Unum, Corporation v. USA
Case Date: 12/01/1997
Court: United States Court of Appeals
Docket No: 96-1877
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United States Court of Appeals United States Court of Appeals For the First Circuit For the First Circuit ____________________ No. 96-1877 UNUM CORPORATION AND UNUM LIFE INSURANCE COMPANY OF AMERICA, Plaintiff-Appellant, v. UNITED STATES OF AMERICA, Defendant-Appellee. ____________________ APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF MAINE [Hon. Gene F. Carter, U.S. District Judge] ___________________ ____________________ Before Torruella, Chief Judge, ___________ Aldrich, Senior Circuit Judge, ____________________ and Lynch, Circuit Judge. _____________ ____________________ William J. Kayatta, Jr., with whom Jared S. des Rosiers, _______________________ _____________________ Pierce Atwood, Barbara H. Furey, Barry W. Larman, and UNUM ______________ _________________ ________________ ____ Corporation and UNUM Life Insurance Company of America were ________________________________________________________ on brief for appellant. Edward T. Perelmuter, Tax Division, Department of ______________________ Justice, with whom Loretta C. Argrett, Assistant Attorney ___________________ General, and David I. Pincus, Tax Division, Department of ________________ Justice, were on brief for appellee. ____________________ December 2, 1997 ____________________ -2- LYNCH, Circuit Judge. The need to raise capital LYNCH, Circuit Judge. _____________ and to compete in increasingly diversified financial markets has led a number of American mutual life insurance companies to convert to being stock companies. This process, known as "demutualization," often involves a conversion of the mutual policyholders' ownership interest in the old company into ownership interest in the form of stock in the new company. This appeal raises important questions about the proper tax treatment of one form of demutualization: whether stock and cash distributed to policyholders in exchange for their mutual ownership interests as part of a statutory demutualization constitute "policyholder dividends" under 808 of the Internal Revenue Code. If so, the insurer may take a deduction for "policyholder dividends" under 805(a)(3). Whether the "policyholder dividends" deduction is available has great financial consequences for the company and for the public fisc. This question involves consideration of the scope of the "policyholder dividend" under 808, as well as the broader relationship between the general corporate tax provisions of the Code (contained in Subchapter C) and the Code's insurance tax provisions (contained in Subchapter L). In this case, UNUM Corp. ("UNUM"), the demutualized successor to Union Mutual Life Insurance Co. ("Union Mutual"), seeks a tax refund based on a "policyholder -2- 2 dividends" deduction of over $652 million. This sum, which UNUM was required to distribute to its policyholders by state law, represents the value of Union Mutual's accumulated surplus. See Me. Rev. Stat. Ann. tit. 24-A, 3477 (West ___ 1996). UNUM's principal argument is that the cash and stock distributed during the demutualization constitute "policyholder dividends" under the plain language of 808(b) and thus are deductible under 805. UNUM further argues that, beyond the statute's plain language, the legislative history and public policy behind the Code's treatment of life insurance companies support this result. The IRS argues that general corporate tax provisions apply to insurance companies in the absence of specific provisions to the contrary in the Code's insurance tax section, and that, under those corporate tax provisions, UNUM is not entitled to any deduction for its reorganization. The IRS argues that nothing in 808 or its legislative history indicates that Congress envisioned 808 as encompassing capital transactions such as UNUM's demutualization. Rather, placed in proper context, 808 is not relevant to the value-for-value exchanges for which UNUM seeks a deduction. -3- 3 The district court entered judgment for the government in UNUM's suit for a refund. We affirm the judgment of the district court. I I This appeal involves only questions of law; we exercise de novo review. Alexander v. Internal Revenue ________ _______________________________ Service, 72 F.3d 938, 941 (1st Cir. 1995). The parties have _______ agreed on the facts. A. Background __________ Demutualization has become increasingly common in the insurance industry. More than 200 mutual life insurance companies have demutualized since 1930. See S. Preston ___ Ricardo, The Deductibility of Policyholder Dividends: UNUM ___________________________________________________ Corp. v. United States, 50 Tax Law. 265, 265 (1996). Between ______________________ 1954 and 1981, the number of mutual insurers declined from 171 to 135; during the same time, the number of