PSB Holdings, Inc. v. Commissioner , 129 T.C. No. 15 ( 2007 )

129 T.C. No. 15
UNITED STATES TAX COURT
PSB HOLDINGS, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 14724-05. Filed November 1, 2007.
P is the holding company of an affiliated group of
corporations that files consolidated Federal income tax
returns. The other members are P’s wholly owned bank
(B) and B’s wholly owned investment company (IC). Both
B and IC own tax-exempt obligations. Only B incurs
interest expenses. IC’s tax-exempt obligations were
either purchased by IC or received from B before the
subject years as contributions to capital. R
determined that B must include all of IC’s tax-exempt
obligations in the calculation of B’s average adjusted
bases of tax-exempt obligations under secs.
265(b)(2)(A) and 291(e)(1)(B)(ii)(I), I.R.C. On the
consolidated income tax returns for the subject years,
B included IC’s obligations in the calculation only to
the extent that B had purchased the obligations and
transferred them to IC; in other words, B omitted from
the calculation those obligations that IC purchased.
Held: The calculation of B’s average adjusted
bases of tax-exempt obligations does not include the
tax-exempt obligations purchased by IC.
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Debra Sadow Koenig, for petitioner.
Lawrence C. Letkewicz, Christa A. Gruber, and Sharon S.
Galm, for respondent.
OPINION
LARO, Judge: This case was submitted to the Court under
Rule 122 for decision without trial.1 Petitioner petitioned the
Court to redetermine respondent’s determination of deficiencies
of $33,622, $38,571, $41,654, and $31,868 in the 1999, 2000,
2001, and 2002 Federal income taxes, respectively, of its
affiliated group. For those years, the group filed consolidated
Federal corporate income tax returns. The group included
petitioner, petitioner’s wholly owned subsidiary Peoples State
Bank (Peoples), and Peoples’ wholly owned investment subsidiary
PSB Investments, Inc. (Investments).
We decide whether Peoples must include the tax-exempt
obligations purchased and owned by Investments in the calculation
of Peoples’ average adjusted bases of tax-exempt obligations
under sections 265(b)(2)(A) and 291(e)(1)(B)(ii)(I). We hold
that the calculation does not include those obligations.
1
Rule references are to the Tax Court Rules of Practice and
Procedure. Unless otherwise noted, section references are to the
applicable versions of the Internal Revenue Code.
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Background
All facts were stipulated or contained in the exhibits
submitted with the stipulations. The stipulated facts and
exhibits are incorporated herein by this reference. When the
petition was filed, petitioner’s mailing address and principal
place of business were in Wausau, Wisconsin.
Petitioner is a holding company and the common parent of an
affiliated group of corporations that file consolidated Federal
income tax returns. Petitioner’s common stock is held by
approximately 1,000 shareholders. The other members of the
affiliated group are petitioner’s wholly owned subsidiary
(Peoples) and Peoples’ wholly owned subsidiary (Investments).
For financial and regulatory accounting purposes, Investments and
Peoples consolidate their assets, liabilities, income, and
expenses.
Peoples was organized in 1962 as a State bank under
Wisconsin law. Peoples’ main office is located in Wausau,
Wisconsin, and it has several branch offices in Wisconsin
communities near Wausau. Peoples is petitioner’s sole
subsidiary. Peoples’ sole subsidiary is Investments.
On or about April 23, 1992, Peoples organized Investments in
Nevada. Investments does business exclusively in Nevada, with
offices in Las Vegas, Nevada, and offsite record storage at a
third-party facility in Las Vegas. Investments has no depository
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or lending powers, and, as relevant here, does not qualify as
either a “bank” or a “financial institution” for Federal income
tax purposes. For other purposes, Investments is considered to
be a financial institution subject to Federal and State
supervision.
Peoples organized Investments to consolidate and improve the
efficiency of managing, safekeeping, and operating the securities
investment portfolio then held by Peoples and to reduce Peoples’
State tax liability. Nevada has neither a corporate income tax
nor a corporate franchise tax. Wisconsin has a corporate
franchise tax of 7.9 percent of a corporation’s net income. For
purposes of the Wisconsin tax, Wisconsin considers “income” to
include interest income from federally tax-exempt obligations. A
wholly owned subsidiary of a Wisconsin corporation with no nexus
to the State is not subject to Wisconsin’s corporate franchise
tax. Investments was organized without a nexus to Wisconsin so
as not to be subject to Wisconsin’s corporate franchise tax.
