Capital Nat'l Bank of Sacramento v. Comm'r of Internal Revenue

• Decision Date: 29 May 1951
• Docket Number: Docket No. 20262.
• Citation: 16 T.C. 1202
• Parties: THE CAPITAL NATIONAL BANK OF SACRAMENTO, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

16 T.C. 1202

THE CAPITAL NATIONAL BANK OF SACRAMENTO, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 20262.

Tax Court of the United States.

Promulgated May 29, 1951.

1. Petitioner issued time certificates of deposit which were outstanding in 1942 and 1943. Held: The certificates of deposit are not includible in petitioner's borrowed capital for 1942 and 1943. National Bank of Commerce, 16 T.C. 579, followed.

2. Petitioner, a national bank on the charge-off basis as to bad debts in 1930, 1931, and 1932 reduced its accumulated earnings and profits on the recommendation of the national bank examiner by $50,000 in both 1930 and 1931 because of the partial worthlessness of Reclamation District bonds by setting up a reserve for depreciation in value. It did not make a charge-off of the partial worthlessness on its books which was necessary before it could take a deduction for the amounts under section 23(j) of the Revenue Act of 1928. In 1932 the basis of the bonds was reduced by $100,000. Held: Petitioner may restore to its accumulated earnings and profits in order to compute its equity invested capital a proportionate part of the $100,000 reduction which it had improperly made in its accumulated earnings and profits. Held, further: Petitioner may restore to the basis of those bonds sold in 1942 a proportionate part of the improper reduction in their basis in order to compute the gain or the loss from their sale. Harrison H. Simpson, Esq., Valentine Brookes, Esq., and G. E. Oefinger, C.P.A., for the petitioner.

T. M. Mather, Esq., for the respondent.

Respondent determined deficiencies in petitioner's excess profits tax for the year 1942 and 1943 of $92,176.50 and $31,126.75, respectively. Petitioner claims an overpayment for the se years in the respective amounts of $77,895.06 and $125,728.85.

The issues presented are (1) whether certificates of deposit issued by petitioner are properly includible in its borrowed capital within the meaning of section 719(a)(1) of the Internal Revenue Code; (2) whether, in computing its equity invested capital, petitioner may restore to its accumulated earnings and profits that part of a $100,000 valuation reserve which it set up on its books in 1930 and 1931 because of the partial worthlessness of Reclamation District No. 2047 bonds, which is proportionate to the bonds still owned; and (3) the determination of the adjusted basis of certain of the bonds for the purpose of computing the gain or the loss from their sale in 1942.

Other adjustments made by respondent are not contested by petitioner.

Petitioner filed its returns with the collector for the first district of California.

FINDINGS OF FACT.

The facts which have been stipulated are so found.

Petitioner is a corporation organized under the laws of the United States with its principal office in Sacramento, California. At all times material hereto, petitioner was a national bank, a member of the Federal Reserve system, a member of the Federal Deposit Insurance Corporation, and designated by the Secretary of the Treasury as a depositary of Government funds.

Issue 1. In its regular course of business, petitioner issued certificates of deposit¹ to private persons. The average daily balances of the certificates of deposit which were outstanding in 1942 and 1943 were $1,407,645.59 and $1,192,119.75, respectively. The terms of the certificates varied from four months to one year, and the interest rate varied from one-half per cent a year to two per cent.

Petitioner also issued certificates of deposit to the California State Treasurer and to the treasurers of Sacramento, Colusa, and Butte counties during 1942 and 1943. The average daily balance of such certificates outstanding in both 1942 and 1943 was $952,681.

The California State Treasurer made deposits under an ‘Agreement for Inactive Deposit‘ entered into in 1937. The agreement provided that the deposits should be evidenced by certificates of deposit which were to be negotiable after their maturity date, which was not to exceed one year after issue. Petitioner was required to deposit with the Treasurer as security, bonds or state warrants which had a value that was 10 per cent greater than the amount of the deposits.

Deposits were made by county treasurers under written agreements for inactive deposits of funds which permitted withdrawal on 30 days' notice and provided that interest be paid quarterly and that the agreement terminate after one year. Petitioner agreed to pledge as security United States bonds or treasury notes or bonds of the State of California or of a political subdivision of the state which had a value 10 per cent greater than the amounts of the deposits. As evidence of the deposits, petitioner issued certificates of deposit which were negotiable when due.

