Commonwealth Inv. Co. v. Commissioner

COMMONWEALTH INVESTMENT COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Commonwealth Inv. Co. v. Commissioner

Docket No. 98060.

United States Board of Tax Appeals

44 B.T.A. 445; 1941 BTA LEXIS 1328;

May 9, 1941, Promulgated

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">*1328 The respondent in determining that certain amounts received by the petitioner ostensibly as compensation for services in 1933 and 1934 constituted income predicated his determination upon the assumption of the honesty and legality of the petitioner's action in receiving such amounts. The petitioner concedes that, except for the question of the illegality of the contract under which it received said amounts and to which it was a party but under which no services were rendered by petitioner, the amounts constituted taxable income. Held, that the petitioner will not be heard to assert the illegality of the contract as a defense against the deficiencies in tax.

William Allen Whitfield, Esq., for the petitioner.

Gene W. Reardon, Esq., for the respondent.

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TURNER

">*445 The Commissioner determined deficiencies as follows:

	Income tax	Delinquency penalty	Excessprofits tax	Delinquency penalty
1933	$117.37	$29.34	$26.92	$6.73
1934	1,992.19		713.81

Two issues are presented by the pleadings: (1) Whether the respondent erred in not excluding from the gross income reported by ">*446 the petitioner for the">*1329 years 1933 and 1934 the amounts of $3,300.87 and $22,815.95 received by the petitioner in the respective years pursuant to an agreement between it and an insurance company, said agreement, thereafter at the instance of state insurance officials, being canceled by the parties and said amounts in 1936 being credited by petitioner as payments on the principal of certain notes owing by the insurance company to it, and (2) whether the respondent erred in disallowing a deduction for 1934 of $13,000 taken for bad debts. The petitioner concedes the correctness of the respondent's disallowance of the bad debt deduction.

FINDINGS OF FACT.

The petitioner is an Iowa corporation organized in 1928, with its principal place of business at Des Moines. Under its articles of incorporation it was and is empowered to act as agent for insurance companies in the solicitation and receipt of applications for accident, health, and other kinds of insurance; to conduct a general insurance business and insurance brokerage business; to loan money; to buy, sell, and deal in bonds, securities, and evidences of indebtedness; and to do any acts or things designed to protect, preserve, improve, or enhance the">*1330 value of any such bonds or other securities or evidence of indebtedness.

The Travelers Mutual Casualty Co., sometimes hereinafter referred to as the Casualty Co., is an Iowa corporation which was organized on September 15, 1927, for a period of 20 years and has its principal place of business at Des Moines. It was organized under the mutual plan of insurance and engaged in the business of insuring persons against loss through accident or sickness. It was also empowered to engage in other kinds of insurance business.

On February 18, 1928, the Casualty Co. and the petitioner entered into a written agreement, sometimes hereinafter referred to as the agency contract, which provided in part as follows:

* * *

WHEREAS, it is the desire of the first [Casualty Co.] and second [petitioner] parties to enter into a contract of employment whereby second party shall become the general agent of first party in and for the purposes of organizing an agency force, soliciting and receiving applications for insurance, and performing such services as are incident to such general agency employment; and,

WHEREAS, second party has heretofore furnished to the first party the sum of $900.00">*1331 for the purpose of aiding first party in the conduct of its business and maintaining the reserve for unearned premium required by the laws of the State of Iowa and the rulings of the Insurance Commissioner of the State of Iowa, and contemplates the furnishing of further sums for said purpose:

NOW THEREFORE, it is hereby agreed by and between first and second parties as follows, to-wit:

">*447 1. In consideration of the mutual covenants and agreements herein contained and as part consideration for sums of money heretofore furnished and to be hereafter furnished by second party to first party for the purposes herein above stated, first party does hereby employ and engage second party to act [sic] as its general agent in and for the purpose of organizing and [sic] agency force for the sale of insurance in first party within and for the State of Iowa, and the employment of agents and representatives to solicit and receive applications for such insurance, and to solicit and receive applications for such insurance on its own account.

