PNC Bancorp, Inc. v. Comm'r of Internal Revenue
| Decision Date | 08 June 1998 |
| Docket Number | 16109–96,No. 16002–95,16003–95,16110–96.,16002–95 |
| Citation | 110 T.C. 349,110 T.C. No. 27 |
| Parties | PNC BANCORP, INC., Successor to First National Pennsylvania Corporation, et al.,1 Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Robert J. Jones, Thomas R. Dwyer, and Anthony J. O'Donnell, for petitioner.2
John A. Guarnieri, David B. Silber, and Richard H. Gannon, for respondent.
These consolidated cases involve deficiencies determined by respondent as follows:
First National Pennsylvania Corp. docket Nos. 16002–95 and 16003–95
+------------------+
¦¦Year¦¦Deficiency ¦
++----++-----------¦
¦¦1988¦¦$101,785 ¦
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¦¦1990¦¦978 ¦
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United Federal Bancorp, Inc. docket Nos. 16109–96 and 16110–96
+------------------+
¦¦Year¦¦Deficiency ¦
++----++-----------¦
¦¦1990¦¦$ 7,863 ¦
++----++-----------¦
¦¦1991¦¦10,236 ¦
++----++-----------¦
¦¦1992¦¦18,885 ¦
++----++-----------¦
¦¦1993¦¦7,659 ¦
+------------------+
The sole issue for decision is whether loan origination expenditures were ordinary and necessary business expenses properly deductible under section 162(a) 3 or whether they are required to be capitalized under section 263.
Some of the facts have been stipulated and are incorporated herein by this reference.
During the years in issue, First National Pennsylvania Corp. (FNPC(FNBP), East Bay Mortgage Co., and other corporations which joined with FNPC in the filing of consolidated Federal corporation income tax returns (Forms 1120) (the FNPC Group). The Forms 1120 of the FNPC Group for the calendar years 1988, 1989, and 1990 were prepared using the accrual method of accounting.
During the years 1990 through 1993, United Federal Bancorp, Inc. (UFB) was a corporation organized under the laws of Pennsylvania and was the owner of all the stock of the United Federal Savings Bank (UFSB) and other corporations which joined with UFB in the filing of Forms 1120 (the UFB Group). The Forms 1120 of the UFB Group for the calendar years 1990 through 1994 were prepared using the accrual method of accounting.
At all times material, FNBP and UFSB were Federally chartered banks that were actively engaged in the banking business.
Petitioner is a bank holding company organized as a corporation under the laws of Delaware. Petitioner's principal place of business was located in Delaware at the time it filed the petitions in these cases.4 On or about July 23, 1992, FNPC was merged into petitioner. On or about January 21, 1994, UFB was merged into petitioner. By virtue of these mergers, petitioner succeeded by operation of law to the assets and liabilities of FNPC and UFB. Petitioner is a transferee at law of assets of FNPC and UFB and as such would be liable under section 6901 for any deficiencies in Federal income tax determined to be owing by FNPC and UFB for the years at issue.
The principal businesses of FNBP and UFSB (collectively referred to as the banks) consisted of accepting demand and time deposits and using the amounts deposited, together with other funds, to make loans. These loans included consumer and commercial term loans and letters of credit, as well as residential and commercial mortgage loans. The banks also provided services and products to customers in addition to the loans. For consumer customers these services and products included checking accounts, savings accounts, money market accounts, safe deposit boxes, automated teller machine (ATM) cards, overdraft insurance, credit protection insurance, certified checks, wire transfers, and traveler's checks. For commercial customers these services and products included, deposit products, treasury management services, investment services, employee benefit plan services, and commercial night drop services.
At all times material, loan interest was the largest source of revenue, and interest on deposits and other borrowings was the largest expense for each bank. Each bank also derived revenues and incurred expenses with respect to safe deposit boxes, ATM cards, late payments on loans, wire transfers, and traveler's checks.
