
    THE PRUDENTIAL INSURANCE COMPANY OF AMERICA v. THE UNITED STATES
    [No. 55-59.
    Decided June 7, 1963]
    
      
      Francis A. Goodhue, Jr. for plaintiff. Arthur E. Schmauder, Frank G. Koch; John H. Perkins, Jr., Peter J. Sturtevant, Dewey, Ballantine, Bushby, Palmer & Wood; and Arnold I. Burns were on the briefs.
    
      Earl L. Huntington, with whom was Assistant Attorney General Louis F. Oberdorfer, for defendant. Edward S. Smith, Lyle M. Turner, and Mitchell Samuelson were on the brief.
    
      Paul F. Myers, John E. Skilling; J oseph H. Collins, George E. Walton, Bernard G. Hildebrand, Gerard J. Talbot, Robert H. Myers, and Williams, Myers and Quiggle filed a brief for the Metropolitan Life Insurance Company, amicus curiae.
    
    Before Jones, Chief Judge, Whitaker, Laramore, Durfee and Davis, Judges.
    
   Durfee, Judge,

delivered the opinion of the court:

This is an action to recover an alleged overpayment by plaintiff of Federal income tax for the calendar year 1949. Plaintiff is a mutual life insurance company organized under the laws of the State of New Jersey. In 1949, it was engaged in the insurance business in the United States and Canada.

During the year 1949, plaintiff paid a tax imposed by the Provinces of Ontario and Quebec of two percent on the insurance premiums collected that year from policyholders residing in the respective provinces. Plaintiff also paid the same tax imposed by the Dominion of Canada on premiums collected in 1949 from policyholders residing in Canada outside of the Provinces of Ontario and Quebec. By payment of these premiums taxes, plaintiff was excused from payment of Canadian income taxes by express provisions of law within each of the three Canadian jurisdictions. The combined total alien premium tax payment amounted to $558,513.57. Plaintiff’s first claim is that by virtue of Internal Eevenue Code provisions, $304,855.84 of this total Canadian tax payment was allowable as a credit against its United States income tax for 1949, but was wrongfully assessed and collected by the Collector of Internal Eevenue. Plaintiff seeks recovery of this amount plus interest as a “foreign tax credit” under sections 131 (a) and (h) and 205 of the 1939 Code.

Section 131(a) as amended, provided in 1949 that the income tax of a domestic corporation “* * * shall be credited with the amount of * * * any income taxes paid or accrued during the taxable year to any foreign country * * For the purposes of this section (131), the term “income * * * taxes shall include a tax paid in lieu of a tax upon income * * * otherwise generally imposed by any foreign country.”

The provision for a foreign tax credit for a tax paid “in lieu of a tax upon income” in subsection (h) of section 131 of the Code was added to this section by section 158(f) of the Eevenue Act of 1942, 56 Stat. 798,858. The reason for this enactment was clearly stated by the Senate Finance Committee, (S. Eep. No. 1631, 77th Cong. p. 131) :

Your committee believes further amendments should be made in section 131. Under that section as it now stands, a credit is allowed against United States tax for income * * * taxes paid or accrued to any foreign country * * *. In the interpretation of the term “income tax,” the Commissioner, the Board, and the courts Time consistently adhered to a concept of income tax rather closely related to our own, and if such foreign tax was not imposed upon a basis corresponding approximately to net income it was not recognized as a basis for such credit. Thus if a foreign country in imposing income taxation authorized, for reasons growing out of the administrative difficulties of determining net income or taxable basis within that country, a United States domestic corporation doing business in such country to pay a tax in lieu of such income tax but measured, for example, by gross income, gross sales or a number of units produced within the country, such tax has not heretofore been recognized as a basis for a credit. Your committee has deemed it desirable to extend the scope of this section. Accordingly, subsection (f) of section 160 provides that the term “income * * * taxes” shall * * * include a tax paid by a domestic taxpayer in lieu of the tax upon income * * * which would otherwise be imposed upon such taxpayer by any foreign country or by any possession of the United States. * * * [Emphasis supplied.]

This statement is a clear expression of intent to widen the judicial interpretation that had previously been given to the term “income taxes” in subsection (a) of section 131 as being limited to foreign taxes based on net income, (i.e. on gain or profit), in order to include a tax measured by gross income or gross sales as a basis for tax credit.

This legislative purpose in adding “taxes paid in lieu of” income taxes for foreign income tax credit was recognized by the United States Court of Appeals for the Ninth Circuit in the case of Northwestern Mut. Fire Ass'n v. Commissioner of Internal Revenue, 181 F. 2d 133 (9th Cir., 1950). That case involved the question whether the premiums taxes paid by a United States mutual fire insurance company to the Dominion of Canada for 1942 and 1943 could be credited against its Federal income taxes for those years under section 131(h)’ of the Internal Revenue Code of 1939, as amended. The court said (p. 135) :

[2] * * * The report of the Senate Finance Committee on proposed § 131 (h) expressly states that foreign taxes measured by “gross sales” would constitute a credit, * * *. Manifestly gross sales have no relation to profits. Gross sales are however analogous to “net premiums.” * * *
[3] Both the language and the legislative history of Int. Rev. Code, § 131(h), force us therefore to conclude that the Canadian “net premium” tax imposed upon petitioner, like the American counterpart imposed by Int. Rev. Code, § 207(a) (2), was “in lieu of a tax upon income” within the meaning of Int. Rev. Code, § 131 (h). It follows that the petitioner is entitled to the credits claimed in the returns for tax years 1942 and 1943, and •that the deficiencies assessed by the Commissioner were erroneous.

