Rev. Rul. 55-240

Advice has been requested whether certain `mutual' insurance companies are in fact mutual insurance companies taxable under the provisions of section 207 of the Internal Revenue Code of 1939.

The companies in question, X and L , have heretofore filed Federal income tax returns as mutual fire and mutual liability companies, respectively. Each company has a paid-up guaranty capital represented by shares all of which have voting rights. There is no requirement that shareholders shall be policyholders, but there is a required equal representation of the shareholders of each company with the policyholders on the boards of directors. The shareholders have the right to one vote for each share owned. The shareholders participate in the earnings of the companies through specified percentage returns on their contributions to the guaranty capital. Upon dissolution the shareholders would receive the par or face value as expressed in the certificates and any accrued interest due. Any balance or surplus funds would be the property of the policyholders whose policies were in force at the time of such liquidation. Neither company is exempt from tax under the provisions of section 101(11) of the Code.

Among the characteristics of a mutual insurance company is the right of all policyholders to be members to the exclusion of other persons and to choose the management. Mutual Fire, Marine & Inland Insurance Co. v. Commissioner , 8 T.C. 1212, 1217, acquiescence C.B. 1947-2, 3. In the case of Keystone Automobile Club Casualty Company et al. v. Commissioner , 122 Fed.(2d) 886, certiorari denied, 315 U.S. 814, the court recognized that democratic ownership and control is a fundamental characteristic of mutual insurance companies and found that there was a substantial departure from the fundamental principle of control where non-policyholders exceeding 20 percent of voting policyholders had the right to vote.

From a study of the above-mentioned court decisions and G.C.M. 6782, C.B. VIII-2, 209 (1929), and authorities referred to therein, it is found that the existence of paid-in guaranty capital represented by shares under certain conditions prevents the classification of insurance companies as mutual insurance companies inasmuch as it deprives such companies of the requisite democratic ownership and control by policyholders. In general, such conditions relate to the following:

(1) The control that the shareholders as a group exercise over the operations of the company.

(2) Voting rights of shareholders.

(3) Representation of shareholders on the board of directors.

(4) Rights of shareholders to participate in the earnings of the company to the extent of receiving a return on their capital investment and in the distribution of the company's assets in the event of dissolution.

In the instant case, the fact that the shareholders, who are not required to be policyholders have voting rights and representation on the boards of directors equal to those of the policyholders and also receive a return on their capital investment through participation in the earnings, is sufficient evidence that there is lacking the `fundamental characteristic of mutual or cooperative organizations-democratic ownership and control' emphasized by the court in the Keystone case. The fact that the shareholders do not share equally with policyholders in distributions in liquidation does not effect such determination. The fact that the companies have previously filed Federal income tax returns as mutual insurance companies does not preclude the Internal Revenue Service, as the result of a detailed examination of current income tax returns and study of the actual ownership and operation thereof, from subsequently holding such companies are not mutual insurance companies.

Accordingly, it is held that in the absence of democratic ownership and control by the policy members an insurance company may not qualify as a mutual insurance company taxable under the provisions of section 207 of the Code. Thus, the insurance companies in the instant case would be subject to tax under the provisions of section 204 of the Code, as insurance companies other than life or mutual companies