Guaranty Bldg. & Loan Co. v. Commissioner ( 1933 )

GUARANTY BUILDING & LOAN COMPANY OF MARION, INDIANA, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Guaranty Bldg. & Loan Co. v. Commissioner

Docket No. 55352.

United States Board of Tax Appeals

27 B.T.A. 754; 1933 BTA LEXIS 1307;

February 20, 1933, Promulgated

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BUILDING AND LOAN ASSOCIATION - EXEMPTION. Petitioner, which was incorporated as a rural savings and loan company under the laws of the State of Indiana and is recognized as a building and loan association under the laws of that state, in accordance with which it conducts its business, is held exempt from Federal taxation under section 231(4) of the Revenue Act of 1926, though control of the organization is by statute placed in the hands of guaranty stockholders and such stockholders are entitled to receive certain preferential treatment in the distribution of profits and are subject to the claims of creditors; entitled upon dissolution to the surplus created. United States v. Cambridge Loan & Building Co.,278 U.S. 55">278 U.S. 55.

L. L. Hamby, Esq., for the petitioner.

Lloyd W. Creason, Esq., for the respondent.

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BLACK

This proceeding is for the redetermination of a deficiency in income tax of $40.50 for the year 1927. Previously there was assessed against the petitioner for the year 1927 income tax in the amount of $947.83, which was paid in 1928, and which petitioner alleges was an overpayment in the full amount thereof. The questions presented for our determination are: (1) Is the petitioner entitled to exemption from income tax as a building and loan association within the meaning of section 231(4) of the Revenue Act of 1926?; (2) If the petitioner is not an exempt corporation, but is taxable, is it entitled to deduct, as interest on its indebtedness, amounts paid to members other than guaranty stockholders, in determining its taxable net income?

FINDINGS OF FACT.

The petitioner was incorporated April 2, 1924, under the laws of the State of Indiana, chapter 265, page 714, Laws of 1913, relating to rural savings and loan associations. The official report of the 1913 Laws of Indiana, chapter 265, topically characterizes the subject in the following manner: "Building and Loan Associations - Rural Companies."

Petitioner was incorporated under the name of Indiana Rural Savings and Loan Association, and the deficiency notice mailed to it was addressed to that name. Its name was changed April 29, 1931, to Guaranty Building and Loan Company of Marion, Indiana, by which name it now prosecutes this proceeding.

During the year under consideration petitioner's authorized capital consisted of 9,000 shares of a par value of $900,000 of common stock and 200 shares of a par value of $100,000 of guaranty stock. The purpose for which petitioner was incorporated is stated in Article III of its articles of incorporation and this reads as follows:

The object and purpose of this association is to aid and encourage its members, investors and borrowers to acquire and practice habits of saving, thrift and economy; to provide its members a safe and profitable investment for their savings; to loan to its members the accumulations and deposits of the association upon such terms and conditions and for such time as shall be fixed by the laws of the association; to acquire and hold real estate for its own use; to acquire and hold real estate upon foreclosure; to acquire and improve real estate to be sold to its stockholders; to sell, convey, exchange and mortgage real estate and to borrow money for its corporate use and secure the same by its evidence of indebtedness.

Section III of petitioner's by-laws reads:

This association is organized for the purpose of encouraging its members to practice economy, thrift and saving and to encourage its members, investors and borrowers to acquire and practice the habits of thrift, saving, and frugality by the safe and profitable investment of such sums of money as they can spare from their wages and incomes and to encourage home ownership by loaning the savings thus accumulated to its members for their use and purpose in buying, building and paying for homes and for such other uses and purposes as may be authorized by the laws of Indiana. [Italics supplied.]

Section V of petitioner's by-laws provides that any person, firm or corporation, becoming the owner of one or more shares of the capital stock of said association, shall thereby become a member thereof.

