The Puilippiig Averican Lif! Insurance Company vs. Gotste Case Nos 1689 - Commissiontr of Int Canal Ruverue, et al.

REPUBLIC OF THE PHILIPPINES

COURT OF TAX APPEALS

QUEZON CITY

THE PUILIPPIIG avERICaN

Lif! INSURANCE COMPANY ,

Petitioner,

~Versus- GoTste CASE Nos 1689

- COMMISSIONTR OF INT CANAL

RUVERUE, :

ike i wtih Ge ee ae [ie 173

peCcISICN

This is an appeal from a decision of respontent

Commissionor of Internal Revenue dated July 16, 1965,

holding petitioner Liable for the suns of #5199,

' PRL5,7%3.66 and 950,262.00, as deficiency income tax

for 1956, @efietency premium tax for 1953 to 1956,

and Jefteiency withhol4ing tax for 199% to 1956; re=

spectively, or a total of ®171,205.00.

’ Petitionar is a domestic corporation engaged in

the business of Life insuranea, In 2952) respontent

@isalloved petitioner's claim for “architect's fees.”

these were subsequently allowed but to te amortized for

a perio’ of five years from 1952 te 1956, and petition-

ar's claim for refund or tax credit filed therefor trig-

gered off an investigation of its tax liabilitées for

1953 to 1956. Respomtent, in a letter dated March 3,

1960, assessed petitioner the sums of #158,4%30.00,

P1L5,7%3.66 and 850,262.00, as deficiency income tax

mecIsIons -

CTA Cala No. 1689

for 1955, deficiency premium tax for 1953 te 1956,

and defteieney withholéing tax for 195% to 1956, re~

spectively, or a total of p32 435. 66. |

On May 20, 1960, petitioner, through its external

auditors, Sycip, Gorres, velayo & Co., wrote respondent

© letter requesting a reconsideration or withdrawal of

his assesssent. 4s a condition for the grant of said

Pe uest, res pomient required petitioner to execute a

waiver of the statute of linfitetions which it accon-

plished on December 18, 196+. After several conferences

with petitioner, respomient finally sent his letter-

deoision dated July 16, 1965, moaafying his original

assessuent, the relevant portions of which are os fol

lows 1 é.

A226

Net income per return P1,¥12,895.85

| adda ae def uc-

) Fiseal agents feeeP20,000400

) Premium income in-

c@¢

Adda cently interest from

TOTAL AMOUNT DUS & COLLECTIBLE

156

N06

ee, ja ape to the ‘ef icieney premium

Client for the years

ist. to i056, is Office is still of the

opinion thet the aathed aividents dis~

tributes to participating tashendees jure

ing ~ aforesaid yoars the payments

tenants corresponmting te the

insuraney taran by thom are eubjoct to, the

pa, Big te therefore, reiterates the

the collection of the to

tel ameant

of of PIL, 3. 68 sooreenet Foy setener preniun

the years 1953

. Withbeliing tax = 19%) to 2996 - .

song He Office is reiterating its with~

Ang tax assessment Cor the 199% to

19565 it t sores thet the branch

ae client ar a ie a oe rye

es withhol agen

should have vested the corres pond ing -

withhol¢/ing tax on oVer-riding commission

in accordance with Article 2 of &

A of the Hational internal Revenue

Tt ae i neg agp. ope oe that you

i. 2 ert ss 7enbe, $50 r50 20200 and

ps ah

hg acl representing preniun, wi

income taxes, ras tively, greg our Cal

lection Agent in the os =

Director, Regional Office Noe

Soriano ne talidine, Claro %& dl va-~

nila, on or before Auwart 16, ne

Still dissatisfied with the oforessi4 action

taken by respontent, petitioner interposed the present

appeal on Septonbor U%, 1965 In ite petition for

review, petitioner incluted the refund of P10, 5%5.00

alleging that as a result of respondent's allowance

of architect's Cees, it overpaid ate income tax for

157

pecis Ton <

CTA CASE Ne. 1689

»

1956 in the sforesaié amount of P10, 545.00.

| On May 9, 1972, after the case was submitted for

decision, the Court resolved to reset it for hearing

for the purpose of clarifying certain matters. Aecq-

Comfingly, the parties submitted eaditional evitence -

testimonial] and documentary. ;

The issues posed in this appesl are as follows:

le Whether or not the fiseal agents’ fees

anda the a payments made by

tenants the peda Eevee in

the Sve pe suns 0,000,060 ana

42, are deductible or exclui-

able from petitioner's gross income

for 19563 and if in the affirmetive,

whether petitioner made an overpayment, —

as a result of respondent's allowance

of architect's fees, and hence entitled

te a refund; . - .

