Commissioner v. First Security Bank of Utah/Dissent Marshall

by Thurgood Marshall

MR. JUSTICE MARSHALL, dissenting.

The facts of this case illustrate the natural affinity that lending institutions and insurance companies have for each other. Congress depends on the ability of the Commissioner of Internal Revenue to utilize § 482 of the Internal Revenue Code, 26 U.S.C. § 482, to insure that this affinity does not provide a basis for tax avoidance. H.R. Rep. No. 1098, 84th Cong., 1st Sess., 7; S. Rep. No. 1571, 84th Cong., 2d Sess., 8. In my opinion, [p408] today's decision renders § 482 a less efficacious weapon against tax avoidance schemes than Congress intended and provides the respondents with an unwarranted tax advantage. I dissent.

Section 482 provides:

"In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned and controlled directly or indirectly by the same interests, the Secretary or his delegate may distribute, apportion, 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 of such organizations, trades, or businesses."

First enacted as § 45 of the Revenue Act of 1928, 45 Stat. 806, the statute was intended to prevent the avoidance of tax liability through fictions and "to deny the power to shift income... arbitrarily among controlled corporations, and to place such corporations rather on a parity with uncontrolled concerns." Central Cuba Sugar Co. v. Commissioner, 198 F. 2d 214, 216 (CA2 1952). See H.R. Rep. No. 2, 70th Cong., 1st Sess., 16-17; S. Rep. No. 960, 70th Cong., 1st Sess., 24-25. It is intended to serve the same purpose in the present Code.

It is well-established law that in analyzing a transaction under § 482, the test is whether the arrangement as structured for income tax purposes by interlocking corporate interests would have been similarly structured by taxpayers dealing at arm's length. See, e.g., Borge v. Commissioner, 405 F. 2d 672 (CA2 1968), cert. denied sub nom. Danica Enterprises v. Commissioner, 395 U.S. [p409] 933 (1969); Eli Lilly & Co. v. United States, 178 Ct. Cl. 666, 372 F. 2d 990 (1967).

Applying that test to this case, the following facts are relevant. Before 1954, an independent insurance company paid respondents commissions ranging from 40% to 45% for their services in offering insurance to borrowers designed to discharge their debts in the event that they died or became disabled during the term of their loans. After 1954, respondents offered borrowers policies issued by a different insurance company. At this time the holding company that controlled respondents created a new subsidiary to reinsure the borrowers who purchased policies. By paying off the independent insurance company with 15% of the proceeds of the policies, the subsidiary assumed the insurance risks and garnered the remaining 85% of the proceeds. No commission was paid to respondents by either the independent company or the insurance subsidiary.

The tax advantage of the post-1954 structure derived from the fact that the Life Insurance Company Tax Act for 1955, 70 Stat. 36, as amended by the Life Insurance Company Income Tax Act of 1959, 73 Stat. 112, as amended, 26 U.S.C. § 801 et seq., gives preferential treatment to life insurance companies. By funneling all proceeds from the sales of the insurance policies to a subsidiary that qualified for tax treatment as a life insurance company, the holding company avoided the heavier tax that would have been imposed on respondents had they been paid commissions.

The Commissioner's analysis of this case is not overly complex: He saw that respondents performed essentially the same services and generated the same income after 1954 that they did before, and he concluded that § 482 required that they should be taxed on their premiums that they were actually earning.

[p410] Based on respondents' earlier experience dealing at arm's length with an independent insurance company and on the well-known fact that insurers play solicitors a portion of the premium as a commission for generating income, see Local Finance Corp. v. Commissioner, 48 T.C. 773, 786 (1967), aff'd, 407 F. 2d 629, 631-632 (CA7 1969), the Commissioner determined that 40% of the premium income was properly allocated to respondents.

