COMMISSIONER OF INTERNAL REVENUE v. INDEPENDENT LIFE INS. CO., 67 F.2d 470

HICKS, Circuit Judge. Petition by the Commissioner of Internal Revenue to review an order of the Board of Tax Appeals adjudging that respondent had overpaid its income taxes for the years 1923 and 1924 in the sums of $112.86 and $226.79, respectively. Respondent is a life insurance company, and during the years 1923 and 1924 owned a twelve-story building, occupying one story and renting portions of the remainder. The commissioner determined a deficiency in respondent’s taxes for the year 1923 in the sum of $298.97 and for the year 1924-in the sum of $1,115.65.

These alleged deficiencies grew out of the following facts. Although respondent had deducted for each year taxes, expenses, and an allowance for depreciation incurred in connection with its building, as provided in

section 245 (a) (6) and (7) of the Revenue Act of 1921 (42 Stat. 261), and

section 245 (a) (6, 7) of the Revenue Act 1924, 26 USCA § 1004 (a) (6, 7), it had not included in its returns of gross income for those years the rental value of the space occupied by it as required by

section 245 (

b) of the act of 1921, and

section 245 (

b) of the act of 1924 (26 USCA § 1004 (b).

Section 245 (

b) of the act of 1921 is printed in the margin.

Section 245 (

b) of the act of 1924 is similar. By the provisions of these sections, as interpreted by

Article 686 of Treasury Regulation 62, under the Revenue Act of 1921, and Treasury Regulation 65, under the Revenue Act of 1924, the commissioner included in respondent’s gross income $14,784.70 for 1923, and $34,400.08 for 1924, as the rental value of the space occupied by respondent in its building for those years. His aetion gave rise to the deficiencies complained of. The board found that the deficiency for each year was calculated in accordance with

section 245 (

b) as' it appears," respectively, in the Revenue Acts of 1921 and 1924, but that the requirement thereof, for the inclusion in gross income of the rental value of the space .occupied by respondent in its building, violated the Constitution (article 1, § 2, cl. 3; and art. 1, § 9, el. 4) upon the theory that a tax upon such rental value was not an income tax but a direct tax upon real estate without Apportionment. Petitioner insists that

section 245 (

b) of each act was constitutional and that the board was unauthorized to declare otherwise. The court is not concerned with whether the Board of Tax Appeals was authorized to pass upon the constitutionality of these enactments. A decision by us upon that question would not decide this ease. We are, however, required to consider and determine whether the decision of the board that respondent had overpaid its income taxes for the years involved was “in accordance with law.” Revenue Act of 1926, eh. 27, § 1003 (26 USCA § 1226); Commissioner v. Liberty Bank & Trust Co., 59 P. (2d) 320, 324 (C. C. A. 6). In the discharge of this duty the court is called upon to determine for itself whether

section 245 (

b) of the acts of 1921 and 1924 respectively was a valid enactment. Smyth v. Ames, 169 U. S. 526,18 S. Ct. 418, 42 L. Ed. 819. If it was not, the finding of the board, which may be construed as a finding that no additional tax was due, would obviously have been correct, regardless of the power of the board to pass upon the constitutionality of the act of Congress. Prior to the Revenue Act of 1921 (eh. 136, 42 Stat. 227) life insurance companies were classed, for income tax purposes, with ordinary corporations. They were required to report income from all sources with certain minor exceptions not here important.

This included income from premium receipts commonly called underwriting income. The inclusion of premium receipts in gross income was found to be unsatisfactory both to the government and to the companies because these receipts did not always represent true income. See dissenting opinion of Mr. Justice Brandeis in National Life Ins. Co. v. United States, 277 U. S. 508, 522, 523, 48 S. Ct. 591, 72 L. Ed. 968.

With the approval of “Life Insurance Presidents” at their annual meeting in December, 1920, Congress provided for the assessment of income taxes against insurance companies upon- a new basis, embodied in sections 243, 244 (a), 245 (

a) and (bl of the Revenue Act of 1921, ch. 136, 42 Stat.

