Valley Morris Plan
Comm'r of Internal Revenue

This case is not covered by Casetext's citator
Tax Court of the United States.Dec 24, 1959
33 T.C. 572 (U.S.T.C. 1959)

Docket No. 61293.



Frank C. Scott, C.P.A., and Harold J. Willis, Esq., for the petitioner. Aaron S. Resnik, Esq., and John O. Hargrove, Esq., for the respondent.

Frank C. Scott, C.P.A., and Harold J. Willis, Esq., for the petitioner. Aaron S. Resnik, Esq., and John O. Hargrove, Esq., for the respondent.

EXCESS PROFITS CREDIT— BORROWED CAPITAL— SEC. 439(b)(1).— Certificates issued in denominations of $500 and $1,000 for a fixed term (usually 3 years) by an industrial loan company of California, held borrowed capital under section 439(b)(1).

The Commissioner determined deficiencies in the petitioner's income and excess profits taxes as follows:

+---------------+ ¦1951¦$2,768.69 ¦ +----+----------¦ ¦1952¦10,242.64 ¦ +----+----------¦ ¦1953¦10,773.97 ¦ +---------------+

The only issue for decision is whether the petitioner is entitled, in computing its excess profits credit under section 439(b)(1), to include in the computation of its borrowed capital the amount of its outstanding term thrift certificates.


The petitioner was organized in 1917 under chapter 522 of the California Industrial Loan Act as ‘The Stockton Morris Plan Company.’ Its name was changed to ‘Valley Morris Plan’ in 1957. The petitioner at all times has operated under the provisions of the California Industrial Loan Act as amended. (Calif. Fin. Code, div. 7.) It was not a State or national bank.

The petitioner filed its return for 1951 with the collector of internal revenue for the first district of California and its returns for 1952 and 1953 with the director of internal revenue at San Francisco. The petitioner used an accrual method of accounting. Its income for the years in question was predominately from discounts on notes and purchase contracts acquired by it and from interest on loans. The petitioner had capital stock of $100,000 in 1951 and 1952 and $200,000 in 1953.

The petitioner was required under the California Industrial Loan Law to apply to the Department of Investment, Division of Corporations of the State of California, for permits and extensions thereof to sell and issue its ‘Installment Thrift Certificates' and its ‘Term Thrift Certificates.’ A new application has to be made for an extension of the term of a permit and for any additional certificates issued in excess of the amount stated in the permit application. The petitioner must make application to issue new certificates if it desires to change the interest rate on those outstanding. The application must include a current financial statement, a copy of the resolution of the directors pertaining to the issue, the proposed form of certificate, and must state the interest rate to be paid, the number of certificates already issued on existing permits, the total amount of certificates outstanding, the amount being requested, and the term for which requested. The State authority must approve the form of the certificate. The petitioner first issued term thrift certificates in 1950.

The petitioner, upon receiving a permit, advertises to the public that it has certificates for sale. The interest rates paid by the petitioner on its term thrift certificates during the taxable years were about 1 per cent higher than those paid by banks on time certificates. The term thrift certificates have a definite maturity date.

A person desiring to obtain a term thrift certificate comes to the petitioner's place of business, states the amount desired and the name or names in which he desires the certificate or certificates issued, and delivers cash to the petitioner equal to the face amount of the certificates issued. The petitioner maintains a complete record of all outstanding certificates through a retained copy of the essential portions of each certificate. These are kept in a loose-leaf ledger. It does not maintain a similar registry for installment thrift certificates.

Each term thrift certificate represents a lump sum placed with the petitioner as an investment, whereas payments can be made from time to time on installment thrift certificates. The latter have no maturity and bear a rate of interest different from that applicable to the term thrift certificates. The owner of a term thrift certificate must hold it to maturity in order to get the full rate of interest. He may cash it prior to maturity for its redemption value computed at a lower rate of interest. The petitioner has never invoked the 30-day notice restriction on the right of holders to surrender the term thrift certificates. The certificate remains in effect at the full interest rate if the owner does not surrender it at maturity. The petitioner can redeem the term thrift certificates at any time upon 30 days' notice.