2. The term of this employment is nineteen years from this date.

* * *

5. As and for compensation for the services of second">*1332 party, and in consideration of sums of money heretofore furnished and to be hereafter furnished by second party as hereinbefore stated, first party agrees to pay to second party, ten (10) percent of the gross premium income of first party from any and all business written within the State of Iowa by and through whatsoever source or agency and to pay such sum within thirty days from the end of each three months period ending on the first days of January, April, July, and September of each year.

* * *

7. Second party hereby accepts said employment according to the terms and conditions as hereinbefore provided and agrees to perform the services provided for to the best of its ability.

On February 28, 1928, the contract was approved by the Commissioner of Insurance of the State of Iowa.

On November 21, 1932, the parties amended the agency contract of February 18, 1928, so as to provide not only for the petitioner's acting as general agent of the Casualty Co. in organizing an agency force for the sale of insurance in the Casualty Co. in the State of Iowa, but in all other states in which the Casualty Co. might be licensed, and further that the 10 percent of gross premiums of">*1333 the Casualty Co. to be paid to the petitioner was not to be limited to business written in the State of Iowa. By an amendment entered into on March 9, 1935, the business written in Illinois was excepted from the application of the stated 10 percent. By August 1935 the Casualty Co. was transacting business in 16 states, including Iowa.

As contemplated by the parties according to the recitals in the agency contract, the petitioner from time to time made certain advancements or contributions to the surplus of the Casualty Co. in the form of cash, real estate, mortgages, bonds, and other securities. For these the petitioner received waiver notes or agreements of the Casualty Co., bearing interest at the rate of 6 percent per annum and payable when and if the surplus of the Casualty Co. became such as to so permit, but no repayment to be made when the surplus was less than $135,000 or when a repayment would reduce the surplus below that amount, and after obtaining the written consent of the Commissioner of Insurance of the State of Iowa. Although the petitioner made the foregoing advances as contemplated in the agency ">*448 contract, it did not at any time throughout the years">*1334 1928 through 1936 render to the Casualty Co. any of the other services specified in that contract which it had agreed therein to perform for the Casualty Co.

In 1933 and 1934 the petitioner accrued on its books the amounts of $5,278.42 and $26,309.80, respectively, as representing commissions on insurance written by the Casualty Co. and owing by that company to the petitioner under the agency contract. Of the amounts thus accrued the petitioner received in cash and reported as income in its income tax returns for 1933 and 1934 the amounts of $3,300.87 and $22,815.95.

In the fall of 1935 the Insurance Commissioner of the State of Iowa, cooperating with insurance commissioners of other states and acting pursuant to the regulatory powers vested in him under the statutes of the State of Iowa, completed a convention examination of the condition and affairs of the Casualty Co. as of August 31, 1935, and under date of November 9, 1935, filed his report. He found that the five directors of the petitioner constituted five of the eight directors of the Casualty Co. During the years 1933 through 1936 the secretary of the petitioner was also president of the Casualty Co. The insurance">*1335 commissioner made a complete analysis of the accounts of the Casualty Co. relating to the advancements or contributions by the petitioner to the surplus of the Casualty Co. and the payments made by it to the petitioner under the agency contract. In his report he stated that the petitioner was entitled to repayment of the net contributions to the surplus of the Casualty Co. as well as interest at the rate stipulated in the waiver notes or agreements in accordance with the terms thereof, but that the amount of the net contributions should be governed by the value of the donated items as shown in his report. Respecting the portion of the agency contract relating to the services to be performed by the petitioner as general agent of the Casualty Co., he found that the petitioner had received from the Casualty Co., ostensibly as compensation, a total of $92,702.04 on insurance written by the Casualty Co. prior to August 31, 1935, but that no duties were performed by the petitioner for such compensation, as the business of the Casualty Co. was obtained through other agencies, for which the usual commissions were paid, and that the services rendered by the petitioner did not justify the">*1336 payment of an overriding commission on the business transacted by the Casualty Co. Based on the situation thus found, the insurance commissioner expressed the opinion that the agency contract "wherein it relates to a compensation for services should be voided by amendment and that no further compensation should be paid in connection therewith."