Section VII provides that:

* * * the owners of the guaranty stock shall have the sole voting power in said association and the guaranty stockholders of the association shall be jointly and severally liable in addition to the par value of the guaranty stock in a sum equal in amount to the stock subscribed to pay and satisfy the debts and liabilities of the association after all the assets and resources of the association shall be exhausted.

The shares of the common stock shall be the same as shares of stock in domestic building and loan associations, except that said shares of common stock are non-voting and the holders or owners thereof shall have no liability thereon after the par value is paid in to the association, the manner of payment may be as provided and classified in the by-laws of the association and they shall have no other interest in the earnings and assets of the association, except that which is necessary to pay to them the amount they have paid in on their stock and the regular interest, as specified in these by-laws.

Sections VIII and IX provide that the prudential affairs of the petitioner as well as the general management and control of its business shall be controlled by a board of directors consisting of 14 members chosen from the guaranty stockholders.

Section XI gives the board of directors the right at any time to require any member or members holding installment stock or certificates of deposit to surrender them and that the same may be canceled upon payment to said members of the amount standing to his or her credit thereon, together with all interest credited and accrued and remaining unpaid to the date of the call for the surrender of said stock.

Section XIII reads:

The association shall set apart and accumulate a sinking fund and a surplus fund after the expense of management and operation, taxes and other expenses are deducted by setting aside semi-annually from the semi-annual gross profits three (3) per cent thereof for the sinking fund, which is to provide against contingent losses, any also at least two (2) per cent thereof for a surplus fund of the Guaranty stock, that said sinking fund may be accumulated to an amount equal to six (6) per cent of the assets of the association and that said surplus fund may be maintained when accumulated at an amount not less than ten (10) per cent in excess of the Guaranty stock as a part thereof. Provided that the said surplus fund may be considered as part of said Guaranty stock and share in dividends as paid up or Guaranty stock. Provided further, that in the event of liquidation of this association, any amount remaining in the sinking and surplus funds after the apyment of all losses, and amount due common stockholders shall be and become the property of and credited to the Guaranty stockholders pro rata.

Section XIV provides that all officers of the petitioner must be "Guaranty" stockholders.

Section XXI provides:

On the first days of January and July of each year the Board of Directors of said association shall declare such dividends as they deem advisable upon the Guaranty stock payable to said Guaranty stockholders of said association in proportion to the amount of Guaranty stock owned by them whieh has been fully paid. Provided further, that such dividend shall only be declared and paid out of the profits of said association after deducting therefrom all expenses of operation, all losses, the interest on all common stock and after setting aside to the contingent fund and the surplus fund an amount not less than the amount herein, and by the statute of the State of Indiana, provided, and provided further, that if any guaranty stockholder has not paid his stock in full, the amount of the dividend which he, she or it would be entitled to shall be credited to the holder of said guaranty stock, which had not been fully paid.

Section XXV provides:

The common stock of this association may be issued at any time and shall consist of installment stock, deposit stock, and borrowers stock, and the owner and holder thereof shall have no liability thereon for any of the debts or liabilities of this association and no owner or holder of any of the common stock of this association shall have any interest of any kind whatsoever in or to the profits of this association but in lieu of all interest in and to said profits, the owners of the common stock of this association shall received interest from this association on the amount of money invested by him, them or it, or deposited with this association at such rate per annum and at such times as shall be specified in the certificate of common stock issued to him, them or it, by said association and as provided in these by-laws.

Section XXVIII provides that borrower's stock be canceled upon the full payment of the loan and the borrowing stockholder thereby ceases to be a member upon the cancellation of this stock.

Section XXX provides that all loans made by this association shall be secured by first mortgage security on real estate and not to exceed two-thirds of the appraised value thereof or by assignment and delivery to the association of certificates and pass books of installment stock and certificates of deposit of depositing members, or upon such other security as shall be approved by the finance committee and the board of directors.

