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O. Jan Tyler, 2030 Republic Bank Building, Dallas, Tex. 75201, for Southwestern Life Ins. Co. Frank D. McCown, United States Attorney, Ft. Worth, Tex. 76102, Martha Joe Stroud, Assistant United States Attorney, Dallas, Tex. 75202, Scott P. Crampton, Assistant Attorney General, Gary R. Allen, Gilbert E. Andrews, Bennet N. Hollander, Richard Farber, Department of Justice, Washington, D. C. 20530, for U. S.

Before TUTTLE, GOLDBERG and CLARK, Circuit Judges.

This appeal presents for consideration the correctness of the trial court's judgment in a suit for refund filed by the insurance company by which judgment the trial court resolved several of the contested issues in favor of the taxpayer and the remaining issues in favor of the Commissioner. Since the parties are not content to leave the split solution where it stands, it is necessary for us to give separate consideration to each of the many points at issue in the trial court. We shall first discuss the five issues which the trial court resolved in favor of the taxpayer, and which the Government has raised on its direct appeal to this Court. We then turn to the issues resolved in favor of the Commissioner and brought before us here by cross-appeal by the insurance company. Fortunately, both for the Court and for those affected by the opinion of this Court, counsel for the appellees followed the pattern of the Government's brief in discussing the several issues and, with an effort to get quickly to the merits of the controversy, counsel for the appellees followed almost verbatim the wording of the Government's brief in positing the issues which, on the Government's direct appeal, we state as follows:

I. Issues on Direct Appeal

     1. Whether the district court erred in holding that it had

The issues in this case arise under the Life Insurance Company Income Tax Act of 1959, 26 U. S. C. Section 801 through 820. Congress has long recognized the difficulties in accurately establishing life insurance company annual income and, as reflected in the legislative history, S. Rep. No. 291, 86th Cong., 1st Sess., p. 5 (1959-2 Cum. Bull. 770-775) an apparent tax advantage is allowed to such companies on account of the nature of their long-term contracts which make it possible that what might appear to be income in the current year could conceivably be required later to fulfill insurance contracts. It is not deemed necessary for our consideration of the several issues involved to outline the precise method by which taxable income of life insurance companies is measured. It can be assumed, of course, from the fact that the issues are raised that their resolution will affect the ultimate income tax liability of the taxpayer.

III. Issues Numbers 1 and 2--Reserve Strengthening under Section 809(d)(5)

These issues are treated together, because it is the Government's position that the Commissioner's disallowance of the ten percent deduction for increases in life insurance reserves attributable to nonparticipating contracts under Section 809(d)(5) was not challenged by the taxpayer by a claim for refund before the filing of the suit now before the Court. If we find this contention to be correct, we do not reach the merits of the question.

The "ground" for the taxpayer's contention that it is entitled to a refund as to this item arises from the unique provisions of the Code dealing with the treatment of certain reserves which is not brought about by normal additions to reserves. The Code authorizes the deduction in the tax year by an insurance company of the total amount normally added to reserves. In a case of "reserve strengthening" that is, when the company elects to increase its reserves beyond those required by Section 808 of the Act, the Code requires that the deduction of the amount, here $820,068, be made over a period of 10 years, beginning the following year. This is called the "spread" rule. The statute further authorizes the deduction of an additional 10% of the amount of any reserve increase attributable to nonparticipating contracts. The taxpayer claims, and the trial court held, that this 10% could all be deducted for the tax year because it was not covered by the "spread" rule. The government contends, to the contrary, that the statute requires the same treatment of this additional 10% as is given to the principal amount itself: None is deducted in the tax year but deductions must be spread over the succeeding 10 years. Resolution of this issue depends upon the construction of Section 809(d)(2), 809(d)(5) and 810(d) of the Code.

Section 7422 of the Internal Revenue Act of 1957 provides as follows:

     "No Suit prior to filing claim for refund--No suit

The Supreme Court has long since held that a failure to raise factual and legal grounds in a claim for refund bars a recovery on such a claim in a subsequently filed suit for refund, United States v. Felt & Tarrant Manufacturing Co., 283 U. S. 269, 51 S. Ct. 376, 75 L. Ed. 1025 (1931); Angelus Milling Co. v. Commissioner of Internal Revenue, 325 U. S. 293, 65 S. Ct. 1162, 89 L. Ed. 1619 (1945). This Court has stated in Alabama By-Products Corp. v. Patterson, 258 F.2d 892, 900 (1958):

     "All grounds upon which a taxpayer relies must be stated in

 "Schedule E-2, Part III

     "In Rider 8, the adjustment was listed as erroneously have

We must conclude, therefore, that the trial court did not have jurisdiction to consider the Section 809(d)(5) claim on the merits. This, then, disposes of issues numbered 1 and 2, supra.