From on or about April 23, 1992, through December 1, 2002,
Peoples transferred to Investments cash, tax-exempt obligations,
taxable securities, and loan participations (fractional interests
in loans originated by Peoples), including substantially all of
Peoples’ long-term investments. The cash totaled $18,460 and was
transferred to Investments upon its organization in exchange for
all of its common stock. The tax-exempt obligations and taxable
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securities totaled $38,141,487, and the loan participations
totaled $27,710,909; these three categories of assets were
transferred to Investments as paid-in capital. No security or
tax-exempt obligation of any kind was transferred by Peoples to
Investments during the subject years. Of the taxable securities
and tax-exempt obligations that Peoples transferred to
Investments, 17 percent were federally tax-exempt municipal
securities, 41 percent were federally taxable securities (issued
primarily by Government agencies), and 42 percent were loan
participation interests. At the time of the transfers, no
liabilities encumbered the transferred securities or obligations,
and Investments did not assume any liability of Peoples.
Investments did not sell any tax-exempt obligation or taxable
security before maturity, and all such obligations and securities
received from Investments matured by the end of the subject
years. Investments’ income for the subject years was
attributable to holding federally taxable securities, federally
tax-exempt obligations, and loan participations. Investments did
not own any other asset, and it did not provide services to
unrelated third parties.
Investments’ total assets during the subject years
represented about 20 percent of the total assets of Investments
and Peoples combined. During each of those years, Peoples
incurred approximately $8 million to $12 million of interest
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expenses; Investments incurred no interest expense. During 1999
and 2000, Investments owned almost $14 million in tax-exempt
obligations; Peoples owned virtually none. During 2001 and 2002,
Investments owned over $17 million in tax-exempt obligations,
which represented more than 80 percent of the tax-exempt
obligations owned by Investments and Peoples combined.
The Internal Revenue Code provides (as further discussed
below) that the amount of a financial institution’s interest
expense allocated to tax-exempt interest, and thus rendered
nondeductible, is computed by multiplying the otherwise allowable
interest expense by a fraction prescribed in the statutes. The
fraction’s numerator (numerator) equals “the taxpayer’s average
adjusted [bases] * * * of [tax-exempt] obligations”. See secs.
265(b)(2)(A), 291(e)(1)(B)(ii)(I). The fraction’s denominator
(denominator) equals the “average adjusted [bases] for all assets
of the taxpayer”. See secs. 265(b)(2)(B), 291(e)(1)(B)(ii)(II).
On the consolidated returns filed by petitioner’s affiliated
group for the subject years, Peoples included its adjusted basis
in its Investments’ stock in Peoples’ calculation of the
denominator. Peoples’ basis in its Investments’ stock equaled
Investments’ basis in Investments’ assets. For each subject
year, Peoples included all of the tax-exempt obligations that
were purchased by Peoples and that were outstanding as of the end
of the year in Peoples’ calculation of the numerator. Some of
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those obligations were owned by Investments during the year,
having been earlier transferred by Peoples to the capital of
Investments.
The notice of deficiency states as follows:
It has been determined that you transferred
tax-exempt securities from your bank to investment
subsidiaries. By this transfer, you managed to
separate tax-exempt investments from their interest
expense which resulted in a reduction of your exposure
to the TEFRA interest expense disallowance rules under
Internal Revenue Code sections 291 and 265(b).
It has further been determined that the investment
subsidiaries do not carry on any real business
operations on their own. Rather, they are merely an
incorporated “Shell” whose only real purpose is to
avoid taxation. In actuality, their business is
conducted by or through their parent banks.
It has further been determined that the investment
subsidiaries’ assets and liabilities are those of their
parent banks, since for all other reporting purposes,
both financial and regulatory, reporting is required to
be done on a consolidated basis. The assets and
liabilities are considered those of their parent banks.
Therefore, it is determined that for purposes of
computing your income tax liabilities, you must include
the assets and tax-exempt securities of the
subsidiaries in your computation of unallowable
interest expense under the TEFRA provisions.