The petitioner carries the term thrift certificates on its books as liabilities but it is not required to keep and does not keep cash reserves against its liabilities. There is no specific security provided for the payment of the term thrift certificates. The amount paid for a term thrift certificate is not subject to check. The term thrift certificates are not negotiable, are not traded on any exchange or otherwise, and give the holders no right to participate in the management of the petitioner's business. An average of about 73 per cent of the term thrift certificates issued by the petitioner in the taxable years had not been redeemed by the owners at the end of the third year after issue.

The petitioner had earned surplus and undivided profits in excess of $125,000 at the close of each of the years in question. The average daily balances of the petitioner's indebtedness on bank loans, term thrift certificates, and installment thrift certificates were as follows:

+----------------------------------------------------------------------+ ¦ ¦1951 ¦1952 ¦1953 ¦ +-------------------------------+------------+------------+------------¦ ¦Bank loans ¦$68,698.63 ¦$25,204.92 ¦$14,178.08 ¦ +-------------------------------+------------+------------+------------¦ ¦Term thrift certificates ¦271,169.96 ¦558,662.57 ¦780,360.27 ¦ +-------------------------------+------------+------------+------------¦ ¦Installment thrift certificates¦1,572,456.78¦1,939,761.93¦2,318,660.20¦ +----------------------------------------------------------------------+

The amount of interest paid or accrued on these items was as follows:

+--------------------------------------------------------------+ ¦ ¦1951 ¦1952 ¦1953 ¦ +-------------------------------+---------+---------+----------¦ ¦Bank loans ¦$3,321.90¦$1,131.25¦$621.88 ¦ +-------------------------------+---------+---------+----------¦ ¦Term thrift certificates ¦10,931.40¦20,650.74¦29,579.56 ¦ +-------------------------------+---------+---------+----------¦ ¦Installment thrift certificates¦42,805.08¦58,312.71¦70,202.04 ¦ +-------------------------------+---------+---------+----------¦ ¦Total ¦57,058.38¦80,094.70¦100,403.48¦ +--------------------------------------------------------------+

The full paid term thrift certificates for the periods here in question were issued on printed forms in denominations of $500 and $1,000. The front and reverse sides of a $1,000 certificate are as follows: (CERTIFICATE OMITTED)

All of the petitioner's advertising is supervised by the Division of Corporations. The petitioner uses the word ‘accounts' in its advertising referring to its thrift certificates. The petitioner has never represented itself as a bank, has never accepted deposits, does not issue certificates of deposit, and is prohibited by law from issuing certificates of deposit. The Federal Deposit Insurance Corporation denied it insurance, stating: ‘As an industrial loan company of California is not authorized to engage in the business of receiving deposits, it does not come within the definition of the term ‘State bank’ under the Federal Deposit Insurance Act.'

The money obtained by the petitioner on the issuance of certificates is used in its business in making loans and purchasing paper, notes, conditional sales contracts, and other evidence of indebtedness. The only other money which the petitioner has available for business purposes is capital and money borrowed from banks.

The regulations imposed by the Department of Investment under which the petitioner makes loans are stringent, limiting the interest rate, the term, and the security. It is in competition with other industrial loan companies, small loan companies, personal property brokers, credit unions, finance companies, banks, pawnbrokers, and others. There are no restrictions on banks and finance companies as to the term or interest rate of loans, but there are in the case of small loan companies, personal property brokers, and credit unions. The petitioner is required to file a detailed annual report with the Division of Corporations, including a financial statement and an analysis of surplus.

The petitioner has never attempted to become a member of the Federal Reserve System. It once discussed the possibility of qualifying as a bank but concluded that it could not qualify.

The petitioner acquired the right to use the name ‘Morris Plan’ in 1917 from the Industrial Finance Corporation of New York. The petitioner has had no dealings with the Morris Plan Corporation of America. It is a member of the Morris Plan Bankers Association, of the American Bankers Association, and of the Consumer Bankers Association.

The stamp tax imposed by section 1801 of the Internal Revenue Code of 1939 on the issuance of corporate securities was not levied or paid on the term thrift certificates issued by the petitioner during the taxable years.

The Commissioner's notice of deficiency states that the petitioner's obligations evidenced by its term thrift certificates and installment thrift certificates did not constitute borrowed capital within the meaning of section 439 of the Internal Revenue Code of 1939.

All stipulated facts are incorporated herein by this reference.



