PSB Holdings, Inc. v. Comm'r of Internal Revenue
| Decision Date | 01 November 2007 |
| Docket Number | No. 14724–05.,14724–05. |
| Citation | 129 T.C. 131,129 T.C. No. 15 |
| Parties | PSB HOLDINGS, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
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.
Debra Sadow Koenig, for petitioner.
Lawrence C. Letkewicz, Christa A. Gruber, and Sharon S. Galm, for respondent.
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.
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 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 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 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 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.
Respondent has since conceded the determination stated in the second paragraph quoted above. Respondent also concedes that Investments was created to...
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