IV. Issue Number 3--Mortgage Escrow Funds and Other Amounts Held in Cash by Taxpayer for Employees as "Assets"

(a) Mortgage Escrow Funds. For simplification, we adopt the formula as stated in the government's brief to give an indication of the importance of ascertaining whether certain items carried on the taxpayer's books as assets are "assets" as defined in Section 805(b)(4) and as used to compute taxpayer's tax liability under the act. There is an exclusion for the policyholder's share of the investment income as a step in the computation of the tax. In highly simplified form, the excluded portion of a company's investment income is computed as follows:

Investment Yield/Assets = Earnings Rate

Earnings Rate x Reserves (adjusted) + interest paid = exclusion

It is clear that the higher the amount of the company's assets in this formula, the lower is its earnings rate and thus the higher would be its taxable share of investment income.

The mortgage escrow funds, represented by bank deposits in the general bank accounts of the taxpayer, are claimed by the company not to fall within the definition of assets for the purpose of this computation. The trial court accepted this view of the matter and concluded that Liberty National Life Insurance Company v. United States, 463 F.2d 1027 (5th Cir. 1972) required this result.

During the years in question, the taxpayer held substantial amounts of mortgages on real estate, some having been made directly between the taxpayer and the borrower and others having been made through mortgage loan correspondents or servicing agents who serviced the loans pursuant to written contracts entered into with taxpayer. Under the standard contracts employed by the taxpayer, the mortgagor was required to make monthly payments which consisted of a reduction of principal, interest, and a sum sufficient when added to subsequent monthly payments to enable the taxpayer to pay the year's property taxes and insurance when these items should come due. The items other than principal and interest are called by both parties "mortgage escrow funds." These funds were deposited in the general checking accounts of the taxpayer. During the tax years, the cash of the taxpayers, which included the escrow items, was deposited in approximately 1500 different banks, which held annually reported balances varying from a few hundred dollars to approximately one million dollars.

The amount of "mortgage escrows" was substantial, amounting on December 31, 1958 to $333,036.18 and increasing thereafter to $674,608.89 in 1965.

In addition, correspondents or servicing agents had on deposit in their general bank accounts much more substantial amounts of cash in 1963, 1964, and 1965 all subject to the control of the taxpayer. The amounts of these escrows for the tax years follows:

 Mortgage Escrow Funds Held by Taxpayer:

Section 805(b)(4) contains a definition of the term "assets" for purposes of determining an insurance company's earnings rate:

     "For purposes of this part, the term `assets' means all

The difficulty here is that we do not know what was stated in the mortgage documents referred to in the Liberty National case to cause the court to hold that the monthly payments of the escrow amounts created a trust for the mortgagor with the insurance company as trustee; nor, in this case, do we know the terms of the agreements between mortgagors and insurance company. The company, as plaintiff in this refund suit, did not deem it necessary to prove the terms under which these payments were made to the taxpayer. Thus, proof is lacking on whether the agreement created a trust of the kind alluded to in Liberty or merely created the relation of debtor and creditor. There is no evidence in this record of a single document that creates an express trust, although both parties treated the matter as we know it actually occurred, that is, that each dollar deposited in the mortgage escrow account represented a payment made by a mortgagor against the company's later payment of certain items that were payable once a year.

Moreover, the government's brief states that the taxpayer has conceded in a trial brief that none of the mortgage documents created an express trust. This statement is not challenged by any of the subsequent briefs filed by the taxpayer. Since it is clear that the money was paid under a written agreement and since the company does not undertake to claim that it has breached any trust relationship by which it got possession of these funds or mishandled them after receiving them, we fail to see how a constructive trust could be impressed on the funds as against the company. See, e. g., Blankenship v. Citizens National Bank of Lubbock, 449 S. W. 2d 77, 79 (Tex. Civ. App. 1965); Nichols v. Acers Co., 415 S. W. 2d 683 (Tex. Civ. App. 1967). So far as the record discloses the company had every right to consider that its receipt of these funds from the various mortgagors created merely an obligation to pay the taxes and insurance when they became due, a contractual obligation and nothing more.

