Petitioner's officers are elected annually by its directors and its directors are elected annually by its members. Each policyholder is a member and entitled to vote. Each policy issued by petitioner from October 1934 to 1940, inclusive, contained the following provision:

The Order is a mutual legal reserve insurance corporation, and is owned wholly by its policyholders who are its members. This Policy constitutes the evidence of the Insured's membership in the Order and is the certificate thereof. Membership begins upon the taking effect of this Policy and shall end upon the death of the member, or the lapsing or other termination of this Policy. * * Any failure to comply with the provisions of this Policy shall render invalid any claims hereunder.

Since its inception petitioner has been primarily an organization of railroad employees. Its officers and directors have always been railroad men and at the time of the hearing approximately 90 percent of its members were railroad employees.

On the 1st day of March 1931 petitioner distributed to its then members and policyholders a dividend aggregating $53,918.80. This distribution was made pursuant to resolutions of the board of directors of petitioner adopted on November 11, 1930, and February 11, 1931. Immediately thereafter, and for a period of several years, petitioner's losses and expenses exceeded its current income. This resulted from the nationwide economic depression. As a result of this experience the directors decided it would be inadvisable to pay any dividends "for the time being." Their ambition and desire, as expressed at the hearing by their president, was "to make the financial condition of the Order absolutely solid and impervious to any kind of condition that might arise in the way of strikes, epidemics or those other conditions that cut so heavily into our income as a result of claims and decreased premium receipts." It was expected that this policy would "insure the prompt and equitable payment of claims." During 1934 and thereafter petitioner issued policies providing for payments during the lifetime of the insured, if accidentally injured, whereas the earlier policies had provided for payments during not to exceed 24 months. It also increased its payments for illness from 6 months to 16 months. The directors were desirous of building the surplus up to a point where tificate holder at least thirty days before the day fixed for the meeting. A certified copy of all proceedings relative to such action shall be filed with the commissioner, who, if he finds that the proceedings have been in accordance with law, shall approve the same. (Added by Stats. 1935, p. 1001.)

Sec. 10,881. Amending transformed corporation's articles and by-laws. Such transformed corporation may amend its articles and by-laws, and shall be considered a continuation of the original corporation by the same name. (Added by Stats. 1935, p. 1001.)

Sec. 10,882. Law applicable to transformed insurer. Thereafter the insurer shall not include in its policies the provisions required by the preceding article, but shall be subject as to subsequent business to the test of solvency provided for life, disability, and life and disability insurers by this code and to all other provisions relating to mutual life, and disability insurance not on the stipulated premium plan. But such election shall not affect the rights or obligations of the insurer or its members on any contract theretofore made. (Added by Stats. 1935, p. 1001.)

these additional contingencies would be taken care of. In recent years they were also conscious of the uncertainties created by war. While the declaration of a dividend was discussed, none was made or paid by petitioner after 1931.

During the years 1931 to 1940, inclusive, the reserve funds held by petitioner, and the purposes for which they were held, were as follows:

During each of the taxable years petitioner issued policies of insurance providing for the payment of accident and illness benefits as well as for the payment of a specified principal sum if loss of life resulted from injuries sustained by accidental means. Straight life insurance policies were not issued after 1931.

The following table shows the number of certificates of membership of insurance policies which were outstanding, issued or lapsed during the years 1931 to 1940, inclusive:

Petitioner's income tax returns for the taxable years were filed with the collector of internal revenue for the first district of California. In the statement attached to the deficiency notice, the respondent gave the following reasons for determining the deficiencies:

It is held that you are not taxable under the provisions of sections 201, 202, and 203 of such revenue laws [Revenue Act of 1936 and corresponding sections of subsequent revenue acts] because you were not a life insurance company engaged in the business of issuing life insurance and annuity contracts during

the taxable years under consideration. You ceased the issuance of life insurance policies and annuity contracts prior to January 1, 1936, and thereafter only issued other types of insurance policies, principally health and accident insurance contracts.

It is held that you are not taxable under the provisions of section 207 of such revenue laws because you have not conducted your business as a mutual insurance company. It is of the essence of mutual insurance that the excess in the premiums over the actual costs as later ascertained should be returned to the policyholders. There is nothing in your articles of incorporation or by-laws showing that in any event members (policy-holders) are entitled to receive any amount which properly represents a return of the excess of their premiums over the actual cost of the policies as later determined and you did not, during the period under consideration, refund to policyholders any amount of the excess premiums over the cost of such insurance.

You are consequently taxable under the provisions of section 204 of the applicable revenue laws as an insurance company other than life or mutual and your tax liability has been so computed in the following schedule.

OPINION.

MELLOTT, Judge: The issue is: Under which section of the revenue act shall petitioner be taxed? Respondent has taxed it under section 204 (a) of the Revenue Act of 19362 and similar provisions of the Revenue Act of 1938 and the Internal Revenue Code as an insurance company other than life or mutual. Petitioner contends that it is taxable under section 201 (a) as a life insurance company, though it places its chief reliance upon, and devotes most of its brief to establishing, the fact that it is a mutual insurance company and hence taxable under section 207 (a).*

3

In its reply brief petitioner concedes that it does not have the necessary reserve funds held for the fulfillment of life policies to entitle it to classification as a life insurance company under recent decisions of this tribunal. Independent Life & Accident Insurance

2 SEC. 204.

INSURANCE COMPANIES OTHER THAN LIFE OR MUTUAL.

(a) IMPOSITION OF TAX.

(1) IN GENERAL.-In lieu of the tax imposed by sections 13 and 14, there shall be levied, collected, and paid for each taxable year upon the normal-tax net income of every insurance company (other than a life or mutual insurance company) a tax of 15 per centum of the amount thereof. SEC. 201.