stock insurers increased from 661 to 1,823. Edward X. Clinton, The ___ Rights of Policyholders in an Insurance Demutualization, 41 _________________________________________________________ Drake L. Rev. 657, 659 n. 13 (1992). Today, fewer than 80 mutual insurers have assets of over $100 million. See ___ William B. Dunham, Jr., et al., Introduction, in ____________ __ Demutualization of Life Insurers, 648 PLI/Comm 9, 16 (1993). _________________________________ These figures suggest that mutual insurers are rapidly demutualizing, and that new insurance companies prefer the stock form at the outset. -4- 4 State legislatures have facilitated this demutualization process by passing statutes permitting such conversions. Presently, at least forty-one states have specific statutes that provide for demutualization of mutual life insurers. Alexander M. Dye, Distributing Consideration __________________________ to Policyholders, in Demutualization of Life Insurers, 648 ________________ __ _________________________________ PLI/Comm 75, 78 (1993). Only Hawaii and Idaho expressly prohibit direct mutual to stock conversion, although they still permit demutualization through the alternate method of bulk reinsurance conversion. See Clinton, supra, at 673 n. ___ _____ 116. Every state, including those that lack specific demutualization statutes, permits at least some form of demutualization. See id. ___ ___ There are three usual types of mutual to stock conversions: a statutory conversion whereby the insurer directly converts its form of business, merger with a stock insurer, and bulk reinsurance of the mutual company's policies. See id. at 660-61. This case only concerns the ___ ___ first type of conversion: a statutory conversion, in which a mutual company alters its organizational form to become a stock insurer by redistributing all the mutual policyholder's ownership interest in the mutual insurer into shares of stock in a new stock corporation. "This type of reorganization may properly be regarded as a reorganization of the company -5- 5 because the policyholders are exchanging membership in the mutual for shares in the new corporation." Id. at 660. ___ By demutualizing, mutual insurers can obtain certain advantages available to stock insurers. Stock corporations are better able to raise capital because they may sell stock on the equity markets. See id. at 666-671. ___ ___ Stock companies can more easily diversify their operations by creating upstream holding companies which can own subsidiaries engaged in other businesses. See id. at 671-72. ___ ___ They can also create incentives for superior management performance through stock option plans. See id. at 672-74. ___ ___ Mutual insurers can only raise capital by retaining earnings or charging excess premiums, and are generally subject to comprehensive regulation by state authorities. These limitations can hinder their ability to grow and diversify. See id. at 666. ___ ___ Much is at stake in this process. Mutual insurance companies have historically lagged behind stock insurers in growth of assets and capital. Demutualization and subsequent stock sales may improve a mutual insurer's capital position and competitive standing with other insurers and financial institutions. Mutual insurers naturally want to contend in the increasingly competitive and deregulated financial services markets. Many mutual insurers regard -6- 6 demutualization as an important step toward bolstering their financial strength and flexibility. B. Facts _____ Union Mutual, based in Maine, was organized as a mutual insurance company in 1848. Union Mutual's business was selling various types of insurance and annuity products. As a mutual company, Union Mutual had no stock and was owned by its participating policyholders.1 Policyholders contributed to Union Mutual's surplus by paying premiums that exceeded the actuarial cost of their policy coverage. In 1984, Union Mutual's management decided to reorganize the company as a stock insurer. The management decided that the company would gain four principal business advantages from this conversion: an increased ability to ____________________ 1. Mutual life insurance companies do not raise money by issuing capital stock, but rather by charging policyholders a "redundant premium" that exceeds the amount actuarially anticipated to pay the policy's benefits and expenses. The excess portions of these premiums are accumulated, retained, and invested as "surplus". A mutual insurer's accumulated surplus is the excess of assets over liabilities. Such an excess results from the accumulation of redundant premiums and investment earnings over the life of the company. Surplus generally belongs to the mutual insurer's members in proportion to their contributions, and is generally returned to policyholders through policyholder dividends. Mutual insurers are thus owned by their policyholders. Policyholders