Holders of certificates of installment stock became members of the petitioner corporation by signing the certificate of installment stock and accepting the provisions of such class of sotck in the proper place on the reverse side thereof, and by receiving a pass book. Holders of certificates of deposit stock became members of the petitioner corporation upon receiving certificates of deposit stock and signing an acceptance on the back thereof and receiving a certificate of deposit. The holders of certificates of installment stock and of deposit stock ceased to be members of the petitioner corporation and their stock was canceled or retired upon withdrawal by them of the full amount of their deposits, which they could do at any time upon their demand.

During the year 1927 the petitioners made loans on real estate mortgage security to holders of borrowers' stock in the amount of $134,980, and additional loans were made on pass book credits in the amount of $5,055. Substantially all the loans made during the year under consideration were to holders of borrowers' stock.

The rate at which holders of installment, deposit and borrowers' stock certificates were paid on amounts invested or deposited by them for the year 1927 was 6 per cent. The rate of dividends paid by petitioner to holders of its certificates of guaranty stock for the year 1927 was 6 per cent of the par value of the stock outstanding. During the year 1927 petitioner paid to the installment stock members, $20,746.04; to deposit stock members, $2,211.23; to borrowers' stock members, $1,917.74; and to guaranty stockholders, $6,000.

The credit balances of reserve for contingencies and of surplus and undivided profits accounts as they appeared on the books of the petitioner as at December 31, 1926, and December 31, 1927, were as follows:

Name of account	12/31/26	12/31/27
Reserve for contingencies	$400.00	$700.00
Surplus and undivided profits	4,524.02	7,161.89

During the year under consideration four new homes were built through loans made by petitioner. Forty-nine loans were made for the purpose of making additional improvements on homes already owned by borrowers and 82 loans were made in order to enable members to purchase homes of their own.

These rural savings and loan associations incorporated under the laws of the State of Indiana are required to file annually, on the same form used by the domestic building and loan associations, a report to the Building and Loan Association Division of the State Banking Department of Indiana, and they are inspected annually by the same officer who inspects the domestic associations.

For the fiscal year ending September 30, 1928, the annual report of the Department of Banking of the State of Indiana, under the heading "List of Building and Loan Associations by counties, together with location, date of organization, assets, etc.," lists petitioner, among many other such associations, as follows:

Location	Name	Date organized	Assets	Stock in force	Capitalization
Marion	Indiana Rural Savings and Loan Association.	April, 1924	$677,964.98	$691,900	$1,000,000

A statement of petitioner's receipts and disbursements for the 12 months ending December 31, 1927, is as follows:

Receipts
Cash on hand December 31, 1926	$17,403.63
Dues on running stock	168,682.11
Paid-up and prepaid stock	54,323.76
Stocks and bonds	20,000.00
Loans on mortgage security repaid	78,565.82
Loans on stock or pass book security repaid	7,227.08
Real estate contracts	17,649.57
Interest	41,200.69
Fines	578.60
Borrower's stock	92,190.98
Loan fees	2,016.30
Borrowed money	74,500.00
Real estate sold	3,720.00
Refunded insurance and taxes	292.02
Rents from company's real estate	1,421.70
Due on loans	141,396.53
Sale of furniture and fixtures	30.00
Total	720,898.79
Disbursements
Loans on mortgage security	$136,428.03
Loans on stock or pass book security	5,063.77
R. E. contracts	45,983.00
Withdrawals of running stock and dividends	114,852.39
Withdrawals paid up and prepaid stock and dividends	51,485.88
Dividends on paid-up, prepaid stock	24,875.01
Expenses as per schedule	7,738.01
Borrowed money repaid	54,500.00
Interest on borrowed money	576.50
Insurance and taxes paid for borrowers	392.43
Real estate - purchase price	3,720.00
Stocks and bonds	20,000.00
Guaranty stock dividend	6,000.00
Repairs on company's real estate	174.00
Cash on hand December 31, 1927	28,877.10
Due on loans	143,565.86
Sheriff certificates	3,372.26
Loan fees	1,043.90
Borrower's stock	72,250.65
Total	720,898.79

OPINION.

