Commissioner v. First Security Bank of Utah/Dissent Blackmun

by Harry Blackmun

MR. JUSTICE BLACKMUN, with whom MR. JUSTICE WHITE joins, dissenting.

As I read the Court's opinion, I gain the impression that it chooses to link legality with taxability or, to put it better oppositely, that it ties illegality to receive with inability to tax. I find in the Internal Revenue Code no authority for the concoction of a restrictive connection of that kind. Because I think that the Commissioner's allocation of income here, under the auspices of § 482 of the 1954 Code, and in the light of the establishes facts, was proper, I dissent.

1. Section 482^[1] surely contemplates taxation of income without formal receipt of that income. That, indeed, is the scope and purport of the statute. It is directed at income distortion by a controlling interest among two or more of the controlled entities. I, therefore, am not convinced that the fact the income in question here did not flow through the Banks at any time—because it was deemed proscribed by the 1916 Act (if the pertinent portion thereof, 39 Stat. 753, is still in effect, a proposition which may not be free from doubt),^[2] and because the [p419] controlling interest routed it elsewhere—serves, in and of itself, to deny the efficacy of the statute.

2. Section 482 has a double purpose and a double target. It authorizes the Secretary or his delegate, that is, the Commissioner, to allocate whenever he determines it necessary so to do in order (a) "to prevent evasion of taxes" or (b) "clearly to reflect the income of any" of the controlled entities. The use of the statute, therefore, is not restricted to the intentional tax evasion. No evasion of tax, in the criminal sense, by these Banks is specifically suggested or at issue here. And I do not subscribe to my Brother MARSHALL's intimation that what the Banks were doing was otherwise illegal. The second alternative of the statute, however, is directed at something other than tax evasion or illegality. It is concerned with the proper reflection of income (or deductions, credits, or allowances) so as to place to controlled taxpayer on a tax parity with the uncontrolled taxpayer. It is designed to produce for tax purposes, and to recognize, economic realities and to have the tax consequences follow those realities and not some structured non-reality. This is the aspect of the statute with which the Commissioner and these respondents are here concerned. Thus, legality and illegality seem to me to be beside the point.

3. From this it follows that the Court's repetitive emphasis on the missing § 92 and the inability of these Banks legally to receive the insurance commissions give undue emphasis to the first alternative of § 482, and seem almost wholly to ignore the second.

4. The purpose of the controlling interest in structuring the several entities it controls is apparent and [p420] cannot be concealed. The Banks were wholly owned subsidiaries of Holding Company. The Tax Court found—and the respondents concede^[3]—that one of the purposes of the Banks' arranging for borrowers' credit life insurance^[4] was "to provide an additional source of income—part of the premiums from the insurance—to Holding Company or its subsidiaries." T.C. Memo 1967-256, p. 67-1453. For me, that means to provide an additional source of income for the group irrespective of the particular pocket into which that income might initially be routed.

5. What, then, happened? The chronology was revealing:

(a) Initially, that is, until 1954, the Banks solicited the insurance, charged the premium, and forwarded it to Management Company. The latter in turn sent it on to the then-favored independent insurance carrier. That carrier paid the recognized sales commission to Smith, Management Company's wholly owned insurance agency.^[5]

(b) In 1954 the American National-Security Life arrangement appeared on the scene. This was prompted by the blossoming of the credit insurance business as a profitable understanding. Obviously, it was a matter of concern to established and independent insurance companies when they came to realize that lending institutions were in a position to form their own insurance affiliates [p421] to tap and drain away profits that the independents theretofore had received without hindrance. Security Life was just such an emerging insurance affiliate of Holding Company and of Management Company. But American National, by its proposal to Management Company, as well as to other financial institutions, salvaged 15% of the premium dollar in return for actuarial and accounting services. Security Life never did develop into a full-line insurance company; it remained essentially a re-insurer and yet it accomplished the purpose for which it was given life. Now no sales commissions needed to be paid. In fact, none were paid; they just disappeared, and that erstwhile cost remained as profit in Security Life. But the Banks, as before, solicited their borrowing customers to purchase credit life insurance.

(c) The Life Insurance Company Tax Act for 1955 was enacted, 70 Stat. 36, followed by the Life Insurance Company Income Tax Act of 1959, 73 Stat. 112. These statutes served to accord preferential tax treatment—as compared to ordinary corporations—to life insurance companies. See United States v. Atlas Life Ins. Co., 381 U.S. 233 (1965). This happily coincided, of course, with Security Life's development.