in mutual companies are denominated "members" of the company; their ownership rights in the company are their "membership interests". Members of mutual insurance companies have many of the same rights as stockholders in corporations, including the right to vote and the right to residual surplus upon liquidation. -7- 7 raise capital, greater flexibility to diversify into new markets, an increased accountability for company performance by management, and an enhanced ability to attract and retain key personnel. Under Maine law, Union Mutual was not permitted to implement its conversion plan until the plan was approved by the Maine Superintendent of Insurance. See Me. Rev. Stat. ___ Ann. tit. 24-A, 3477 (West 1996). Maine law imposes several conditions that a demutualization plan must satisfy in order to receive approval by the Superintendent. These include, inter alia, (1) that the company pay policyholders a _____ ____ "fair and equitable" amount for their ownership interests in the company, (2) that the "equity share" of each policyholder be determined under a fair and reasonable formula based upon the insurer's entire surplus as stated in a financial statement filed with the Superintendent, (3) that the conversion plan give each member of the demutualizing insurer a preemptive right to acquire his or her proportionate part of the proposed capital stock of the new stock company, (4) that the plan provide for payment to each member of his or her entire equity share in the insurer, with the payment to be made in cash or stock of the stock company, and (5) that policyholders entitled to receive stock or cash include all policyholders within three years prior to the date the plan was submitted for approval to the Superintendent. See id. ___ ___ -8- 8 On December 14, 1984, Union Mutual submitted a plan of recapitalization and conversion to the Superintendent. Union Mutual amended the plan several times in response to rulings by the Superintendent. On July 11, 1986, Union Mutual submitted its fourth and final amended plan, which was approved by the Superintendent on August 8, 1986. The approved plan of conversion may be generally described as follows. A holding company was formed to own all the stock of the new stock company. Those who were "eligible policyholders"2 transferred their "membership interests" in Union Mutual to the holding company in exchange for stock in the holding company. "Membership interests" were defined in the conversion plan as: [A]ll the rights or interests of each policy and contract holder of Union Mutual including, but not limited to, any right to vote, any rights which may exist with regard to the surplus of Union Mutual not apportioned by the Board for policyholder dividends, and any rights in liquidation or reorganization of Union Mutual, but shall not include any other right expressly conferred by a policyholder's insurance policy or contract. ____________________ 2. "Eligible policyholders" were generally defined in the conversion plan as all Union Mutual policyholders during the three years prior to December 31, 1984. -9- 9 Eligible policyholders who qualified as "cash option eligible policyholders"3 could elect to exchange their membership interests for cash instead of stock. The holding company, after obtaining 100% of the membership interests in Union Mutual, exchanged the membership interests for 100% of the shares of the newly formed stock insurer. The holding company sold stock not issued to policyholders to insiders and the general public. At the conclusion of the Plan, UNUM Life Insurance Co. ("UNUM Life"), the new stock company, was a wholly owned subsidiary of UNUM, the holding company. UNUM was in turn owned by former Union Mutual policyholders, insiders, and members of the general public. The approved plan included an actuarial formula for calculating the consideration to be paid to each policyholder in exchange for his or her membership interest in Union Mutual. This figure, denominated each policyholder's "equity share" in Union Mutual, was defined as "the dollar amount of that part of Union Mutual's Adjusted Surplus attributable to" the particular policyholder. Each policyholder's "equity share" comprised two components: a "minimum equity share" and the individual's "contribution to statutory surplus". On December 31, 1985, the day Union Mutual presented its consolidated balance sheet for final review by the ____________________ 3. "Cash option eligible policyholders" were generally defined in the conversion plan as policyholders with equity of less than $2,500 in Union Mutual. -10- 10 Superintendent, Union Mutual's adjusted surplus was $652,050,097.4 Based on that figure, Union Mutual's management determined that each policyholder should receive a per capita amount of $612.25 as the "minimum equity share". The "contribution to statutory surplus" varied by individual policyholder. The formula for