TITLE INSURANCE COMPANY OF MINNESOTA v. [And six other cases.] *

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Court of Appeal, First District, Division 4, California.

TITLE INSURANCE COMPANY OF MINNESOTA, Plaintiff and Respondent, v. STATE BOARD OF EQUALIZATION, Defendant and Appellant. [And six other cases.] *

No. A045664.

Decided: June 24, 1991

John K. Van de Kamp, Atty. Gen., Timothy G. Laddish, Asst. Atty. Gen., Oakland, for defendant and appellant. Stanford H. Atwood, Jr., Robert Knox, John H. Blake, Atwood, Knox & Anderson, San Jose, for plaintiff and respondent.

The questions presented in these consolidated actions for refund of taxes are whether a title insurance company which issues a policy of title insurance realizes taxable income from the total amount of the premium the insured pays for the policy, and from payments made by the title insurance company's local agent who satisfies claims against the title insurance company under the policy.   We conclude that the State Board of Equalization correctly determined that the title insurance company is liable to taxation on the full amount of the premium and on the payments made to discharge its indemnity obligation.

BACKGROUND

As is common in refund litigation, the refund complaints were submitted for decision on the basis of a written stipulation of facts executed by the parties' counsel.   We summarize the pertinent contents as follows:

Plaintiffs are seven corporations in the business of issuing title insurance policies within California.   They do so through an underwritten title company, acting as their agent, which:  conducts a search of the public records affecting title;  prepares a preliminary report, which indicates the conditions under which title insurance would be available, including a statement of what would be excepted from coverage;  prepares and issues the title insurance policy using the forms provided by the title insurer;  determines the premium from the title insurer's rate schedule;  and collects the premium.1

The relationship between plaintiffs and the underwritten title companies is set forth in written underwriting agreements between them.   In addition to the duties to be performed by the underwritten title companies as just detailed, these agreements specify that each underwritten title company retains most of the premium fee (usually about 90 percent) for itself and pays the remainder to the title insurer for its acceptance of the hazard in insuring title as set forth in the policy.   Plaintiffs reported and paid taxes upon that portion of each title insurance premium which was passed on to them by the underwritten title companies.   What they did not report was that portion of the insurance premiums which was retained by the underwritten title companies.

Although the title insurer and its insured were the only parties to the title insurance policy, under the underwriting agreement the underwritten title company was obligated to the title insurer to pay a specified portion of certain insurance claims.   In some circumstances and under some underwriting agreements, the underwritten title company would make such payment to the insured party;  in others the underwritten title company would make such payment to the title insurer.2

The Board issued deficiency assessments covering various years between 1975 and 1984, which plaintiffs unsuccessfully contested in administrative proceedings before the Board.   Once those were concluded, plaintiffs paid the assessments and commenced separate actions for refunds.   After the actions had been consolidated and a nonjury trial conducted on the stipulated facts, the trial court found in favor of plaintiffs.   A judgment ordering refunds totalling approximately $93,000 was entered in due course.   The Board then perfected this timely appeal.3

REVIEW

Taxation of title insurance companies doing business in California is governed by section 28 of Article XIII of the California Constitution (hereinafter cited as “section 28”).   It subjects title insurers to a tax based on “all income upon business done in this state.”  (Emphasis added.)

Section 28 spells out the details in these terms:  “In the case of an insurer not transacting title insurance in this state, the ‘basis of the annual tax’ is, in respect to each year, ․ all income upon business done in this state, except:  [¶] (1) Interest and dividends.  [¶] (2) Rents from real property.  [¶] (3) Profits from the sale or other disposition of investments.   [¶] (4) Income from investments.”  (§ 28, subd. (c) [emphasis added];  see Rev. & Tax.Code, § 12231.)

Title insurers are taxed at a rate of 2.35 percent (§ 28, subd. (d)), and (subject to certain exceptions not applicable here) “[t]he tax imposed on insurers by this section is in lieu of all other taxes and licenses, state, county, and municipal, upon such insurers and their property” (§ 28, subd. (f)).

 The entire amount of the premium paid for a title insurance policy constitutes income to the title insurer.

The sole constitutional phrase about which the parties cannot agree is the central one, the “all income” concept, which section 28 does not define.   They do, however, submit that we may attempt a definition using the federal income tax concept of “gross income.”   This agreement accords with established practice allowing us to look to the national analogue for guidance.  (See Holmes v. McColgan (1941) 17 Cal.2d 426, 430, 110 P.2d 428;  Spurgeon v. Franchise Tax Board (1984) 160 Cal.App.3d 524, 528, 530, 206 Cal.Rptr. 636.)

This is the pertinent text of the federal statute:

“[G]ross income means all income from whatever source derived, including (but not limited to) the following items:

“(1) Compensation for services, including fees, commissions, fringe benefits, and similar items;

“(2) Gross income derived from business;

“(3) Gains derived from dealings in property;

“(4) Interest;

“(5) Rents;

“(6) Royalties;

“(7) Dividends;

“(8) Alimony and separate maintenance payments;

“(9) Annuities;

“(10) Income from life insurance and endowment contracts;

“(11) Pensions;

“(12) Income from discharge of indebtedness;

“(13) Distributive share of partnership gross income;

“(14) Income in respect of a decedent;  and

“(15) Income from an interest in an estate or trust․”  (26 U.S.C. § 61, subd. (a).)

As might be expected from the sweeping language employed, the scope of the federal definition of gross income is quite expansive.   Treating income in its “plain popular meaning” (United States v. Kirby Lumber Co. (1931) 284 U.S. 1, 3, 52 S.Ct. 4, 4, 76 L.Ed. 131), the United States Supreme Court “has given a liberal construction to this broad phraseology in recognition of the intention of Congress to tax all gains except those specifically exempted.”  (Commissioner v. Glenshaw Glass Co. (1955) 348 U.S. 426, 430, 75 S.Ct. 473, 476, 99 L.Ed. 483.)   In accordance with this approach, the Court has deemed the statutory language indicative of an obvious intent to comprehensively encompass sources of income to the fullest extent of constitutional taxing power.  (See Commissioner v. Kowalski (1977) 434 U.S. 77, 82–83, 98 S.Ct. 315, 318–319, 54 L.Ed.2d 252;  Commissioner v. Jacobson (1949) 336 U.S. 28, 49, 69 S.Ct. 358, 369, 93 L.Ed. 477;  Helvering v. Clifford (1940) 309 U.S. 331, 334, 60 S.Ct. 554, 556, 84 L.Ed. 788.)   In doing so the Court has retreated from the definition of income enunciated inEisner v. Macomber (1920) 252 U.S. 189, 207, 40 S.Ct. 189, 193, 64 L.Ed. 521 4 (construing a predecessor version of 26 U.S.C. section 61 which contained language not continued in the present version)—a definition upon which plaintiffs and the dissenting opinion place substantial reliance.  (See Commissioner v. Kowalski, supra, 434 U.S. at p. 94, 98 S.Ct. at 325;  Commissioner v. Glenshaw Glass Co., supra, 348 U.S. at pp. 430–431, 75 S.Ct. at pp. 476–477;   Helvering v. Bruun (1940) 309 U.S. 461, 468–469, 60 S.Ct. 631, 634–635, 84 L.Ed. 864.)