The respondents make, in essence, two arguments in their attempt to rebut the Commissioner's position. First, they urge that they never received any funds as a result of offering the policies to borrowers, and that it is therefore unfair to tax them on any portion of said proceeds. If § 482 is to have any meaning, that argument must be rejected. It makes absolutely no sense to examine this case with a technical eye as to whether respondents actually received or had a "right" to receive any commissions. This is not a case involving independent companies or private individuals where we must scrupulously avoid taxing someone on money he will never receive regardless of his will in the matter. See, e.g., Blair v. Commissioner, 300 U.S. 5 (1937); cf. Teschner v. Commissioner, 38 T.C. 1003 (1962). This is a case involving related corporations, and § 482 recognizes that such corporations may be treated differently from natural persons or unrelated corporations for certain tax purposes.

We need not look far to find that this entire complicated economic structure—established, designed, administered, and amendable by the holding company—had the right to the proceeds. Pursuant to § 482, the Commissioner properly attempted to insure that the proceeds would be equitably allocated.

The Court apparently concedes that if respondents' only argument against taxation were that they have [p411] received no money, that argument would fail. This concession is, in fact, mandated by various decisions of this Court, including Harrison v. Schaffner, 312 U.S. 579 (1941); Helvering v. Horst, 311 U.S. 112 (1940), and Lucas v. Earl, 281 U.S. 111 (1930).

Having implicitly rejected the argument that mere nonreceipt of money is sufficient to avoid taxation, the Court proceeds to accept respondents' second argument that in this case the taxpayer is legally barred from ever receiving money, and in this circumstance he cannot be taxed on it. Respondents find a legal bar to receipt of the proceeds at issue here in 12 U.S.C.A. § 92, which provides:

"In addition to the powers now vested by law in national banking associations organized under the laws of the United States any such association located and doing business in any place the population of which does not exceed five thousand inhabitants, as shown by the last preceding decennial census, may, under such rules and regulations as may be prescribed by the Comptroller of the Currency, act as the agent for any fire, life, or other insurance company authorized by the authorities of the State in which such bank is located to do business in said State, by soliciting and selling insurance and collecting premiums on policies issued by such company; and may receive for services so rendered such fees or commissions as may be agreed upon between the said association and the insurance company for which it may act as agent; and may also act as the broker or agent for others in making or procuring loans on real estate located within one hundred miles of the place in which said bank may be located, receiving for such services a reasonable fee or commission:

Provided, however, That no such bank shall in any case guarantee [p412] either the principal or interest of any such loans or assume or guarantee the payment of any premium on insurance policies issued through its agency by its principal;

And provided further, That the bank shall not guarantee the truth of any statement made by an assured in filing his application for insurance."

This statute by inference and the regulations of the Comptroller of the Currency, 12 CFR §§ 2.1-2.5, by explicit language bar national banks in communities with more than 5,000 inhabitants from selling, soliciting, or receiving the proceeds from selling insurance. Respondents are within the legal prohibition and the penalties provided for a violation are indeed severe. Assuming that the respondents will not attempt to violate the law and not wishing to appear to encourage a violation, the Court concludes that respondents will receive none of the proceeds and that they cannot be taxed on money they will never receive.

But the crucial fact in this case is that under their own theory respondents have already violated the federal statute and regulations by soliciting insurance premiums. Title 12 U.S.C.A. § 92 was added to the federal banking laws in 1916 at the suggestion of John Skelton Williams, who was then Comptroller of the Currency. He wrote to Congress to recommend that national banks in small communities be permitted to associate with insurance companies, but that banks in larger communities be prohibited from doing the same:

"It seems desirable from the standpoint of public policy and banking efficiency that this authority should be limited to banks in small communities. This additional income will strengthen them and increase their ability to make a fair return to their shareholders, while the new business is not likely to [p413] assume such proportions as to distract the officers of the bank from the principal business of banking. Furthermore in many small places the amount of insurance policies written... is not sufficient to take up the entire time of an insurance broker, and the bank is not therefore likely to trespass upon outside business naturally belonging to others.

