SCOTUS Reports

Tag: Section 719 IRC

  • Ames Trust & Savings Bank v. Commissioner, 12 T.C. 770 (1949): Certificates of Deposit as Borrowed Capital for Excess Profits Tax

    12 T.C. 770 (1949)

    Certificates of deposit issued by a bank, which are not subject to check, bear interest, and are payable only at fixed maturities, can be included in “borrowed capital” under Section 719 of the Internal Revenue Code for calculating excess profits credit.

    Summary

    Ames Trust & Savings Bank sought to include outstanding certificates of deposit in its “borrowed capital” to increase its excess profits credit for the years 1942-1944. The Tax Court ruled that these certificates, which were not subject to check and payable only at 6- or 12-month maturities, qualified as certificates of indebtedness and could be included in borrowed capital. The court distinguished these from ordinary bank deposits, emphasizing their investment-like characteristics, aligning with the precedent set in Economy Savings & Loan Co.

    Facts

    Ames Trust & Savings Bank, an Iowa banking corporation, issued standard form certificates of deposit. These certificates were not subject to check, bore interest, and were payable only at maturity dates of either six or twelve months. The bank generally repaid the principal only at maturity, except in cases of unusual hardship where the holder forfeited accrued interest. The daily average amounts of outstanding certificates were substantial, reaching $41,201.28 in 1944.

    Procedural History

    The Commissioner of Internal Revenue determined deficiencies in the bank’s excess profits tax for 1943 and 1944, disallowing the inclusion of the certificates of deposit in borrowed capital. The bank challenged this determination in the Tax Court, also claiming an overpayment for 1944.

    Issue(s)

    Whether outstanding obligations evidenced by certificates of deposit issued by the bank, not subject to check, bearing interest, and payable only at maturities of 6 months and 1 year, are includible in borrowed capital under Section 719 of the Internal Revenue Code for purposes of computing the bank’s excess profits credit.

    Holding

    Yes, because the certificates of deposit represent indebtedness with the general character of investment securities rather than ordinary bank deposits, and therefore, qualify for inclusion in borrowed capital under Section 719.

    Court’s Reasoning

    The Tax Court relied heavily on its prior decision in Economy Savings & Loan Co., which also involved certificates of deposit. The court distinguished the certificates from ordinary bank deposits, noting their fixed maturity dates, interest-bearing nature, and non-checkable status. The court reasoned that these characteristics gave the certificates the “general character of investment securities,” making them eligible for inclusion in borrowed capital. The court rejected the Commissioner’s argument that the certificates should be excluded because the bank was in the banking business, stating that the form and function of the certificates, not the nature of the issuer, were determinative. The court observed that the regulation excluding bank deposits from borrowed capital was “manifestly directed at the ordinary bank deposit of a demand nature” and did not apply to these certificates, which had a fixed term and were not payable on demand. The Court stated “The regulation is manifestly directed at the ordinary bank deposit of a demand nature. Under the principle of noscitur a sociis, the association of certificates of deposit with passbooks and checks satisfies us that what was referred to was a certificate of demand deposit.”

    Practical Implications

    This case clarifies that not all certificates of deposit are treated equally under tax law. The key is the nature of the instrument: if it functions more like an investment security (fixed term, interest-bearing, not subject to check), it is more likely to be considered borrowed capital. This decision emphasizes a functional analysis over a formalistic one. Later cases must look to the specific terms of the certificate of deposit to determine whether it more closely resembles a demand deposit or an investment security. This ruling affects how banks and other financial institutions calculate their excess profits credit, providing a potential avenue for reducing their tax liability by carefully structuring their certificate of deposit offerings.

  • West Construction Company v. Commissioner, 7 T.C. 974 (1946): Defining Borrowed Invested Capital for Excess Profits Tax

    7 T.C. 974 (1946)

    Advances made by the U.S. government to a company under war contracts, not evidenced by formal debt instruments, do not qualify as ‘borrowed invested capital’ for excess profits tax computation under Section 719 of the Internal Revenue Code.

    Summary

    West Construction Co. sought to include advances from the War Department as borrowed invested capital to reduce its excess profits tax. The Tax Court ruled against West Construction, holding that these advances, not being evidenced by a formal bond, note, or similar instrument, did not meet the statutory definition of borrowed capital under Section 719 of the Internal Revenue Code. The court emphasized that the advances lacked the characteristics of traditional debt that Congress intended to include in the calculation of invested capital and were more akin to advance payments.

    Facts

    West Construction Co. received advances from the War Department under four construction contracts in Alaska during 1943. These contracts were supplemented by agreements allowing for advance payments, with interest, up to a certain percentage of the contract price. West Construction deposited these advances, along with reimbursements, into special bank accounts. The company never executed any formal debt instrument, such as a bond or note, for these advances.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in West Construction’s excess profits tax for 1943, disallowing the inclusion of the government advances as borrowed invested capital. West Construction challenged this determination in the Tax Court.

    Issue(s)

    Whether advances made by the United States Government to West Construction under war contracts, not evidenced by a formal bond, note, mortgage, etc., constitute borrowed invested capital for the purpose of computing excess profits tax credit under Section 719 of the Internal Revenue Code.

    Holding

    No, because the advances were not evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust, as required by Section 719 of the Internal Revenue Code to qualify as borrowed invested capital.

    Court’s Reasoning

    The Tax Court focused on the statutory language of Section 719, which specifies that borrowed capital must be evidenced by certain formal debt instruments. The court acknowledged that while the advances had some characteristics of indebtedness, they did not meet the specific documentary requirements of the statute. The court emphasized that Congress intended to include in invested capital only those funds that were at the risk of the business, similar to equity investments. The court also noted that a provision in Section 719(a)(2) specifically addressed advance payments in the context of foreign government contracts made before 1941, implying that absent such specific language, advance payments would not be includible. The court stated, “Underlying the whole plan of the statute is the assumption that invested capital may consist, not only of equity interests typically represented by stock, but of borrowed capital as well.” Because the advances in this case were not evidenced by the required formal documents, the court concluded that they were not the type of debt Congress intended to include as borrowed invested capital.

    Practical Implications

    This case clarifies the strict requirements for debt to be considered ‘borrowed invested capital’ for excess profits tax purposes. It highlights the importance of formal documentation when structuring financing arrangements intended to qualify as debt under the tax code. The case suggests that the absence of a formal debt instrument is a strong indicator that the funds advanced are not truly ‘borrowed’ in the tax sense. This ruling has implications for how companies structure financing, especially in situations involving government contracts or other forms of advance payments, and serves as a reminder that tax law often prioritizes form over substance. Later cases have cited this decision to underscore the necessity of adhering to the precise requirements outlined in the Internal Revenue Code when claiming tax benefits related to invested capital.