6. Only the Banks were the responsible force behind the premium income. No one else was. Certainly American National was not. Certainly Security Life was not. Smith was out of the picture. And if it can be said that Management Company or Holding Company contributed a part, they did so only secondarily. It was the participating bank that explained to the borrower the function and availability of the insurance; that gave the customer the application form; that examined the application; that prepared the certificate of insurance; that collected the premium or added it to the loan; and that sent the form and the premium to Management Company. It was the participating bank that thus [p422] offered and sold on behalf of a life insurance company under common control with the bank. It was the participating bank, in short, that did what was necessary, and all that was necessary, to sell the insurance. Clearly, services were rendered by that bank on behalf of its commonly controlled affiliate. Just as clearly, those services would have been compensated had the corporations been dealing with each other at arm's length.

7. It is no answer to say that generation of income does not necessarily lead to taxation of the generator; here the earnings themselves stayed within the corporate structure dominated by Holding Company, and did not pass elsewhere with consequent tax impact elsewhere. I do not so easily differentiate, as does the Court, ante, at 401 n. 11, between referral outside the affiliated structure and referral conveniently within that structure to a re-insurance company that could be taxed on the premium income (unreduced by commissions) at advantageous tax rates.

8. That the selling effort of the Banks seems comparatively minimal and that the processing cost seems comparatively negligible are, I believe, beside the point and quite irrelevant. No one else devoted effort or incurred cost of any significance whatsoever. Taxability has never depended on approximating expenses to receipts; in fact, the less the cost, the greater the net income and the greater the tax burden.

9. Neither is it an answer to say that before the organization of Security Life the Banks did not receive income from credit insurance premiums and that, therefore, the emergence of Security Life did not change the situation so far as the Banks were concerned. For me, it very much changed the situation, for the controlled structure took over the insurance business and the premiums thenceforth were nestled within that structure. [p423]

10. Taxability, despite nonreceipt, is common in our tax law. It is present in a variety of contexts. For example, one has been held taxable, under the applicable statute's general definition of gross income, for income and earnings assigned to another and never received;^[6] for the income from bond coupons, maturing in the future, assigned to another and never received;^[7] for dividends paid to the shareholders of a transferor corporation pursuant to a lease with no defeasance clause;^[8] for another's income from a short-term trust^[9] (until § 673, with its 10-year measure, came into the tax structure with the 1954 Code); for the employer's payment of income taxes on his employees' compensation;^[10] and for an irrevocable trust's income used to pay insurance premiums on the settlor's life,^[11] or, in the absence of particular state law provisions, distributed to a divorced wife in lieu of alimony^[12] (until § 215 came into the Code with the Revenue Act of 1942, 56 Stat. 817).

11. In the area of federal estate taxation an obvious parallel is found in the many instances of includability in the decedent's gross estate of property not owned or possessed by the decedent at his death. The Code itself provides for the inclusion of transfers theretofore [p424] effectively made, but in contemplation of death, 26 U.S.C. § 2035; of a variety of inter vivos irrevocable transfers in trust, 26 U.S.C. §§ 2036-2038; and of joint interests, 26 U.S.C. § 2040, in all of which situations the ownership interest at death was nonexistent or less than full.

12. This demonstrates for me that there have been and are many examples of taxation of income without that "complete domination" over it that the Court now finds so necessary. The quotation, cited by the Court, from Mr. Justice Holmes' opinion in Corliss v. Bowers, 281 U.S. 376, 378 (1930), consists of language used to support the taxation of income; it is not language, as the Court would make it out to be, that supported the nontaxation of income. The Justice's posture—and the Court's—in that case surely looks as much, and perhaps more, to includability here than it does to excludability.^[13]

13. The Court shrinks from extending the possibility of taxation-without-receipt to the situation where the taxpayer is "prohibited from receiving" the income by another statute. It states that no decision of the Court has as yet gone that far. It is equally true that no decision of the Court has refrained from going that far.

[p425] The Seventh Circuit has not been concerned with the existence of a prohibitory regulating statute, Local Finance Corp. v. Commissioner, 407 F.2d 629 (1969), cert. denied, 396 U.S. 956, and this Court should not be. The Congress, in enacting the Life Insurance Company Tax Act for 1955, was of the opinion that § 482 was available to the Commissioner with respect to insurance companies that are captives of "finance companies." H.R. Rep. No. 1098, 84th Cong., 1st Sess., 7; S. Rep. No. 1571, 84th Cong., 2d Sess., 8.^[14]

14. The Court's reluctance is reminiscent of the "claim of right" doctrine, which found expression in the unfortunate and short-lived (15 years) decision in Commissioner v. Wilcox, 327 U.S. 404 (1946), to the effect that embezzled income was not taxable to the embezzler. Wilcox, of course, stood in sharp contrast to Rutkin v. United States, 343 U.S. 130 (1952), where money obtained by extortion was held to be taxable income to the extortioner; it was overruled, at last, in James v. United States, 366 U.S. 213 (1961). In Wilcox, as here, the Court wrestled with the concept and imaginary barrier of illegality, was impressed by it, and, as in this case, concluded that illegality and taxability did not mix and could not be linked. That doctrine encountered resistance in Rutkin and in James, and was rightly rendered an aberration by those later decisions.