At present, income is generally equated with “undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.”  (Commissioner v. Glenshaw Glass Co., supra, 348 U.S. 426 at p. 431, 75 S.Ct. at p. 477;  accord Commissioner v. Kowalski, supra, 434 U.S. 77 at p. 83, 98 S.Ct. at p. 319.)  “Consistent with ․ economic reality,” and “recogniz[ing] that ‘income’ may be realized by a variety of indirect means,” the Court—with a preference for substance over form—now tests for the presence of “economic benefit” realized by taxpayers.  (See Diedrich v. Commissioner (1982) 457 U.S. 191, 194–198, 102 S.Ct. 2414, 2417–2419, 72 L.Ed.2d 777.)

 There can be no question that the premiums paid in exchange for title insurance policies issued by plaintiffs are income to plaintiffs.   The economic reality of the transactions is a simple bilateral exchange between insured and insurer:  the insureds made unconditional payments of money in consideration for the policies.   Without question, those payments qualify as “undeniable accessions to wealth, clearly realized” (Commissioner v. Glenshaw Glass Co., supra, 348 U.S. 426 at p. 431, 75 S.Ct. at p. 477), and thus constitute income to the insurers.

 The fact that most of the premium remained with the underwritten title companies reinforces the characterization of the entire premium as income to the title insurers.   Retention by the underwritten title companies was in accordance with the underwriting agreements with the insurers.   Under both the form and substance of those arrangements, the premiums were left with the underwritten title companies at the express direction of the title insurers.   The premiums are regarded as income to the insurers because “The power to dispose of income is the equivalent of ownership of it.   The exercise of that power ․ is the enjoyment, and hence the realization, of the income by him who exercises it.”  (Helvering v. Horst (1940) 311 U.S. 112, 118, 61 S.Ct. 144, 148, 85 L.Ed. 75;  accord Harrison v. Schaffner (1941) 312 U.S. 579, 580, 582, 61 S.Ct. 759, 760, 761, 85 L.Ed. 1055;  Helvering v. Eubank (1940) 311 U.S. 122, 124–125, 61 S.Ct. 149, 150–151, 85 L.Ed. 81;  Stone v. C.I.R. (D.C.Cir.1989) 865 F.2d 342, 343.)   It was not necessary for the premiums to first take a trip to the title insurers in order to be considered as income to them because in tax law a payment attributable to a taxpayer's earnings that bypasses the taxpayer and goes to one designated by the taxpayer is taxed as a payment to taxpayer.  (Matter of Larson (7th Cir.1988) 862 F.2d 112, 116.)   Taxation cannot be escaped by contracts designed to prevent money when paid from vesting even for a second in the taxpayer who earned it.  (Lucas v. Earl (1930) 281 U.S. 111, 115, 50 S.Ct. 241, 241, 74 L.Ed. 731.)   The full amount of the premium therefore qualifies as an accession to wealth over which the title insurers have complete dominion (Commissioner v. Glenshaw Glass Co., supra, 348 U.S. 426 at p. 431, 75 S.Ct. at p. 477), and is therefore counted as income for purposes of federal taxation.  (American Title Co. v. Commissioner (3d Cir.1935) 76 F.2d 332, 333;  Title & Trust Company of Florida v. United States (M.D.Fla.1965) 243 F.Supp. 42, 43–44 [“title insurance premiums are includible in gross income of title insurance companies and no part of them may be excluded or deducted from gross income for tax purposes․  Premiums of a title insurance company constitute income and should be taxed as such”], aff'd per curiam (5th Cir.1966) 360 F.2d 285.)

 California, which has adopted the federal definition “gross income” for its own tax laws (see Rev. & Tax Code, §§ 17071, 24271), brings us to the same destination.   Numerous decisions make clear that a variety of costs and payments to agents of the insurer are included within the definition of gross premiums used to tax all insurers not in the business of writing policies of title insurance.  (See Metropolitan Life Ins. Co. v. State Bd. of Equalization (1982) 32 Cal.3d 649, 186 Cal.Rptr. 578, 652 P.2d 426 [funds paid to insured by agent instead of insurer];  U.S. Fid. & Guar. Co. v. State Bd. of Equal. (1956) 47 Cal.2d 384, 303 P.2d 1034 [bail bond surcharge retained by insurer's agent];  Groves v. City of Los Angeles (1953) 40 Cal.2d 751, 256 P.2d 309 [same];  Ind. Indem. Exch. v. State Bd. Equalization (1945) 26 Cal.2d 772, 161 P.2d 222 [portion of premiums returned by insurer to attorney in fact];  Interinsurance Exchange v. State Bd. of Equalization (1984) 156 Cal.App.3d 606, 203 Cal.Rptr. 74 [service fees collected and retained by insurer's agent];  Allstate Ins. Co. v. State Board of Equal. (1959) 169 Cal.App.2d 165, 336 P.2d 961 [installment payment fees].)

Like the federal authorities this state looks beyond the labels the parties have given to the transactions to determine the true economic substance of the arrangement and whether it inures to the economic benefit of the insurer.   (Metropolitan Life Ins. Co. v. State Bd. of Equalization, supra, 32 Cal.3d 649 at pp. 656–657, 661, 186 Cal.Rptr. 578, 652 P.2d 426.)   As the California Supreme Court colorfully puts it, “a mere bookkeeping method cannot thwart the law.”  (Groves v. City of Los Angeles, supra, 40 Cal.2d 751 at p. 760, 256 P.2d 309.)

A guiding principle is that the expense of administering the insurance is a part of the premium charged for the insurance.  (Allstate Ins. Co. v. State Board of Equal., supra, 169 Cal.App.2d 165 at p. 173, 336 P.2d 961.)   Thus, when the agent in Groves v. City of Los Angeles, supra, 40 Cal.2d 751, 256 P.2d 309, kept a portion of the premiums for bail bonds pursuant to an agreement with the insurer, our Supreme Court held the entire amount taxable as the insurer's gross premiums.  “[T]he amount charged the applicant for a bond is the premium on that bond.   It is not significant how [the insurer and the agent] choose to allocate that amount, such as for various services, premiums, etc.   That is nothing more than an intramural arrangement for their convenience․  What the agent receives, in legal effect the insurer receives.”  (Id. at pp. 760–761, 256 P.2d 309.)   Similarly, in Interinsurance Exchange v. State Bd. of Equalization, supra, 156 Cal.App.3d 606, 203 Cal.Rptr. 74, at issue was the retention by the insurer's agent of a $1 service fee charged to insureds who elected to pay the premium on an installment basis.   The Court of Appeal held that although the Interinsurance Exchange did not actually receive the service fees, they did receive an economic benefit from those fees which were collected by the Automobile Club.   “One could reasonably assume that had the Automobile Club never offered the installment plan along with its service fee, the number of individuals for whom they write coverage would have been significantly reduced.   Also, judging by the amount of fees collected by the Automobile Club in one year on service fees alone, the significance of this plan was astronomical.   Also, the service fee here can be undoubtedly classified as part of ‘the loading.’ 5  As such, it is a part of the ‘gross premiums' and taxable to the insurer.”  (Id. at p. 614, 203 Cal.Rptr. 74.)   In Metropolitan Life Ins. Co. v. State Bd. of Equalization, supra, 32 Cal.3d 649, 186 Cal.Rptr. 578, 652 P.2d 426, an insurer and employers agreed that the employers would assume the insurer's obligations to pay medical benefit claims of employees up to a specified “trigger-point” amount above which the insurer would pay all claims.   If the employer failed to do so, the insurer would satisfy the claim and then seek reimbursement from the employer.   Our Supreme Court held that under the arrangement the employers functioned not as independent insurers but as agents or distributors of funds for the insurer, with the consequence that the pretrigger-point claims payments, although financed by the employers, were included within the total amount on which the insurer must pay a gross-premiums tax.   The portion of the insurer's burden shouldered by the employers was deemed part of the expense of administering the insurance as well as being a component of the premium charged by the insurer for the insurance, and thus taxable to the insurer.