The recalculation of non deductible interest
expense, under Sections 291 and 265(b) of the Internal
Revenue Code, based on the inclusion of the assets and
tax-exempt balances of Peoples State Bank and/or PSB
Investments, Inc. with that of the assets and
tax-exempt balances of their respective parent banks
increases your taxable incomes by: $98,890 for the
year ended 12-31-1999; $113,445 for the year ended
12-31-2000; $122,513 for the year ended 12-31-2001 and;
$93,731 for the year ended 12-31-2002. Refer to
Exhibit A through Exhibit D for further explanation.
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Respondent has since conceded the determination stated in the
second paragraph quoted above. Respondent also concedes that
Investments was created to reduce State taxes and is a separate
business entity that is not a sham.
Discussion
We decide the narrow issue of whether Peoples must include
the tax-exempt obligations purchased and owned by Investments in
the calculation of Peoples’ average adjusted bases of tax-exempt
obligations under sections 265(b)(2)(A) and 291(e)(1)(B)(ii)(I).2
Petitioner argues that the relevant text in those sections
provides that Peoples calculate the numerator without regard to
those obligations.3 Respondent disagrees. As respondent sees
2
Petitioner invites the Court to decide that the
calculation does not include any tax-exempt obligation owned by
Investments. We decline to do so. The consolidated returns
reported that the calculation included all outstanding tax-exempt
obligations purchased by Peoples and transferred to Investments,
and respondent’s determination in the notice of deficiency
relates to that position. Moreover, petitioner states in its
opening posttrial brief that it is not requesting either an
adjustment or a refund as to its reporting position. Nor does
the petition request such an adjustment or refund. We consider
it inappropriate to decide the issue proffered by petitioner
because it does not relate to the decision that we will enter on
the amount of deficiency (if any) in the affiliated group’s
income tax for the subject years.
3
We set forth the applicable text of secs. 265(b) and
291(e) in the appendix. The relevant text of sec. 265(b)(2)(A),
“the taxpayer’s average adjusted bases (within the meaning of
section 1016) of tax-exempt obligations” is similar to the
relevant text of sec. 291(e)(1)(B)(ii)(I), “the taxpayer’s
average adjusted basis (within the meaning of section 1016) of
obligations described in clause (i)”; i.e., tax-exempt
(continued...)
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it, the relevant text when read in the light of the statutes’
legislative intent allows respondent for purposes of the
numerator to treat Investments’ assets as owned by Peoples. We
agree with petitioner that the relevant text does not include in
the numerator the tax-exempt obligations purchased and owned by
Investments.
Section 265(a)(2) provides that no deduction shall be
allowed for interest on indebtedness incurred or continued to
purchase or carry obligations the interest on which is wholly
exempt from Federal income tax. For purposes of that provision,
whether a taxpayer’s indebtedness was incurred or continued to
purchase or carry tax-exempt obligations generally depends on the
taxpayer’s purpose in incurring the indebtedness. See Wisconsin
Cheeseman, Inc. v. United States, 388 F.2d 420, 422 (7th Cir.
1968). In other words, a disallowance of interest expenses under
section 265(a)(2) requires a finding of a sufficiently direct
relationship between a borrowing and a tax-exempt investment.
See id.
Congress enacted section 291(a)(3) and (e)(1)(B) in 1982.
See Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA),
Pub. L. 97-248, sec. 204(a), 96 Stat. 423. As enacted, those
3
(...continued)
obligations. For purposes of our analysis, we consider the
relevant text of each of those sections to be the same and refer
to that text as the relevant text.
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provisions provided a 15-percent cutback in a corporate tax
preference item affecting certain financial institutions.4 The
cutback applied to the deduction otherwise allowable for “the
amount of interest on indebtedness incurred or continued to
purchase or carry [tax-exempt] obligations acquired after
December 31, 1982”. The amount of the cutback was calculated by
applying to the otherwise allowable interest expense a fraction
that is virtually the same as in the current version of the
statutes. The report of the Senate Finance Committee, the
committee in which TEFRA section 204(a) originated, sets forth
the following rationale with respect to the cutback and similar
provisions:
Numerous corporate tax preferences have been
enacted over the years in order to stimulate business
investment and advance other worthwhile purposes. For
several reasons, some of these tax preferences should
be scaled back. First, the federal budget faces large
deficits, which will require large reductions in direct
Federal spending. In addressing these deficits, tax
preferences should also be subject to careful scrutiny.
Second, in 1981 Congress enacted the Accelerated Cost
Recovery System, which provides very generous
incentives for investment in plant and equipment. ACRS
makes some corporate tax preferences less necessary.