">*449 At a special meeting of the board of directors of the petitioner held on December 29, 1935, the following resolution was adopted:

In view of the opinions contained in the preliminary examination report of the convention examination of the Travelers Mutual Casualty Company, dated August 31st, 1935, the correctness of which we do not admit, and pursuant to recommendations and instructions of the examiners and the insurance departments concerned, it is hereby resolved that the sum paid on business written during the year 1935 by the Travelers Mutual Casualty Company under the terms of the General Agency Contract dated February 18th, 1928, as amended, be applied to reduce the principal amount of the waiver notes given by the Travelers Mutual Casualty Company to the Commonwealth Investment Company, that the notes be so endorsed and">*1337 proper acknowledgment of such payments be made by the officers of this Company to the Travelers Mutual Casualty Company and that the provisions of paragraph five of such contract, as amended, shall be nullified and voided for the period affected.

On some undisclosed date prior to March 16, 1936, but as of November 1, 1935, and pursuant to the action of the boards of directors of the petitioner and the Casualty Co., such action being taken pursuant to request from the insurance commissioner, the agency contract, in so far as it related to compensation for services, was canceled by the parties thereto as from its inception.

In the early part of 1936 the Insurance Commissioner of the State of Iowa began a convention examination of the condition and affairs of the Casualty Co. as of December 31, 1935, and under date of March 16, 1936, made a preliminary report of his findings. He found that as of December 31, 1935, the Casualty Co. had sustained an impairment of approximately $225,000 attributable to (1) inadequate premium rate schedules in effect prior to November 15, 1935, (2) heavy losses sustained during the latter months of 1936, (3) excessive acquisition costs which represented">*1338 the amounts paid to the petitioner by the Casualty Co. of 10 percent of its premiums, and (4) inadequate claim reserves. The Casualty Co. was unable to procure contributions or to effect reinsurance arrangements which would relieve the situation. Consequently, in January 1935, it levied a 50 percent assessment, effective December 31, 1935, on all policyholders whose policies were in force between August 31 and December 31, 1935. Beginning on or before March 16, 1936, all receipts of the Casualty Co. from renewal premiums and premiums on new insurance were impounded under the control of the insurance commissioner, and a representative of whom was supervising current operations of the company.

At a special meeting held on October 5, 1936, the directors of the petitioner adopted the following resolution:

WHEREAS, the State Insurance Examiners in making an examination of the records of the Travelers Mutual Casualty Company have found that the services to be performed by the Commonwealth Investment Company as General ">*450 Agent under that certain contract by and between the Travelers Mutual Casualty Company and the Commonwealth Investment Company, dated February 18, 1928, and">*1339 amendments thereto, have in fact not been performed, and,

WHEREAS, the Travelers Mutual Casualty Company has paid to the Commonwealth Investment Company $38,036.42, representing commissions earned during the period February 18, 1928, to December 31, 1934, both dates inclusive, and

WHEREAS, resolutions have been passed by the Board of Directors of the Commonwealth Investment Company and the Board of Directors of the Travelers Mutual Casualty Company canceling in their entirety the provisions of that certain contract dated February 18, 1928, by and between the Commonwealth Investment Company and the Travelers Mutual Casualty Company in so far as these provisions had reference to agency service to be performed by the Commonwealth Investment Company, and,

WHEREAS, over a period of time the Commonwealth Investment Company has contributed large sums of money to the Travelers Mutual Casualty Company accepting in return therefor certain conditional notes receivable which are now held by the Commonwealth Investment Company in the total amount of $187,851.89.

NOW, THEREFORE, be it resolved that the officers of the Commonwealth investment Company be and they are hereby authorized and">*1340 directed to endorse as payments received on the principal of the above named Conditional Notes Receivable $38,036.42, this being the amount received by the Commonwealth Investment Company as commissions under the terms of the Agency Contract as set out above during the period February 18, 1928, to December 31, 1934.