[p426] 15. I doubt if there is much comfort for the Court in L.E. Shank Latex Products, Inc., 18 T.C. 940 (1952), for there the significant fact was that the taxpayer could not have raised its price even to a noncontrolled distributor.

In conclusion, I note that the Court of Appeals remanded Management Company's case to the Tax Court for consideration of the § 482 allocation, alternatively proposed, to that corporation. With this I must be content. At least Management Company is not a national bank, and the barrier that the Court has found in the missing § 92 supposedly does not provide a protective coating for Management Company or, for that matter, for Holding Company.

And so it is. The result of today's decision may not be too important, for it affects only a few taxpayers. It seems to me, however, that it effectively dulls one edge of what has been a sharp two-edged tool fashioned and bestowed by the Congress upon the Internal Revenue Service for the effective enforcement of our federal tax laws.

Notes

1. Section 482 is not new. It appeared as § 45 of the Revenue Act of 1928, 45 Stat. 806, and has predecessors in § 240 (f) of the Revenue Act of 1926, 44 Stat. 46, and in § 240 (d) of the Revenue Act of 1924, 43 Stat. 288.
2. The revisers of the United States Code in 1952 omitted the section because of the possibility of its having been repealed by its omission from the amendment and re-amendment in 1918 of § 5202 of the Revised Statutes by § 20 of the War Finance Corporation Act, 40 Stat. 512. Compare administrative ruling No. 7110 of the Comptroller of the Currency with the Comptroller's current regulations, 12 CFR §§ 2.1-2.5. See Saxon v. Georgia Association of Independent Insurance Agents, Inc., 399 F.2d 1010 (CA5 1968); Commissioner v. Morris Trust, 367 F.2d 794, 795 (CA4 1966); Hackley, Our Baffling Banking System, pt. 2, 52 Va L. Rev. 771, 777-779 (1966). United States Code Annotated carries the provision as § 92 of its Title 12.
3. Brief for Respondents 2.
4. I use this and other terms as they have been defined in the Court's opinion.
5. Despite this payment to Smith, it was not Smith, but Management Company, that reported the commissions as taxable income. This reveals the fluidity of control of the structure. Of course, the fact that the Commissioner did not allocate the premiums to the Banks during the period is of small, if any significance, for, as the Court points out, ante, at 397-398, n. 2, the then tax rate for each of the corporate entities was likely the same. The Government thus would lose nothing by not allocating.
6. Harrison v. Schaffner, 312 U.S. 579 (1941); Helvering v. Eubank, 311 U.S. 122 (1940); Burnet v. Leininger, 285 U.S. 136 (1932); Lucas v. Earl, 281 U.S. 111 (1930). Cf. Hoeper v. Tax Comm'n, 284 U.S. 206 (1931); Blair v. Commissioner, 300 U.S. 5 (1937). See Commissioner v. Sunnen, 333 U.S. 591, 604-610 (1948); United States v. Mitchell, 403 U.S. 190 (1971).
7. Helvering v. Horst, 311 U.S. 112 (1940).
8. United States v. Joliet & Chicago R. Co., 315 U.S. 44 (1942).
9. Helvering v. Clifford, 309 U.S. 331 (1940).
10. Old Colony Trust Co. v. Commissioner, 279 U.S. 716 (1929).
11. Burnet v. Wells, 289 U.S. 670 (1933).
12. Douglas v. Willcuts, 296 U.S. 1 (1935); Helvering v. Fitch, 309 U.S. 149 (1940); see Commissioner v. Lester, 366 U.S. 299 (1961).

13. "...But the net income for 1924 was paid over to the petitioner's wife and the petitioner's argument is that however it might have been in different circumstances the income never was his and he cannot be taxed for it. The legal estate was in the trustee and the equitable interest of the wife. "But taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed—the actual benefit for which the tax is paid..." 281 U.S., at 377-378.

    In another case Mr. Justice Holmes said:

    "There is no doubt that the statute could tax salaries to those who earned them and provide that the tax could not be escaped by anticipatory arrangements and contracts however skillfully devised to prevent the salary when paid from vesting even for a second in the man who earned it..." Lucas v. Earl, 281 U.S. 111, 114-115 (1930).

14. "There is a potential abuse situation in the case of the so-called captive insurance companies. It may be possible for a finance company, for example, to establish a subsidiary life insurance company that will issue life insurance policies in connection with the business of the parent. If the subsidiary charges excessive premium on this business, a portion of the income of the parent company can be diverted to the life insurance company. It is believed that section 482 of the Internal Revenue Code of 1954 (relating to allocation of income and deductions among related taxpayers) provides the Secretary of the Treasury ample regulative authority to deal with this problem."