Branches operated by the banks had what are commonly referred to as “teller operations” and “platform operations”. The teller operation at a branch consisted of teller windows staffed by tellers who, among other tasks, accepted deposits, disbursed cash, and sold cashier's checks, traveler's checks, and money orders. Tellers referred customers who were interested in other bank products, such as loan and deposit products, to platform operation employees. The platform operation at a branch was conducted by customer service representatives, branch managers and assistant branch managers, each of whom was assigned a desk on the floor or “platform” of the branch on the customer's side of the tellers' windows. These platform employees were generally responsible for assisting customers in applying for consumer loans, renting safe deposit boxes, obtaining ATM cards, opening checking accounts, and opening new deposit accounts (including time deposits such as certificates of deposit). Each of the banks also had commercial loan officers who were responsible for the commercial products offered by the respective institutions, including loan products, cash management and deposit products, and employee benefit services.
The banks drew their business from their respective geographic service areas through a combination of walk-in business, referrals, prior relationships with customers, advertising, and the direct, active, and personal solicitation of new and existing customers through telephone calls, letters, and other means. Tellers and platform employees of the banks were encouraged to solicit new business, with an emphasis on encouraging the customer to look to the banks for a wide variety of financial services and products. Each of the banks offered financial incentives to certain of its platform employees and tellers to sell multiple products and services (cross-sell incentives). The banks conducted training programs for employees, including classes dealing with lending and the development of skills in selling loans and other products. UFSB employed a sales training officer who met with UFSB platform employees monthly to promote the sale of new UFSB products and services.
Banks generally are able to earn profits only if they successfully manage their “net interest margin”, which is the difference between interest earned and interest paid. In order for banks to operate profitably, their net interest margin plus revenues from fees and other sources must exceed their losses on loans and investments (i.e., losses from bad debts) plus operating costs. A bank's ability to operate profitably is in large part determined by its credit risk management, since loan losses are one of the largest controllable expenses at a bank. Many of the activities that are part of a bank's lending function are related to credit risk management. These activities include the establishment of written policies and procedures, the loan application process, credit investigation, credit evaluation, documentation, collections, and portfolio supervision. A bank establishes its written policies and procedures with respect to loans after it has determined the types of loans that it will offer and the markets that it will target.5 Once the loan products are identified, the bank develops written policies regarding its tolerance for risk, how and under what terms loans are to be made, pricing and profit objectives, documentation requirements, acceptable levels of credit losses, and collection and chargeoff procedures. The risk management process requires continuous adjustment and refinement to address the competing interests of marketing loans to as many customers as possible while at the same time insuring that the bank makes low risk loans.
Platform employees at the banks typically met with prospective consumer borrowers to explain available loan products and to assist the prospective borrowers in completing a loan application where appropriate. The consumer loan applications were generally taken by branch employees. The application identified the prospective borrower and described the prospective borrower's income and assets, existing debt, the purpose of the loan, and other data necessary to evaluate the prospective borrower's financial condition. Where loans were to be secured by an interest in real property, the application would also include a description of the collateral sufficient to permit the ordering of a property report or appraisal.
The application process is the primary means by which banks obtain information from consumer customers. The banks took a loan application for every consumer loan request. At UFSB, approximately 325 to 350 consumer loan applications were taken in a typical month of which approximately 200 to 220 were approved. At the main central branch of FNBP and its two satellite offices, approximately 90 to 100 consumer loan applications were taken in a typical month of which approximately 80 to 90 were approved.
Following completion of the application, the banks obtained a credit report on the prospective borrower. Where a loan was to be secured by real property, the banks typically obtained a property report to identify any liens or other encumbrances. If the result of the property report was satisfactory, an appraisal of the property was typically obtained.
In evaluating whether to make a consumer loan, the banks would consider certain financial ratios as well as other criteria set forth in their established loan policies. The ratios that were examined included debt to income and, where the loan was to be secured with collateral, loan to value. In addition to examination of the various financial ratios, the banks often looked at a loan applicant's payment history and financial stability.
Where the consumer loan application was...
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