computing a policyholder's "equity share" that is referred to in the plan of conversion reveals this two-component scheme. The plan of conversion also provided for creation of an accounting mechanism known as a Participation Fund Account ("PFA"). The PFA created the functional equivalent of a closed block5 and was allocated assets which, together ____________________ 4. Surplus can be measured by either statutory accounting principles or generally accepted accounting principles ("GAAP"). The difference between the two methods is primarily one of timing: the costs of selling policies are fully charged when incurred under statutory accounting principles, but are amortized over the expected life of the policies under GAAP. UNUM's accumulated surplus of $652,050,097 was calculated under GAAP. In UNUM's demutualization plan, "surplus" was defined as "the amount of the surplus of Union Mutual as shown by its financial statement as of the Computation Record Date (December 31, 1985) filed with the Superintendent, as may be confirmed or adjusted in the event of an examination by the Superintendent, including all voluntary reserves but without taking into account the value of nonadmitted assets or of insurance business in force." 5. Some states protect the policyholders by requiring that a mutual insurer establish a "closed block" of business as a condition of demutualization. See N.Y. Ins. Laws. 7312 ___ (West 1997); 40 Pa. Cons. Stat. Ann. 915-A (West 1997). Such statutes generally require the mutual insurer's policies and contracts in force at the time of the reorganization be placed by the reorganized insurer into a "closed block" into which the insurer must allocate assets that, together with -11- 11 with premiums from the participating policies, were actuarially sufficient to pay policy claims and policyholder dividends. Under the conversion plan, the amount of the assets in the PFA could not be distributed to stockholders of the demutualized insurer. As with a closed block, it had to be invested and used for the exclusive benefit of the policyholders. The PFA was designed with the aim that Union Mutual's policyholders would continue to receive policyholder dividends after the demutualization at the same level as before, even though policyholders and stockholders would have competing claims on the earning and profits of the company. The PFA thus was meant to assure policyholders that their reasonable expectations about the investment value of their policies would continue to be met. The creation of the PFA was an important consideration in the Superintendent's decision to approve the demutualization plan. In his Final Decision and Order, the Superintendent discussed the PFA at some length, observing that Union Mutual policyholders had bought their policies ____________________ revenue, are sufficient to pay policy claims and policyholder dividends. Thereafter, the insurer may not distribute any earnings or proceeds developed within that block to stockholders. The closed block must be operated for the exclusive benefit of the included policies and contracts, distributions being for policyholder dividend purposes only. See id.; Dye, supra at 115-116. ___ ___ _____ A PFA may be required as a condition of demutualization in states which do not require a closed block. The Maine demutualization statute does not require a closed block. See ___ Me. Rev. Stat. Ann. tit. 24-A, 3477 (West 1996). -12- 12 with an understanding that policy costs would be continually adjusted through dividends reflecting Union Mutual's actual experience. The Superintendent also noted that, when purchasing their policies, policyholders based their dividend expectations on dividend illustrations shown to them by Union Mutual that were in turn based on the dividends the company had been paying pursuant to the dividend scales current at the time of purchase. The Superintendent concluded: Even though these "illustrations" were not guarantees that dividends would be paid, Union Mutual, in practice, typically paid dividends in accordance with these scales. Based upon these illustrations and upon actual practice, policyholders expect that they will continue to receive these dividends as long as their policies are in force. Therefore, I find it appropriate that the Plan, by creating a mechanism such as the PFA, supports these expectations of future dividends. That the PFA would maintain these expectations was, according to the Superintendent, critical to the acceptability of the conversion plan. Union Mutual implemented its plan of conversion on November 14, 1986. To the 105,098 Eligible Policyholders who selected the Cash Option, Union Mutual distributed $129,129,082. To the remaining 58,561 Eligible Policyholders, Union Mutual distributed 20,489,072 shares of UNUM stock. This stock was assessed as having a fair market value of $25.20 per share, making the total value of the UNUM -13- 13 stock distributed under the Plan equal to $522,471,336. Union Mutual also distributed an additional $609,396 in cash to compensate policyholders for the value of fractional shares created by the conversion formula. In total, Union Mutual distributed $652,209,814 to the Eligible Policyholders during the demutualization. Prior to the demutualization, on October 12, 1984, Union Mutual's tax counsel had asked the IRS for a private letter ruling on the tax treatment of the conversion. Contrary to the position taken by UNUM now, Union Mutual then sought to convince the IRS that the stock distributed to policyholders in exchange for their membership interests in Union Mutual would constitute tax free exchanges under 351 of the Code. UNUM also sought to persuade the IRS that the exchange of the membership interests received by the holding company for common stock of the new stock company would constitute a tax free recapitalization under 368(a)(1)(E). In support of these positions, Union Mutual made a submission to the IRS on March 25, 1985 stating that "the equity interest of Union Mutual's policyholders resemble the rights of stockholders in a corporation and have substantial value." The submission further stated that the Supreme Court, in Helvering v. Southwest Consolidated Group, 315 U.S. _________________________________________ 194 (1942), had characterized a recapitalization as a "reshuffling of a capital structure within the framework of -14- 14 an existing corporation," Id. at 202, and argued that "[t]he ___ exchange of evidences of ownership interest in Union Mutual _________ argues for the exchange being treated as a recapitalization" under the Supreme Court's characterization. Id. (emphasis in ___ original). Union Mutual made another submission to the IRS on November 8, 1985, discussing whether the exchange of the membership interests for cash or stock would be treated as nondeductible redemptions of stock under 302 or as deductible "policyholder dividends" under 808 and 805, although UNUM did not specifically ask for a letter ruling on that subject at that time. On December 16, 1986, the IRS issued its private letter ruling to Union Mutual regarding the proper tax treatment of the demutualization. See Priv. Ltr. Rul. 87-11- ___ 121 (December 16, 1996). The letter ruling stated that the exchange between the policyholders and UNUM of the policyholders' membership interests in Union Mutual for UNUM stock was a tax-free exchange under 351. See id. The ___ ___ ruling also stated that the exchange between UNUM and UNUM Life, the stock insurer that would succeed Union Mutual, of the Union Mutual membership interests for UNUM Life voting common stock was a tax free recapitalization under 368(a)(1)(E). See id. The ruling further stated that the ___ ___ cash distributed to policyholders in exchange for their -15- 15 membership interests constituted value-for-value transfers and were, accordingly, properly characterized as nondeductible redemptions under 302, not deductible "policyholder dividends" under 808 and 805. See id.6 ___ ___ The IRS viewed the stock-for-membership interest exchanges, in contrast, as non-recognition exchanges subject to 351 (no gain or loss recognized to policyholders), 354 (no gain or loss recognized to holding company on exchange of membership interests to converted company for stock, and 1032 (no gain or loss recognized to either holding company or converted company on receipt of property for stock). On its 1986 consolidated federal income tax return, UNUM did not claim a "policyholder dividend" deduction for the cash and stock distributed to policyholders during the demutualization. UNUM had entered into an agreement with the IRS extending the time period within which the IRS could audit the 1986 return, after which UNUM would be given an ____________________ 6. The IRS has not always held this view regarding the tax treatment of distributions from surplus made during a demutualization. In 1983, the IRS issued a non-binding technical advice memorandum addressing the demutualization of a mutual casualty insurer through merger with a stock insurer. Tech. Adv. Mem. 8409003 (Nov. 4, 1983). In this memorandum, the IRS took the view now advanced by UNUM that cash distributions paid out of surplus to policyholders during the demutualization were policyholder dividends under then 822(e)(2) and 822(c)(11). In 1989, the IRS withdrew this memorandum without comment. Tech. Adv. Mem. 9010003 (Nov. 13, 1989). Because such memoranda are nonbinding, we do not base our conclusions upon them. We nonetheless recognize that the IRS has not consistently maintained the positions it presently advances in this appeal. -16- 16 additional six months within which to decide whether to amend the return to claim a refund. The IRS audit, which ended in 1991, concluded that UNUM had properly characterized the cash distributions as nondeductible