Defendant has attempted to distinguish this case from the present one because gross premiums of fire insurance companies involved in the Northwestern Mut. Fire Ass’n case, supra, were includable in gross income for Federal tax purposes, whereas premiums on life insurance, presently involved, are not included in the income of a life insurance company for Federal taxation. This distinction was eliminated by the language of the Senate Finance Committee Report previously quoted, which expressly contemplated that the scope of section 131(a) was to be extended to include “a tax in lieu of such income tax but measured, for example, by gross income, gross sales, or a number of units is supplied within the country.” [Emphasis supplied.] Whatever legal distinctions were drawn prior to enactment of this amendment as to the basis for taxing the income of fire insurance companies as distinguished from life insurance premiums collected in determining foreign income tax credit, the life insurance premiums taxes paid by plaintiff in Canada were measured by gross income or by gross sales.

The Ontario premiums tax for 1949 was imposed by section 4 of The Corporations Tax Act of Ontario (3 Geo. VI (1939), c. 10, as amended). That section declared in subsection (1) that “Every insurance company shall pay a tax in respect to life insurance premiums of two per centum calculated upon the gross premiums received during the fiscal year from policyholders resident in Ontario,” excluding premiums returned and certain other items. The same statute provided in subsection (1) of section 14 that “* * * every incorporated company * * * which transacts business in Ontario, shall for every fiscal year of such company pay a tax of seven per centum calculated upon the net income of the incorporated company;” but subsection (3) (h) of section 14 expressly provided that “Any incorporated company paying taxes under this Act as * * * [an] insurance company” should not be subject to the tax imposed by section 14. Therefore, plaintiff was excused from paying the Ontario tax calculated on the net income of corporations because it was an insurance company paying a premiums tax under another section of the same statute. It seems obvious that if the Ontario premiums tax was not an “income” tax, it was certainly a tax paid “in lieu of” income tax and, therefore, that it clearly came within the scope of subsection (h) of section 131 of the Internal Revenue Code of 1939, as amended.

The premiums tax which plaintiff paid to the Province of Quebec for 1949 was imposed by subdivision 3 of section 3 of the Quebec Corporation Tax Act (11 Geo. VI (1947), c. 33). This subdivision imposed on “every insurance company, a tax of two per centum on every premium received by the company * * * in respect of the business transacted in Quebec.” Other subdivisions of section 3 (it contained a total of 19 subdivisions) imposed taxes of various kinds on other types of companies, such as banks, loan companies, navigation companies, etc. Then section 6 of the same statute provided that “every company * * * contemplated by subdivisions 1, 4, 5, 6, 7, 8, 11, 13, 14, 15, 16, 17, 18 and 19 of section 3 * * * shall pay annually a tax equivalent to seven per centum of the net revenue of their respective financial year * * *.” The failure of section 6 in the portion just quoted to refer to subdivision 3 of section 3, covering insurance companies, had the effect of excusing insurance companies from the payment of the 7 percent tax on net revenue imposed by section 6.

The premiums tax which plaintiff paid to the Dominion of Canada in 1949 was payable under the Dominion’s Excise Tax Act (Rev. Stat. of Can. 1927), c. 179, as amended). That act provided in section 14(1) that “Every company authorized under the laws of the Dominion of Canada or of any province thereof to transact the business of insurance * * * shall pay to the Minister a tax of two per centum upon the net premiums received by it in Canada less net premiums paid for reinsurance to companies or associations to which this section applies * * The term “net premiums” was defined to mean “in the case of a company transacting life insurance, the gross premiums received by the company other than the consideration received for annuities, less premiums returned and less the cash value of the dividends paid or credited to policyholders.” However, an insurance company was permitted to deduct the amounts of any premiums taxes paid to any Provinces of Canada, and in 1949 only the Provinces of Ontario and Quebec were imposing such taxes. Another statute of the Dominion of Canada, The Income Tax Act (11-12, Geo. VI. (1948), c. 52, as amended), imposed in section 36 a tax on the net income of corporations, the rate on the taxable income, or on the taxable income earned in Canada, being 10 percent of the first $10,000 and 33 percent of amounts over $10,000. However, it was provided in section 29 of The Income Tax Act that the taxable income of a life insurance corporation should be “the aggregate of the amounts credited to shareholders’ account or otherwise appropriated for or on account of shareholders during the year,” less certain specified amounts. As plaintiff is a mutual insurance company, it does not have any shareholders; and accordingly, it was excused by section 29 of The Income Tax Act of Canada from paying the income tax imposed on corporations by that act.

Thus, it will be seen that plaintiff in 1949 was excused from paying the respective income taxes imposed by the Provinces of Ontario and Quebec and by the Dominion of Canada on the net income or net revenue of corporations, but that plaintiff was required to pay, and did pay, to each of these jurisdictions a tax measured in terms of its gross income or gross sales, i.e., on premiums received.

We conclude that the tax on insurance premiums which plaintiff paid within the three Canadian tax jurisdictions involved was “a tax paid in lieu of a tax upon income * * * otherwise generally imposed” within these three foreign tax jurisdictions, within the meaning of sec. 131 (h) of the Internal Revenue Code. Accordingly, we need not also determine whether these premiums taxes were “income taxes paid or accrued during the taxable year” to the Canadian jurisdictions, within the meaning of sec. 131(a).

Plaintiff was entitled to utilize the premiums taxes paid in Canada in 1949 as a credit against its 1949 Federal income tax.