"I think it would be unwise and therefore undesirable to confer this privilege generally upon banks in large cities where the legitimate business of banking affords ample scope for the energies of trained and expert bankers. I think it would be unfortunate if any movement should be made in the direction of placing the banks of the country in the category of department stores..." Letter of June 8, 1916, to Senate, 53 Cong. Rec. 11001.

There is nothing in the history of the provision to indicate that Congress was more concerned with banks' actually receiving money than with their performing the activities that generated the money. In fact, the history that is available indicates that it is the activities themselves that Congress wished to stop. Banks in large communities were simply not permitted to do anything that insurance agents might do, i.e., they were not permitted to solicit insurance.

Under respondents' theory of the case, the legal violation is thus a fait accompli and the respondents are taxable as if there had been no illegality.^[1] See, e.g., United [p414] States v. Sullivan, 274 U.S. 259 (1927); Rutkin v. United States, 343 U.S. 130 (1952); James v. United States, 366 U.S. 213 (1961). See also Tank Truck Rentals v. Commissioner, 356 U.S. 30 (1958).

[p415] The Court seeks, however, to distinguish all of the prior cases holding that a taxpayer may be taxed on income illegally earned on the ground that the issue was never raised as to whether the taxpayers in those cases had actually received the income. The distinction is valid but it does not warrant a different result in this case.

The reasoning of the majority runs along these lines: if A violates the law—by attempted embezzlement or by illegally soliciting insurance sales, for example—but he receives no money and has no "legal right" to receive any money, then he cannot be taxed as if the money had been received; but, if A actually embezzles money or receives insurance premiums in violation of the law, A can be taxed even though he may have transferred the money without any personal gain to a third party from whom he has no right of recovery.

I would agree with this analysis in most cases. Where I differ from the Court is in which category to place this transaction. To pretend that respondents have not received any money and have no right to any money is to ignore the thrust of § 482. That section requires that we treat this case as if the commissions had been paid to [p416] respondents and had been transferred to the insurance subsidiary by them. Of course, that did not occur. But, we know that the whole notion of the section is to look behind the form in which a transaction is structured to its substance. The substance is either that the respondents violated federal law, earned illegal income, attempted to avoid taxation on the income by channeling it somewhere, and were caught by the Commissioner; or, that they did not violate federal law by soliciting sales of insurance and that there is no legal bar to their receiving the proceeds from their sales. In either case, the result is the same, and respondents cannot prevail.

If respondents had actually received the proceeds and transferred them to the insurance subsidiary, they would still be free to make essentially the same argument that they make in this case, i.e., they argue that federal law prohibited them from receiving the money; that they violated federal law, but had no right to keep the money; and that they should not be taxed on receipt of funds which they could not legally keep.

To be consistent with the assignment-of-income cases, Helvering v. Horst, supra, and Lucas v. Earl, supra, and the line of cases that involves Rutkin v. United States, supra, and James v. United States, supra, the Court would have to reject this argument. Yet, I maintain that this is just what the taxpayer is arguing here. The Commissioner has determined that in reality the respondents have earned income, and that he has taxed it under § 482. To reject his position is to give undue weight to the absence of technical temporary possession of money and some abstract concept of a "right" to receive it. I had thought that this kind of technical reasoning was rejected in James v. United States, supra, when the Court overruled Commissioner v. Wilcox, 327 U.S. 404 (1946).

[p417] Finally, even if there is some mysterious reason why the banking laws should be read in the manner suggested by respondents, there is still another reason why they should not prevail. The fact would remain that they consciously chose to perform services in order that their parent holding company would reap financial rewards.^[2] Certainly, there is nothing in the federal banking laws that required the performance of these services. In the context of a complex corporate structure ministered by one large holding company, the purposes of § 482 are best served by permitting the Commissioner to allocate income to the company that earns it, rather than to the company that receives it. Again, we must remember that this is not a case of unrelated private individuals or independent corporations where there might be some danger that in allocating income to the person who generated but did not receive it, the Commissioner would render that person financially unable to pay his taxes. This case involves one large interrelated system. It would be total fiction to assume that the holding company would leave its subsidiaries in a financial bind. Hence, there is no good reason to bar the Commissioner from taxing respondents on the money that they earn.^[3]

In my view, the Commissioner has done exactly what § 482 requires him to do in this case. Accordingly, I [p418] would reverse the decision of the Court of Appeals and would remand the case with a direction that judgment be entered for the petitioner.