Obviously, all of these California authorities deal with what is included within the meaning of gross premiums.   But that concept is more narrow than the “all income” standard of section 28.   Thus, what constitutes gross premiums is necessarily included within the broader ambit of section 28.   Such semantics aside, the full measure of the premiums must be treated as income realized by the title insurers.   The premiums are paid by the insureds in consideration of the policies issued by plaintiffs.   The underwritten title companies play no role in this bilateral transaction apart from acting as agents for the title insurers;  they are not parties to the contracts between the insurers and the insureds.

 It is irrelevant that the title insurers and the underwritten title companies have between themselves provided by separate agreements that most of the premiums should remain with the title companies.   The undisguisable truth is that upon payment of a premium by an insured, and before the premium is divided pursuant to such an agreement, the full amount of the premium is attributed to the insurer by operation of law.   As was the situation in Groves v. City of Los Angeles, supra, 40 Cal.2d 751, 256 P.2d 309, the subsequent division of the premium remains nothing more than an “intramural arrangement” for the convenience of the parties to the underwriting agreements.

The dissenting opinion makes much of the fact that the division of premiums between a title insurer and an underwritten title company has statutory sanction.6  The legitimacy of this form of fee splitting, however, does not determine the point at issue—to whom is the premium attributed as taxable income after it has been paid by the insured but before it is split?   It is the insured's payment of the premium to the title insurer which is the crucial moment for purposes of taxation.   That the title insurer leaves a large portion of the premium with the underwritten title company as compensation for past services undoubtedly rendered pursuant to the underwriting agreement cannot disguise that the title insurer is directing the disposition of money paid to it and at the least constructively received by it.   Insofar as the logic of the dissent appears to suggest that the statutory scheme somehow effects a change in the operation of the constitutional language of section 28, it goes too far.  “ ‘Wherever statutes conflict with constitutional provisions, the latter must prevail.’ ”  (Delaney v. Superior Court (1990) 50 Cal.3d 785, 800–801, fn. 11, 268 Cal.Rptr. 753, 789 P.2d 934 [citation omitted].)

 The same analysis applies to the fact that those underwriting agreements obligated the title companies to act as mere agents of the title insurers by accumulating funds to be disbursed in a manner which was to the economic benefit of the title insurers.  (See Metropolitan Life Ins. Co. v. State Bd. of Equalization, supra, 32 Cal.3d 649 at p. 661, 186 Cal.Rptr. 578, 652 P.2d 426.)   It does not matter whether the portion of premiums not forwarded to the insurers is deemed to be compensation for services already performed by the underwritten title companies prior to issuance of the title insurance policies (see Ins.Code, § 12412, quoted at note 6, ante ) or instead is viewed as an informal method of establishing a fund for the payment of claims.   Under either evaluation those funds must be treated as (1) an integral part of “the entire charge ․ for each ․ title policy” (Ins.Code, § 12401.1) which the insured is required to pay for coverage (see Groves v. City of Los Angeles, supra, 40 Cal.2d 751 at pp. 760–761, 256 P.2d 309), as well as (2) a component of the “loading” (see note 5, ante ) charged by the insurer as an “expense of administering the insurance.”  (See Allstate Ins. Co. v. State Board of Equal., supra, 169 Cal.App.2d 165 at p. 173, 336 P.2d 961.)   Under either construction the portion of premiums left with the title companies is taxable to plaintiffs as an indivisible component of the latter's costs “of the insurance coverage provided to the insured” and “of doing insurance business in this state.”   (See Metropolitan Life Ins. Co. v. State Bd. of Equalization, supra, 32 Cal.3d 649 at pp. 660, 661, 186 Cal.Rptr. 578, 652 P.2d 426.)

By providing that the major portion of premiums was to remain with the underwritten title companies, and by specifying the manner in which their obligations as title insurers were to be partially satisfied by the underwritten title companies, plaintiffs subjected themselves to the rule that “[t]he power to dispose of income is the equivalent of ownership of it.   The exercise of that power ․ is the enjoyment, and hence the realization, of the income by him who exercises it.”  (Helvering v. Horst, supra, 311 U.S. 112 at p. 118, 61 S.Ct. at p. 148.)   The entire amount of premiums paid for title insurance is therefore taxable income to plaintiffs.

 The payment by the underwritten title companies of policy claims against the title insurers constituted income to the title insurers.

 One of the most firmly entrenched principles of federal tax law is that a discharge of a taxpayer's debt by payment made for his benefit is realizable income to him.  (Commissioner v. Jacobson, supra, 336 U.S. 28 at p. 39, fn. 5, 69 S.Ct. at p. 364, fn. 5;  accord e.g., United States v. Hendler (1938) 303 U.S. 564, 566, 58 S.Ct. 655, 656, 82 L.Ed. 1018;  Old Colony Tr. Co. v. Comm'r Int. Rev. (1929) 279 U.S. 716, 729, 49 S.Ct. 499, 504, 73 L.Ed. 918.)   Many years have passed since the United States Supreme Court held that “income was received by a taxpayer, when, pursuant to a contract, a debt or other obligation was discharged by another for his benefit.   The transaction was regarded as being the same in substance as if the money had been paid to the taxpayer and he had transmitted it to his creditor.”  (Douglas v. Willcuts (1935) 296 U.S. 1, 9, 56 S.Ct. 59, 62, 80 L.Ed. 3;  accord Burnet v. Wells (1933) 289 U.S. 670, 677, 53 S.Ct. 761, 763, 77 L.Ed. 1439;  Falkoff v. C.I.R. (7th Cir.1979) 604 F.2d 1045, 1051.)   Such a payment “is merely a short cut.”  (U.S. v. Boston & M.R. Co. (1929) 279 U.S. 732, 734, 49 S.Ct. 505, 505, 73 L.Ed. 929.)   This principle is now codified in the definition of gross income.  (See 26 U.S.C. § 61, subd. (a)(12), quoted ante.)   In addition to incorporating by reference the federal experience (see Rev. & Tax.Code, §§ 17071, 24271;  Holmes v. McColgan, supra, 17 Cal.2d 426 at p. 430, 110 P.2d 428), California reaches the same conclusion on its own legs.   (See Metropolitan Life Ins. Co. v. State Bd. of Equalization, supra, 32 Cal.3d 649, 186 Cal.Rptr. 578, 652 P.2d 426, discussed ante.)

 The heart of plaintiff's argument as communicated to us at oral argument is:  “To realize income you have to put it in your pocket.   You have to get the tangible benefit of it.”   Plaintiffs seem to insist that unless the taxpayer actually receives cash money (or its tangible equivalent), there is no income to tax.   The authorities we have cited proceed on a different basis, paying more attention to “economic reality” (Diedrich v. Commissioner, supra, 457 U.S. 191 at p. 198, 102 S.Ct. 2414 at p. 2419) than to plaintiffs' concept of “tangible benefit.”   As with income in general, the payment of a legal obligation of a taxpayer is income to the taxpayer even though he does not actually receive it.  (Schaeffer v. Commissioner of Internal Revenue (6th Cir.1958) 258 F.2d 861, 864.)   The economic reality is that title insurers realize monetary benefit when liabilities they would otherwise pay are paid by underwritten title companies.

