Citizens Federal S. & L. Ass'n of Cleveland v. United States

• Decision Date: 07 June 1961
• Docket Number: No. 502-58.,502-58.
• Citation: 290 F.2d 932
• Parties: CITIZENS FEDERAL SAVINGS AND LOAN ASSOCIATION OF CLEVELAND v. UNITED STATES.
• Court: U.S. Claims Court

290 F.2d 932 (1961)

CITIZENS FEDERAL SAVINGS AND LOAN ASSOCIATION OF CLEVELAND v. UNITED STATES.

No. 502-58.

United States Court of Claims.

June 7, 1961.

Harlan Pomeroy, Washington, D. C., for plaintiff. Norman A. Sugarman, Cleveland, Ohio, was on the briefs.

Jerry M. Hamovit, Washington, D. C., with whom was Asst. Atty. Gen., Louis F. Oberdorfer for defendant. Lyle M. Turner and Eugene Emerson, Washington, D. C., were on the brief.

DURFEE, Judge.

The general question presented by this suit is whether or not a "Federal Insurance Reserve" deducted from income in previous years by a liquidated domestic building and loan association is taxable to a transferee building and loan association for the year in which it acquired all of the assets and liabilities of the liquidated association.

Prior to November 1955, the Berea Savings and Loan Company was a building and loan association operating in Ohio, as the plaintiff is at the present time. In July of that year, Berea's stockholders voted to accept plaintiff's offer to purchase Berea's assets and assume its liabilities. Negotiations for the transfer were undertaken and a plan of dissolution was adopted in October. On November 1, 1955, Berea sold plaintiff all of its business and property, subject to its liabilities, for about $414,000, an amount arrived at using a basis of $450 for each share of stock outstanding. The sale price was paid into a trust account for the benefit of the stockholders and Berea abandoned its corporate authority and franchise a short time later. Mortgage loans in the face amount of $3,160,805.56, representing amounts loaned by Berea, were transferred to plaintiff.

On its corporation income tax returns for the years 1952 through 1954 and for the portion of 1955 before it ceased operations, Berea had deducted amounts from gross income in the aggregate sum of $133,361.17. In each case the amounts were equivalent to Berea's net income and were credited to a "Federal Insurance Reserve," (hereafter referred to as "reserve") described in the returns as a bad debt reserve. Because of amounts credited prior to 1952, the reserve was carried on Berea's balance sheet at $216,715.93, as of October 31, 1955. Berea's final tax return disclosed the sale of the business during that year but it did not report any gain on the sale.

In 1957, the Commissioner of Internal Revenue determined that the amounts charged to the reserve from 1952 to 1955 should be lumped together and taxed as income for the tax period ended October 31, 1955. A deficiency of $63,754.80 for 1955 was asserted principally as a result of this adjustment. That amount, together with interest, was paid by the plaintiff as transferee of Berea and timely claim for refund was filed with the District Director of Internal Revenue.

The position of the Commissioner which resulted in the deficiency was that the reserve was a bad debt reserve which, because of the sale of the business, had lost its purpose so that the portion of the reserve which had originally conferred a tax benefit must be finally closed out to profit and loss and the remaining amount restored to surplus. The charges made to the reserve since 1952 had resulted in a tax benefit of $133,361.17, it was determined. Basically plaintiff's theory of recovery is that a liquidation of the kind here involved gives rise to no recognizable gain and that no part of the $133,361.17 is income for 1955 or any other year.

In its argument and briefs, the plaintiff immediately comes to the point of its presentation, namely, that sections 336 and 337 of the Internal Revenue Code of 1954¹ provide that no gain shall be recognized to a corporation which distributes its property pursuant to an approved plan for complete liquidation. In the opinion of the plaintiff, the transaction presently under consideration satisfies the criteria for nonrecognition and there is no reason to depart from such treatment. The development of the positions of the parties has given rise to what had seemed like an ancillary point but which, in fact, is basic to the entire problem. The plaintiff suggests that the reserve maintained by Berea was intended by the Congress to be wholly tax exempt. The Government says that if this is true, it is a complete answer to its position. Consequently, the resolution of that controversy is the starting point in deciding this case.