Not only did the taxpayer fail to prove that these funds actually belonged to others than the mortgagor by producing an agreement to that effect but also the company's treatment of the funds was clearly inconsistent with its present contention that they were trust funds. It is clear that taxpayer did not deal with these funds in the manner required of trustees by the Texas statutes, Article 7425b, Section 10, p. 228. In Langford v. Shamburger, 392 F.2d 939 (5th Cir. 1968), this Court construed this statute and we there held that it forbids a trustee from comingling trust funds with its own, citing and construing the Texas case, Langford v. Shamburger, 417 S. W. 2d 438 (Tex. Civ. App. - Ft. Worth, 1967, writ ref'd n. r. e.) which in turn cites Bogert on Trusts as follows:

     "The trustee may violate the duty of loyalty by lending

     ". . . Under section 10 of the Texas Trust Act, the section

In Liberty, even though the Court determined that the funds there were trust funds, we pointed out that if such funds were used for the benefit of the insurance company, we would consider them to be assets within the meaning of Section 805(b)(4). We said:

     "Unless it could be shown that the escrow funds actually

This Court had previously held in Langford, supra, that under Texas law, which controls here, the legal consequences of the relationship between mortgagor and mortgagee here-such comingling of funds-confer a benefit on the comingler. In that case we said:

     "In developing this idea, we will assume the cash balances

Of course, we do not hold that if the taxpayer should violate the Texas statute with regard to the handling of trust funds it necessarily follows that such funds are not indeed trust funds. We point to this handling of the matter by the taxpayer only to indicate that on this record which is otherwise silent as to the existence of a trust, the company's conduct was inconsistent with its present contention that these funds "belong to someone else."

Not only was the handling of these funds by the taxpayer inconsistent with its claim that they were trust funds but a further distinction appears from the fact situation which was discussed by the court in Liberty. That is, that there is proof in this record that the general funds of the company, including the mortgage escrow amounts, were scattered over some 1500 different banks, apparently in every hamlet, town and village in a large area of the southwest. It would seem that this use of the escrow funds must have been for some business purpose which would, of course, be a benefit to the taxpayer which the Liberty court found lacking.

Essentially, we have a simple issue: Were these funds assets of the insurance company or did they belong to someone else? The presumption of correctness that follows the deficiency notice places the burden on the taxpayer of establishing all matters necessary to show that it does not owe the taxes in question. Helvering v. Taylor, 293 U. S. 507, 55 S. Ct. 287, 79 L. Ed. 623; Gibbs v. Tomlinson, 362 F.2d 394 (5th Cir. 1966).

We conclude that not only did the taxpayer not carry this burden by proof that the money carried in these bank accounts were not assets but the proof, such as it was, is to the contrary. The trial court erred in holding that these funds were not assets of the company within the contemplation of the statute.

(b) Amounts Withheld from Taxpayer's Employees and Miscellaneous Other Funds Held by Taxpayer. These items, which together would add something over one million dollars to the assets reportable for 1962 and in excess of two hundred thousand dollars in the years 1963, 1964 and 1965, included an item denominated "liability for cash held in escrow-Roberts," "withholding taxes-federal, state, and city," "mortgage participation-Sun Ray," "amounts deducted from employees' pay to be used for various items" and "miscellaneous." The government contends that these items should all be treated in the same manner as are the mortgage escrow funds. The taxpayer says with respect to these items. "These same principles [the principles applicable to treatment of `mortgage escrow funds'] and arguments apply with respect to amounts withheld from taxpayer's employees and miscellaneous other funds held by taxpayer as agent or trustee. See Section 7501 and Arcnell [ Artnell] v. Commissioner, 18 [48] Tax Ct. 411 (1967)."

Reference to Section 7501 makes it plain that so far as the amounts included any federal internal revenue tax, these amounts were held by the company in trust for the benefit of the United States. Title 26 U. S. C. Section 7501 provides:

     "(a) General rule--Whenever any person is required to

In view of the fact that the taxpayer agrees that the same considerations that apply to the mortgage escrow funds shall be applied to these other items, and does not undertake to distinguish between them, we treat them in that manner, except for the withheld federal internal revenue taxes. The trial court therefore erred in excluding such items from the company's assets for the tax years in question.

V. Issue Number 4: "Due" and "Unpaid" Accident and Health Premiums as "Assets."

During the tax years in question, taxpayer sold both cancellable and non-cancellable accident and health insurance policies in addition to its life insurance business. The policies typically provide for a grace period of 31 days during which the policy remains in force notwithstanding the failure of the insured to pay the premium on the due date. As of the end of each of the years in issue, taxpayer had a substantial number of policies in force by virtue of the grace period provision. The premiums which would ultimately be paid on these if they were kept in force are referred to by the taxpayer on its books and statements as "due and unpaid."

Even though taxpayer had no legal claim or entitlement to these amounts if the policyholders should elect not to renew them, experience had dictated that a very substantial number were actually paid and the taxpayer included them in "admitted assets" in its annual statement for the years in question. Due and unpaid accident and health premiums are also included in taxpayer's "gross premiums" in the summary of operations section of its annual statements and in its gross premiums for federal income tax purposes. However, for the purpose of computing its assets under Section 805(b) of the Code, taxpayer did not include any portion of the due and unpaid premiums.