Third, there is increasing concern about the equity of
the tax system, and cutting back corporate tax
preferences is a valid response to that concern.
4
The 15-percent cutback was increased to 20 percent in the
Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 68(a),
98 Stat. 588. The referenced corporate tax preference was that
under prior law, banks had been effectively excused from sec.
265(a)(2) on the ground that their obligations to their
depositors did not constitute “indebtedness” within the meaning
of that section.
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For these reasons, the committee bill contains a
15-percent across-the-board cutback in a series of
corporate tax preferences. [S. Rept. 97-494 (Vol. 1),
at 118-119 (1982).]
Four years later, in 1986, Congress enacted section 265(b).
See Tax Reform Act of 1986, Pub. L. 99-514, sec. 902(a), 100
Stat. 2380. According to the report of the House Ways and Means
Committee, Congress enacted section 265(b) for two reasons.
First, the report states, financial institutions had been allowed
to deduct interest payments regardless of their tax-exempt
holdings, a result, the committee concluded, that discriminated
in favor of financial institutions at the expense of other
taxpayers. See H. Rept. 99-426, at 588-589 (1985), 1986-3 C.B.
(Vol. 2) 1, 588-589. Second, the report states, financial
institutions had been allowed to reduce their tax liability
drastically by investing in tax-exempt obligations. Id. The
report explains that
To correct these problems, the committee bill
denies financial institutions an interest deduction in
direct proportion to their tax-exempt holdings. The
committee believes that this proportional disallowance
rule is appropriate because of the difficulty of
tracing funds within a financial institution, and the
near impossibility of assessing a financial
institution’s “purpose” in accepting particular
deposits. The committee believes that the proportional
disallowance rule will place financial institutions on
approximately an equal footing with other taxpayers.
[Id.]
The report explains that the amount of interest allocable to
tax-exempt obligations for purposes of section 265(b) is
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determined under rules similar to those that apply under section
291(a)(3) and (e)(1)(B). Id.
As enacted, sections 265(b) and 291(a)(3) and (e)(1)(B)
reduce the interest expense deductions of financial institutions
without requiring evidence of a direct relationship between
borrowing and tax-exempt investment. Specifically, those
sections disallow a deduction with respect to the portion of a
financial institution’s interest expense that is allocable, on a
pro rata basis, to its holdings in tax-exempt obligations. While
section 265(b) disallows a deduction for the entire amount of
that portion of a financial institution’s interest expense
allocable to tax-exempt obligations, section 291(a)(3) and
(e)(1)(B) disallows only 20 percent of the interest expense
allocable to those obligations.
The 20-percent rule of section 291(a)(3) and (e)(1)(B)
applies with respect to tax-exempt obligations acquired from
January 1, 1983, through August 7, 1986. The 100-percent rule of
section 265(b) generally applies to those tax-exempt obligations
acquired after August 7, 1986. In the latter case, however,
section 265(b)(3) provides a special rule for a “qualified
tax-exempt obligation”, defined in section 265(b)(3)(B) as a
certain tax-exempt obligation issued by small issuers. Under
section 265(b)(3)(A), a “qualified tax-exempt obligation”
acquired after August 7, 1986, is treated for purposes of
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sections 265(b)(2) and 291(e)(1)(B) as if it were acquired on
August 7, 1986; thus, qualified tax-exempt obligations reduce
interest expense deductions under section 291(a)(3) and
(e)(1)(B), rather than under section 265(b). The parties agree
that the tax-exempt obligations owned by Investments are
“qualified tax-exempt obligations”.
In calculating the amount of the denominator for Peoples,
the parties agree that the denominator includes Peoples’ adjusted
basis in its Investments stock. The parties lock horns on
whether the tax-exempt obligations purchased and owned by
Investments must be included in the numerator. On the
consolidated returns, Peoples omitted those obligations from the
numerator. Respondent determined that those obligations are
included in the numerator. As respondent sees it, because the
basis of Peoples’ Investments stock is included in the
denominator, the portion of that basis attributable to the bases
of Investments’ tax-exempt obligations is included in the
numerator.