stock redemptions under 302 and the stock distributions as made pursuant to nonrecognition exchanges of its stock for property. UNUM thereafter changed its view of the proper tax treatment of the transaction by timely amending its 1986 return to claim the cash ($129,738,478), then the value of the stock ($522,471,336), as deductible policyholder dividends under 808 and 805. UNUM sought a refund in excess of $77 million. The IRS denied these claimed deductions. In 1993, UNUM filed suit in the district court, seeking deductions and a refund of the $77 million. The district court ruled in favor of the government, holding that the cash and stock distributions could not be construed as "policyholder dividends" under 808. UNUM appeals. II II UNUM makes a colorable but ultimately unpersuasive argument that this appeal involves only the narrow task of interpreting 808 and 805 of the Code. UNUM would have at least a plausible argument that it was entitled to a "policyholder dividend" deduction if those two sections were the only potentially relevant Code sections to this case. But we must construe the Code as a whole. The Supreme Court -17- 17 admonished in Helvering v. N.Y. Trust Co., 292 U.S. 455 _________ ________________ (1934), that "the expounding of a statutory provision strictly according to the letter without regard to other parts of the Act and legislative history [may] often defeat the object intended to be accomplished." Id. at 464. ___ Therefore, courts must not look merely to a particular clause in which general words may be used, but . . . take in connection with it the whole statute (or statutes on the same subject) and the objects and policy of the law, as indicated by its various provisions, and give to it such a construction as will carry into execution the will of the Legislature, as thus ascertained, according to its true intent and meaning. Id. (citation and internal quotations omitted). ___ We conclude that 808 and 805 do not govern this case. UNUM's demutualization constitutes a capital transaction and is accordingly subject to the general corporate tax rules under Subchapter C which govern such transactions. These rules clearly bar any deduction for amounts distributed during a capital transaction. A. Structural Overview ___________________ Because this case involves the interplay between two Subchapters of the Code, we describe them in general terms. Subchapter C is a broadly applicable section of the Code which contains many of the Code's general corporate tax provisions. It applies to all corporations, including mutual and stock insurance companies. See 7701(a)(3) ("When used ___ -18- 18 in this title, . . . [t]he term 'corporation' includes . . . insurance companies."); 7701(a)(8) ("the term 'shareholder' includes a member in an . . . insurance company."). Subchapter C governs corporate capital transactions and the taxation of all corporate distributions and adjustments, including the organization, operation, liquidation, and reorganization of all corporate enterprises and their distributions to shareholders and associates. See ___ 301-85. Many general rules in Subchapter C as well as additional rules in other sections of the Code contain language that, by their literal terms, bar the deduction UNUM seeks. Sections 162, 311, 354, and 1032 apply with particular force. We explain these sections and discuss why they apply later. Subchapter L, in contrast, is a highly focused section of the Code which specifically governs certain aspects of the taxation of life insurance companies. See ___ 801-818. Subchapter L enacts a special scheme of determining the gross income, deductions, and taxable income of life insurance companies, whether of the stock or mutual variety. It accommodates the unique manner by which life insurance companies raise and distribute capital. One purpose behind this parallel system of income calculation is to determine more accurately the taxable income of life -19- 19 insurance companies than general tax rules otherwise would permit. While Subchapter L applies specifically to life insurance companies, the existence of Subchapter L does not exempt insurance companies from the application of the rest of the Code. Subchapter L at times specifically displaces otherwise applicable rules. For example, life insurance company taxable income is defined in 801 as "life insurance gross income" reduced by "life insurance deductions". 