 Recompensing insureds for losses covered by insurance is the very essence of the business of insurance.  (See Ins.Code, § 22.)   It is also the very essence of title insurance, which is a contract to indemnify against loss through defects in the title or against liens or encumbrances that may affect the title.  (Ins.Code, § 12340.1;  King v. Stanley (1948) 32 Cal.2d 584, 590, 197 P.2d 321.)   In California that indemnification function can be performed only by title insurers.  (See Ins.Code, §§ 12340.4, 12340.5, quoted at note 1, ante.)   To the extent an underwritten title company contributes to the payment of a policy claim by an insured it operates only as an agent acting to discharge a liability of the title insurer.  (See California Physicians' Service v. Garrison (1946) 28 Cal.2d 790, 804, 172 P.2d 4.)   No other conclusion is possible.   The underwritten title company is not a party to the contract of insurance and is statutorily barred from assuming the indemnity functions of a title insurer.   Having assumed no responsibility to the insured for loss suffered by the insured, the title company simply provides a service to the title insurer by acting as the conduit for the title insurer in satisfying its contractually-assumed risk of indemnification.  (Id. at p. 809, 172 P.2d 4.)

It is hard to imagine an underwritten title company—the agent of a title insurer—unilaterally assuming the defining role of its principal, particularly when by doing so the title company runs the risk of losing its license to do business (Ins.Code, § 12411) and of incurring criminal penalties (Ins.Code, § 12414.25).   It is therefore reasonable to impute to the insurer payments made by an underwritten title company to the insured by reason of the occurrence of a loss covered by a policy of title insurance.   This is nothing more than the converse of the rule that what the agent receives is in legal effect what the insurer receives.  (Groves v. City of Los Angeles, supra, 40 Cal.2d 751 at p. 761, 256 P.2d 309.)

It is also fair to assume that such payments are made by title companies under the compulsion of their underwriting agreements with title insurers.7  When such payments are made by the title companies, they discharge the obligations of the title insurers.   The payment to the insured is (to use plaintiffs' imagery) money in the pocket of the insured and money out of the pocket of the title company.   The money actually paid by the title company would otherwise come out of the insurer's pocket.   But because it has come out of the title company's pocket, the money the insurer would otherwise have to pay remains in the insurer's pocket.

The consequences of acceding to plaintiffs' argument would create a situation at odds with fairness and at war with common sense.   As matters stood before the Board changed its assessment practice in 1973,8 title insurers were able to shift a very large portion of their tax burden to the underwritten title companies by the mechanism of paying over to the latter the lion's share of their premium-generated income.   Whether this was to reimburse the title companies for the title search and other work performed by the title company preparatory to issuance of a title policy is immaterial.   Unlike other taxpayers, the title insurers thus transmuted two taxable transactions into one.9  The insurers also had in place a system by which they received additional income without taxation when they were reimbursed by title companies for disbursements the insurers had made for losses suffered by the insureds.   Should they prevail, plaintiffs would remove a considerable portion of their gross income from all taxation.  (See § 28, subd. (f), quoted ante.)

Undeniably the economic reality is that the payments made by the title companies to discharge or reimburse plaintiffs' obligations to their insureds amount to the disbursement of funds in a manner that inures to the economic benefit of plaintiffs.  (See Metropolitan Life Ins. Co. v. State Bd. of Equalization, supra, 32 Cal.3d 649 at p. 661, 186 Cal.Rptr. 578, 652 P.2d 426;  Interinsurance Exchange v. State Bd. of Equalization, supra, 156 Cal.App.3d 606 at pp. 613–614, 203 Cal.Rptr. 74.)   Those payments therefore constitute income and are taxable to plaintiffs.

 Plaintiffs are not entitled to refunds.

The preceding discussion has established that plaintiffs' position arguing for exclusions from their income is contrary to the overwhelming weight of state and federal authority, both statutory and decisional.   The exclusions they wish recognized here are not authorized by section 28, subdivision (c), quoted ante, or by the applicable statutes.  (See Rev. & Tax.Code, § 12231;  cf. 26 U.S.C. § 108, subd. (a)(1) [specifying exceptions to rule of 26 U.S.C. § 61, subd. (a)(12) including income from discharges of indebtedness in gross income];  Rev. & Tax.Code, § 17131 [adopting federal exclusions from gross income for state taxation purposes].)   Finally, we reject plaintiffs' arguments because they would authorize an illogical enclave of income immunized from taxation, a situation that would be at odds with fairness and common sense.   We decide these matters as issues of law on the basis of the uncontradicted contents of the record.  (See Southern California Edison Co. v. State Board of Equalization (1972) 7 Cal.3d 652, 659, fn. 8, 102 Cal.Rptr. 766, 498 P.2d 1014;  Communications Satellite Corp. v. Franchise Tax Bd. (1984) 156 Cal.App.3d 726, 746–747, 203 Cal.Rptr. 779.)

This appeal comes to us with an unusual posture.   When the parties commenced litigation they were concerned only with whether plaintiffs were entitled to a refund for those amounts paid by the underwritten title companies to satisfy claims against the title insurers.   During the course of argument before the trial court the Board expanded its position to encompass whether the full amount of premiums was taxable as part of “all income” received by plaintiffs within the meaning of section 28.   This change of theory is permitted for the purpose of demonstrating that no refund is owed.  (See Owens–Corning Fiberglass Corp. v. State Bd. of Equalization (1974) 39 Cal.App.3d 532, 536–537, 114 Cal.Rptr. 515;  Lewis v. Reynolds (1932) 284 U.S. 281, 283, 52 S.Ct. 145, 146, 76 L.Ed. 293.)   Unlike the dissenting opinion, plaintiffs do not argue to the contrary, nor have they urged the existence of an estoppel.   The issue was decided by the trial court.   It was fully briefed and argued to us.   Judicial economy will not be served by deferring a resolution of this certain to recur question.

 Not reflected in this record is the amount of premiums which the Board claims—consistent with the appropriate statute of limitations—to be due and owing.   This omission does not prevent a full resolution on this appeal.   Whatever the amount of this claim, it has already been shown that plaintiffs are not entitled to a refund of the amount already collected by the Board as taxable income paid to plaintiffs by underwritten title companies to assist plaintiffs in satisfying claims by insureds.

The judgment is reversed and the cause is remanded to the trial court with directions to enter judgment in favor of the Board.

I believe that neither the underwritten title companies' payment of claims nor that portion of the premium retained by them is taxable income to the insurer.   Furthermore, I am satisfied that the latter decision was not properly before the trial court and should not be decided here.1  Therefore, I respectfully dissent.

I. THE MAJORITY DECISION IS OVERLY BROAD

The expansive majority decision unnecessarily creates two new and distinct bases of tax liability where only one was the product of administrative agency action and review.   The Board of Equalization (Board) issued the assessments in question only for amounts which the underwritten title companies paid to satisfy insureds' claims under their title insurance policies.   These loss payments, it asserted, constituted income to respondent title insurers on a discharge of indebtedness theory.   Title insurance companies paid the assessments under protest, unsuccessfully petitioned for reconsideration, and then brought the present refund action in superior court.   They won below but lose here.   While I disagree with the majority that when an underwritten title company satisfies an insured's claim, the title insurer recognizes taxable gain, that conclusion should have decided the instant tax liability controversy and ended the matter.

Nevertheless, the majority also decides the much broader issue of whether the title insurer should include the total amount of premiums paid for title insurance within the “all income” measure of its insurance tax.   The Attorney General conceived of this theory of tax liability on the eve of trial, advancing it for the first time as a defense to the judicial refund action.   Respondent title insurers never had a Board hearing or the opportunity to present evidence on this theory.   However, after today, title insurers must pay the insurance tax on 100 percent of all premiums collected from insureds (as opposed to roughly 10 percent), as well as on all claims paid by the underwritten title companies.   In light of the procedural posture of this case, I think this “double whammy” approach is unfair.