TAX ON LIFE INSURANCE COMPANIES.

(a) DEFINITION.-When used in this title the term "life insurance company" means an insurance company engaged in the business of issuing life insurance and annuity contracts (including contracts of combined life, health, and accident isurance), the reserve funds of which held for the fulfillment of such contracts comprise more than 50 per centum of its total reserve funds.

SEC. 207. MUTUAL INSURANCE COMPANIES OTHER THAN LIFE.

(a) APPLICATION OF TITLE.-Mutual insurance companies, other than life insurance companies, shall be taxable in the same manner as other corporations, except as hereinafter provided in this section, and except that they shall not be subject to the surtax imposed by section 14, and except that the normal tax imposed by section 13 shall be at the rate of 15 per centum instead of at the rates provided in such section, and such normal tax shall be applicable to foreign corporations as well as domestic corporations; but foreign insurance companies not carrying on an insurance business within the United States shall be taxable as other foreign corporations.

Co., 47 B. T. A. 894; United Life Insurance Co., 47 B. T. A. 960; General Life Insurance Co., 1 T. C. 555. See also Mothe Burial Benefit Life Ins. Co. v. Fontenot, 46 Fed. Supp. 978. Cf. Swift & Co. Employees Benefit Association, 47 B. T. A. 1011; National Protective Insurance Co. v. Commissioner, 128 Fed. (2d) 948, affirming 44 B. T. A. 978; certiorari denied, 317 U. S. 655; and First National Benefit Society v. Stuart, 134 Fed. (2d) 438. The first two cases cited are pending upon appeal in the Circuit Court of Appeals for the Fifth Circuit. General Life Insurance Co., supra, was reversed by a divided court (C. C. A., 5th Cir., July 8, 1943). With all due deference to the court, we adhere to the views heretofore expressed and hold that, since petitioner did not maintain reserves on its health and accident policies on any actuarial basis and inasmuch as it was not “engaged in the business of issuing life insurance and annuity contracts" in the taxable years, it can not be classified as a life insurance company.

But is petitioner taxable as a mutual insurance company other than life? Respondent argues that it is not, pointing out that its life and accident and health policyholders pay fixed and level cash premiums, that it is not specifically obligated to distribute to its policyholders each year the excess of the premiums over the cost of the insurance, and that it is engaged to a limited extent in the life insurance business. The existence of the first circumstance is not disputed; but that does not prevent taxing petitioner as a mutual insurance company. Ohio Farmers' Indemnity Co., 36 B. T. A. 1152; affd., Ohio Farmers' Indemnity Co. v. Commissioner, 108 Fed. (2d) 665.

The second point raised by the respondent and the real basis of his determination is: "It is of the essence of mutual insurance that the excess in the premium over the actual cost as later ascertained shall be returned to the policyholder," Penn Mutual Life Insurance Co. v. Lederer, 252 U. S. 523; New York Life Insurance Co. v. Bowers, 283 U. S. 242. Recognizing that the Supreme Court has not laid down any rule requiring that a "dividend" or refund of the excess be declared or paid in the year in which the premium is paid, respondent insists that refund to the class of policyholders must be mandatory. He argues that this petitioner is under no obligation to pay any dividend to any of its policyholders at any time. He also points out that there were many lapsed policies during the period from 1932 to 1940 and under petitioner's contract with the holders of such policies they forfeited any interest which they had therein. He argues that this circumstance prevents petitioner from being a true mutual.

Petitioner points out that its articles of incorporation expressly provide that it is a mutual company, "not formed with a view to

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pecuniary gain or profit to its members"; that it is required * * from time to time to distribute to the members any surplus of net income which in the judgment of the board of directors it is not necessary to retain for the purposes of the corporation"; that its members are the owners of the entire surplus or reserve and they, by appropriate action, could have compelled distribution to themselves at any time; that the fact that holders of lapsed policies forfeited their interest in the surplus does not cause the company to become other than a mutual; and that it should not be denied classification as a mutual merely because its directors, in the exercise of their sound discretion, failed to authorize any distribution to be made during the years 1932 to 1940, inclusive.

The evidence was directed largely toward showing why dividends had not been declared. None was adduced indicating that the directors had acted in bad faith or had been guilty of any abuse of discretion. Without attempting to summarize the evidence, it may be stated generally that the factors which influenced the directors in refraining from declaring a dividend were: (1) The near catastrophe which resulted from the economic depression following the 1931 dividend and which substantially reduced the surplus available for meeting contingencies; (2) the possibility of a recurrence of similar economic depressions; (3) uncertainties, particularly since 1939, created by the second World War; (4) the extra risk involved in issuing accident policies having no cut-off on monthly payments other than the duration of the injury; (5) the increased risk resulting from issuing policies providing for 16 monthly payments in connection with sickness instead of 6 as theretofore; (6) the always present possibility of epidemics; and (7) the possibility that a strike or reduced employment among railroad employees, which constituted approximately 90 percent of petitioner's membership, would result both in increased claims and in decreased revenue.

In Penn Mutual Life Insurance Co. v. Lederer, supra, it was stated: "In a mutual company, whatever the field of its operation, the premium exacted is necessarily greater than the expected cost of the insurance, as the redundancy in the premium furnishes the guaranty fund out of which extraordinary losses may be met." In a mutual company some payment to the policyholder, representing such excess, is ordinarily made every year, though, as the court pointed out, it "is rarely made within the calendar year in which the premium was paid." Provisions are usually contained in the charter, articles of incorporation, or policies of a mutual insurance company, vesting in its board of directors discretionary power to determine when the surplus income is to be divided among the members or classes and the proportion thereof. McKean v. Biddle, 37 A. 528; 181 Pa. St. 361;

*