ADJUSTMENT FOR CERTAIN RESERVES

During the year 1949, life insurance companies were taxed under section 201(a) (1) of the Internal Revenue Code of 1939, as amended by section 163(a) of the Revenue Act of 1942, 56 Stat. 798, 867, on their “adjusted normal-tax net income.” The term “adjusted normal-tax net income” was defined in section 202(a) of the 1939 Code, as amended in 1942, 56 Stat. at p. 870, to mean “the normal-tax net income minus the reserve and other policy liability credit provided in subsection (b) [of section 202] and flus the amount of the adjustment for certain reserves frovided in subsection (c) [of section 202]” [Emphasis supplied.] Subsection (c) of section 202, as amended in 1942, 56 Stat. at p. 870, defined the phrase “adjustment for certain reserves” in the following language :

“(c) Adjustment for certain reserves. — In the case of a life insurance company writing contracts other than life insurance or annuity contracts (either separately or combined with noncancellable health and accident insurance), the term ‘adjustment for certain reserves’ means an amount equal to 3]4 per centum of the unearned premiums and unpaid losses on such other contracts which are not included in life insurance reserves. For the purposes of this subsection such unearned premiums shall not be considered to be less than 25 per centum of the net premiums written during the taxable year on such other contracts.

In preparing its income tax return for the year 1949, and in computing “the amount of the adjustment for certain reserves” that was to be added to its normal-tax net income in accordance with section 202(c) of the Internal Revenue Code of 1939, as amended, plaintiff, with respect to the item of “unpaid losses,” included 3)4 percent of the amount ($1,078,876.87) held by it as reserves against unaccrued liabilities arising from its cancellable health and accident insurance contracts. Plaintiff did not include in this computation 3)4 percent of the amount ($2,469,553.50) of its accrued but unpaid liabilities arising from such contracts.

Subsequently, the Internal Revenue Service assessed a deficiency in plaintiff’s Federal income tax for 1949, based upon an administrative determination that there should be included in plaintiff’s “adjustment for certain reserves” 3)4 percent of the $2,469,553.50 representing the amount of plaintiff’s accrued but unpaid liabilities in respect of unsettled policy claims on cancellable health and accident contracts. This deficiency, in the amount of $30,498.99, plus interest thereon in the amount of $8,274.84, or a total of $38,773.83, was paid by plaintiff on July 20, 1950.

The claim for refund which plaintiff filed on or before December 26, 1956, with respect to its 1949 income tax, as indicated in an earlier part of this opinion, included an item relative to the refund of the $38,773.83 (plus interest) referred to in the preceding paragraph. The Internal Revenue Service did not allow this phase of plaintiff’s claim, and it is included in the present litigation.

Plaintiff calls attention to the fact that the heading of section 202(c) of the Internal Revenue Code of 1939, as amended in 1942, was “Adjustment for Certain Reserves.” Plaintiff also says that the committees of the Congress in charge of the proposed legislation that later enacted the 1942 version of section 202(c) referred to “unearned premiums” and “unpaid losses” as “these reserves” in discussing the particular provision (H. Rep. No. 2333, 77th Cong., p. 112; S. Rep. No. 1631, 77th Cong., p. 142). Plaintiff then cites court decisions — e.g., Commissioner v. Monarch Life Ins. Co., 114 F. 2d 314, 319 (1st Cir., 1940) — holding that, in the technical sense, insurance reserves are sums set up and maintained for the purpose of liquidating claims which are (among other things) unaccrued.

On the basis of the factors outlined in the preceding paragraph, plaintiff argues that the term “unpaid losses” in section 202(c) of the Internal Revenue Code of 1939, as amended, should be construed as being limited to reserves for unaccrued losses under the policies mentioned in the statutory provision.

Plaintiff, in effect, is asking the court to amend section 202(c) of the Internal Revenue Code of 1939, as amended, by limiting the scope of the plain words, “unpaid losses,” used by the Congress.

It is fundamental that an unambiguous statute should be given effect according to its plain and obvious meaning. Bate Refrigerating Co. v. Sulzberger, 157 U.S. 1, 36-37 (1895); Christner v. Poudre Valley Cooperative Ass'n, 235 F. 2d 946, 950 (10th Cir., 1956). This principle is as applicable to a revenue statute as it is to any other type of legislation. Crane v. Commissioner, 331 U.S. 1, 6 (1947).

Furthermore, the fact that the heading of section 202(c), as amended, contained the word “reserves” could not limit the meaning of the plain language used in the text of the statutory provision. Railroad Trainmen v. B. & O. R. Co., 331 U.S. 519, 528, 529 (1947).

We conclude that plaintiff is not entitled to recover on the phase of its claim relating to the “adjustment for certain reserves.”

PREPAYMENT PEES

Plaintiff in 1949 held investments in residential and commercial mortgages and in unsecured corporate obligations which contained provisions allowing the obligor to prepay the mortgage or corporate obligation upon the payment to plaintiff of an amount in excess of the principal amount payable at maturity, plus unpaid interest accrued to the date of the prepayment. Pursuant to such provisions contained in mortgage agreements, plaintiff in 1949 received prepayment fees totaling $542,789.35, and pursuant to the prepayment provisions contained in corporate obligations that were neither in registered form nor with coupons at-tacbed, plaintiff in 1949 received prepayment lees totaling $324,753.48.

The amounts of the prepayment fees referred to in the preceding paragraph were not reported by plaintiff as taxable income on its Federal income tax return for 1949. In its first amended answer, defendant asserts that these prepayment fees were erroneously omitted from plaintiff’s taxable income, and that the amount due the Government because of such omission should be set off against any recovery by plaintiff on its claim.