Seriatin.

sapere tale ae tne

Cigcal Agents ' pees. 1956 (619,000.00)

Ae

158

pecisI0u «

STA CARE Bone 24389

5

Aespontant disallowed the fiseal azents" fees

Claimed by petitioner as defuction from its gross in=

come for 1956 on the grounds that it faile? to prove

that saa? fees were actually spent; that they were

ordinary an‘ necessary; ant that services had bean

actually rendere? as required by Section 30(a)(1) of

the feVenus Cote.

This pretension fis belied by documentary as wall

as testironial evidence, Accoriing to Dlisis Fernan-

fo, petitioner's treasurer, american Internationel Re-

imeurance Co., Inc., perent company of petitioner ané@

a subsidiary of ©. Ve Starr & Coe, debited potitionsr

the sums of $2,500.00 on March 31, 19596 ana $2,500,00

on Septerber 19, 1956 for the fisesl egents' fees puis

te G Ve Starr & Company covering ths perio’ from Jan-

aary Ly 2956 to December 31, 1956, in connection with

its Lnves tnants afviees to petitioners that petitioner

rendered pertotic reports to G vs Starr & Company on

investrents and the latter commented on its ani that

executives of C.V. Starr & Company cane te the Philip=

pines an? attente4 potitioner's annual boar? msetings

to 4isems all matters concerning investeants. ai-

carto Banco’, treasurer of petitioner in 196%, eerti-

fied that the fiseu1 agents fees wore paid to Ce Ve

Starr & Company for reniering the following services:

» 459

NSCIS ION =

CTA GASES Bo. 1689

le To assist in the forrulation of

the inves taent ieies of the company

during ite init years of organization;

2. To Clive s@vice on specific invest-

ment projects er proposals which the con

pany may rofer for consultation;

3. To help of to give a@vice in Life

insurance application involving ¢ifficult

question of me@ical an’ lay underwriting,

a in group insurance business,

rosnore Tesilitine siroal fon"tae™

operation.

AD expense is consifered “ordinery” when it is

common, normal, or not anusuel to ineur in the trade

or business of a particular taxpayer. The eontrelling

guide is the kinéd of trensaction involving the ex-

_ penditure an@ ite nermalcy in the particular business.

On the other hand, am expense is "necessary" {f it is

appropriate an4 helpful in 4eveloping and naintaining

the taxpayer's business, All these eriteria an¢ prin-

Ciples rest, at least in part, on an underlying in-

plication "that whether an expenditure is both ‘or-

@inary and necessary’ will fepend upon « determination

as to whether ea hari-headed businessman woul? have

incurred it under like circumstances," This is what

ig known as the deetrine of “commercial reality."

(Canton Cotten Mills Vs UsSe, 9+ F. Supp. 5614 eee

alse Mertens, Law of Federal Income Taxation, Vol. %,

par. 25.09. )

160

avery snpusente bus {ness cons is te of tvo major

acbivitdes s undervr ting and Seniniensitbiie (Mertens,

Law of Federal Income Taxation, Vol. 8, pare W.0%,

Sees. 197-200, Act No. 2427 ZInsurance act7.) Invest=

ment advisers are not uncommon in present-day bus i-

ness world an? it seems normal for petitioner te seek

advice from one vho is tediested to the stuay of in-

Ves trent. |

Me

Petitioner exelute? the sun of »42,896.79 fron

its Grose income for 1956 on the groun? that it repre«

sents payments mate by its tenants in the Quezon City

housing projects, which are in the nature of self

insurance credited to the "Investeent Reserve Punt" —

and treated by the company as more deposits. It is

aPguet that since feposits are not income, cain or

profit, they are not taxable within the purview of

Section 29{a) of the Wwvenue Code. azpontant, how-

ever, treated the said amount as a Sa on

insurance subject to incom tax. j

Tt appears that petitioner maintained a housing

project in Quezon City consisting of lots ani houses

sold to tenants unter conditional sales contracts.