At a special meeting held on the same day the directors of the Casualty Co. adopted the following resolution:

* * *

WHEREAS, it is agreed by the Commonwealth Investment Company and the Travelers Mutual Casualty Company that inasmuch as the ten per cent (10%) commission payments made by the Insurance Company were not earned by the Commonwealth Investment Company,

NOW, THEREFORE, be it resolved that the officers of the Travelers Mutual Casualty Company be and they are hereby authorized and directed to correct the records to show that the payments made to Commonwealth Investment Company as commissions earned under the provisions of that certain contract dated February 18, 1928, which contract has heretofore been cancelled by the resolution passed by the Board of Directors December 29, 1935, were in fact paid in error inasmuch as the services stipulated were not performed.

">*1341 BE IT FURTHER RESOLVED that the payments above referred to in the total amount of $38,036.42 be shown on the records as payments made upon the principal of outstanding waiver notes given by the Travelers Mutual Casualty Company to the Commonwealth Investment Company in return for contributions made.

Pursuant to the authorization of October 5, 1936, from the board of directors of the petitioner, entries were made on the books of petitioner under date of October 31, 1936, whereby the surplus account was debited in the amount of $38,036.04 and the conditional notes receivable account was credited with the same amount, with the following explanation being given of such entries:

">*451 Reducing principal of waiver notes per payments originally entered as commission income, February 18, 1928, to December 31, 1934, both dates inclusive, and January 8, 1935 - $2,500.00; January 24, 1935 - $850; February 5, 1935 - $2,121.40; as per resolutions adopted by the B. of D. October 6, 1936.

Pursuant to the resolutions adopted by the directors of the petitioner and the Casualty Co. on October 5, 1936, endorsement was made in 1936 on the waiver notes of the Casualty Co. owned by the">*1342 petitioner, reducing the principal amount of said notes by the amount of $38,036.04. The same procedure was followed with respect to commissions paid or accrued for the period January 1, 1935, to the date as of which the agency contract was canceled.

In determining the deficiencies the respondent did not eliminate from the petitioner's income the amounts of $3,300.87 and $22,815.95 received by the petitioner in 1933 and 1934, respectively, from the Casualty Co. under the agency contract.

OPINION.

TURNER: The petitioner rests its case upon the proposition that the contract of Frbruary 18, 1928, between it and the Casualty Co. was illegal and void from its inception and for that reason urges that the amounts received in 1933 and 1934 from the Casualty Co. pursuant thereto did not constitute taxable income to it. It concedes that but for the illegality of the contract the amounts received thereunder did constitute taxable income.

The respondent, relying on ; ">*1343 ; affd., , and other cases of similar import, contends that, since the petitioner received the amounts under a claim of right and had unrestricted use of them, they are to be treated as income for the years in which received, irrespective of the fact that restitution was made in a subsequent year.

From the facts it appears that from the date the contract was entered into until it was canceled the petitioner received from the Causalty Co. as payments under the contract a total of approximately $93,000, which total includes the amounts here in issue. For the sums received petitioner rendered no services and apparently had no intention of rendering any services. In short, the petitioner, in order to avoid the tax consequences of the payments under the said contract, pleads its participation with the Casualty Co. in a scheme whereby funds of the Casualty Co. were illegally and wrongfully paid over to petitioner. It is a fundamental principle of law that a person may not take advantage of his own wrong. In ">*1344 ; affd., , we said:

It is thus readily perceived that, reduced to plain words, taxpayer seeks to plead in this litigation with the Government over taxes its own participation in ">*452 an illegal contract to avoid the consequences of such contract on its tax liability. There is a complete barrier to such action. * * *

See also ;; ; and . The respondent has predicated his determination upon the assumption that the contract, until canceled by the parties and at the instigation of the insurance commissioner, was binding and legal, and the petitioner, conceding that under such circumstances the amounts here in question constituted income in the taxable years, has rested its case entirely upon the ground that illegality of the contract would relieve it of the income tax consequences. The above cases require the contrary conclusion and the action of the respondent in treating">*1345 the sums received by the petitioner from the Casualty Co. during the taxable years as income to the petitioner is accordingly sustained.

Decision will be entered for the respondent.