In 1949, life insurance companies were taxed under the Internal Revenue Code of 1939, as amended, on their investment income, consisting of interest, dividends, and rents. The question whether prepayment fees of the sort involved here were taxable as “interest” was before this court in the case of Equitable Life Assurance Soc. of U.S. v. United States, 149 Ct. Cl. 317; 181 F. Supp. 241 (1960), cert. denied, 364 U.S. 829. The question was answered in the affirmative by the court. See also Pattiz v. United States, 160 Ct. Cl. 121, 311 F. 2d 947 (1963).

As there is outstanding a fairly recent decision by this court squarely on the question of whether prepayment fees received by life Insurance companies were taxable as “interest” under the Internal Revenue Code of 1939, as amended, it must be concluded that the failure of plaintiff to include in its 1949 return, and pay the tax on, the prepayment fees mentioned earlier in this part of the opinion provides a basis for an offset by defendant against plaintiff’s recovery on the foreign tax credit issue.

COMMITMENT FEES

In its first amended answer, defendant also asserted that plaintiff erroneously failed to include in its 1949 taxable income amounts received by it during that year from loan applicants for investment commitments made by plaintiff.

Plaintiff concedes that it erroneously failed to include in its taxable gross income for 1949 the sum of $50,293.43 representing fees received by it in that year for investment commitments. Therefore, this item will also provide a proper basis for an offset against the amount of plaintiff’s recovery.

Plaintiff is entitled to recover on the foreign tax credit issue, but defendant is entitled to set off against the amount of plaintiff’s recovery the amounts due defendant because of plaintiff’s failure to include certain prepayment fees and commitment fees in its taxable gross income for 1949. Judgment is entered to this effect; the amount of recovery and offsets will be determined pursuant to Rule 38(c).

FINDINGS OE FACT

The court, having considered the evidence, the report of Trial Commissioner Mastín G. White, and the briefs and argument of counsel, makes findings of fact as follows:

The Plaintiff

1. The plaintiff is, and at all times material to this case it was, a mutual insurance company duly organized and existing as a corporation under the laws of the State of New Jersey, with its principal office and place of business at 763 Broad Street, Newark, New Jersey.

2. During the calendar year 1949, the plaintiff was engaged in the insurance business in the United States and Canada. It was a “life insurance company,” as that term was defined in Section 201(b) of the Internal Eevenue Code of 1939, as amended.

Payment of Income Tax for 1949

3. On or before December 15, 1950, the plaintiff duly filed with the Collector of Internal Eevenue, Fifth District, New Jersey, its United States Life Insurance Company Income Tax Eetum for the calendar year 1949, prepared on the calendar year basis and on the cash method of accounting.

4. On the plaintiff’s Federal income tax return for 1949, the plaintiff reported a normal-tax net income of $219,725,-286.19, of which $11,826,677.32 was from Canadian sources.

5. (a) On its reported normal-tax net income for 1949, the plaintiff computed and paid a Federal income tax to the United States in the amount of $5,502,991.71.

(b) The plaintiff’s Federal income tax for the calendar year 1949 was duly paid to the Collector of Internal Revenue, Fifth District, New Jersey, in four installments, three in the amount of $1,375,747.93 each and the fourth in the amount of $1,375,747.92. The installment payments were made by means of four checks dated December 15, 1950, March 15, 1951, June 15, 1951, and September 15, 1951, respectively. All of the checks were collected in due course.

Foreign Tax Credit

6. Pursuant to The Corporations Tax Act, 1939, of Ontario (3 Geo. VI, c. 10, as amended), the plaintiff paid to the Province of Ontario, with respect to premiums received from policyholders resident in Ontario, taxes accrued in the calendar year 1949 in the amounts of $217,698.27 and $81,-661.43 ($239,468.34 and $89,827.66 in Canadian currency at the official rate of exchange of .909090 for converting Canadian dollars to United States dollars), or a total of $299,359.70.

7. Pursuant to the Corporation Tax Act of Quebec (11 Geo. VI, c. 33 (1947)), the plaintiff paid to the Province of Quebec, on premiums received in respect of insurance of persons resident in Quebec, taxes accrued in the calendar year 1949 in the amount of $154,714.30 ($170,185.79 in Canadian currency at the official rate of exchange of .909090 for converting Canadian dollars to United States dollars) .5

8. Pursuant to the Dominion Excise Tax Act (Rev. Stat. of Can., 1927, c. 179, as amended), the plaintiff paid to the Dominion of Canada, with respect to premiums received from policyholders resident in Canadian Provinces other than Ontario and Quebec, taxes accrued in the calendar year 1949 in the amount of $104,439.57 ($114,883.64 in Canadian currency at the official rate of exchange of .909090 for converting Canadian dollars to United States dollars) ,

9. On its Federal income tax return for the calendar year 1949, the plaintiff did not claim a credit against its Federal income tax for any taxes imposed by the Province of Ontario, the Province of Quebec, or the Dominion of Canada. The plaintiff did not claim, and has not been allowed, any deduction for such taxes.

10. By virtue of written agreements of various dates between the plaintiff and the Commissioner of Internal Revenue, the plaintiff’s time within which to file a claim for refund of Federal income tax paid for the calendar year 1949 was extended until December 30,1956.