We begin our analysis with the relevant text. We interpret
the text with reference to the legislative history primarily to
learn the purpose of the statutes and to resolve any ambiguity in
the text. See United States v. Am. Trucking Associations, Inc.,
310 U.S. 534, 543-544 (1940). We apply the text as written
unless we find that a word’s meaning is “‘inescapably ambiguous’”
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or that such an application “‘would thwart the purpose of the
overall statutory scheme or lead to an absurd or futile result.’”
Booth v. Commissioner, 108 T.C. 524, 568, 569 (1997) (quoting
Garcia v. United States, 469 U.S. 70, 76 n.3 (1984), and
Albertson’s, Inc. v. Commissioner, 42 F.3d 537, 545 (9th Cir.
1994), affg. 95 T.C. 415 (1990)); see United States v. Am.
Trucking Associations, Inc., supra at 543; see also United States
v. Shriver, 989 F.2d 898, 901 (7th Cir. 1992); Allen v.
Commissioner, 118 T.C. 1 (2002).
The applicable text refers to “the taxpayer’s average
adjusted [bases] * * * of [tax-exempt] obligations” and the
“average adjusted bases for all assets of the taxpayer”. We read
that text to refer to the tax-exempt obligations and assets owned
by Peoples alone or, in other words, by the “taxpayer” for whom
the subject calculation is performed. We do not read that text
to provide that a taxpayer such as Peoples must include in its
tax-exempt obligations any tax-exempt obligation purchased and
owned by another taxpayer, whether the taxpayers be related or
not. Cf. First Chicago NBD Corp. v. Commissioner, 135 F.3d 457
(7th Cir. 1998) (holding that section 902 did not allow
aggregation where the statute referred literally to “a”
corporation rather than to a group of affiliated corporations),
affg. 96 T.C. 421 (1991). We understand Congress to have enacted
the text as a means for raising revenue and bolstering equity in
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our tax system. We understand Congress to have intended for the
statutes to deny some or all of a financial institution’s
otherwise allowable interest expense deduction to the extent that
the interest is allocable to the tax-exempt obligations it owns.
We do not understand Congress to have specifically spoken through
the statutes to the situation here, where tax-exempt obligations
are purchased and owned by a subsidiary of a financial
institution.
Respondent asserts that the adjusted bases of Peoples’
assets in the denominator include the adjusted basis of Peoples’
stock in Investments which, in turn, reflects the assets owned by
Investments. Respondent concludes that Investments’ assets are
therefore considered assets of Peoples for purposes of
calculating the numerator. We disagree. The numerator consists
of the “taxpayer’s average adjusted bases * * * of tax-exempt
obligations”, but Peoples has no adjusted bases in any of the
tax-exempt obligations purchased and owned by Investments.
Moreover, the statutes use the term “taxpayer” in the singular,
and well-established law treats Peoples and Investments as
separate taxpayers notwithstanding the fact that they join in the
filing of a consolidated return. See, e.g., Wegman’s Props.,
Inc. v. Commissioner, 78 T.C. 786, 789 (1982) (citing, inter
alia, Natl. Carbide Corp. v. Commissioner, 336 U.S. 422 (1949),
Interstate Transit Lines v. Commissioner, 319 U.S. 590 (1943),
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and Woolford Realty Co. v. Rose, 286 U.S. 319 (1932)); cf.
Gottesman & Co. v. Commissioner, 77 T.C. 1149, 1156 (1981) (“to
the extent the consolidated return regulations do not mandate
different treatment, corporations filing consolidated returns are
to be treated as separate entities when applying other provisions
of the Code”). Nor do the consolidated return regulations, as
applicable here, change this result. Those regulations require
that Peoples calculate its net income separately from
Investments’ net income. See sec. 1.1502-11(a)(1), Income Tax
Regs. (stating that taxable income is calculated for an
affiliated group by taking into account the separate taxable
income of each member of the group). Respondent has not
identified, nor are we aware of, any provision in the
consolidated return regulations that would require the tax-exempt
obligations purchased and owned by Investments to be taken into
account in the calculation of Peoples’ interest expense
deduction. Nothing that we read in the statutes or in the
consolidated return regulations directs us to ignore the separate
existence of Investments and Peoples or otherwise to treat
Investments’ self-purchased tax-exempt obligations as owned by
Peoples for purposes of calculating the numerator as to Peoples.
Congress knew how to require a taxpayer to take into account
the assets of another taxpayer had Congress intended to include
respondent’s “look-through” approach in the applicable statutes.