Moreover, when the taxpayer brings a suit for refund and attempts to assert a new theory, courts will not consider the newly raised issue.   This is because the taxpayer's earlier administrative claim for refund restricts the scope of judicial action.  (Atari Inc., v. State Bd. of Equalization (1985) 170 Cal.App.3d 665, 672, 216 Cal.Rptr. 267.)   The administrative claim must “state the specific grounds upon which it is founded.”  (Rev. & Tax.Code, § 12979.)   If the Board denies the claim, the taxpayer “may bring an action against the board on the grounds set forth in the claim․”  (Rev. & Tax.Code, § 13103, emphasis added.)   This rule acts as a jurisdictional bar:  trial and appellate courts “are without jurisdiction to consider grounds not set forth in the claim.”  (Atari Inc., supra, 170 Cal.App.3d at p. 672, 216 Cal.Rptr. 267.)   The cases which the majority cites as authority for permitting the Board to assert a new theory as a defense to a refund action are statute of limitation cases which have nothing to do with the scope of issues that can be entertained in such an action.   Courts should demand the same vigilance on the Board's part as the Legislature demands from the taxpayer.

II. BACKGROUND

Before analyzing the correctness of the trial court's opinion (and thereby distinguishing my reasoning from that of my colleagues), I find it necessary to review the contractual relationships and litigation history between the parties, as well as the applicable taxing scheme.

A. Contractual Relationships

During the business years in question, respondent title insurers issued title insurance policies in California to insureds either exclusively through independent underwritten title companies or directly through their own branch offices as well as through underwritten title companies.   These companies were not licensed in California as title insurers.2  Respondents entered into underwriting agreements with various underwritten title companies pursuant to which they appointed company employees or officers as their agents, authorized to issue policies up to specified levels of coverage.

The title insurer appeared on the policy as the insurance company;  the underwritten title company was not a party to the insurance contract, nor was the insured a party to the underwriting agreement.   Under the various title insurance policies, the title insurer would agree to insure the insured against specified losses or damages according to the applicable schedules.   The insured in turn promised to notify the insurer of adverse claims and provide proof of loss.   Once the loss or damage was fixed in accordance with policy terms, the title insurer agreed to pay the loss or damage within a specified time.

Pursuant to the underwriting agreements, the underwritten title companies agreed to conduct title searches, examine title documents and prepare the preliminary reports.   Acting as agent of the title insurer and using the insurer's forms, the company would prepare and issue the policy, determine the premium from rate schedules compiled by the insurer and collect the premium.   The premium amount included all costs of searching and examining title and preparing the preliminary report.3  The title search and examination work is the most costly and time consuming aspect of the process culminating in issuance of a title insurance policy.   The underwriting agreements allocated the premium between respondents and the underwritten title company, the latter retaining in the neighborhood of 90 percent of the fee with respondents receiving the balance for their acceptance of the hazard in insuring title as set forth in the policies.

The agreements also allocated to the underwritten title companies a portion of the responsibility for title claims under each policy.   Depending on the particular agreement and the circumstance, the company would pay either the insured or the insurer.   Typically, the underwritten title company assumed responsibility for 100 percent of certain losses, including those resulting from the company's intentional omission from an insurance policy of certain title defects;  other losses would be allocated between the two entities on a formula basis.

B. Litigation Background

Historically, no title insurer reported as part of its taxable income those payments which an underwritten title company made to reduce the insurer's liability under a title insurance policy.   All this changed in 1972 when the Department of Insurance decided such amounts should be included in the insurers' income measure for purposes of calculating their tax burden under California law.   Both sides agree that there was no known change in industry practices, the terms of insurance policies or the contractual relationships between title insurers and underwritten title companies which prompted this policy change.   Consistent with this new policy, the Board began assessingrespondent title insurers for the loss payments made by underwritten title companies.

In response to these deficiency assessments, all seven respondents paid the additional tax and then filed claims for refund of insurance tax for various business years from 1975 through 1984;  the Board denied all claims.   The now-consolidated complaints for refund of taxes followed.

As a preliminary trial matter, the Board asserted by way of set-off that respondents should have reported and paid taxes on the full value of the insureds' premiums, including that portion which the underwritten title companies retained pursuant to the underwriting agreements.   Respondents have always reported and paid taxes on that portion of the premium which the underwritten title companies remitted to them.   The remainder was neither reported by respondents nor included as income by the Board in calculating the assessments which led to this lawsuit.

The trial court ruled against the Board on both theories and entered judgment for respondents.

C. Taxing Scheme

California taxes insurance companies differently from all other corporations.   Under the California Constitution insurers pay an annual tax which is in lieu of all other state and local taxes except real property and motor vehicle taxes and fees and, with respect to title insurers with trust departments, taxes on the trust business.  (Art.4 XIII, § 28, subds. (b), (f);  see parallel provisions in Rev. & Tax.Code, §§ 12204, 12231.)

For title insurers, “ ‘the basis of the annual tax’ is ․ all income upon business done in this state, except:  [¶] (1) Interest and dividends.  [¶] (2) Rents from real property.  [¶] (3) Profits from the sale or other disposition of investments.  [¶] (4) Income from investments.”  (Art. XIII, § 28, subd. (c);  Rev. & Tax.Code, § 12231.)   All other insurance companies are taxed on the basis of gross premiums, less return premiums.  (Art. XIII, § 28, subd. (c).)

The annual tax is subject only to those deductions specified in article XIII, section 28.  (Art. XIII, § 28, subd. (b).)  Thus the deduction for ordinary and necessary business expenses allowed under our Bank and Corporation Tax Law (Rev. & Tax.Code, §§ 12001 et seq. and 24343) would not apply to an insurance company.   For example, respondents could not deduct from their income tax any funds which they paid out on insurance claims arising under their policies.   The underwritten title companies contracting with respondents, however, are taxed as corporations and, thus, can take advantage of the corporate deduction for business expenses.

III. THE ENTIRE PREMIUM IS NOT INCOME TO THE INSURER

I disagree that respondent title insurers realize income to the extent of 100 percent of premiums recovered from the insureds.   Not only was this issue not ripe for decision by this court, it is wrongly decided.

As I understand the majority opinion, its reasoning proceeds on two fronts:  (1) Under federal law, the total consideration that the insured pays for a title insurance policy qualifies as income to the title insurer because it is the insurer and no one else who contracts with the insured and at all times controls the disposition of the premium.   It matters not that the underwritten title companies retained 90 percent of the premium because the insurers directed this fee division in accordance with the underwriting agreements.   By virtue of their “power to dispose of” the full amount of the premiums, the insurers realized a commensurate “undeniable accession to wealth” which should be subjected to the insurance tax.  (2) Under California decisional law defining and explaining the concept of “gross premium,” the gross premium is the entire cost to the insured for the insurance.   This cost includes the net premium as well as a loading factor designed to cover the expense of administering the insurance.   When an agent for the insurer issues a policy and collects the premium, any private agreement respecting allocation of the premium is nothing more than an “intramural arrangement” for the parties' mutual convenience;  under agency law, what the agent receives the principal receives and, thus, by operation of this same “law” 100 percent—not 10 percent—of the premium is attributed to our principal, the title insurer.   This gross premium, as defined, is a narrower category than the “all income” measure of the title insurer's tax and, therefore, is necessarily encompassed within the “all income” measure.   That the division of the fee is legal is irrelevant because the underwritten title company's share is still an integral component of the insurer's cost of administering the insurance.   Vis-á-vis the underwriting agreement, the insurer controls and directs the disposition of all premiums, coming full circle to the rule that the power to dispose of the premium is equivalent to its ownership and the exercise of that power is the realization of income.