11. On or before December 26, 1956, the plaintiff duly filed with the District Director of Internal Revenue, Newark, New Jersey, in accordance with the applicable provisions of law and the regulations of the Secretary of the Treasury established in pursuance thereof, a claim for the refund of Federal income tax theretofore paid by it for the calendar year 1949 in the amount of $343,629.67, together with interest thereon.

12. The claim for refund of 1949 Federal income tax filed by the plaintiff included a claim in the amount of $304,855.84, together with interest thereon, on the ground that the premiums taxes paid by the plaintiff to the Provinces of Ontario and Quebec and to the Dominion of Canada pursuant to The Ontario Corporations Tax Act, 1939, the Quebec Corporation Tax Act, and the Dominion Excise Tax Act (see findings 6-8) constituted either income, war-profits, or excess-profits taxes or taxes paid in lieu of such taxes otherwise generally imposed by the Provinces of Ontario and Quebec and the Dominion of Canada, within the meaning of Sections 205 and 131(a) and (h) of the Internal Revenue Code of 1939, as amended, and that, as such, the taxes were allowable (subject to the limitations contained in Section 131(b) of the 1939 Code, as amended) as credits under Sections 205 and 131(a) of the 1939 Code, as amended, against the plaintiff’s Federal income tax for the calendar year 1949.

13. The plaintiff’s claim for refund of 1949 Federal income tax contained a valid election to have its foreign tax credit for 1949 computed on the accrual basis.

14. The plaintiff did not pay to the Province of Ontario for the calendar year 1949 any tax imposed by Section 14(3) (h) of The Corporations Tax Act, 1939, of Ontario.

15. The plaintiff did not pay to the Province of Quebec for the calendar year 1949 any tax imposed by Section 6 of the Corporation Tax Act of Quebec.

16. In 1942, all the Canadian Provinces executed agreements with the Dominion of Canada, known as the “Wartime Tax Agreements,” which provided for the suspension or repeal, for the period of World War II, of a number of Provincial taxes, including premiums taxes and corporation income taxes, in exchange for payment of compensation therefor by the Dominion to the Provinces. In 1949, Ontario and Quebec were the only Provinces that imposed premiums taxes.

17. Since 1943, when the plaintiff became a mutual company, it has had no shareholders, nor has it in any year since then credited any amount to shareholders’ accounts or otherwise appropriated any amounts for or on account of shareholders.

18. The plaintiff did not pay to the Dominion of Canada for the year 1949 any tax imposed by The Income Tax Act of the Dominion.

Adjustment for Certain Reserves

19. In computing its adjusted normal-tax net income on its return for the calendar year 1949, the plaintiff included as “unpaid losses” in its computation of the “adjustment for certain reserves” under Section 202(c) of the Internal Kev-enue Code of 1939, as amended, only the amount ($1,078,-876.87) held by it as reserves against unaccrued liabilities arising from its cancellable health and accident insurance contracts, and excluded therefrom the amount ($2,469,553.50) of its accrued but unpaid liabilities arising from such contracts.

20. (a) The Commissioner of Internal Kevenue assessed a deficiency in the plaintiff’s Federal income tax for the calendar year 1949, based upon his determination that there should be included in the plaintiff’s “adjustment for certain reserves” as “unpaid losses” the amount of $2,469,553.50, being the amount of the plaintiff’s accrued but unpaid liabilities in respect of unsettled policy claims on cancellable health and accident insurance contracts.

(b) This deficiency, in the amount of $30,498.99, plus interest thereon in the amount of $8,274.84, or a total of $38,773.83, was paid by the plaintiff on July 20, 1955, to the District Director of Internal Revenue, Newark, New Jersey.

21. The claim filed by the plaintiff for the refund of income tax paid by it for the calendar year 1949 (see finding 11) included a claim for the refund of $38,773.83, together with interest thereon, on the ground that the amount of the plaintiff’s accrued but unpaid liabilities arising from its cancellable health and accident insurance contracts was not properly includible as “unpaid losses” in the computation of its “adjustment for certain reserves,” within the meaning of Section 202(c) of the Internal Revenue Code of 1939, as amended.

22. During 1949, the plaintiff did not have in force any noncancellable health and accident insurance contracts not combined with life insurance.

23. During 1949, all of the plaintiff’s cancellable health and accident insurance contracts in force were group health and accident policies. With respect to the bulk of these contracts, the premiums were payable monthly.

24. During 1949, the principal benefits provided for in the plaintiff’s cancellable health and accident insurance contracts were accidental death and dismemberment benefits payable in a lump sum, amounts payable periodically toward loss of income due to accident or sickness, and amounts payable toward hospital bills, medical care, and surgical fees.

25. Upon the occurrence of an accident -under circumstances requiring the plaintiff, under the terms of a can-cellable health and accident insurance contract, to pay a lump-sum benefit for death or dismemberment, the lump-sum death or dismemberment benefit became an indebtedness of the plaintiff which was immediately due and payable, subject to submission of the required application and proof. At any given time after the accident and prior to payment of the claim, the obligation to pay the lump-sum benefit constituted an accrued but unpaid liability, regardless of what stage had then been reached in the adjustment procedure or whether the claim was being resisted. As an accrued but unpaid liability, the plaintiff did not include this obligation as an “unpaid loss” in the computation of its “adjustment for certain reserves.”