Section 243 provides that: “There shall be levied, collected, and paid for the calendar year 1921 and for each taxable year thereafter upon the net income of every life insurance company a tax as follows : * * * ” (Italics ours.)

Section 244 (

a) provides that the term “gross income” means the gross amount of income received during the taxable year from interest, dividends and rents. (Italics ours.)

Section 245 (

a) provides the method for the determination of “net income.” The pertinent provisions of sections 243, 244 (

a) and 245 (

a) are similar in the acts of 1921 and 1924, respectively (Revenue Act 1924, §§ 243, 244 (a), 245 (a), 26 USCA §§ 1003 (a), 1004 (a), and § 1001 note). In determining, therefore, whether the rental value of the space occupied by the life insurance company in its own building should be included in the return of gross ineome, an accurate conception of the terms, “income,” “gross income” and “net income,” are of fundamental importance. It might be said, with a fair show of reason, that benefit in the form of actual rental value accruing to one who occupies his own building is in the nature of income from rents.

But we may not adopt such conception here. "We are required to follow the standard definition of income found in the Sixteenth Amendment and the interpreta-' tion thereof by the Supreme Court. The well-established meaning of income in this connection is found in Eisner v. Macomber, 252 U. S. 189, 207, 40 S. Ct. 189, 193. 64 L. Ed. 521, 9 A. L. R. 1570—“ ‘Derived— from—capital’; ‘the gain — derived—from— capital,’ etc.

Here we have the essential matter: not a gain accruing to capital; not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value, proceeding from the property, severed from the capital, however invested or employed, and coming in, being ‘derived’ — that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal — that is income derived from property. Nothing else answers the description.” In Bowers v. Kerbaugh-Empire Co., 271 U. S. 170, 174, 46 S. Ct. 449, 451, 70 L.

Ed. 886, the court said: “After full consideration, this eourt declared that income may be defined as gain derived from capital, from labor, or from both combined, including profit gained through sale or conversion of capital. Stratton’s Independence v. Howbert, 231 U. S. 399, 415, 34 S. Ct. 136, 58 L. Ed. 285; Doyle v. Mitchell Brothers Co., 247 U. S. 179,185, 38 S. Ct. 467, 62 L. Ed. 1054; Eisner v. Macomber, 252 U. S. 189, 207, 40 S. Ct. 189, 64 L. Ed. 521, 9 A. L. R. 1570. And that definition has been adhered to and applied repeatedly. See, e. g., Merchants L. & T. Co. v. Smietanka, supra [255 U.

S.] 518 (41 S. Ct. 386 [65 L. Ed. 751, 15 A. L. R. 1305]); Goodrich v. Edwards, 255 U. S. 527, 535, 41 S. Ct. 390, 65 L. Ed. 758; United States v. Phellis, 257 U. S. 156, 169, 42 S. Ct. 63, 66 L. Ed. 180; Miles v. Safe Deposit Co., 259 U. S. 247, 252, 253, 42 S. Ct. 483, 66 L. Ed. 923; United States v. Supplee-Biddle Co., 265 U. S. 189', 194, 44 S. Ct. 546, 68 L.Ed. 970; Irwin v. Gavit, 268 U. S. 161, 167, 45 S. Ct. 475, 69 L. Ed. 897; Edwards v. Cuba Railroad, 268 U. S. 628, 633, 45 S. Ct. 614, 69 L. Ed. 1124. In determining what constitutes income substance rather than form is to be given controlling weight.

Eisner v. Macomber, supra [252 U. S.] 206 (40 S. Ct. 189 [64 L. Ed. 521, 9 A. L. R. 1570]).” Whatever might be said as to the power of Congress to require life insurance companies to include in their gross income the actual or fair rental value of space occupied by them in their own buildings (a question not necessary here to determine) it is manifest to us that the amount required to be added to gross income under

section 245 (b), before deductions may be taken, is not income when measured by the rule in Eisner v. Ma-comber, supra, and Bowers v. Kerbaugh-Empire Co., supra. It does not represent actual gain. It is neither of exchangeable value nor is it severed from capital. It is not something received or drawn by the taxpayer for his separate use and disposal.