Although the trial court held in the government's favor as to a seemingly similar item of "due and unpaid" life insurance premiums, which judgment has since submission of this case been partially approved by the Supreme Court's decision in Commissioner of Internal Revenue v. Standard Life & Accident Ins. Co., (No. 75-1771) - U. S. -, 97 S. Ct. 2523, 53 L. Ed.2d 653, dec. June 23, 1977, the court concluded that due and unpaid accident and health premiums did not constitute assets based on its finding that:

     "No life insurance reserves are maintained or established

While the taxpayer contends that the amount set aside for such "free" policies are entitled to a different treatment, the trial court did not make this determination. It found that no such reserves were set aside even for non-cancellable policies. This is evidently wrong. The thrust of the Court's opinion in Standard Life, supra, is that if the taxpayer benefitted taxwise from setting aside the amount as reserves, then it must be treated uniformly when its inclusion favors the tax gatherer. This issue must be remanded to the trial court to determine whether, and to what extent, the setting aside of reserves for these policies benefitted taxpayer in the several computations, and then to require a corresponding inclusion of this amount as assets under Section 805(d).

VI. Issue No. 5: "Amounts in the Nature of Interest"--Section 805(e)(2).

In addition to the selling of life insurance, Southwestern is in the business of administering qualified pension and profit sharing plans. It maintains life insurance reserves with respect to the contracts setting up these plans. Under state law, the maximum interest rate taxpayer can use in computing these reserves is 3 1/2%. In order to be competitive with banks and other financial institutions that administer pension plans, taxpayer enters into an agreement with the plans that purchase its contracts in which it agrees to pay these plans an annual amount in excess of the 3 1/2% interest used in computing the reserves. The taxpayer is enabled to do this because it actually earned on its investments of the reserves substantially in excess of 3 1/2%. This excess, of course, does not become a part of the reserves; nevertheless, in an equation utilized by the statute to determine the exclusion from investment earnings of that part of investment income deemed to be the policyholder's share, the statute treats all income derived from reserves uniformly. That is to say, the statute provides for an equation to determine the exclusion from the taxable investment income which gives the same effect in the ultimate determination of tax liability to that part of the income which is added to the reserve and to that part which is in excess of the statutory rate. That equation is expressed as follows:

 "policy and other

The numerator "policy and other contract liability requirements" is equal to the sum of three items (Section 805(a)):

     (1) the adjusted life insurance reserves, multiplied by the

     ". . . (2) Amounts in the nature of interest.--All

The commissioner contends that a proper interpretation of this section under normal rules of grammar would preclude the use of these payments to increase the amount of "interest paid" and furthermore that any different construction would, in effect, give a double benefit to the taxpayer because the excess earnings on its reserves, as we have already pointed out, have already been included in the numerator of the fraction because all of the company's earnings on reserves, including the excess over the 3 1/2% rate, have been included in the term "the adjusted life insurance reserves."

The taxpayer does not deny that its construction of Section 805(e)(2) provides some increased benefits to the extent that it is permitted to deduct as interest amounts which it has never reported as income. However, it contends that Congress intended to achieve this result in order to equalize insurance companies engaged in this business with non-insurance company competitors. The record does not indicate to what extent the special tax provisions for insurance companies places them in a competitive position with others. We can't simply construe one provision of the definition of interest as one part of a complex formula for determining taxable income for an insurance company by comparing it with some particular part of an ordinary income tax statute affecting non-insurance company taxpayers. Taxpayer also contends that a proper construction of Section 805(e)(2) would yield the result for which it contends.

The construction argument revolves around the question whether the words "which do not involve, at the time of accrual, life, health, or accident contingencies" modify the word "amounts" or the word "contracts." The taxpayer contends that the section should be construed to read as follows: "All amounts in the nature of interest . . . for the taxable year . . . which do not involve, at the time of accrual, life, health or accident contingencies."

The government concedes that if this is the proper construction, then these amounts do become allowable as interest. However, it contends that the section should be construed to read as follows: "All amounts in the nature of interest . . . for the taxable year or insurance or annuity contracts . . . which do not involve, at the time of accrual [of the amount], life, health, or accident contingencies." Citing Strunk & White, The Elements of Style, 1962 ed., pp. 22-24, the government says it is a basic rule of English grammar that modifiers in a sentence should be placed, whenever possible, next to the word they are intended to modify. Under this rule, of course, the words "which do not involve, at the time of accrual, life, health or accident contingencies" would modify the word "contracts" and would not modify the word "amounts." It is clear that if the phrase modifies "contracts" the trial court was in error in sustaining the taxpayer's position because it is plain that the contracts do involve life contingencies.

