Why are dividends from a mutual insurer not subject to taxation?

Dividends from a mutual insurer are classified as a return of premium because they represent the policyholder's share of the insurer's surplus. In essence, these dividends are the result of the insurer collecting more in premiums than it paid out in claims and expenses. Therefore, when a mutual insurer issues dividends, it is essentially refunding excess premiums to its policyholders. This refund is not considered taxable income, as it is not profit that has been earned or received, but rather a return of the policyholder's own money.

This concept underscores the nature of mutual insurance, where policyholders are also the owners of the insurer; hence, any surplus is returned to them rather than distributed as profit to shareholders, as in stock insurers. The classification as a return of premium ensures that policyholders do not incur a tax liability on these dividends, distinguishing them from taxable earnings.