801(b). "Life insurance gross income" is specifically defined in 803, not the generally applicable definition of gross income provided in 61. And "life insurance deductions" are specifically governed by 804 and 805, even though 804 and 805 incorporate many of the general rules about deductions by reference. But Subchapter L does not alter general tax rules governing subjects not within its ambit. Specifically, Subchapter L does not exempt insurance companies from the general corporate tax rules of Subchapter C "[e]xcept to the extent that [Subchapter L makes] specific provisions." S. Rep. No. 291, 86th Cong., 1st Sess. 39 (1959), reprinted in 1959-2 C.B. 770, 798. ____________ The Supreme Court addressed the relationship between Subchapter C and Subchapter L in Colonial American _________________ Life Ins. Co. v. Commissioner, 491 U.S. 244 (1989). Colonial _____________ ____________ ________ American involved the question of whether "ceding ________ -20- 20 commissions" paid by a reinsurance company to a direct insurer under an indemnity reinsurance contract could be deducted in the year in which they were paid, or whether they had to be capitalized over the estimated life of the underlying policies. See id. at 246-47. The taxpayer argued ___ ___ that the ceding commissions were analogous to certain agents' commissions deductible under 809 and should be similarly deductible. See id. at 249-50. The IRS responded that the ___ ___ ceding commissions were more properly characterized as a type of capital expenditure and should, as is usual for such expenditures, be amortized over their useful life under 263. See id. at 252-53. The Court ruled against the ___ ___ taxpayer, holding that 809 did not expressly provide for the requested deduction and that 263 should apply in the absence of a specific provision to the contrary. See id. at ___ ___ 260. The taxpayer's argument, the Court stated, at most proves only that Congress decided to carve out an exception for agents' commissions, notwithstanding their arguable character as capital expenditures. We would not take it upon ourselves to extend that exception to other capital expenditures, notwithstanding firmly established tax principles requiring capitalization, where Congress has not provided for the extension. Id. at 252. ___ Under the rule of Colonial American, general __________________ corporate tax provisions of Subchapter C apply to insurance -21- 21 companies unless Subchapter L makes a specific provision to the contrary. The question that this case poses, therefore, is whether the cash and stock distributions made by UNUM during its conversion are made specifically deductible by 808 and 805 of Subchapter L, notwithstanding the fact that they are clearly not deductible under 162, 311, 354, 1032 and other relevant provisions of the Code. B. UNUM's burden of proof ______________________ It is a now "familiar rule" that an income tax deduction "'is a matter of legislative grace and that the burden of clearly showing the right to the claimed deduction is on the taxpayer.'" INDOPCO, Inc. v. Commissioner, 503 ______________ ____________ U.S. 79, 84 (1992) (quoting Interstate Transit Lines v. __________________________ Commissioner, 319 U.S. 590, 593 (1943)). Deductions must ____________ therefore be "strictly construed" and allowed "'only as there is clear provision therefor.'" Id. (quoting New Colonial Ice ___ ________________ Co. v. Helvering, 292 U.S. 435, 440 (1934)). Subchapter L ___ _________ has been subject to narrow construction because its provisions "give life insurance companies tax benefits over other taxpayers." National Life & Accident Ins. Co. v. ____________________________________ United States, 385 F.2d 832, 833 (6th Cir. 1967). Thus it is _____________ UNUM's burden to demonstrate that the cash and stock distributed during the demutualization constitute deductible "policyholder dividends" under 808. C. Analysis of UNUM's arguments ____________________________ -22- 22 UNUM's principal argument is that the cash and stock distributions constitute "policyholder dividends" under the plain meaning of 808, 808(b)(1) in particular, and are therefore deductible under 805(a)(3). Bolstering this position are two overlapping contentions: (1) the legislative history and public policy underlying the Code's scheme of life insurance taxation demonstrate that Congress intended the term "policyholder dividend" to include the distributions made during UNUM's demutualization; and (2) because "policyholder dividends" are broader than classic corporate dividends, "policyholder dividends" need not possess the essential characteristics of a dividend -- i.e., they are not subject to the constraints which limit the classic definition of dividends. We reject both arguments. There is no dispute that 805(a)(3) allows life insurance companies to deduct "policyholder dividends" from income. Section 805(a)(3) expressly states: "there shall be allowed the following deductions: . . . --The deduction for policyholder dividends. . . ." 