It seems unlikely that in drafting such a provision as this, Congress would use a structure that doesn't make sense, which would be the case if we construed the section to mean "all amounts . . . which do not involve . . . contingencies." It is not plain how "an amount," presumably accrued on the books, could "involve, at the time of accrual, life, health, or accident contingencies." What does this mean? How does an amount ever involve anything? In order to give it meaning, the taxpayer must interpret it as saying "all amounts whose computation does not involve, etc."

On the contrary, the straightforward reading of the section points to the interpretation urged by the commissioner since it has a complete meaning as written. That is, "all amounts in the nature of interest . . . on insurance or annuity contracts . . . which do not involve, at the time of accrual . . . contingencies." Here it is plain that these contracts did involve "life, health, or accident contingencies" and, therefore under this interpretation the amounts did not meet the requirements of the section.

Moreover, as pointed out by the commissioner, substantial amounts earned on the reserves in excess of the 3 1/2% rate, although not required or permitted to be retained as reserves, were nevertheless utilized by the company as part of the reserves to increase the size of the numerator of the fraction. If taxpayer is permitted to add as a third element of the numerator in addition to the life insurance reserves and the pension plan reserves, an item of interest which largely corresponds with untaxed investment income held for the company's use, this would clearly give a double benefit to the taxpayer for this item to the extent that they were the same.

We conclude, therefore, that a construction of Section 805(e)(2) that the words "which do not involve, at the time of accrual, life, health, or accident contingencies" modify the word "contracts" rather than the word "amounts" is more nearly in accord with the Congressional purpose. The trial court erred in holding to the contrary.

VII. Issues on Cross-Appeal

As stated by the taxpayer in its cross-appeal from those parts of the judgment of the trial court adverse to it, the issues on cross-appeal are:

     (1) Whether the district court erred in holding that the

In 1961, taxpayer purchased the entire capital stock of the Atlantic Life Insurance Company from its sole stockholder, Life Companies, Inc. The total price for the acquisition was $128,226,896 which was represented by cash of $29,000,000, reserve requirements assumed $94,536,860, other liabilities assumed $4,690,036. Taxpayer received tangible assets agreed to have a fair market value of $118,798,778, leaving an excess of $9,864,131 which it allocated on its books to the value of the "insurance in force" acquired from Atlantic. It is not disputed that taxpayer was willing to pay this amount more than the fair market value of the assets it received because of its expectation of profiting in the future from the insurance contracts which had already been written by Atlantic. The taxpayer deducted the full amount of $9,864,131 as an ordinary and necessary business expense in the nature of commissions. The Commissioner disallowed the deduction but allowed the taxpayer to amortize the amount over the average life of the policies, determined to be ten years. The trial court sustained the Commissioner's position.

The Commissioner supports the trial court's decision upon the fundamental principle of federal taxation that the cost of acquiring a capital asset may not be currently deducted but rather must be amortized or depreciated over the useful life of the asset. On the other hand, the taxpayer contends that all costs of "putting policies on the books" are currently deductible as a cost of doing business whether such cost is represented by payments to salesmen currently selling the company's policies or in payment of the 100,000 policies theretofore written by Atlantic.

Treasury Regulation 1.87-4 supports the Commissioner's view of the matter. It provides:

     Special Rules.

It cannot be gainsaid that the government's basic premise is correct. That is, as stated in Woodward v. Commissioner of Internal Revenue, 397 U. S. 572 at 574, 90 S. Ct. 1302, at 1304, 25 L. Ed.2d 577:

     "Since the inception of the present federal income tax in

Moreover, this Court has heretofore analyzed the effect of such a contract. In Mutual Savings Life Ins. Co. v. United States, 488 F.2d 1142 (C. A. 5 1974) we held expressly that "if the reinsurer has paid consideration for the policies, the payment cannot immediately be deducted, but must be amortized over the estimated life of the contracts." 488 F.2d 1142, 1144. Here, it is plain from the undisputed evidence at the trial, that the $9,800,000 was paid as consideration for the outstanding policies.

The taxpayer's effort to equate the current deductibility of commissions paid in the life insurance industry to agents who put new polices on the books of the company with the payment of $9,800,000 for the acquisition of some 100,000 outstanding policies is not an apt comparison. Atlantic has already paid commissions to its agents for the acquisition of these same policies and the value of the policies to the taxpayer here in no way represents that cost of putting the business on the books of the company. It represents, instead, an estimate of the current value to the taxpayer that is represented by having these policies on its books with the expectation of the continuing premiums to be paid in the future. This may or may not approximate the total loading cost to Atlantic. Certainly it cannot be said to proximate the amounts paid as commissions when the policies were originally solicited. Southwestern points to no statutory provision, other than the general statutory authorization for the deduction of current expenses on which it seeks to rely as a basis for its broad contention that any payment that may be required as a cost of putting the business on the books must be currently deductible.

The trial court correctly decided this issue in favor of the government.