26. (a) Upon the occurrence of an accident or the inception of a sickness as a result of which the plaintiff, under the terms of a cancellable health and accident insurance contract, might be required to pay benefits toward hospital, medical, or surgical bills, the plaintiff had also to provide for the anticipated benefits. The plaintiff’s obligation with respect to these benefits was then unaccrued, since nothing was then due and the amount of its potential liability was contingent upon the disabled person’s survival, his continued disability, and the hospital, medical, or surgical bills incurred. To provide for these benefits, the plaintiff set up as a reserve such amoimt as would, on the average, be sufficient to cover its liability. Such reserve was determined by actuarial computations modified in the light of recent experience. The amounts thus reserved were the amounts held by the plaintiff as reserves against unaccrued liabilities arising from its can-cellable health and accident insurance contracts.

(b) As disabilities continued and hospital, medical, or surgical bills were incurred, the plaintiff’s liability on account of these items became fixed, and amounts unpaid as of a given date with respect to the bills for prior periods became accrued liabilities. The plaintiff did not include these accrued but unpaid liabilities in its “unpaid losses” in the computation of its “adjustment for certain reserves.”

27. In 1949, under arrangements with a number of the employers with whom the plaintiff had cancellable group health and accident insurance contracts in force providing coverage for a large number of employees, many of the claims were processed and paid by the employers themselves by the use of drafts drawn on the plaintiff, on forms furnished by it, for acceptance by a named bank with which the plaintiff maintained balances especially for this purpose. Such drafts were invariably accepted upon presentation, and they were forwarded daily by the banks to the plaintiff, whereupon they were recorded in due course by the plaintiff’s accounting department. In such cases, records of the employers were periodically audited by the plaintiff.

28. As of any given date, under the terms of its cancellable health and accident insurance contracts, the plaintiff had incurred liabilities to pay benefits as to which no proof of loss or reports had yet been received. These liabilities were included by the plaintiff in the annual statement prescribed by the Commissioner of Banking and Insurance of the State of New Jersey under the title “Estimated Net Losses Incurred But Not Yet Reported,” a title prescribed by the insurance commissioner. The plaintiff’s estimate of such liabilities was made by actuarial computations modified in the light of recent experience. This amount was excluded from the plaintiff’s computation of its “unpaid losses” component of its “adjustment for certain reserves,” since it was an accrued but unpaid liability.

29. The amount held by the plaintiff as reserves against unaccrued liabilities arising from its cancellable health and accident insurance contracts, which was included by the plaintiff as “unpaid losses” in its computation of the “adjustment for certain reserves” on its income tax return for 1949, was the mean of the amounts described on its annual statements as the “present value of amounts not yet due on claims under accident and health policies” at the beginning and end of the year 1949.

30. The amount of accrued but unpaid liabilities arising from the plaintiff’s cancellable health and accident insurance contracts which was included by the Commissioner of Internal Revenue as “unpaid losses” in the computation of the plaintiff’s “adjustment for certain reserves,” for purposes of the deficiency assessment for 1949 (see finding 20), was the mean of the amounts described on its annual statements as the “Total Liability for Outstanding [Accident and Health] Policy Claims and Losses” at the beginning and end of the year 1949. As of December 31, 1949, these policy claims and losses outstanding, which the Commissioner of Internal Revenue included in his computation of the plaintiff’s “unpaid losses,” were composed of:

Due but Unpaid- 0

Incomplete Proofs Under Adjustment, or Adjusted but Not Due_ $365, 958. 00

Resisted- 27, 237. 00

Deduct Reinsurance_ 1, 350. 00

Net Reported Outstanding Policy Claims and Losses _ 391, 845. 00

Estimated Net Losses Incurred but Not Yet Reported_ 2,191, 000. 00

Total Liability for Outstanding Policy Claims and Losses- 2, 582, 845. 00

31. The forms for annual statements, and supporting schedules thereto, required of life insurance companies during the year in question by the Commissioner of Banking and Insurance of the State of New Jersey (and in nearly all other States), to which the plaintiff conformed, required the reporting in Schedule O of “Losses and claims unpaid” and “Estimated liability on unpaid losses and claims Dec. 31 of previous year, per Item 16a, Column 7, page 5 of last annual statement.” The amounts so reported by the plaintiff in this schedule to the Commissioner of Banking and Insurance were the sum of its reserves against unaccrued liabilities and its accrued but unpaid liabilities. For 1949, the year in question, the plaintiff footnoted the second entry so that it read, “Estimated liability on unpaid losses and claims Dec. 31 of previous year, per Item 16a, Column 7, page 5 of last annual statement, $3,194,170.00 (Includes $837,908.00 which was shown in item 9c, page 5, of the annual statement for the year ended December 31, 1948).”

32. The forms for annual statements and supporting schedules thereto, required of life insurance companies during the year in question by the Commissioner of Banking and Insurance of the State of New Jersey (and in nearly all other States), to which the plaintiff conformed, required the reporting in Schedule S, “Showing Names and Locations of Companies and Amounts Recoverable for all Reinsurance on Paid and Unpaid Losses and Claims,” of “Unpaid Losses” covered by reinsurance. The amount so reported by the plaintiff for the year in question was equal to the deduction from accrued liability reported as “Deduct Reinsurance” in column 4, line 16A, page 5, of the corresponding statement.

33. The premiums on the plaintiff’s cancellable health and accident insurance contracts that were in force in 1949 were actuarially computed to provide the plaintiff with sufficient funds, on the average, to meet all the policy claims arising during the period covered by the premiums, plus an amount known as “loading” to cover expenses and contingencies.