The tenants who were insured with petitioner mate in-

stallment payments with the company which were credited

161

PeCIs ION «

CTA CASE No. 2689

to the value of the lots and houses. Under the terns

of the contract, a purchaser would be relieved of the

further payment of his balance if he dies during the

period of installments and because of this, part of

said installment payments crs premiumsen insurance.

Petitioner adwits that the sum of e&2,896.79 cor~-

Pesponis to said premium for 1956. As premium, it

shoul4 be subject to income tax.

Petitioner, however, considers the paynents mate

by its tenants in its howing projects as mere depos-

ite and not as premiums. “We cannot subseribe to this

pretension, The taxability of the payments here in-

Volved depends not upon the nance attributed te it by

the petitioner but upon the actual nature of the pay-

ments. Here, there is no question thet the premiums

were paif in consideration of the insuranes taken by

the purchasers or tenants whereby petitioner obligated

to release them from making further payments if they

die during the period of installments, ‘There is,

therefore, Jef initely un insuranes contract between

petitioner and the purchssers of the houses an‘ lots

an@ the premiums peid thereon are incotie te petitioner

subject to income tax.

Gn the claim ef petitioner that the promium pay~

ments in question were provisions for self-insurance

which were ¢eredited to its investment reserve funt,

162

DECI IO“ =

CTA CASE No, 1689

9

suffice it to say that there is no showing that such

reserve was authorized or required by law (see Kanmoth

Life & Accifent Ins. Co.,g 6 BTA 369; Greenvile Coal

Cosy 3 DTA 13234 Spring Canyon Coal Cos, 13 DLA 199). Moreover,

these provis ions ate in the natare of a deduetion

whieh can be allowed only when plainly authorised

“Glatvering ¥. Inter-Vountain Life Ine, Cosy 79 be od

1227). .

In view of our finding thet the premium paynents

{im the amount of £42,896.79 are subject to income tax

ana only the sun of ¥10,000,00, as fiscal agents’

fees, is deductible from tha sross incons, instead of

being entities to a refunt, potitioner is still liable

for 1956 for the payment of the sum of 1,595.08 as

' Geficiency income tax, inclusive of 4% monthly interest,

compute? as follows: . a

L226

Net income per return -<--~-

housing projects which was cred-

cones ete ceneekte Of tenants -

bene ane enortization of architects

ah Wssethoues ae 4978)

paw subject

Tax due thereon

Less: Tax already assessed

Adds $8 interest from 6/20/59

] eo ee

Tetal amount due & collectible

* 163

oecIsIonN -

16

3

* $ a% ’ Qe ¢ ‘4

Loo, 1900 & 1995 (Fl Zt 00!

The defieiency premium taxse, inclusive of 25%

surcharge, broken down as follows:

5 RE A ce am SE OR HR I HO oe "age

1

Total

arese frome

(1) The treatment by respontent of the dividends

paid te participating policy holders from 1953 te 1956

in the amount of §2,9%2,360.08 as part of petitioner's

taxable receipts subject to the premium tax; ani

(2) The treateent by respon’ent of the premius

payments mate by tenants in petitioner's housing —

projects for 1955 ant 1956, im the anonts of /15,15%. 65

and #42,896.79, respectively, also es part of its tax-

able receipts subject to the premium tax.

Ae Dividends Paid to Participating Policy Holijors

Petitioner contents that the so-called “premium

or policy aividends” paid to policy holders are not

in the true sense dividends or sarnings but rather

return of premiums not incluiible tn tts taxable re-

ceipts pursuant te Section 255 of the ReVenue Cote.

Respomtent disagrees an! insists that the amounts re-

present dividenis or profits taken from the accunulete?

~

PECISION «

CTA CASE No. 1689

od

earnings or eurples of the corporation subject to the —

premium tax.

The exclusion of the “preniun or policy dividends"

from petitioner's taxable receipts for premium tax

purposes is being justified under the provision of

Section 255 of the Wevenue Code, which, insofar as it

| is material to the issue at han’, is quoted hereunfers

A from every ———

ny» or corporation (except

Cooperative companies or associations) fo-

ing insurance business of any sort in the

Philippines of

the r

such prem are D money, ag

remiuns

4a, partly provides s

‘tun MD, on agains t st the carve

scoring promtusy ain }

It appears that petitionar, @uring the yoars in

question, condueted its life insurance business under

the so-calle? “Level premium plan." This plan is the

one in general use by oll life insuranes companies.