IX. Cross-Appeal Issue No. 2: Treatment of Advance Interest on Policy Loans.

As provided for by the terms of the insurance policies issued by the taxpayer, Southwestern made loans to its policyholders, the insurance contracts providing such loans would be made up to the amount of the cash surrender value of the individual policy. Under the express terms of the policy, interest was paid in advance to the end of the policy year, and annually thereafter, in advance, on the policy anniversary date for the ensuing year. Payment of interest in advance could be accomplished in one of two ways. The policyholder could pay the company in cash for the year's interest or the company would advance to him the amount of the loan requested less 5% for the remaining term of the policy year. Interest for the ensuing policy year which was not paid in cash was added in advance to the amount of the principal debt. In either event, when cash was not paid for advance interest, the cash surrender value of the policy was reduced by such amount. Under the policy agreement, any prepayment of the loan before the end of the policy year would require repayment by the taxpayer of the rateable amount of unearned interest. The same thing occurred if the policyholder should surrender his policy for the cash value or if he should die during the policy year.

The taxpayer showed such amounts of interest for the entire term of the policy loan on its books as "interest on policy loans." Nevertheless, the taxpayer reported only such part of these payments as represented a ratable amount of interest up to the end of the tax year, rather than the full amount collected as investment income. The government contends, and the trial court held, that the entire amount collected by the taxpayer as "interest on policy loans" was taxable when received or charged against the policy's cash surrender value.

The taxpayer undertakes to support a thesis that this transaction was not loan at all, but merely a return to the taxpayer of a part of the value of his policy--in other words, a partial cash surrender.

The method which taxpayer used in keeping its books of account by accruing the entire amount of interest, even though taxpayer may, in the event of prepayment or death of the policyholder, be required to make a repayment of a rateable amount, is consistent with the accrual basis of accounting. There is no reason to permit the taxpayer, for tax purposes only, to treat a transaction which it and the policyholder expressly considered to be a loan and the payment of interest to be something entirely different. This is the view taken by the Court of Appeals for the Fourth Circuit in Jefferson Standard Life Ins. Co. v. United States, 408 F.2d 842, 856-857 (C. A. 4 1969) and the Seventh Circuit in what we conclude in a comparable situation in Franklin Life Ins. Co. v. United States, 399 F.2d 757, 762-763 (C. A. 7 1968).

Even though we were not to hold that the legal result is as followed by these two courts, it is true, as the government points out, that no proof was introduced in this record to show what proportion of the total amounts in dispute dealing with this issue were amounts actually paid in cash by the policyholder, and thus clearly reportable as interest and what amount was simply charged against the cash surrender value of the policy. The burden is, of course, on the taxpayer to show his entitlement to recover in a suit of this kind and such failure of proof would bar recovery of the amounts involved in this issue in any event. The trial court correctly held for the United States on this issue.

X. Cross-Appeal Issue No. 3: Computation of Special Deduction for Increases in Reserves under Section 809(d)(5) for the Year During Which Such Contracts Become Participating Contracts.

The taxpayer's claim here arises from a provision of the statute which provides a special deduction to insurance companies if during the year there is an increase in the company's reserves for its nonparticipating contracts./2/ This deduction amounts to 10 percent of the increase during the taxable year in a company's reserves for its nonparticipating contracts.

As pointed out by the taxpayer, Congress recognized that companies issuing nonparticipating contracts need an additional reserve cushion. The government does not contest the theory upon which Congress authorized this additional 10 percent deduction. It merely questions the manner in which the annual increase is computed.

The government takes the position that there is a clearly recognized amount on the taxpayer's books at the beginning of the year representing Reserves for Nonparticipating Contracts and that there is a corresponding figure at the end of the tax year. If the figure at the end of the year exceeds that at the beginning of the year, the government contends, then the 8.09(d) (5) deduction of 10 percent of that difference is available to the taxpayer. The insurance company, on the other hand, claims that the difference should be greater than that arrived at by the simple calculation of subtracting the beginning figure from the closing figure for the year. It says that the reserves attributable to those contracts which are converted from nonparticipating to participating during the year should be excluded from the opening amount of capitalized reserves for nonparticipating contracts at the beginning of the year because there will be no reserves attributed to such contracts at the end of the year because in the meantime they have become participating contracts.

We conclude as did the trial court that this construction by the taxpayer is not based on any reasonable construction of the statute or regulations. Congress was concerned about the impact of an increase in any reserves required for nonparticipating contracts in gross, that is to say, it viewed the financial impact on a stock company, when compared with mutual insurance companies, by having to increase its reserves during a particular tax year. In our opinion, it makes no difference what caused the increase or decrease during the year, whether increased by the writing of new business or whether decreased by death of the policyholder, surrender of the policy or conversion from a nonparticipating to a participating contract. We conclude that the opening figure is to be subtracted from the closing figure and the 809(d)(5) deduction applied to the difference, as was decided by the trial court.