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See, e.g., sec. 265(b)(3)(E). Congress, however, did not in
those statutes provide any aggregation or indirect ownership rule
that would apply to the numerator. Instead, Congress referred
simply to the obligations of the “taxpayer” for purposes of
making that calculation. “‘[W]here Congress includes particular
language in one section of a statute but omits it in another
section of the same Act, it is generally presumed that Congress
acts intentionally and purposely in the disparate inclusion or
exclusion.’” Russello v. United States, 464 U.S. 16, 23 (1983)
(quoting United States v. Wong Kim Bo, 472 F.2d 720, 722 (5th
Cir. 1972)).
Respondent argues that not reading the relevant text as
providing for Peoples’ indirect ownership of the subject
tax-exempt obligations leads to an “absurd” result. We disagree.
As discussed above, Congress apparently did not specifically
intend through the applicable statutes to address the gap left
open in the setting at hand. We apply the law as written by
Congress and leave it to Congress or to the Department of the
Treasury, the latter through and to the extent of its regulatory
authority or by other permissible means, to address any gaps in
the statutes as written. See Lamie v. United States, 540 U.S.
526, 538 (2004). To be sure, agencies such as the Internal
Revenue Service have a great amount of authority to issue
regulations to fill gaps in a statute. See, e.g., Chevron
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U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837,
842-844 (1984). In addition, as applicable to taxpayers who file
consolidated returns, such as here, the Commissioner has vast
authority to prescribe regulations to curtail or otherwise
address any perceived abuse. See United Dominion Indus., Inc. v.
United States, 532 U.S. 822, 836-837 (2001).
Respondent also argues for a contrary reading, noting that
Peoples and Investments consolidated their assets, liabilities,
income, and expenses for financial and regulatory accounting
purposes.5 We are unpersuaded by this argument. Neither
financial nor regulatory accounting controls the manner in which
a taxpayer must report its operations for Federal income tax
purposes. See Thor Power Tool Co. v. Commissioner, 439 U.S. 522,
542-543 (1979); Signet Banking Corp. v. Commissioner, 106 T.C.
117, 130-131 (1996), affd. 118 F.3d 239 (4th Cir. 1997). In
fact, we note another major difference from the manner in which
Investments is treated for Federal income tax purposes; to wit,
that Investments is considered to be a financial institution for
Federal and State oversight purposes but is not considered to be
a bank or financial institution for Federal income tax purposes.
We also note that respondent has not argued, nor do we find, that
5
While the inconsistency between financial and regulatory
accounting, on the one hand, and tax accounting, on the other
hand, appears from the notice of deficiency to be a primary
determination by respondent, respondent in brief has relegated
this inconsistency to simply a factor to consider.
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he exercised any discretion afforded to him by section 446(b) or
482. Instead, as discussed above, the linchpin of respondent’s
arguments is that the statutes on their face require that the
basis of Peoples’ Investments stock be included in the
denominator and that the portion of that basis attributable to
the bases of Investments’ tax-exempt obligations is therefore
also included in the numerator.
Lastly, respondent observes, the Commissioner has issued
Rev. Rul. 90-44, 1990-1 C.B. 54, interpreting the applicable
statutes to provide that the tax-exempt obligations of a
subsidiary may be taken into account in calculating the numerator
for a parent bank. Respondent asserts that the Commissioner
issued this ruling under the same formal procedures that he would
have been required to follow had he prescribed regulations on the
subject. Respondent argues that the revenue ruling is entitled
to “judicial respect” as “persuasive precedent that should be
followed unless unreasonable”.
While we believe that the Commissioner’s interpretation as
set forth in Rev. Rul. 90-44, supra, is entitled to consideration
by this Court, we decline respondent’s invitation to equate the
authority of the ruling with that of a regulation or otherwise to
give the ruling the degree of deference that is typically
afforded to regulations under Chevron U.S.A. Inc. v. Natural Res.
Def. Council, Inc., supra, and its progeny. As explained below,
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we evaluate the revenue ruling under the less deferential
standard enunciated in Skidmore v. Swift & Co., 323 U.S. 134
(1944), according the ruling respect proportional to its “power
to persuade”. See United States v. Mead Corp., 533 U.S. 218,
234-235, 237 (2001).
