Rev. Rul. 74-321

Advice has been requested as to the proper treatment of amounts received by a production credit association (PCA) organized to make loans to farmers, under the facts and circumstances described below.

The production credit association in the instant case is a 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 PCA 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 PCA the insurance company will pay to the PCA 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 PCA, 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 by the insurance company to the PCA 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 a production credit association shall not receive benefits directly or indirectly as a result of the program;

(3) The Federal Intermediate Credit Bank may authorize a production credit association to recover the cost of handling credit life insurance, if permissible under state law; and (4) Experience dividends received by the production credit association in excess of approved costs must be used for the benefit of the production credit association's borrowers.

In the past several years, annual dividends earned on the policy have been paid to the PCA in cash without any allocation of the dividend to the individual policy holders (the PCA's borrowers). In view of the absence of such an allocation, the PCA 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 PCA'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; and

(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 (borrowers) should be reduced by an amount necessary to balance the premium take and the death loss outgo.

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

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

The PCA does not include in its gross income the money received from its borrowers to pay the annual insurance premium and the dividends received from the insurance company. The PCA also does not deduct the amounts paid to the insurance company for the annual premium on the insurance policy.

The facts disclose that it was the intent of all the parties that the PCA act as agent for the borrowers in collecting and paying the insurance premiums and of holding the insurance dividends to reduce future premiums of the borrowers. The PCA acts according to the requirements set forth by the Federal Farm Credit Administration in the management of the program. The PCA has only ministerial powers over the funds and cannot divert them to its own purposes. Although the cash payments are commingled with the association's operating funds, such payments are earmarked and retained for the benefit of the borrowers from the time they are received by the PCA until the time they are expended. The PCA has on hand at all times cash and securities in excess of the amounts it holds as agent.

Accordingly, the PCA is not required to include the payments by the borrowers or the insurance dividends in its gross income and it is not entitled to a deduction for the annual premium payment.

See Rev. Rul. 74-319, page 15, this bulletin, with respect to amounts received by a corporation from its dealers that it holds in a "fund" to be used for national advertising.

Rev. Rul. 69-96, 1969-1 C.B. 31, is hereby superseded since the substantive position stated therein is restated in this Revenue Ruling.