XI. Cross-Appeal Issue No. 4: Losses for Bad Debts on Advances to Life Insurance Agents as Deductible in Computing Net Investment Income.

During the years 1961 through 1965, Southwestern charged off as worthless bad debts, advances it had previously made to former life insurance agents no longer employed by the company. These amounts were substantial. Taxpayer claims a deduction of these amounts as for bad debt losses from gross investment income in determining net investment yield.

The taxpayer found it necessary in engaging life insurance agents to made advances to them until such time as they were producing enough commissions to maintain their standard of living. All income from the taxpayer earned by an agent is represented by commissions based on life insurance business written. The agents continued to receive such advances until such time as their commission exceeded their monthly advances and thereafter the excess over the monthly advance was applied to reduce the balance which had been accumulated. Only one out of three agents continue with the company for more than two years. Therefore many agents terminate their relationship before the entire amount of advances has been recovered by the taxpayer. It is clear from the record that when these advances are originally made they are made as a loan to the agent. The company charges 4 percent interest on the outstanding balances of the advances and sends a letter to the agent each month showing the state of his account. Following the termination of an agent, it is the taxpayer's policy and practice to leave all unpaid advances outstanding until such time as all commissions have been collected and applied to the account. Thereafter, for some period of time, a monthly statement is sent to the agent showing the amount of the unpaid advances and the amount of his commissions, if any. When the taxpayer has credited an agent's account with all of the commissions to which he is entitled, the agent is so advised in a letter as follows:

     "Since the advances we made to you as an agent for our

     "[T]he Court finds that in January of the year after all

From this state of the record, the trial court found that the taxpayer could not take a bad debt loss deduction for these sums in the tax year when the debts were forgiven.

     "The question of the worthlessness of [a] debt . . . is

Furthermore, there is no more merit in taxpayer's contention as an alternative, if the Court holds that a bad debt deduction is not available, then the advances should be considered as additional compensation to the former agents at the time payments were made. These payments were not intended by the parties to be compensation when the advances were made, but were considered by the parties to be the creation of a debt. To be sure the forgiveness of the debt, at a period considerably later, after termination of employment, did create an obligation on the part of the former agent to report a forgiveness of the debt as income to him at the time it occurred. That is the only year in which the debt was translated into additional compensation to the former agent.

The trial court's judgment against the taxpayer with respect to this item was correct.

XII. Cross-Appeal Issue No. 5: Are (A) Deferred and Uncollected Premiums on Life Insurance and Annuity Contracts; (B) "Unearned" Interest on Policy Loans; (C) Advances to Insurance Agents; (D) Amounts Due from Reinsurers; (E) Taxpayer's Participation Interest in Reinsurance Pools; and (F) the Unamortized Cost of Insurance Policies in Force Acquired from Atlantic Life "Assets" of the Taxpayer Within the Meaning of Section 805(b) of the Code?

In stating this issue, we have utilized the statement from the government's brief rather than that of the cross-appellant, because the taxpayer lumps together under this issue two other items with which we have already treated in this opinion, to-wit: (1) whether accident and health premiums due and unpaid and (2) mortgage escrow funds in amounts held by taxpayer as agent or trustee for others are "assets" within the meaning of Section 805(b).

Southwestern makes an underlying argument in its attack on the government's position that these items are to be considered within the definition of "assets" under Section 805(b). This argument, briefly put, is that the term "assets" as used in this section was intended to include only those items of property which actually produced income and were includable as investments under Section 804(b), plus money belonging to the company; that items which do not actually contribute to investment income, as this argument goes, arise out of the insurance trade or business, and therefore under the definition section do not belong to the taxpayer or do not constitute property and are excludable from the asset definition. As was the trial court, we remain unconvinced that the legislative history requires a construction of the definition of assets so limited as propounded by the taxpayer. However, we no longer need consider this question, because it has been answered definitively by the Supreme Court in Commissioner of Internal Revenue v. Standard Life & Accident Insurance Co., (No. 75-1771), - U. S. -, 97 S. Ct. 2523, 53 L. Ed.2d 653, dec. June 23, 1977. This follows inevitably from the decision of the Supreme Court which held that the "net valuation" portion of unpaid life insurance premiums must be included in a life insurance company's assets, the issue discussed infra under A. It is clear that no part of such unpaid premiums produce any income for the taxpayer, yet the court found them to be assets.