Rev. Rul. 90-44, 1990-1 C.B. at 57, states in relevant part:
If one or more financial institutions are members
of an affiliated group of corporations (as defined in
section 1504 of the Code), then, even if the group
files a consolidated return, each such institution must
make a separate determination of interest expense
allocable to tax-exempt interest, rather than a
combined determination with the other members of the
group.
However, in situations involving taxpayers which
are under common control and one or more of which is a
financial institution, in order to fulfill the
congressional purpose underlying section 265(b) of the
Code, the District Director may require another
determination of interest expense allocable to
tax-exempt interest to clearly reflect the income of
the financial institution or to prevent the evasion or
avoidance of taxes.
The first quoted paragraph parallels the text of the statutes,
stating that the subject calculation “must” be made separately
for each member of the affiliated group. The second quoted
paragraph departs from that text, creating an exception that
“may” apply to taxpayers under common control when one or more of
the taxpayers is a financial institution. The ruling sets forth
no reasoning or authority for the exception, other than stating
that the exception was prescribed “in order to fulfill the
congressional purpose underlying section 265(b)” and may be
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invoked “to clearly reflect the income of the financial
institution and to prevent the evasion or avoidance of taxes”.
At the outset, we note that the notice of deficiency makes
no mention of Rev. Rul. 90-44, supra. Thus, while the ruling
states that the District Director may require a determination of
interest expense under a rule that is different from that stated
in the statutes, we find no basis in the record from which to
find (or to conclude) that the District Director has in fact
exercised the authority purportedly given to him by the statutes.
To the contrary, we read the notice of deficiency to indicate
that respondent observed that Peoples had transferred tax-exempt
obligations to Investments so that Peoples afterwards had
interest expenses but little to no tax-exempt interest income and
determined that the transfer was ineffective for Federal income
tax purposes because: (1) Investments was not a legitimate
business entity with independent business operations but was a
sham created solely to avoid taxes, and (2) Investments’ assets
and liabilities are viewed as those of Peoples because Peoples
and Investments reported their operations for financial and
regulatory reporting purposes on a consolidated basis.
All the same, we are not bound by an interpretation in a
revenue ruling. See Rauenhorst v. Commissioner, 119 T.C. 157,
173 (2002); see also Johnson v. Commissioner, 115 T.C. 210, 224
(2000). The Court of Appeals for the Seventh Circuit has held
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similarly, stating that revenue rulings are entitled to limited
deference. See Bankers Life & Cas. Co. v. United States,
142 F.3d 973, 978 (7th Cir. 1998); First Chicago NBD Corp. v.
Commissioner, 135 F.3d 457 (7th Cir. 1998); see also U.S.
Freightways Corp. v. Commissioner, 270 F.3d 1137, 1141 (7th Cir.
2001) (discussing the level of deference owed to agency
interpretations after United States v. Mead Corp., supra), revg.
113 T.C. 329 (1999). The Commissioner also recognizes the
limited strength of a revenue ruling, explaining in his
procedural rules that “The conclusions expressed in Revenue
Rulings will be directly responsive to and limited in scope by
the pivotal facts stated in the revenue ruling”, sec.
601.601(d)(2)(v)(a), Statement of Procedural Rules, and “Revenue
Rulings published in the Bulletin do not have the force and
effect of Treasury Department Regulations”, sec.
601.601(d)(2)(v)(d), Statement of Procedural Rules.
In United States v. Mead Corp., supra, the Supreme Court
considered the degree of judicial deference afforded to a ruling
by the U.S. Customs Service as to a tariff classification. The
Court stated: “We agree that a tariff classification has no
claim to judicial deference under Chevron, there being no
indication that Congress intended such a ruling to carry the
force of law, but we hold that under Skidmore v. Swift & Co.,
323 U.S. 134 (1944), the ruling is eligible to claim respect
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according to its persuasiveness.” Id. at 221. In Skidmore v.
Swift & Co., supra at 140, the Court stated:
We consider that the rulings, interpretations and
opinions * * * while not controlling upon the courts by
reason of their authority, do constitute a body of
experience and informed judgment to which courts and
litigants may properly resort for guidance. The weight
of such a judgment in a particular case will depend
upon the thoroughness evident in its consideration, the
validity of its reasoning, its consistency with earlier
and later pronouncements, and all those factors which
give it power to persuade, if lacking power to control.