The central fallacy of this thesis is the notion that respondent title insurers, through the underwriting agreements, command the disposition of the premiums.   This argument has superficial appeal but does not withstand careful analysis of the unique rules governing the title insurance industry and, in particular, its rate structure and inter-entity relations.

By definition, the title insurance industry is an enterprise encompassing the collective efforts of title insurers, underwritten title companies and escrow companies in issuing or proposing to issue title policies, transacting or proposing to transact any phase of title insurance, and performing any service in conjunction with the issuance or contemplated issuance of a title policy.   (Ins.Code,5 § 12340.3, subds. (a)–(c).)   The title insurer can perform search and abstract functions as well as issue the policy as insurer.  (§ 12340.4;  Chicago Title Ins. Co. v. Great Western Financial Corp. (1968) 69 Cal.2d 305, 314, 70 Cal.Rptr. 849, 444 P.2d 481.)   On the other hand, the underwritten title company cannot insure;  it can only prepare “title searches, title examinations, title reports, certificates or abstracts of title upon the basis of which a title insurer writes title policies.”  (§§ 12340.5, 12389, emphasis added.)   As can be seen from this definitional overview, the business of providing title insurance includes at least two separate and discrete functions:  the title search function and the insuring function.   Indeed, there can be no title insurance policy without a preliminary report or similar title examination document upon which the insurer bases its policy.

The premium charged for a title insurance policy reflects the cost of these two functions.   The title insurer's rate schedule, which it must file with the insurance commissioner, “shall set forth the entire charge to the public for each type of title policy included within such schedule and shall include without separate statement thereof that portion of the charge, if any, which is based upon work performed by an underwritten title company;  there shall be no separate filing by an underwritten title company for such work.”   (§ 12401.1.)

The statutory framework specifically contemplates the division of fees between title insurers and underwritten title companies, based on their respective duties.  (§ 12412;  Chicago Title Ins. Co. v. Great Western Financial Corp., supra, 69 Cal.2d at pp. 319–320, 323, 70 Cal.Rptr. 849, 444 P.2d 481.)   Section 12412 provides:  “Nothing in this article prohibits the division of fees or charges, for work and services actually performed, ․ between title insurers and underwritten title companies ․, if such division does not constitute an unlawful rebate as defined by Section 12404.5, or is prohibited by Section 12405.7 or 12408.5.   The entire charge made to obtain a title policy shall be set forth on the title policy.” 6

The mechanism for allocating this fee is the underwriting agreement, which the underwritten title company must file with the insurance commissioner.  (Cal.Code Regs., tit. 10, § 2556.1, subd. (f).)

The point of this statutory review is to illustrate that the title insurer in fact does not have plenary control over the disposition of the premiums.   The premium is a combination of at least two fees:  the insurance fee, and the title examination fee.   The title insurer's rate schedule must collapse both fees into one all-inclusive charge to the public for the title policy;  at the times in question, the insurer was duty bound to either separately identify the two charges in the policy itself or, if it listed a single fee, the policy had to include a statement that the charge included the title insurance fee and the title search fee.   Thus, the title insurer could not and cannot simply charge a net insuring fee and leave it to the underwritten title company to separately assess and collect its fee for its title examination work.   Moreover, the agreement is not, as the majority opinion hints, a contract designed to reroute payments from the real earner to some third party designee.   The title insurer never earned the title examination fee in the first place, a reality which the agreement recognizes.

Nothing in section 12412 can be construed as attributing the full amount of the premium to the insurer, let alone charging it with realization thereof for purposes of determining its tax liability.   The statutory scheme dictates that the entire charge to the insured be disclosed on the policy, and contemplates that when underwritten title companies and title insurers work together, this single fee will be distributed according to each entity's share of “work and services actually performed.”   It does not square with these statutory rules to conclude that the insurer, through the underwriting agreement, exercises complete dominion over the premiums so as to realize income in the amount of 100 percent thereof.   The underwriting agreement is nothing more than a vehicle for accomplishing what the statutes require and allow.

I have no quarrel with the proposition that underwritten title company's charges for work and services actually performed are part of the cost to the insured for purchasing the policy and, thus, part of the gross premium under California law.   Indeed, these charges are the lion's share of the cost because, as all parties acknowledge, the title search and examination work is the most costly element of the title insuring process.   However, I cannot agree that “gross premiums” are a subset of, and thus subsumed by, the “all income” basis of the title insurer's insurance tax.

The two concepts are very different.   The insurer subject to the gross premiums measure is “assessed a tax on the total cost of the insurance coverage provided to the insured.”  (Metropolitan Life Ins. Co. v. State Bd. of Equalization (1982) 32 Cal.3d 649, 660, 186 Cal.Rptr. 578, 652 P.2d 426.)   This measure is “designed to approximate the volume of business done in this state, and thus the extent to which insurers have availed themselves of the privilege of doing business in California.”  (Id., at p. 656, 186 Cal.Rptr. 578, 652 P.2d 426.)   In the title insurance context and in the context of this particular controversy, the gross premium includes the insurance fee as well as the underwritten title company's charges for performing the title workup and issuing the policies.7  To say that the title insurer realizes an economic gain in the amount of 100 percent of the premium, when, pursuant to statutory authority the underwritten title company recoups its share of the premium, makes no sense.   From a practical standpoint the statutory scheme compels the underwritten title company to forgo assessing a separate charge because by law their charges must be reflected in the premium charged to the public, and that premium must be set forth in the policy itself.

The majority suggests that my statutory analysis conflicts with the constitutional mandate compelling a tax on “all income” of a title insurer.   To the contrary, I merely have attempted to show why, within this industry, and under the statutes regulating this industry, only a portion of the premium qualifies as income to the insurer.

From the frustratingly scant record before this court, one cannot determine to a certainty whether the underwritten title company's 90 percent share equates exactly with its charges for title search and related administrative tasks.   My impression, from all the papers and arguments, is that the 90 percent at least includes this amount.   Under these circumstances, and in view of the law as I understand it, I conclude the Board has not sustained its burden of demonstrating that respondent title insurers owe taxes on any portion of the premium retained by the underwritten title company.8

IV. THE UNDERWRITTEN TITLE COMPANY'S PAYMENT OF CLAIMS IS NOT INCOME TO THE INSURER

As I see it this appeal poses the primary question whether the “all income” measure of a title insurer's annual tax includes policy claims which an underwritten title company pays pursuant to its underwriting agreement with the title insurer.

Neither the constitutional provision nor its statutory counterpart defines the term “all income.”   By analogy, state law 9 defines “gross income” with reference to its federal counterpart found in section 61 of the Internal Revenue Code.  (26 U.S.C. § 61.)   Under this statute, gross income is income “from whatever source derived, including ․ (12) Income from discharge of indebtedness․”  (26 U.S.C. § 61(a)(12).)   The pertinent regulations further explain:  “The discharge of indebtedness, in whole or in part, may result in the realization of income.   If, for example, an individual performs services for a creditor, who in consideration thereof cancels the debt, the debtor realizes income in the amount of the debt as compensation for his services.   A taxpayer may realize income by the payment or purchase of his obligations at less than their face value.”  (26 C.F.R. § 1.61–12(a).)