A. Deferred and Uncollected Premiums

As is common in the life insurance industry, taxpayer's policyholders may elect to pay premiums on life insurance and annuity contracts in semi-annual, quarterly or monthly installments. The portions of the gross annual premiums which are not due until after December 31 of each year, and which in fact remain unpaid as of that time, are generally referred to as "deferred" premiums. Furthermore, as a general rule such contracts provide for a grace period during which the policy remains in force notwithstanding the failure of the insured to pay the required premium. At the end of the years in issue, taxpayer had a number of policies in force by virtue of the grace period provision. Premiums owing but uncollected with respect to those policies as of December 31 of each year are normally referred to as "due and unpaid." We refer to these two classifications as "deferred and uncollected" premiums. The method of dealing with these items for tax purposes has been much mooted in the courts, this Court in Western National Life Insurance Co. of Texas v. Commissioner of Internal Revenue, 432 F.2d 298 (5th Cir. 1970) having held that since the insurance companies accrued these items in computing their reserves they would have to accrue them for all other purposes, including inclusion as assets under Section 805(b)(3). Other Circuits arrived at the same conclusion, see Jefferson Standard Life Ins. Co. v. United States, 408 F.2d 842 (C. A. 4 1969), cert. denied 396 U. S. 828, 90 S. Ct. 77, 24 L. Ed.2d 78; Western & Southern Life Ins. Co. v. Commissioner of Internal Revenue, 460 F.2d 8 (6th Cir. 1972), cert. denied 409 U. S. 1063, 93 S. Ct. 555, 34 L. Ed.2d 517; Franklin Life Ins. Co. v. United States, 399 F.2d 757 (7th Cir. 1968). The Court of Appeals for the Tenth Circuit disagreed, Standard Life & Accident Ins. Co. v. Commissioner of Internal Revenue, 525 F.2d 786 (10th Cir. 1976), and created a conflict which has now been resolved by the Supreme Court.

The Supreme Court recognized that the statute which in Section 818 provided for the use for computation purposes either of an accrual method of accounting or a combination of an accrual method with any other except cash receipts and disbursements further provided "except as provided in the preceding sentence, all such computations shall be made in a manner consistent with the manner required for purposes of annual statement approved by the National Association of Insurance Commissioners." The Court then said:

     The legislative history makes it clear that the accounting

The trial court's treatment of this item was in accord with our earlier decision in the Western National Life case which has now been partially overruled. The final disposition of the amounts involved under this issue can, however, be readily ascertained, since the Court has now mandated the treatment of this item for tax purposes in the same manner as is required to be accounted for in the statement prescribed by NAIC.

B. "Unearned" Interest on Policy Loans

In Part IX, supra, we held that the amount charged by the company as interest on policy loans to its policyholders is includable in taxpayer's investment income. In doing so, we rejected taxpayer's argument that such amounts were not truly interest because the policy loans were not real loans. Taxpayer here argues that such accrual interest is not includable as an asset for the same reason. We reject this argument for the same reason.

We have heretofore held that such interest is to be accounted for as income because such policy loans are to be treated for tax purposes as the "loan" which the company says they are in its dealings with its policyholders.

The trial court therefore correctly held that this item should be included in the Section 805(b) assets.

C. Advances to Insurance Agents; (D) Amounts Due from Reinsurers; (E) Taxpayer's Participation Interest in Reinsurance Pools; and (F) The Unamortized Cost of Insurance Policies in Force Acquired from Atlantic Life.

Aside from its underlying argument, previously discussed, to the effect that only those assets which produced income are to be included under Section 805(b), an argument now foreclosed by Standard Life, supra, taxpayer cites no authority for its contention that the trial court erred in its disposition of these four last issues. The amounts representing each of these items, as recognized by the trial court, must be included in assets because of the broad definition of the term used in the statute and the underlying regulations as interpreted by the courts. See Jefferson Standard Life Ins. Co. v. United States, 408 F.2d 842 (4th Cir. 1969) and regulations Section 1.805-5(a)(4)(iii), Section 1.805-5(a)(4)(i).

The judgment is vacated and the case is remanded to the trial court for further proceedings consistent with this opinion. Each party shall bear its own costs.

² Section 809(d)(5) provides as follows:

"(d) Deductions. For purposes of subsection (b) (1) and (2) there shall be allowed the following deductions:. . . .

(5) Certain nonparticipating contracts.--An amount equal to 10 percent of the increase for the taxable year in the reserves for nonparticipating contracts or (if greater) an amount equal to 3 percent of the premiums for the taxable year (excluding that portion of the premiums which is allocable to annuity features) attributable to nonparticipating contracts (other than group contracts) which are issued or renewed for periods of 5 years or more. For purposes of this paragraph, the term "reserves for nonparticipating contracts" means such part of the life insurance reserves (excluding that portion of the reserves which is allocable to annuity features) as relates to nonparticipating contracts (other than group contracts). For purposes of this paragraph and paragraph (6), the term "premiums" means the net amount of the premiums and other consideration taken into account under subsection (c)(1).