34. In the case of cancellable health and accident insurance policies, unearned premiums as of any given date are equal to the sum of fractions of premiums which are in each case proportionate to the unexpired parts of the respective periods for which such premiums were paid. Upon the due date, for example, of a monthly premium receivable under a cancellable group health and accident insurance contract, the plaintiff set aside the full amount of the premium as unearned premium.. By the 10th day of the policy month, one-third of the premium would have been earned and two-thirds would be unearned. A similar practice was followed in computing unearned premiums in the case of policies providing for payment of premiums on an annual, semi-annual, or quarterly basis. While computation of the premiums was based on mortality and morbidity tables, plus “loading,” no reference to such tables was required in computing, as of any given date, the fractions or amounts of such premiums that were unearned.

Prepayment Fees

35. The plaintiff in 1949 held investments in residential and commercial mortgages and in unsecured corporate obligations which contained provisions allowing the obligor to prepay the mortgage or corporate obligation upon the payment to the plaintiff of an amount in excess of the principal amount payable at maturity, plus unpaid interest accrued to the date of prepayment.

36. Pursuant to the prepayment provisions contained in mortgage agreements, the plaintiff in 1949 received prepayment fees totaling $542,789.35; and pursuant to the prepay-menfc provisions contained in corporate obligations that were neither in registered form nor with coupons attached, the plaintiff in 1949 received prepayment fees totaling $324,753.48. These amounts were not reported by the plaintiff as taxable income on its Federal income tax return for 1949.

37. Of the total amount of $867,542.83 received by the plaintiff in 1949 as prepayment fees in connection with mortgages and corporate obligations that were neither in registered form nor with coupons attached, the sum of $25,822.57 was from Canadian sources.

38. The plaintiff in 1949 also received prepayment fees on corporate obligations in registered form or with coupons attached. The plaintiff did not report such amounts as taxable income on its Federal income tax return for 1949; and the parties have stipulated for the purposes of this case only that such amounts were correctly excluded from the plaintiff’s taxable income.

39. A prepayment fee or charge is a charge made by the lender for either partial or full payment of the loan in advance of the maturity date. There is no difference between a prepayment charge and that portion of a “call price” which is in excess of the par value of the obligation.

40. The price at which a debt instrument with a fixed rate of interest and no prepayment privilege may be purchased will rise and fall as the general level of interest rates fluctuates. The price will go above par when interest rates, obtainable for an instrument of similar credit risk, go down. It will fall below par when interest rates, obtainable for an instrument of similar credit risk, go up.

41. The appreciation in market value of a debt instrument which would otherwise result from a fall in the general level of interest rates will not occur if, under the instrument, the obligor has the privilege of prepayment at any time without penalty.

42. Prepayment fees are commonly fixed according to a scale providing for decreasing amounts as the maturity date of the instrument approaches. This is because such capital appreciation as may have resulted from a drop in the general level of interest rates will diminish as the maturity date of an instrument approaches.

43. Some prepayment provisions contained in obligations owned by the plaintiff in 1949, and pursuant to which the plaintiff received prepayment fees in such year, called for payment of prepayment fees in amounts which decreased as the debt instruments approached maturity.

44. Prepayment fees are intended to compensate the investor in debt instruments for possible loss of capital appreciation. Such fees represent gain realized upon the surrender by the investor of such instruments to the obligor; and they are a substitute, negotiated in advance, for the gain which might be realized, in the absence of prepayment privileges, upon sale of such instruments to other investors.

45. The terms of prepayment provisions included in debt instruments of the kind pursuant to which the plaintiff received prepayment fees in 1949 are a matter of negotiation between borrower and investor, with the result dependent upon the relative bargaining strength of the parties at the time.

46. The great cost to any lender of lending money is the risk that the borrower may fail to pay both interest and principal as they become due. The longer the term to maturity of a debt instrument, the greater the risk to the investor.

47. Normally, because of the greater risks inherent in lending money for extended periods, a long-term instrument will command a higher rate of interest and a higher yield than a short-term instrument of like credit standing. This has been generally true during the past 30 years.

48. The expenses of maintaining and servicing the plaintiff’s investment portfolio constitute the principal cost of running its investment departments. Only a minor part of the operating expenses of such departments is attributable to the initiation or acquisition of loans.

49. The proceeds of the prepayment of an obligation are reinvested by large institutional investors without delay, so that there is no loss of interest income by reason of the prepayment of an obligation. Furthermore, there are no special costs connected with reinvesting funds that are prepaid as opposed to tbe reinvestment costs incurred when loans are repaid at maturity.

50. The interest rates which are negotiated by a life insurance company with respect to its entire investment portfolio are expected by the company to be — and, if the company is well managed, they will be — sufficient to cover all of the investment expenses incurred by the company in connection with loans, including those of initiation and servicing and the risk of loss. Prepayment fees are not relied on to cover such expenses.

51. There is no correlation between prepayment charges provided for in debt instruments and the costs to investors of acquiring or servicing these investments.

52. There is no fixed relationship in a debt instrument between the amounts fixed as prepayment fees and the stated interest rate.

53. Prepayment fees do not represent compensation paid for the use of the investor’s money.

54. Prior to the enactment by Congress of the Eevenue Act of 1921, the Bureau of Internal Eevenue of the Treasury Department published Bulletin “H,” which was entitled “Income Tax Eulings Peculiar to Insurance Companies.” This bulletin stated (among other things) that:

When a payment is received by a company * * * for the privilege of paying the principal of such mortgage in advance, the payment received constitutes gain and should be included in gross income.

Bulletin “H” indicated that such gain should be included as miscellaneous income, from sources other than interest, dividends, and rent.