Section 439 of the Internal Revenue Code of 1939 was added by section 101 of the Excess Profits Tax Act of 1950 and applies to all taxable years ending after June 30, 1950. It pertains to an excess profits tax credit based upon invested capital, which credit includes 75 per cent of the average borrowed capital for the taxable year computed under section 439(a). The average borrowed capital under section 439(a) is the aggregate of the daily borrowed capital for each day of the year divided by the number of days in the year. Section 439(b)(1) provides, inter alia, that there shall be included in daily borrowed capital

The amount of the outstanding indebtedness (not including interest) of the taxpayer, incurred in good faith for the purposes of the business, which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, deed of trust, bank loan agreement, or conditional sales contract. * * *

The only issue for decision in this case is whether the petitioner is entitled, in computing its excess profits credit under section 439(b)(1), to include in the computation of its borrowed capital the amount of its outstanding ‘Term Thrift Certificates.’ It is not claiming here that the amount due on its ‘Installment Thrift Certificates' should be included in the computation of its borrowed capital. It states that no excess profits taxes will be due if its outstanding indebtedness on its term thrift certificates is included in the computation of borrowed capital.

The petitioner's indebtedness on the term thrift certificates was incurred in good faith for the purpose of its business, and the question is whether it was ‘evidenced’ by one of the items mentioned in the above-quoted portion of section 439(b)(1). This question narrows under the arguments of the parties to whether the term thrift certificate might fairly be regarded as a ‘certificate of indebtedness' within the meaning of the section.

The Commissioner has provided in Regulations 130, section 40.439-1(e) and (f), that

The name borne by the certificate is of little importance. More important attributes to be considered are whether or not there is a maturity date, the source of payment of any ‘interest’ or ‘dividend’ specified in the certificate (whether only out of earnings or out of capital and earnings), rights to enforce payment, and other rights as compared with those of general creditors.

The term ‘certificate of indebtedness' includes only instruments having the general character of investment securities issued by a corporation as distinguishable from instruments evidencing debts arising in ordinary transactions between individuals. * * * Borrowed capital does not include indebtedness incurred by a bank arising out of the receipt of a deposit and evidenced, for example, by a certificate of deposit, a passbook, a cashier's check, or a certified check, and the term ‘bank loan agreement’ does not include the indebtedness of a bank to a depositor.

The petitioner was not a bank and was prohibited by law from receiving deposits. Its term thrift certificates were not certificates of deposit. Those certificates had a maturity date, usually 3 years after issuance. The interest specified in the certificate was to be paid in any event and was not limited to payment out of earnings. The certificates were not ‘instruments evidencing debts arising in ordinary transactions between individuals' but were distinguishable from such instruments in much the same ways as are ‘instruments having the general character of investment securities issued by a corporation.’ They were issued by a corporation under express authority of the Department of Investment. They represented investments by the holders of the certificates. They were similar in many respects to the types of evidences of indebtedness listed in section 439(b)(1). It is difficult to exclude these certificates from borrowed capital under section 439(b)(1) even under the Commissioner's regulations, although their payment was not secured by a lien on any particular property of the petitioner or by any designated cash reserve but was payable generally from the funds of the petitioner.

The parties cite some cases arising under section 719(a)(1) of the Internal Revenue Code of 1939. This Court in Economy Savings & Loan Co., 5 T.C. 543, involving an Ohio building and loan corporation, allowed the indebtedness which the petitioner owed upon ‘certificates of deposit’ to be included in the computation of invested capital. The evidences of indebtedness mentioned in section 719(a)(1) are similar to those in section 439(b)(1) and include ‘certificate(s) of indebtedness.’ Regulations 112, section 35.719-1(d), in describing ‘certificate of indebtedness,‘ is substantially the same as Regulations 130, section 40.439-1(f). The Economy case was Court reviewed and, on appeal, was modified only as to other issued, 158 F.2d 472.