805(a)(3). The real question, rather, is whether the definition of "policyholder dividend" in 808 encompasses the cash and stock distributed during UNUM's demutualization. In this regard, UNUM's principal argument is that the plain meaning of 808 entitles it to deduct the amounts -23- 23 distributed during the demutualization.7 We believe that, in order to make this claim successfully, UNUM must demonstrate that the distributions satisfy both 808(a) and 808(b). Section 808(a) provides that: [F]or purposes of this part, the term "policyholder dividend" means any dividend or similar distribution to policyholders in their capacity as such. 808(a). Under 808(b)(1), upon which UNUM hinges the main body of its argument, a "policyholder dividend" may include: any amount paid or credited (including as an increase in benefits) where the amount is not fixed in the contract but depends on the experience of the company or the discretion of the management. 808(b). UNUM asserts that the distributions easily satisfy 808(a), which, UNUM claims, merely emphasizes the broad scope of "policyholder dividends." The source of UNUM's authority for this claim is unclear. UNUM seems to rely ____________________ 7. Section 808(a) and (b) provide in full: (a) Policyholder dividend defined.--for purposes of this part, the term "policyholder dividend" means any dividend or similar distribution to policyholders in their capacity as such. (b) Certain amounts included.--For purposes of this part, the term "policyholder dividend" includes-- (1) any amount paid or credited (including as an increase in benefits) where the amount is not fixed in the contract but depends on the experience of the company or the discretion of the management. (2) excess interest, (3) premium adjustments, and (4) experience-rated refunds. -24- 24 principally on Republic Nat'l Life Ins. Co. v. United States, ____________________________ _____________ 594 F.2d 530 (5th Cir. 1979), in which the court stated that "policyholder dividends" have an "expansive definition" and "include more than just classic dividends." Id. at 532. ___ UNUM seems also to rely on Treas. Reg. 1.811-2(a) (1997), which tracks the language of 808(a), as further evidence of the broad scope of the "policyholder dividend." Because "policyholder dividends" are "expansive", UNUM argues, they necessarily encompass the amounts distributed during the demutualization. We are not persuaded by these arguments, which attempt to sweep the language of 808(a) under the table. Rather, we think that 808(a) presents a major obstacle, which UNUM fails to overcome. UNUM argues that the real test is whether the distributions satisfy 808(b). UNUM focuses its attention on the text of 808(b)(1), arguing: (1) Nothing in the insurance contracts between UNUM and its policyholders addressed the amounts due to the policyholders in a demutualization; therefore the amounts were "not fixed in the contract"; (2) The cash was distributed out of Union Mutual's accumulated surplus, which represents the fruits of the company's considerable business success since its founding; therefore the amounts "depend[ed] on the experience of the company"; (3) Union Mutual's management, though subject to the supervision of the Maine Superintendent of Insurance and -25- 25 obligated to present "fair and equitable" terms to the policyholder, decided the amounts within that range which would be paid to policyholders in exchange for their equity interests; therefore, the amounts were based "on the discretion of management." The combination of these circumstances, UNUM argues, satisfies the elements of 808(b)(1), and thus the distributions are "policyholder dividends" deductible under 805(a)(3), regardless of the general corporate tax provisions contained in Subchapter C. While we recognize that UNUM's argument is plausible, we nonetheless find it unpersuasive. As we explain later, 808(b) describes categories of distributions that may constitute policyholder dividends provided that the definition of 808(a) is met. But UNUM has failed to satisfy us that the term "policyholder dividend" under 808(a) includes value-for-value exchanges that occur during a corporate reorganization such as this. UNUM's argument ultimately suffers from a fundamental defect: it assumes that Congress wished to ignore the context in which the cash and stock distributions took place. We later explain why UNUM's arguments that the distributions fit within 808(a) fail. We first set the stage as to why Subchapter C applies. D. Application of Subchapter C ___________________________ In a paradigmatic recapitalization, the corporation is not allowed a deduction for distributions made in the -26- 26 course of the transaction. See Woodward v. Commissioner, 397 ___ ________ ____________ U.S. 572, 579 n.8 (1970) ("[W]herever a capital asset is transferred to a new owner in exchange for value either agreed upon or determined by law to be a fair quid pro quo, the payment itself is a capital expenditure . . ."); United ______ States v. Houston Pipeline Co., 37 F.3d 224, 226 (5th Cir. ______ ____________________ 1994) ("Stock redemptions, as a general rule, are characterized as capital transactions, and the purchase price of a stock redemption is not deductible.") (footnotes |