During 1942 and 1943, petitioner accepted commercial (checking) and savings accounts. No interest was paid on the former type of account, and the interest rates in effect on savings accounts varied from 1 1/2 per cent to 2 per cent. Although petitioner reserved the right to require notice of withdrawal of savings accounts, it has never exercised this right.

Petitioner was not required to redeem certificates of deposit before maturity. It did redeem them in an emergency. During the period 1940 to 1944, inclusive, petitioner redeemed four certificates prior to maturity. A certificate issued to the State Insurance Commissioner for a term of 1 year was redeemed on December 17, 1941, two months after issuance, to permit investment of the amount, $11,500, in defense bonds. Three certificates issued to J. D. Greene in the amount of $50,000 each and for terms of 6 months were redeemed on January 11, 1944, within 2 months of issuance, at the request of Greene who desired to make a payment on farm property. No interest was paid on the certificates redeemed prior to maturity.

Issues 2 and 3. During the years 1930, 1931, and 1932 petitioner was on the charge-off basis of accounting for bad debts, under which it took deductions for bad debt losses at the time their worthlessness became known and the debts were charged off on its books.

On or before May 11, 1928, petitioner purchases bonds of Reclamation District bonds) which had a par value of $464,000 for $437,795. Petitioner established a separate account on its books for the bonds. Subsequent sales reduced the balance in the account to $351,280 by 1930. The carrying rate of the bonds was 94.33 per cent of their par value at this time.

In 1930 bank examiners from the office of the Comptroller of the Currency determined that bonds and securities owned by petitioner were overvalued on its books by $173,726.78 due primarily to a $215,120 overvaluation of the Reclamation District bonds. The chief examiner's report stated that:

A net depreciation of $173,726.78 estimated a loss at this examination. The management has set up a reserve of $25,000.00 against this item, and on December 31, 1930, will increase this reserve account $25,000.00, making a total of $50,000.00. Notwithstanding this, non-conforming irrigation and reclamation district #2047 bonds indicate a total depreciation of $215,120.00. The bonds of reclamation district #2047 have depreciated heavily over the last examination, and previous examinations have shown a tendency to lower level depreciation, which at this time stands at 49 bid and 53 ask. These quotation have been checked at reliable bond houses. The market for the sale of these bonds is stagnant, evidencing their nonmarketability, resulting in their nonconformity. * * *

At the last examination the net depreciation of all bonds was $127,181.00, and your examiner then requested the following:

- - - ‘that the above estimated loss be charged off the books at the end of the current period at the rate of 25%, and that a reserve for bond depreciation be set up on the books for the balance.‘

In view of the further heavy depreciation resulting since the last report, your examiner suggests that the procedure in charging off 25% of the estimated depreciation existing at this examination be done, and that a reserve be set up on the books for the balance, as contemplated. No charge off has as yet been made as previously suggested.

On December 29, 1930, the Comptroller of the Currency informed petitioner:

The report of examination of your bank completed November 28 by National Bank Examiner Leo Shapirer has been received and shows a net depreciation in your bond holdings of $173,726.78. This is a much heavier depreciation than was shown by the previous report of last May and exists chiefly in Reclamation District bonds #2047, which are carried at $351,820 and for which there is apparently no market. In view of these facts you should, as recommended by the examiner, charge off at least 25 per cent of the net depreciation at this time, in addition to increasing your present reserve for depreciation in the sum of $25,000 on December 31, 1930, as contemplated. Thereafter, you should semi-annually provide for at least one-fourth of the remaining depreciation by charging off or crediting your reserve with that amount until the entire depreciation has been taken care of.

On June 30, 1930, petitioner set up a valuation reserve out of its accumulated earnings and profits by charging its undivided profits account and crediting an account designated as ‘Reserve for Bond Depreciation‘ for $25,000. In accordance with the recommendation of the Comptroller of the Currency, the valuation reserve was increased to $50,000 on December 31, 1930, by charging an additional $25,000 to the undivided profits account. However, actual charge-off of part of the depreciation in value was not made during 1930. Petitioner's income tax return for 1930 listed under ‘Other deductions‘ $50,000, which was described as ‘Reserve for Depreciation Loss on Bonds Per Order Chief Bank Examiner.‘ The return showed a net loss of $44,435.46.

On June 30, 1931, the...