The United States Supreme Court has viewed the sweeping language of the federal gross income provisions as evidencing Congress' intent “to exert in this field ‘the full measure of its taxing power.’ ”  (Commissioner v. Glenshaw Glass Co. (1955) 348 U.S. 426, 429, 75 S.Ct. 473, 476, 99 L.Ed. 483.)   This is an intent to tax all gains except those specifically exempted.   (Id., at p. 430, 75 S.Ct. at p. 476;  Commissioner v. Kowalski (1977) 434 U.S. 77, 82–83, 98 S.Ct. 315, 318–319, 54 L.Ed.2d 252.)   The issue in Glenshaw was whether taxpayers realized income upon receipt of exemplary damages.   Concluding that the taxing laws contemplated such payments, the court characterized the payments as “instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.”  (Commissioner v. Glenshaw Glass Co., supra, 348 U.S. at p. 431, 75 S.Ct. at p. 477;  see Commissioner v. Kowalski, supra, 434 U.S. at p. 83, 98 S.Ct. at p. 319.)

The very essence of the concept of taxable income “is the accrual of some gain, profit or benefit to the taxpayer.”  (Commissioner v. Wilcox (1946) 327 U.S. 404, 407, 66 S.Ct. 546, 548, 90 L.Ed. 752, overruled on other grounds in James v. United States (1961) 366 U.S. 213, 221, 81 S.Ct. 1052, 1056, 6 L.Ed.2d 246.)   And in deciding whether a taxable gain has accrued to the taxpayer, courts consider all relevant facts and circumstances.   (Ibid.)  Sometimes income is realized by indirect means;  in such cases it is the substance, not the form of the agreed transaction that controls.   (Diedrich v. Commissioner (1982) 457 U.S. 191, 195, 102 S.Ct. 2414, 2417, 72 L.Ed.2d 777.)

Courts have found income from the discharge of indebtedness in numerous situations.   For instance, a taxpayer will be charged with taxable gain when a third party extinguishes the taxpayer's debt as compensation for services rendered, or consideration for property transferred.   As an example, an employer's payment of the employee's income taxes is characterized as payment “in consideration of the services rendered by the employee and was a gain derived by the employee from his labor.”  (Old Colony Tr. Co. v. Comm'r Int. Rev. (1929) 279 U.S. 716, 729, 49 S.Ct. 499, 504, 73 L.Ed. 918.)   The employer's discharge of the employee's tax obligation “is equivalent to receipt by the person taxed.”  (Ibid.)  So, too, where a mortgagor sells property subject to the mortgage, the buyer's assumption of the debt is additional consideration and the seller “realizes a benefit in the amount of the mortgage․  If he transfers subject to the mortgage, the benefit to him is as real and substantial as if the mortgage were discharged․”  (Crane v. Commissioner (1947) 331 U.S. 1, 14, 67 S.Ct. 1047, 1055, 91 L.Ed. 1301.)

Further, in the more recent Diedrich case involving a gift of highly appreciated property conditioned on the donee's payment of the gift tax, the Supreme Court approved of the agency's characterization of the transaction as a “discharge of indebtedness through a part gift and part sale of the gift property transferred.”  (Diedrich v. Commissioner, supra, 457 U.S. at p. 198, 102 S.Ct. at p. 2419.)   The agency treated the transfer itself as a below market sale, the consideration being the donee's discharge of the donor's gift tax indebtedness;  it treated the balance of the value transferred as a gift.   The donor, relieved of the gift tax obligation, is in a better position as a result of the discharge and has realized an immediate economic benefit.   (Id. at pp. 197–199, 102 S.Ct. at pp. 2418–2420.)

The rationale underlying Old Colony, Crane and Diedrich—that the debt discharge in reality is compensation or consideration to the taxpayer for services rendered or property transferred—does not fit the facts at hand.   In those cases, the value of taxpayer's services or property included the amount of the debt which the third party paid or assumed.   This situation involves risk allocation under very divergent facts.   At the outset the insurer/obligorhas bargained for and received services from the title company including its partial assumption of the risk attendant to certain losses.   The underwriting agreement distributes the respective benefits (premiums) and burdens (potential liability for loss claims) between insurer/obligor and title company in recognition of the specific duties each agrees to perform in connection with the business of providing title insurance.   The insurer takes in a fraction (approximately 10 percent) of the premiums precisely because the title company has done the lion's share of the title work and is assuming the lion's share of the risk of compensable mistake or omission flowing therefrom.

Whereas the employee in Colony is unquestionably enriched by the amount of the tax liability which the employer discharges, under the allocation framework operative here the enrichment from third party assumption of liabilities is offset by the diminished intake of premiums.   Similarly, although a corporation realizes taxable income when it repurchases its own bonds for less than face value because its bonded liability is no longer in parity with the gain enjoyed upon receipt of the purchase price,10 there is no such liability/asset imbalance here;  this case does not involve borrowed funds or discounted repayments.

The Board has also alluded to situations involving a third party's payoff of a guaranteed debt.   For example, in Tennessee Securities, Inc. v. C.I.R. (6th Cir.1982) 674 F.2d 570 three brothers were principal owners, officers and directors of a securities broker-dealer firm.   They personally guaranteed a loan to a franchise in an arm's length transaction in exchange for the right of first refusal to underwrite any future public offering of the franchise.   The franchise failed but when the bank sought payment under the guarantee, it was the broker-dealer firm, not the brothers that satisfied the debt.   The service imputed income to the brothers in the amount of the payoff.   The reviewing court agreed, holding that satisfaction of the personal guarantee conferred an economic benefit on the brothers.  (Id., at p. 573.)   Because they received consideration for entering the guaranty which gave rise to their eventual indebtedness, they realized income when the firm extinguished their counterobligation to make good on the guaranty.  (Id., at p. 574.)

This case does not involve a gratuitous discharge of another's contractual obligation.   In Tennessee, the brothers got something (a speculative right of first refusal) for nothing because when the bank tendered payment to them under the guaranty, a third party stepped in and paid the debt.   The insurer is not getting something for nothing when the title company pays part of a loss claim;  the insurer has relinquished most of the premium to the title company pursuant to an arm's length agreement involving division of labor, premiums and liabilities.

The majority propounds that the title insurers realize income when an underwritten title company steps in and pays a claim because by law, only they can fulfill the indemnity role of a title insurer;  therefore, payment by a third party literally discharges the insurer's obligation.   This argument mistakenly assumes that because the duty itself is nondelegable, it can only be discharged by direct payment.   To the contrary, by virtue of the underwriting agreement which is in place from the outset and before any claim arises, the underwritten title company is legally obligated to the insurer to pay certain claims.   The insurer discharges its duty to the insured when the underwritten title company honors its agreement to pay the claim.   The insurer has never divested itself of its duty to indemnify.   If the underwritten title company becomes insolvent or otherwise breaches the agreement, the insurer is still primarily liable to the insured.   Nor has the underwritten title company assumed an indemnity role vis-á-vis the insured.   No one has suggested, nor would the facts support any inference, that the underwriting agreement is a third party beneficiary contract such that the insured could enforce it against the underwritten title company.

I conclude the underwritten title company's payment of a compensable claim is not an untaxed windfall to the insurer;  in substance there is no gain to the insurer when the company pays on a claim.   Moreover, substantively it makes no difference whether the title company pays the insured directly or reimburses the insurer for its payment.

To recap, the insurer has agreed, on an aggregate basis, to take in only 10 percent of all premiums on the assumption that the risk-sharing and actual claims pay out is approximately proportionate.   It thus actually receives consideration from the insured commensurate with that portion of the risk which has not contractually shifted to the underwritten title company.   The apportionment of premiums cancels the apportionment of liabilities.