BLACK: The petitioner contends that it is exempt from taxation under section 231(4) of the Revenue Act of 1926, which reads as follows:

The following organizations shall be exempt from taxation under this title -

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(4) Domestic building and loan associations substantially all the business of which is confined to making loans to members; and cooperative banks without capital stock organized and operated for mutual purposes and without profit.

Respondent contends that petitioner is not exempt because it is not a domestic building and loan association within the meaning of the above quoted section of the 1926 Revenue Act. During the year 1911 the Legislature of Indiana enacted the Organic Building and Loan Association Act. Section 1 of that act is printed in the margin. ^{*1319 in this proceeding are printed in the margin. *1320 The principal ground urged by respondent in the instant case as to why petitioner should not be classed as a building and loan association is that control of the organization is by statute placed in the hands of guaranty stockholders and such stockholders are entitled to receive preferential treatment in the distribution of profits and, subject to claims of creditors, are entitled, upon dissolution, to the surplus created. On this point we may point out that there is nothing in the Federal statute which restricts exemption to building and loan associations that do not issue guaranty stock.}

Guaranty or nonwithdrawal permanent capital stock is authorized to be issued by building and loan associations in the manner and with the same responsibility and liability as that here involved, in the following States: Arkansas (see Laws of 1929); Colorado (see Session Laws of 1896, 1897, 1907, 1920). In "History of Building and Loan in the United States," by Morton Bodfish, at page 332, the following is stated in respect to Colorado:

In 1920 the first three permanent stock companies were organized. [Naming them.]

Nearly all associations formed since that time have been organized on the permanent or guaranty stock plan. Building and loan associations have had their greatest growth since 1920 * * *.

California (see Special Session of 1907, ch. 412; Statutes of 1909, Civil Code, Title XVI, secs. 633 to 648(a)). In that state the associations are authorized to operate either on the guaranty plan or without the issuance of guaranty stock. Kansas (see Laws of 1899, ch. 78); Oregon (see Code of 1931, enacted June 11); and Wyoming (see Session Laws 1927, ch. 103).

We think our decision in the instant case is controlled by the decision of the Supreme Court in , affirming the Court of Claims in . There the Government contended that, because the Cambridge Association loaned most of its funds to nonmembers during the years under the 1918 Act, and received most of its funds used for loans from nonmembers in all the taxable years, and because it paid a fixed rate of dividend to prepaid stockholders different from that paid or credited to the installment or running stock members (the borrowing members) and therefore claimed by the Government not to be mutual; and because it loaned money for other purposes than the building of homes for the occupancy of members; and because a borrowing member was not required to subscribe to stock in an amount equal to his loan (being only required to subscribe to one or more shares) and being permitted to have its payments credited to the loan rather than upon the stock subscribed for; and because it accepted deposits, paying interest thereon, in amounts far beyond the needs of its borrowing members and loaned them to nonmembers when there was no application therefor by members; and because it invested some of its funds in purchasing outstanding mortgages on real estate that were given to secure loans advanced by others; and because its methods of operation were not in accord with orthodox methods that were employed by the original unincorporated building societies; it was therefore not a building and loan association within the meaning of the Acts of 1918 and 1921 (containing the same provisions as section 231(4) of the Revenue Act of 1926), although all of those things to which exceptions were taken were permitted by the laws of the State of Ohio, where the association was organized and was doing business. The Court of Claims overruled these contentions of the Government, and held that the Cambridge Association was exempt from taxation. The Supreme Court affirmed this decision, Justice Holmes delivering the opinion of the court, and, among other things, said:

But for such an association to start it must have some money to lend, and the typical member does not have it. Long before Congress dealt with loan and building associations, an esteemed writer upon the subject had insisted on the reasonableness of allowing them to issue full paid stock with fixed dividends, both in his book and upon the bench. Endlich Building Associations, 2d Ed. (1895) Sec. 462; . The same author recognized depositors (Sec. 56) and with more or less qualification the right to lend to outsiders (Secs. 314 et seq.) and to borrow (Secs. 297 et seq.). Under the Ohio statute the respondent had these powers, and still, as we have said, is called a building and loan association by that state. The same name was commonly used in other states and similar powers were given with more or less restriction. When Congress exempted such associations from the income tax of course it was speaking of existing societies that commonly were known as such, not of ideals that would have been hard to find and this is not left to inference alone. * * * The statutes speak of "domestic" associations, that is, associations sanctioned by the several states. They must be taken to accept with the qualifications expressly stated what the states are content to recognize, unless there is a gross misuse of the name.