See also Christensen v. Harris County, 529 U.S. 576, 587 (2000)
(an agency’s interpretation reached without formal notice and
comment rulemaking is entitled to respect only when it has the
“power to persuade”); cf. Kort v. Diversified Collection Servs.,
Inc., 394 F.3d 530, 539 (7th Cir. 2005).
We conclude that we must evaluate the revenue ruling at hand
under the “power to persuade” standard set forth in Skidmore.
While respondent invites the Court to afford the ruling greater
judicial deference by asserting that the ruling was issued in the
same manner as regulations on the subject would have been, we
decline that invitation. Cf. Ind. Fam. & Soc. Servs. Admin. v.
Thompson, 286 F.3d 476, 480 (7th Cir. 2002). In addition to the
fact that the Commissioner’s procedural rules state specifically
that revenue rulings “do not have the force and effect of
Treasury Department Regulations”, sec. 601.601(d)(2)(v)(d),
Statement of Procedural Rules, we consider most significant the
fact that the revenue ruling, unlike most Treasury Department
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regulations, did not undergo any public review or comment before
its issuance.
In accordance with the analysis under United States v. Mead
Corp., 533 U.S. 218 (2001), we decline to adopt the exception set
forth in Rev. Rul. 90-44, supra. First, as we have discussed,
the exception does not properly interpret the text of the
statutes as written. See Commissioner v. Schleier, 515 U.S. 323,
336 n.8 (1995). Second, we find in the ruling neither adequate
“thoroughness evident in its consideration” nor adequate
“reasoning” as to the presence of the exception in the statutes.
See Skidmore v. Swift & Co., supra at 140. The ruling simply
states that the exception was included in the revenue ruling “in
order to fulfill the congressional purpose underlying section
265(b)” and may be invoked “to clearly reflect the income of the
financial institution and to prevent the evasion or avoidance of
taxes”. Rev. Rul. 90-44, 1990-1 C.B. at 57. Third, the revenue
ruling was issued many years after the enactment of the relevant
statutes, approximately 8 years after the enactment of section
291(a)(3) and (e)(1)(B) and 4 years after the enactment of
section 265(b).
We hold that the numerator does not include the tax-exempt
obligations purchased and owned by Investments and sustain
petitioner’s reporting position. We have considered all of the
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parties’ arguments and have rejected those arguments not
discussed herein as irrelevant or without merit.
Decision will be entered
under Rule 155.
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APPENDIX
SEC. 265(b). Pro rata Allocation of Interest
Expense of Financial Institutions to Tax-Exempt
Interest.--
(1) In general.--In the case of a
financial institution, no deduction shall be
allowed for that portion of the taxpayer’s
interest expense which is allocable to
tax-exempt interest.
(2) Allocation.--For purposes of
paragraph (1), the portion of the taxpayer’s
interest expense which is allocable to
tax-exempt interest is an amount which bears
the same ratio to such interest expense as--
(A) the taxpayer’s average
adjusted bases (within the meaning
of section 1016) of tax-exempt
obligations acquired after August
7, 1986, bears to
(B) such average adjusted
bases for all assets of the
taxpayer.
SEC. 291(e). Definitions.--For purposes of this
section--
(1) Financial institution preference
item.--The term “financial institution
preference item” includes the following:
* * * * * * *
(B) Interest on debt to carry
tax-exempt obligations acquired
after December 31, 1982, and before
August 8, 1986.--
(i) In general.--In
the case of a financial
institution which is a
bank (as defined in
section 585(a)(2)), the
amount of interest on
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indebtedness incurred or
continued to purchase or
carry obligations
acquired after December
31, 1982, and before
August 8, 1986, the
interest on which is
exempt from taxes for the
taxable year, to the
extent that a deduction
would (but for this
paragraph or section
265(b)) be allowable with
respect to such interest
for such taxable year.
(ii) Determination of interest
allocable to indebtedness on
tax-exempt obligations.--Unless the
taxpayer (under regulations
prescribed by the Secretary)
establishes otherwise, the amount
determined under clause (i) shall
be an amount which bears the same
ratio to the aggregate amount
allowable (determined without
regard to this section and section
265(b)) to the taxpayer as a
deduction for interest for the
taxable year as--
(I) the taxpayer’s
average adjusted basis
(within the meaning of
section 1016) of
obligations described in
clause (i), bears to
(II) such average
adjusted basis for all
assets of the taxpayer.