It is simply an arbitrary figure, determined by a mathematical formula, to which must be added' rents received from other tenants and from which must be deducted taxes, depreciation, and all other expenses to reach a net income of 4 per cent, per annum of the book value (not actual value) of the building at the end of any given taxable year. It does not even purport to approximate the true rental value of the space occupied. It must be increased or diminished inversely, each year, to the increase or decrease of rents received. In Burk-Waggoner Oil Ass’n v. Hopkins, 269 U. S. 110, 114, 46 S. Ct. 48, 49, 70 L.

Ed. 183, the court said: “It is true that Congress cannot make a thing income which is not so in fact.” See, also, Flint v. Stone Tracy Co., 220 U. S. 108, 145, 31 S. Ct. 342, 55 L. Ed. 389, Ann. Cas. 1912B, 1312. It is here urged, as was urged in National Life Insurance Co. v.

United States, supra, that the present tax is a special excise tax-laid upon life insurance companies and measured by the aggregate of certain receipts by such companies; that in levying such an excise tax Congress was not acting under the Sixteenth Amendment, and hence the proper definition of income, as used in that Amendment, is wholly immaterial; and, since the respondent has continued to do business in corporate form, it is estopped to deny the validity of the conditions upon which Congress has said this could be done. To so hold would be to deny the obvious fact.

In form and substance the Internal Revenue Acts under consideration levy income taxes and not excise taxes. Respondent has accepted no benefits under

section 245 (

b) of either act. None are in effect granted therein. It has chosen, as it had a right to do, to claim d.eductions allowed by

section 245 (a) (6) and (7) of each act and to resist deficiency assessments founded upon the compulsory inclusion in gross income of that which cannot in any sense be regarded as income. The record fails to disclose that respondent has acquiesced in the provisions of these sections or recognized them as valid. See Frost v. Corporation Commission, 278 U. S. 515, 528, 49 S. Ct. 235, 73 L. Ed. 483.

We therefore conclude that the inclusion of the indicated items in respondent’s gross income for 1923 and 1924, respectively, as the rental value of the space occupied by it in its building, was in effect the taxation of something nontaxable (Evans v. Gore, 253 U. S. 245, 40 S. Ct. 550, 64 L. Ed. 887, 11 A. L. R. 519; Miles v. Graham, 268 U. S. 501, 45 S. Ct. 601, 69 L. Ed. 1067) and was invalid. It is said that the purpose of

section 245' of each act was, not to include in gross income that which was not income, but to limit the deductions of taxes and other expenses paid with respect to real estate owned by life insurance companies, and of the allowance for exhaustion and obsolescence granted in

section 245 (a) (6) and (7) of each act. It is urged that this may be done because deductions are statutory, and, although income is controlled by the Constitution, Congress may grant deductions or withhold them entirely or limit the amounts thereof. The same argument was advanced in National Life Insurance Co. v. United States, supra, but the court there said (277 U. S. page 520, 48 S. Ct. 591, 593, 72 L. Ed. 968): “The suggestion that, as Congress may or may not grant deductions from gross income at pleasure, it can deny to one and give to another, is specious, but unsound.” Congress may, of course, allow to ail life insurance companies the deductions granted in

section 245 (a) (6) and (7), but having done so it cannot then say that it will deny these same deductions to those life insurance companies which own and occupy in whole or in part their own real estate unless they submit to taxation upon income which is nonexistent. No claim is made that

section 245 (a) (6) and (7) of the acts under consideration, by virtue of which respondent took deductions, are unconstitutional. Both the acts, 1921 and 1924, contain the usual

section to the effect that if any of their provisions are held invalid, the remainder shall not be affected, thereby. The order of the Board of Tax Appeals is affirmed. “Sec. 245. (

b) No deduction shall be made under paragraphs (6) and (7) of subdivision (

a) on account of any real estate owned and occupied in whole or in part by a life insurance company unless there is included in the return of gross income the rental value of the space so occupied. Such rental value shall be not less than a sum which in addition to any rents received from other tenants shall provide a net income (after deducting taxes, depreciation, and all other expenses) at the rate of 4 per centum per annum of the book value at the end of the taxable year of the real estate so owned or occupied.”