Notes

1. Neither the statute nor the regulations use the words "originating and referring" insurance. These are the words chosen by the Court to describe the respondents' activities, ante, at 405. The statute and regulations speak of "soliciting and selling." Because the respondents themselves argue that they would violate § 92 and the regulations were they to receive the income generated by their activities, I assume that they, in effect, are admitting that these activities amounted to "soliciting and selling" insurance. Thus, the Commissioner could properly determine that the state was violated by the acts of solicitation, and, as the Court recognizes, since "the illegality involved was the act which gave rise to the income," this Court's prior decisions permit the Commissioner to tax the income of the lawbreakers.

   If, however, the Court is attempting to distinguish sub silentio between "originating and referring" and "soliciting" and is concluding only that the latter is illegal, then there is nothing in the statute or regulations that would make illegal the receipt of income generated by the former. Hence, the Commissioner could reject the respondents' second argument that it would violate federal banking laws to include the proceedings in their income.

   Whichever approach the Court selects, the statute requires consistency—i.e., the statute requires that the activities that produce income be illegal before the receipt of the income is deemed to violate the law.

   I agree with the Court that deference be paid to the expertise of the Comptroller, but in proposing that § 92 be added to the already existing banking laws, Comptroller Williams himself noted that "[i]t is certainly clear that the Comptroller of the Currency has no right to authorize or permit a national bank to exercise powers not conferred upon it by law." Letter of June 8, 1916, supra.

   Senator Owen, who shepherded the 1916 legislation through the Senate, noted at one point that § 92 is not a very important part of the statute. 53 Cong. Rec. 11001. Perhaps, it is therefore unimportant whether or not the respondents have technically violated it. Whether or not the Comptroller has properly permitted such activities to take place may also be of no great moment.

   What is critical to a correct disposition of this case, in my view, is that if respondents' activities are not illegal, there is no reason that receipt of the income generated from them should be illegal. It should be pointed out that the theory that receipt of said income would be illegal was first proffered by respondents' counsel. This theory is certainly self-serving in the sense that it provides what the Court regards as the dispositive factor in this case without hindering the activities of the holding company in any way.

   The Court suggests that the Commissioner has never relied on the theory of the case expressed in this opinion. On the contrary, the Commissioner argued in his brief (p. 13) as follows:

   "The Commissioner's allocation does not force respondents to violate the federal banking law. It was they, not the Commissioner, who chose to solicit and sell credit life insurance at a rate set at a sufficiently high level to permit the payment of commissions. If their activities did not violate the banking law, the Commissioner's allocation will not, of itself, constitute a violation on their part. And, surely, the payment of taxes would not be an illegal act."

   Both sides dealt with this point in oral argument. Tr. of Oral Arg. 14-18, 30, 40.

   This is the nub of the case. What is there in the legislative history or the purpose of § 92 that requires that we treat the activities as legal, but the receipt of the income they generate as illegal?

2. While the premiums from the insurance policies were not paid directly to the parent, there can be no doubt that the parent benefited from the financial success of its subsidiaries.
3. We know that nontax statutes do not normally determine the tax consequences of a particular transaction. There is no inherent inconsistency in reading the banking legislation as making the receipt of insurance premiums illegal, and, at the same time, reading the Internal Revenue Code as allowing the Commissioner to allocate the income from the sale of insurance policies to the party actually earning it, so long as the income is received by the corporation controlling that party.