Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 69-96

1969-1 C.B. 31

IRS Headnote

Dividends received on a group credit life insurance policy by a farm production credit association administering it for member-borrowers is not includible in the association's income, and their use in partial payment of the annual premium is not a deductible expense.

Full Text

Rev. Rul. 69-96

Advice has been requested whether a farm production credit association organized to make loans to farmers must include in its gross income dividends received on a group credit life insurance policy administered by it for the benefit of its member-borrowers. In addition, the question is asked whether the association may deduct that part of these dividends expended for the benefit of its member-borrowers as partial payment of the group policy's annual premium.

The production credit association is a profit-making corporation organized principally to make loans to farmers to finance the current production costs of operating their farms. Its activities in this regard are regulated by the Federal Farm Credit Administration and, at the regional level the Federal Intermediate Credit Bank.

The association has made provision for a group credit life insurance policy insuring the lives of any of its borrowers wishing to take advantage of the coverage. This policy provides that if the insured borrower dies before his indebtedness is repaid to the association the insurance company will pay to the association towards the discharge of the borrower's indebtedness an amount equal to the lesser of (a) the unpaid balance on his obligation, or (b) $10,000. Premiums are paid by the individual borrowers to the association, which in turn makes a lump sum payment of the annual premium to the insurance company. Similarly, any dividends earned on the group policy are paid to the association in a lump sum.

The Federal Farm Credit Administration has approved group life insurance programs for production credit associations under the following requirements:

(1) Credit life insurance must be optional with each borrower;

(2) Personnel of an association shall not receive benefits directly or indirectly as a result of the program;

(3) The Federal Intermediate Credit Bank may authorize an association to recover the cost of handling credit life insurance, if permissible under state law; and

(4) Experience dividends received by the association in excess of approved costs must be used for the benefit of association borrowers.

In the past several years, annual dividends earned on the policy have been paid to the association in cash without any allocation of the dividend to the individual policyholders. In view of the absence of such an allocation, the association cannot pass on the dividends, in correct proportion, to the borrowers actually earning them. Therefore, in compliance with the requirements of the Federal Farm Credit Administration respecting the handling of such annual dividends the association's board of directors adopted a resolution establishing a liability account, "Undistributed Dividends--Credit Life Insurance," in which to account for the dividend payments. It was also resolved that such dividends would be held for the following purposes:

(1) If it becomes necessary for the insurance company to raise premium rates in the future, these funds will be used to maintain the present rate.

(2) If it is not necessary for the insurance company to raise the rate and the dividend accumulates to the sum of twenty thousand dollars ($20,000) then the rate of the insurance to the members should be reduced by an amount necessary to balance the premium take and the death loss outgo.

Since 1960 the balance of the association's insurance liability account has exceeded the $20,000 standard. Accordingly, the association has been making partial payments of the annual premiums payable on the group policy.

The liability account set up by the association reflects the cumulative balance of the dividends received reduced by the premiums paid by the association. This balance is included on the balance sheet with the association's other current liabilities. Despite this segregation of the balance of the undistributed dividend account on the association's books of account, the actual cash represented by this account has not been segregated but has been commingled with other cash of the association.

In the case of The Seven-Up Company v. Commissioner, 14 T.C. 965 (1950), acquiescence, C.B. 1950-2, 4, the Tax Court of the United States found that amounts received by the Seven-Up Company from bottlers pursuant to the explicit understanding that these funds were to be used in a national advertising campaign did not constitute income to the company. In making this determination, the court noted, at page 977, that

"While petitioner had the right to receive the bottlers' contributions under its agreements with them, all the facts and circumstances surrounding the transaction clearly indicate that it was the intention of all of the parties concerned that these contributions were to be used to acquire national advertising for the 7-Up bottled beverage and for that purpose only, and that petitioner was to be a conduit for passing on the funds contributed to the advertising agency which was to arrange for and supply the national advertising."

The court found that the amounts contributed by the bottlers constituted a trust fund administered by the petitioner as a "trustee" or agent. Since the petitioner did not receive the bottlers' contributions as its own property but received them burdened with the obligation to use them for a specified purpose and only for that purpose, it was not required to include these payments in its income.

Revenue Ruling 58-209, C.B. 1958-1, 19, distinguishes the Seven-Up Company case from the one under consideration therein and states that the Seven-Up Company case will be followed by the Internal Revenue Service only in those cases where the factual pattern is similar, i.e., where the facts show that the organization is a mere conduit for the expenditure of a fund established for a specific purpose. Revenue Ruling 58-209 holds that payments received by a nonprofit membership corporation organized to promote the sale of automobiles by financing advertising campaigns with payments received from its automobile dealer-members are includible in the organization's gross income since under its charter the organization was authorized to expend such payments for other activities of a nonadvertising nature to promote the general business welfare of its dealer-members.

In the instant case it is apparent that all of the parties concerned intended that the dividends received by the association were to be used only for the specific purpose of maintaining or reducing the borrowers premium rates with the association acting merely as an agent in holding the dividends for this purpose. Although the cash payments were commingled with the association's operating funds, such payments were earmarked and retained for the benefit of the borrowers from the time they were received by the association until the time they were expended.

Accordingly, if the association has on hand at all times cash and securities in excess of the amount of the undistributed dividends and if its books clearly establish that it is acting as a mere trustee or conduit with respect to such payments, the amount of such payments will not be gross income of the association, and the expenditure of such funds pursuant to the association's obligation to make annual payments of the premium on the group policy will not be a deductible expense.