprice to come in and say, Aha!
There is so much commission, we allocate it to you, lose your franchise.
No, there would not be anyway.
Justice Byron R. White: Are the years or 1959 (Inaudible)
Mr. Stephen H. Anderson: Yes Your Honor.
More than a million dollars in tax is set up for those later years.
Justice Byron R. White: That turns on this case?
Mr. Stephen H. Anderson: Turns on this case and there is no income.
Justice Byron R. White: (Voice Overlap) 1959 Amendments really did not make the whole arguments?
Mr. Stephen H. Anderson: Death tax is all bunched in the first years because of the reserved deferral.
Life insurance companies are attached just like other corporations, but they set out reserves and there is a deferral.
In the setting up of the reserves and in the previous income there was this tax.
Justice Byron R. White: (Inaudible) even at post 1959 years it will make a substantial difference whether the banks or insurance companies made it or not?
Mr. Stephen H. Anderson: Well, there will be -- the difference tails are -- the difference tails are.
Justice Byron R. White: (Voice Overlap) purporting to the allocated income in the post 59 years.
Mr. Stephen H. Anderson: Yes sir.
Justice Harry A. Blackmun: Well, is it your point that the -- that was they are trying to reallocate to the banks as already been taxed at some rate, in some amount to the insurance company?
Mr. Stephen H. Anderson: For the years 194 -- 1954 to 1959 Your Honor, the life insurance companies were not subject to tax and has not been taxed.
Justice Harry A. Blackmun: I mean, post 1959?
Mr. Stephen H. Anderson: Post 59, there has been a tax.
Justice Harry A. Blackmun: But there is still a difference?
Mr. Stephen H. Anderson: Well --
Justice Harry A. Blackmun: The rate or amount?
Mr. Stephen H. Anderson: I gave you a figure, now I start thinking clearly about it.
I gave a figure which would be reduced some by what I presume would be a correlative adjustment and I do not know what the net would be.
I would -- we have not even studied that, yes.
Unknown Speaker: (Voice Overlap) But those years are still open and they are still (Inaudible)
Mr. Stephen H. Anderson: Are they ever, yes.
Chief Justice Warren E. Burger: Thank you Mr. Anderson.
Mr. Stephen H. Anderson: Thank you.
Chief Justice Warren E. Burger: Mr. Brown you have one minute left.
Rebuttal of Ernest J. Brown
Mr. Ernest J. Brown: Just a --
Justice William J. Brennan: Mr. Brown, for the post 1959 years, do you have any idea what the difference is to the Government in dollars?
Mr. Ernest J. Brown: I do not have the record Justice Brennan I am sorry I do not know what the figures are.
There is a substantial difference and it stands and it is right in saying that the rates are, but there is still a substantial difference in the method of computation of income taxes for insurance companies and others.
I would like to point out briefly on the post -- this time when it been -- the banks suggested they might cancel the re-insurance.
American National said it was then paying insurance to -- commissions to in its designated agency.
But Mr. Anderson has referred to National Carbide which is rather interesting because there by contract income was payable to a parent corporation but it was taxed to subsidiaries because they are ended and in this case the adjustments, the parent corporation is no great hardship.
The parent corporation can make any adjustments.
The Commissioner will allow of course corresponding deductions to the --
Justice Byron R. White: Mr. Brown, let us assume that in this years that the holding companies that controlled banks was different from the holding company that controlled the insurance company in the sense that there -- the stock holdings were not identical.
Perhaps the boards were the same or overlapping.
Would that not make a difference?
Mr. Ernest J. Brown: The statute does not require it.
Of course, identity requires common control of 50%, but in any event the possibility of divorce I take it cannot frustrate the use of 482 for the years when there is common control --
Justice Byron R. White: Well in (Inaudible) would it be -- if it were actually proved that there was divorce?
Mr. Ernest J. Brown: It -- for the years after the divorce, not for the years before which was expected by the Court.
Chief Justice Warren E. Burger: Thank you Mr. Brown.
Thank you Mr. Anderson.
The case is submitted.