The next case was Ames Trust & Savings Bank, 12 T.C. 770. The findings there show that the petitioner was an Iowa banking corporation engaged exclusively in a general banking business in Iowa. Its indebtedness on ‘certificates of deposit’ was allowed in the computation of borrowed capital under section 719(a)(1) following the Economy case. We there stated that Regulations 112, section 35.719-1, was directed only to ordinary bank deposits of a demand nature, that is, to certificates of deposit payable on demand. That case was reversed by the United States Court of Appeals for the Eighth Circuit, 185 F.2d 47. Thereafter, the Tax Court in National Bank of Commerce, 16 T.C. 769, held, expressly following the reversal in the Ames case, that the indebtedness of a United States national banking corporation on certificates of deposit payable at a stated time was not to be included in the computation of borrowed capital. That decision was followed on similar facts in Capital National Bank of Sacramento, 16 T.C. 1202, appeal dismissed on stipulation. The last three cases all involved regular banking institutions claiming borrowed capital on certificates of deposit and are not in point here where the petitioner is not a bank, either State or national, is not permitted by law to issue certificates of deposit, and, of course, is not making any claim based upon certificates of deposit.

The next cited case is Jackson Finance & Thrift Co., 29 T.C. 272. The two corporations in that case were engaged in business as industrial loan corporations. They were regularly inspected and supervised in the conduct of their business by examiners in the office of the bank commissioner of the Utah State Banking Department, but the petitioners never held themselves out in any way as a bank. The report avoided deciding whether they were banks. The indebtedness there was on installment thrift certificates represented by a passbook and the creditor could make additional payments at any time increasing the amount of the indebtedness. All additional payments would be entered in the passbook. No maturity date was fixed for the indebtedness. Amounts of less than $100 could not draw interest under the contract. The petitioner could redeem the thrift book by paying the face value with accrued interest at a uniform rate on any date by giving 10 days' notice and agreed to redeem the thrift book at any time at the request of the owner at its face value and accrued interest at the uniform rate, subject to the right of the petitioner to require 30 days' notice in writing and to limit the amount of withdrawals in a certain way. Those restrictions were not enforced. The Tax Court in an opinion reviewed by the Court held that the indebtedness due on the installment passbooks was not to be included in the computation of invested capital under section 439(b)(1) and Regulations 130, section 40.439-1(f).

That case is distinguishable from the present case because it did not involve certificates similar to the term thrift certificates here involved and the present case does not involve installment thrift certificates issued by the petitioner by use of a passbook similar to those involved in the Jackson case. The installment payments evidenced by the pass book bear considerable resemblance to an ordinary bank savings account. The purchasers of the petitioner's term thrift certificates obviously intended to make a loan, an investment, of the $500 or $1,000 represented by each certificate, subject to close supervision by the State Department of Investment. The certificate issued to them was quite unlike an ordinary bank savings account. Several of the reasons in the Jackson case for holding against those petitioners are not applicable here because they are based upon facts present there but absent here. It was pointed out in the Jackson case that there was no maturity date for payment of the amount due; that only amounts in excess of $100 bore interest; that the amount due was payable with interest upon surrender of the passbook (the rate of interest was the same regardless of when paid); and that the passbook evidences deposits ‘under a thrift plan contract, and is more analogous to a deposit than an investment security.’ The opinion states that the holding in the Economy case ‘that a certificate of deposit is a certificate of indebtedness and constitutes borrowed capital for excess profits tax purposes, will no longer be followed.’ The dissent points out that the portion of the regulations mentioning certificates of deposit and a passbook expressly relates only to banks and the Court of Appeals in Commissioner v. Ames Trust & Savings Bank, supra, distinguished Economy Savings & Loan Co,, supra, on the ground that Economy Savings & Loan Co. was not engaged in the banking business. The dissent in the Jackson case reasoned that the Ames case would not be authority in Jackson unless it was held that the taxpayers in the latter case were banks, and the report refused to hold whether or not they were banks. This dissent supports the statement made above that the present case is not controlled by the Jackson case. The Jackson case was reversed by the Court of Appeals for the Tenth Circuit, 260 F.2d 578.

None of the cited cases reviewed above is precisely in point here although, of course, if this Court was correct in the Economy case in allowing certificates of deposit to be included in borrowed capital, then surely the term thrift certificates involved herein (which were not certificates of deposit but at least a step removed in a direction favorable to the petitioner) would be borrowed capital within the meaning of section 439(b)(1).

The answer is not free from doubt, but the Court concludes that the petitioner is entitled to include in the computation of the invested capital credit, the indebtedness evidenced by its term thrift certificates.

Reviewed by the Court.

Decision will be entered under Rule 50.

An alternative to Lexis that does not break the bank.

Casetext does more than Lexis for less than $65 per month.