Yar a thereuch understanting of how this plan operates,

DRcIsIon = '

CTA CASE Bo. 1689

12

we are reproducing below potitioner's letter to re-

apormlent dated May 20, 1950, explaining its operation:

Sonapelty's 35 life insurance ~

are operating unde y the so-called

This ge ye ea ~

uniform maxioun —p &

the pol léer during the life -

policy, amount of payment during the |

earlier years being im excess of the cur-

rent cost of his insurance, and a ex-

cass being applied to the Grea tion of a

reserve Sunt, which serves to eaintain the

insurances iff the later yoars

woke oun + te

st level premiun wo

oe terarfacient to meet the curreat cost

ef sueh insurance.

- «Jp the of nenpartic bing iey-

holders he pennies is dof initoly Bm by .

the while 2

in the cas participsate-

a p is stip-

lated, with a provision for its .

uction as éetermined con~

pany. The stipuleted maximum premium in a

annual by the |

ing’ pol S lei oh hp Uade ae Gah Geom

othar as vonce rns

than

} No right of participation.

Tn participating policies, the life

insurance companies te to ths

participating polieyhelsers’ their ins aranca

at cost, ent result 4s accomplished

the amount of such reduction being

terninmed from year to yoar by the company.

The calculation of premium rates

Cotipany may

fealize upor its veh .ossets —_ the

Lifetine of tho Pi Those two factors

determine whet known at the

"net" or continent ane are the

sums considera¢ sarfieient an? necessary te

» 466

pecs ror «

CTA CaS No. 1689

13

pay all outstanding policies os bacone

Clains, provided death occurs

accordance with the table of sertali

as amt the rate of interest sarned

Premium rates so Compute? are, in the

exporienee of Life insurance companics

generally fount to be tn excess of the

g

g

88

:

E

I

pecs ren «

CTA CASS Moe 1639

a

This prerium overpayment techn Ges ig-

nated in insurance ray be apphted “air onte te

ars

or te purchase ction oft insurance

shewsen Whe pontaeseeets 3°

policy, or to accelera ts maturity in

case an enfowment policy. —

This metho? of operation has never been disputed nor

questioned by the respondent. —

On the witness stant, petitioner's witness SLigia

Fernanto, testified that the dividends returned to par-

ticipating policy holders are actually excess premiums,

which are the @ifference between the premiums pai4 ané

the actual cost of carrying the risk as determined at

the end of the year.

The question presente’ for our consideration is one

of first impressior in this jurisdiction. There are,

however, precedents in the United States that can very

well be applied in this jurisdiction. ~

anount of premium pald by a policy holder during the

earlier years are in excess of the current cost of his

insurance. Such excess, in life insurance company,

"eons titutas ite margin of safety and must be sufficient-

ly large te assure the company's ability to pay dts

Claim as they acerue beyond peratventure. the policy

is issuet at a fined progium, That stipulated premium

cannot be incresse@, but may be lessened annually by

DECISION =

CTA CAST Hoe 1689 ©

15

80 much as the experience of the preceding year has

determined it to have been greater than the cost of —

carrying the insurance, ani the difference detween the

amount of the s tipulated premium end the cost of carry-

ing the risk constitutes the so~called dividend. The

stipulated prooium im participating policy is invaria~

bly greater than the fixed premiup in non-participating

policy issucd at the came age and upon the same tern.

this is the kind of dividend which petitioner pai’ te

ite participating policy holders. This dividend, how

ever, ic not in any real sense a dividend. It operates

merely to abate or reduce the stipulated premium te the

extent that it hes been determina’ by experience that

the policy holder paié for his insurance during the pre-

Ceding year more than it actually cost petitioner te

_ Carry the risk. This excess. payment represents, not

profits or receipts, but overpayment. It is an ever-

paymant because being entitled te his insurance at cost

ant having paid by way of premiaus more than it cost,

he is equitably entitle! to have such excess applied

for his benefit. .