55. On January 21, 1926, the John Hancock Mutual Life Insurance Company requested a refund of taxes paid in 1922. It based its refund claim on the ground that it had erroneously included, as interest income, in its 1922 Life Insurance Company Income Tax Return, Form 1120 L, items received from mortgagors as premiums or bonuses for the privilege of anticipating payments of principal. The John Hancock Mutual Life Insurance Company requested a hearing on its refund claim. In April 1926, by a certificate of over-assessment numbered 707142, the Commissioner allowed in full the p.la.im of the John Hancock Mutual Life Insurance Company for refund of income tax paid with respect to prepayment fees.

56. On November 4, 1926, the plaintiff requested a refund of taxes paid in 1921 and 1922 on the ground that it had erroneously included, as income, in its 1921 and 1922 Life Insurance Company Income Tax Returns, Form 1120 L, sums representing premiums charged to borrowers on mortgage loans for the privilege of repaying such loans before maturity. The plaintiff requested a hearing on its refund claims, and a conference with respect thereto was held in Washington on or about March 14, 1927. In May of 1927, by certificates of over-assessment numbered 980816 and 980821, the Commissioner allowed in full the plaintiff’s claims for refund of income taxes paid with respect to prepayment fees.

57. From 1926 until 1950, it was the consistent and unchallenged practice of life insurance companies to exclude from their taxable income receipts occasioned by prepayment of debt instruments in advance of maturity.

Commitment Fees

58. The plaintiff erroneously failed to include in its taxable gross income for 1949 $50,293.43, representing fees received by it in that year for investment commitments.

■59. The plaintiff did not, in 1949, receive any commitment fees from Canadian sources.

Miscellaneous

60. (a) More than 6 months expired between the filing on or before December 26, 1956, of the plaintiff’s claim for refund of 1949 Federal income tax (see findings 11-13 and 21) and the commencement of this action.

(b) No notice of the disallowance of the plaintiff’s claim was mailed to the plaintiff by registered mail by the Commissioner of Internal Revenue prior to the commencement of this action. However, on or about 'September 16,1957, the plaintiff received a letter from the District Director of Internal Revenue, Newark, New Jersey, stating that the plaintiff’s claim for refund of income tax paid for the calendar year 1949 disclosed no grounds for reduction in the plaintiff’s tax liability for that year.

61. At the time of filing the petition in this suit, no other action had been taken on the plaintiff’s claim in Congress, by any Department of the United States Government, or in any judicial proceeding.

62. No part of the sum claimed by the plaintiff in its claim for refund of income tax paid for the calendar year 1949 has been credited, refunded, or repaid to the plaintiff or to anyone for its account.

63. The plaintiff is and always has been the sole and absolute owner of the claim presented in this case, and has made no transfer of said claim or any part thereof.

64. The amounts involved in the plaintiff’s claim for refund have been covered into the Treasury as internal revenue taxes in the usual course of business by the Collector of Internal Revenue, Fifth District, New Jersey, and by the District Director of Internal Revenue, Newark, New Jersey.

65. (a) In Ontario, the plaintiff was entitled to do business in 1949 by virtue of having obtained a license from the appropriate Minister of that Province and paying a license fee in the amount of $300, pursuant to the Revised Statutes of Ontario, 1937, c. 256, as amended.

(b) The plaintiff was entitled to do business in Quebec in 1949 by virtue of having obtained a license from and registering with the Provincial Treasurer, by paying a license fee in the amount of $165, and by paying an assessment in the amount of $1,891.59, all in accordance with the Revised Statutes of Quebec, 1941, c. 299, as amended.

(c) With respect to the Dominion of Canada, the plaintiff’s right to do business in 1949 was obtained by registering with and securing a certificate of registration from the appropriate Minister of the Dominion pursuant to The Foreign Insurance Companies Act, 1932 (22-23 Geo. Y, c. 47), and by paying an annual assessment fee in the amount of $10,793.30 pursuant to The Department of Insurance Act (22-23 Geo. V (1932), c. 45).

CONCLUSION OP LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that plaintiff is entitled to recover, together with interest as provided by law, and judgment is entered to that effect. The amount of the recovery and the amount of the offsets will be determined pursuant to Rule 38 (c).

In accordance with the opinion of the court and a memorandum report of the commissioner as to the amount due thereunder, it was ordered on September 27,1963, that judgment for plaintiff be entered for $283,584.67, together with interest thereon as provided by law. 
      
      Trial Commissioner Mastín G. White, at the direction of the court, prepared an opinion and recommended conclusions of law in this case, which were of substantial assistance.
     
      
       The Dominion tax on premiums received by life insurance companies was first imposed in 1942, pursuant to an amendment (6 Geo. VI. e. 32), to the Special War Revenue Act. The title of the Special War Revenue Act was changed in 1947 to the Excise Tax Act (11 Geo. VI. c. 60).
     
      
       The normal-tax net income of life insurance companies in 1949 consisted of interest, dividends, and rents, less investment and real estate expenses, including taxes and depreciation.
     
      
       Plaintiff also received in 1949 prepayment fees on corporate obligations in registered form or with coupons attached. However, such prepayment fees are not involved in the present litigation, as stipulated by the parties. (Finding 38.) we find no subsequent basis for relieving the defendant of this agreement, as proposed.
     
      
       The defendant’s first amended answer also alleged that the plaintiff on its income tax return for 1949 erroneously claimed “deductions as investment expenses for various operating expenses of, and depreciation on, its real estate and offices.” However, this allegation was, in effect, withdrawn by the defendant at the pretrial conference.
     
      
       These taxes were computed at two percent of these premiums.
     
      
       These taxes were computed at two percent of these premiums.
     