The division of fees is legal and contemplated by the statutory scheme.  (§ 12412.)   Moreover, by law the rate schedule must set forth the entire charge to the public for the particular type of policy, including charges based on work performed by an underwritten title company (§ 12401.1.)   And although an underwritten title company cannot legally step into the shoes of the insurer, nothing in the statutory scheme forbids a division of risks between the two entities.

I would affirm the trial court in rejecting both of the Board's theories and in entering judgment for the taxpayers.

FOOTNOTES

1.   The Insurance Code defines “title insurer” as meaning “any company issuing title policies as insurer, guarantor or indemnitor” (Ins.Code, § 12340.4) and “underwritten title company” as meaning “any corporation engaged in the business of preparing title searches, title examinations, title reports, certificates or abstracts of title upon the basis of which a title insurer writes title policies” (Ins.Code, § 12340.5).

2.   Except in those instances—not at issue here—where a title insurer itself did the title searches and issued its policies through its wholly-owned branch office without the involvement of an underwritten title company, in which cases the entire premium was reported as income by the insurer.

3.   The Board appealed from all portions of the judgment except that directing that “All parties shall bear their own costs and attorneys fees” incurred at the trial.

4.   To wit:  “ ‘Income may be defined as the gain derived from capital, from labor, or from both combined․’ ”  (Citing and quoting Stratton's Independence v. Howbert (1913) 231 U.S. 399, 415, 34 S.Ct. 136, 140, 58 L.Ed. 285, and Doyle v. Mitchell Brothers Co. (1918) 247 U.S. 179, 185, 38 S.Ct. 467, 469, 62 L.Ed. 1054.)   Justice Holmes, who was one of the four dissenters, protested against such a limited formulation.   (Eisner v. Macomber, supra, 252 U.S. 189 at pp. 219–220, 40 S.Ct. 189 at pp. 197–198 (dis. opn. of Holmes, J.).)   It was in the context of defining what constituted income that Holmes had—only two years earlier—uttered his famous dictum that “A word is not a crystal, transparent and unchanged, it is the skin of a living thought and may vary greatly in color and content according to the circumstances and the time in which it is used.”  (Towne v. Eisner (1918) 245 U.S. 418, 425, 38 S.Ct. 158, 159, 62 L.Ed. 372.)

5.   “ ‘The gross premium, or the amount charged in a contract of insurance, ordinarily includes two elements, that is, the net premium and the loading.   The loading, or the amount arbitrarily added to the net premium, is intended to cover the expenses of the company.’ ”   (Metropolitan Life Ins. Co. v. State Bd. of Equalization, supra, 32 Cal.3d 649 at p. 660, 186 Cal.Rptr. 578, 652 P.2d 426 [citing and quoting Allstate Ins. Co. v. State Board of Equal., supra, 169 Cal.App.2d 165 at p. 168, 336 P.2d 961].)

6.   “Every title insurer ․ shall file with the [insurance] commissioner its schedule of rates․  Every schedule of rates filed by a title insurer shall set forth the entire charge to the public for each type of title policy included within such schedule and shall include without separate statement thereof that portion of the charge, if any, which is based upon work performed by an underwritten title company;  there shall be no separate filing by an underwritten title company for such work․”  (Ins.Code, § 12401.1.)“Nothing in this article prohibits the division of fees or charges, for work and services actually performed, between title insurers ․ and underwritten title companies․  The entire charge made to obtain a policy shall be set forth on the title policy.”  (Ins.Code, § 12412.)The parties stipulated that the cost of the various services provided by underwritten title companies in accordance with the underwriting agreements were included in the premiums charged by plaintiffs.

7.   Plaintiffs have devoted a great deal of attention to the factor of consideration for the title companies' payments.   If consideration is required, it is present in the various services performed by the underwritten title companies pursuant to the underwriting agreements with plaintiffs.  (See Douglas v. Willcuts, supra, 296 U.S. 1 at p. 9, 56 S.Ct. 59 at p. 62.)   Plaintiffs' largely theoretical arguments to the contrary should not be allowed to obscure economic realities.  (See Diedrich v. Commissioner, supra, 457 U.S. 191 at pp. 194–198, 102 S.Ct. 2414 at pp. 2417–2419;  Helvering v. Clifford, supra, 309 U.S. 331 at p. 334, 60 S.Ct. 554 at p. 556;  Metropolitan Life Ins. Co. v. State Bd. of Equalization, supra, 32 Cal.3d 649 at pp. 656–657, 661, 186 Cal.Rptr. 578, 652 P.2d 426.)

8.   The why and wherefore of the Board's change of position is not germane to this appeal.

9.   The salary or wages paid to a taxpayer constitutes income that is taxable to the taxpayer.   If the taxpayer then uses the salary or wages to purchase goods or services, that is income for which the provider of those goods and services is taxed.   Until the Board changed its assessment policy (see note 8 and accompanying text, ante ), plaintiffs were able to skip the first step of this equation.

1.   This court, of course, has authority to limit the scope of an appeal to matters properly before it regardless of whether the litigants so advocate.

2.   Insurance Code section 12340.4 defines “title insurer” as “any company issuing title policies as insurer, guarantor or indemnitor.”   On the other hand, an “underwritten title company” is “any corporation engaged in the business of preparing title searches, title examinations, title reports, certificates or abstracts of title upon the basis of which a title insurer writes title policies.”  (Ins.Code, § 12340.5.)

3.   By law the rate schedules which the title insurer files with the Insurance Commissioner must include, without separate statement, that portion of the charge based on work performed by an underwritten title company.  (Ins.Code, § 12401.1.)

FN4. All articles referred to are to the California Constitution..  FN4. All articles referred to are to the California Constitution.

FN5. All further statutory references are to the Insurance Code..  FN5. All further statutory references are to the Insurance Code.

6.   The phrase “for work and services actually performed” was added by amendment in 1982, midway through the assessment periods covered by this lawsuit.  (Stats.1982, ch. 972, § 3.)  Section 12412 was further amended, effective January 1, 1986, to delete the following proviso:  “However, a title insurer shall specify on any title policy issued by it, either in a single amount or by itemization, the entire charge made to obtain such title policy, including the charges made by any underwritten title company for the title search, title examination, certificate or abstract of title upon the basis of which such title policy is issued.   If so specified in a single amount, such charge shall be clearly described as the total charge for both the title insurance fee and the title search or examination, or abstract of title, as the case may be, of any underwritten title company.”  (§ 12412, added by Stats.1949, ch. 891, § 2, as amended by Stats.1965, ch. 360, § 3 and Stats.1982, ch. 972, § 3;  quoted provision deleted by Stats.1985, ch. 443, § 1.)

7.   The parties have stipulated that the premium amount for any single insurance policy was stated in the policy and included all costs associated with the procedures of (a) searching and examining title documents and preparing a preliminary report and (b) actually issuing the policies.   Both procedures were performed exclusively by the underwritten title companies.

8.   Nor does the majority's citation to a case stating that “Premiums of a title insurance company constitute income and should be taxed as such” change my mind.  (See Title & Trust Company of Florida v. United States (M.D.Fla.1965) 243 F.Supp. 42, 44.)   The Title & Trust Company case has nothing to do with the structure and composition of premiums under California law.   The sole issue there was whether the amount allocated to an unearned premium reserve—as required by Florida law—qualified as a deduction under the relevant federal tax laws.

9.   Revenue and Taxation Code sections 17071 and 24271.

10.   See United States v. Kirby Lumber Co. (1931) 284 U.S. 1, 3, 52 S.Ct. 4, 4, 76 L.Ed. 131 (repurchase of bonds at below face value “made available ․ assets previously offset by the obligation of bonds now extinct”).

POCHÉ, Associate Justice.

PERLEY, J., concurs.

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