tbute

x x x The members contr

for « common object to a fund which is their

common property; it turns out that have

contributed more than is neetad, and

fore more than ought to have been contrib-

uted by for this objects an? accor4ting=-

Ly their contribution is re@uced by an

amount equal to their proportion of this

PICS Ion -

16

excess. I an at a locs to see how this can

be considsred as a “profit” arising or ac-

ahich shy enrry one” is tran ane al

ay on rue t -

ternative is aliowed

their representatives * elain it in

case of 4eath; but IT cannot th that this

eakes any ¢ifferenes. Mr. Bremner truly

pointed out that, if these se-calle? bonuses

were to be revyarte’ as representing prof ite,

it followed that, if the premiums were

trebled, the its woul@ be increased in

proportion, (New York Life Ins

Abe, 3 “ettea 3 ity late Ae a8 Life ~

Gireuit bas a2 Retolty 198 Pate py ace oon

Fed. 918.)

The 4ivitents herein pait have been apportioned

and applic’ te the re@uetion of the premium named in

the policy contract. In other worts, what petitioner

recalved was the @ifference between the stipulate

premium 4sn4 the so-called ¢ividend. In such a case,

the Aavirends are not sums paid to acpéliqghplier and

_ by him returned in cash, ‘they are not income re-

ceived (Mutual Benefit Life Ine. Co. ¥. Herol’, supra).

They are, therefore, not part af the “total oreniues

ecllectad" but “prenjuss x *« ~-»* feburned for other

reason te person insured « <«" exelutable from the

taxable receipts. (ec. 295, gupra,) It can make

no 44fference im principle whether the surplus is ap~

plied to the reduction of premium or pai? in hard gosh.

In either Case the operation is in substance « return

of part of premiums previously collected for which tax

pecrszon -

CTA CASE Boe 1689

17

has already been pai?. (Mutual Benefit Life IMs. Co.

We Herol’, gupra,) What petitioner receives by way

ef income afd all that it is Liable to be taxed for

4g the reduce? premius,

If, therefore, a policy holder the

7 tS skier caaoe te

have a previous overpayment of premium

applied in reduction of a succeeding

stipulated premium, what he and all

that he pays, or can be to is

the retaced pren cha tha’ te all at

Benefit Life Ins. Co. Vv. Herol¢,

Gupra- ~

Its urged that the @ividents were taken from our~

plus an? paid out to participating policy holders as

@ividents in the real sense. In resolWing « simflar

ergunent, the Federel Court of the U. 5S. helds

x» But it way be urged that

DSCIS ION «

CTA CASE NO. 1689

+ of

insurencee It would seem to be fair and

ree pee a, Sie tha

éLasses of

ium paynents

= upon payments wh at the “oar

ave only “constructively received.” (Ofu-

tual Benefit Life Ins. Gos Ve Merolé, gupra. )

™ View of the above, we are, therefore, of the

opinion that the 4ividents pala to participating poli-

ey hol4ers are in reality return of excess premiums

whieh were properly exclute? from petitioner's texable

receipts for purposes of computing tho premium tax.

jousing Pea incta ip 35) oa 1057

GUA Ae 21s aoe

This item represents payments wate by tenants in.

petitioner*s housing projects. In our 4 isposition of

the second issue, gupra, we hold that there is definite-

ly an insurance on the confitional sales contracts

executed by the tenants in connection with seif housing

projects, Consequently, tha paynents made by the

tenants corresponding to the premium on sai? insurance,

in the Pespective sums of P15,15%.65 and #42,996.79

for 1955 and 1956, are subject te the premium tax un-

der Section 255 of the Nevenue Code, Accordingly,

DECISION «

CTA CaB® No, 16389

ag

petitioner is held liable for the payment of the surs

of #379. und 91,608.63 as deficiency proxiun taxes

ant surcharges for the years 1955 abt 1956, respective=

iy, computec as follows,

L2E8

ts msde b. gay ee in

Ratute SFr PRE

Deficiency & Geubuene mee aun

Iyz .

Withholding Zax. 1954-1956 (250.252.00)

Sespontent has assessed petitioner the gum of

P504262.00, representing withholding tax, surcharge

and compromise penalty, allegedly for failure of peti-~

tioner te withheld the incom: tux on ihe overrifing

commisgions paid to its eighteen (15) unit and branch

managers (managers for short) for the pertol from 195%

to 1956. | |

The basis of the said withholding tax assessment

can be clearly gathered from the inforsensnt of re«

spontent's examiner Mmilie G. de la Cruz to the Chief,