It is clear from the facts detailed in our findings of fact that petitioner is recognized by the State of Indiana as a building and loan association. We do not deem it necessary to restate the facts connected with petitioner's organization and operation. These things have been fully detailed in our findings of fact. Suffice it to say that we think these facts are sufficiently similar to the facts in , as to cause that case to rule our decision in the instant case. Cf. ; .

A decision in favor of petitioner on the first issue makes it unnecessary that we decide petitioner's alternative contention.

Reviewed by the Board.

Decision will be entered for the petitioner.

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Footnotes

• 1. SEC. 1. That every association heretofore or hereafter incorporated under any law providing for the incorporation of building, loan fund and savings associations, and every association heretofore or hereafter incorporated under any law for the purpose of assisting its members to accumulate and invest their savings, by accumulating a fund from periodical payments on its stock, or otherwise, to be loaned among its members, shall be known in this act as a building and loan association. Such associations organized under the laws of this state shall be known as "domestic" associations, and those organized under the laws of any other state, territory or nation, shall be known as "foreign" associations. ↩

• 2. [Burns Annotated Indiana Statutes (1926), chapter 27.]

  SECTION 5127. POWERS, DUTIES, OBLIGATIONS. - 2. Rural loan and savings associations organized under this act shall have and may use the rights, powers and privileges herein given and allowed, and also those of (the) domestic building and loan association(s) under the laws of this state, and shall be subject to the duties, the examinations and the regulations therein and herein provided, but the bonds, notes and mortgages given by its members and the evidence of debt and of security of the association, and the endorsement, assignment or transfer thereof shall be subject only to the provisions of this act. [Italics supplied.]

  SECTION 5129. COMMON STOCK, SHARES. - 4. The shares of common stock shall be the same as shares of stock in said domestic building and loan associations, except that said shares herein are nonvoting and the holder or owner has no liability thereon after the par value is paid into the association, and the manner of payment may be as provided and classified in the by-laws of the association; the guaranty stockholders in the association shall be jointly and severally liable, in addition to the par value of their guaranty stock, in a sum equal to the amount of their several holdings of that stock to pay any unsatisfied debt or liability of the association after all the assets and every other resource of the association shall be exhausted.

  SECTION 5133. BANKING BUSINESS, WHAT MAY DO. - 8. After the guaranty stock shall have been fully paid into the treasury of the association, it may, for and with its stockholders, also do and transact the business now possessed and exercised by banks under the laws of this state, but may not do a general banking or trust business.

  SECTION 5134. SURPLUS FUND - DIVIDENDS. - 9. After the expenses of management and operation, taxes and other expenses are deducted, there shall be set aside from the annual or semiannual gross profits three (3) per cent thereof for the sinking fund, which is to provide against contingent losses, and also at least two (2) per cent thereof for the surplus fund of the guaranty stock; said sinking fund may be accumulated at an amount equal to six per cent of the assets of the association, and said surplus fund may be maintained when accumulated at an amount not less than ten (10) per cent in excess of the guaranty stock as a part thereof; and dividends on stock may be declared as provided in domestic building and loan associations laws: Provided, That the said surplus fund may be considered as part of said guaranty stock and share in dividends as paid-up stock.

  [Acts of Indiana (1931), chapter 153.]

  SEC. 7. TITLE OF ACT - AMENDMENT. That the title of the above entitled act be amended to read as follows: An act concerning guaranty loan and savings associations. ↩