Prior to 1952, savings and loan associations were entirely exempt from income tax. The exemption was removed, and section 313(e) of the Revenue Act of 1951² amended section 23(k) (1) of the 1939 Internal Revenue Code.³ It is the contention of the plaintiff that this legislation creates a partial exemption on earnings until a bank's surplus, undivided profits and reserves totals 12 percent of its deposits, the exemption being articulated in terms of an addition to bad debt reserve. The Government, on the other hand, believes that the reserve, measured as a percentage of deposits, is no different from any reserve for bad debts and should, therefore, be treated no differently.

Section 313 of the Revenue Act of 1951 was amended on the floor of the Senate to provide a minimum reserve for bad debts computed generally like the reserve ultimately authorized by section 23(k) (1) of the 1939 Code but utilizing a figure of 10 percent. Certain of the remarks made in the Senate debate are offered by the plaintiff in support of its "exemption" theory. We have perused the pertinent portions of the debate⁴ and we are not persuaded that that discussion, considered in its entirety, supports the plaintiff's position. In reporting on the agreement of the conferees of both Houses on the 1951 Revenue Act, the Joint (Congressional) Committee on Internal Revenue Taxation staff summary said of section 313:⁵

"Section 313 of the bill removes the income tax exemption of savings and loan associations * * * but allows them to deduct dividends paid to depositors and the amounts placed in bad-debt reserves. The deduction for additions to bad-debt reserves is the same as that previously described in the case of mutual savings banks. Thus, the deduction may be a `reasonable addition to reserve for bad debts\' but in no case less than the institution deems necessary, until the reserves equal 12 percent of total deposits or share accounts."

The debates and reports incline us to the belief that the Congress was thinking in terms of a bad debt reserve rather than an exemption.

But the plaintiff, in furtherance of its argument states, regardless of the reference to "bad debts" in section 23(k) of the 1939 Code and section 593 of the 1954 Code and its own characterization of the reserve as a "bad debt reserve," that the reserve is unlike an ordinary bad debt reserve principally because it is keyed to deposits rather than to debts and does not bear a relationship to loss experience. The defendant suggests, however, that a reserve against long-term loans based on loss experience might well not be sufficient to protect against the loss of customers deposits, the working capital of savings and loan institutions, in the event of a depression or sharp decline in the real estate market. That the Congress may have desired to see unusually large reserves created is not incompatible with the bad debt function of the reserves. The questions of the character of the reserve and the Congressional intent in authorizing it were recently considered by the Tax Court in Arcadia Savings and Loan Association et al. v. Commissioner, 34 T.C. 679, pending on appeal, 9th Cir. Speaking of the petitioner's deduction from income credited to the reserve, the court said, at page 682:

"* * * It was obviously allowed as an addition to a reserve for bad debts. The language of the provision clearly indicates this and there is no reason to depart from that conclusion because of anything that was said by members of Congress in the discussion leading up to the enactment of the provision. Congress was obviously generous in allowing the deduction. This might have been because of its desire to protect the solvency of building and loan associations and provide them with sufficient reserves to withstand possible adverse economic conditions. Nevertheless, the provisions which it made were for a reasonable addition to a reserve for bad debts. * * *"

Similarly, the plaintiff's argument that because the Congress required that reserves be built up to five percent of deposits, as prescribed in the National Housing Act,⁶ it could not have intended reserves measured by 12 percent of deposits to be bad debt reserves must be rejected. Nothing in that provision of the Housing Act suggests that the five percent reserve is other than a minimum figure and, thus, not inconsistent with the 12 percent figure. Moreover, nothing in the provision requires that it be applied to every savings and loan association. Furthermore, we do not think that isolated provisions in the banking laws provide authoritative interpretations for the Internal Revenue Code.

We conclude, therefore, that the Congress, having removed the blanket tax exemption of savings and loan associations, did not intend to exempt the amounts accrued in reserves but rather that it intended to create liberal reserves against the possibility of unrealized loan receivables. Consequently, in proceeding to the issue of recognition on liquidation we will consider the reserve to be a bad debt reserve.

The provision for nonrecognition of gain on the sale of assets by a liquidating corporation was introduced into the 1954 Code⁷ to avoid taxation of both the corporation and the stockholder on the same transaction. The problem of whether the sale had been made by the corporation before liquidation or the stockholders after liquidation had resulted in doubt and confusion in this area.⁸ Mertens, The Law of Federal Income Taxation, Code Commentary, Sec. 337. As we noted at the outset the plaintiff contends that it was a sale within the meaning...