Alpena Sav. Bank v. Commissioner

ALPENA SAVINGS BANK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Alpena Sav. Bank v. Commissioner Docket No. 89273. United States Board of Tax Appeals 45 B.T.A. 665; 1941 BTA LEXIS 1086; November 12, 1941, Promulgated *1086 The petitioner bank was reorganized in the year 1933 in the following manner: Its depositors relinquished 50 percent of their deposits in consideration of receiving certificates of participation in the income and liquidation of specific assets which were set aside in a trust for their benefit. The bank then reopened free of all liability in respect of 50 percent of its deposits for which the depositors had received certificates of participation in the income and liquidation of the trust. All of the income of the trust accrued to the trust; all of the expenses of the trust, including taxes, were to be borne by the trust. Under a ruling of the state banking department any income tax collected or to be collected from the petitioner in respect of the income of the trust was to be reimbured to the petitioner by the trust. The payment of any income tax upon the income of the trust for 1934 would deplete the assets of the trust to such an extent that the depositors would not receive payment in full of their claims against the trust. Held that the collection of any income tax from the petitioner for 1934 in respect of the income of the trust is barred by section 3798 of the Internal*1087 Revenue Code, as amended by section 406 of the Revenue Act of 1939. Johm C. Bills, Esq., for the petitioner. De Witt M. Evans, Esq., and Paul A. Sebastian, Esq., for the respondent. SMITH *665 This proceeding is for the redetermination of deficiencies in income and excess profits tax for the calendar year 1934 in the amounts of $8,373.42 $3and,063.76, respectively. The deficiencies result from the determination of the respondent that the income from certain trust assets, segregated by the petitioner pursuant to a plan of reorganization, constituted income taxable to the petitioner. *666 FINDINGS OF FACT. 1. The petitioner is a banking corporation, organized under the laws of the State of Michigan for the purpose of conducting a general banking business in the city of Alpena, Michigan. Petitioner was organized in 1893 and actively conducted the banking business, receiving deposits and making loans and discounts, without interruption until February 14, 1933. Petitioner assumed its present name on December 28, 1933, by filing amendatory articles of incorporation, it having been known formerly as the Alpena Trust & Savings Bank. *1088 It filed its return for the taxable year with the collector of internal revenue for the district of Michigan. 2. On February 14, 1933, the Governor of the State of Michigan, by proclamation, closed all state banks and they were subsequently ordered to remain closed until further notice. On March 27, 1933, the petitioner applied to the state banking department for the appointment of a conservator in accordance with state law and one was duly appointed. The bank operated under the conservatorship until September 22, 1933, but was closed to depositors during that time. 3. During the conservatorship above mentioned the Michigan State Banking Department, acting through its conservator, devised a plan for the reorganization of the affairs of the closed bank. This plan was embodied in a report made in July 1933 by E. P. Smith, conservator, to the Banking Commissioner of the State of Michigan. A certified copy of this report is in the record as Exhibit 1. 4. The plan sumitted by the conservator in his report above mentioned was approved by the Banking Department of the State of Michigan and by the Governor of the state and put in operation under the provisions of Act No. *1089 32 of the Michigan Public Acts for the year 1933. 5. The conservator recommended that the state banking department levy a 100 percent assessment against the stockholders of the bank. His recommendation in this regard was carried out. The stockholders were directed to pay the assessment to the petitioner, which in turn was to pay it over to the three trustees appointed by the state banking department. 6. As contemplated by the plan the bank reopened for business on September 22, 1933. Certain depositors enumerated in the plan were paid off in full. Each other depositor in the bank when it was closed was credited with a deposit in the reopened bank in an amount equal to 50 percent of the amount that he had on deposit when the bank closed. The bank opened free from liability to its former depositors for the remaining 50 percent of the amount of the said deposits as of the time the bank closed. Under date of September 19, 1933, a trust *667 was created between the bank and three trustees appointed by the state banking commissioner. Certain designated assets of a book value of $2,287,148.67 of the closed bank were turned over to the trust, which assets were to be liquidated*1090 for the benefit of the depositors. The amount of their deposits thus to be liquidated was $2,167,857.25. It was provided that the depositors could look only to the proceeds of these assets, segregated and put in trust, for the recovery of the remaining 50 percent of their deposits. They were to receive interest upon such deposits, but only out of the trust of segregated assets "at such rate as may be determined from time to time by the Commissioner of Banking of the State of Michigan." The bank, in turn, surrendered all claims to the segregated assets of the trust unless and until the depositors were paid in full, principal and interest, and the expenses of administering the trust had been paid. The trust fund composed of the segregated assets of a book value of $2,287,148.67 was augmented by the 100 percent stock assessment referred to above. 6. The trust above mentioned has been in existence since September 19, 1933, during which time it has been in process of liquidation for the benefit of the depositors, beneficiaries therein. All income received from the trust and the proceeds from the liquidation thereof have accrued to the trust. All expenses involved in the operation*1091 of the trust, including taxes of all kinds, have been borne by the trust. 7. Paragraph 4 of the trust agreement of September 19, 1933, provides in part: Such trustees may, with the approval of the Commissioner, pay any and all taxes, assessments, special assessments, and levies necessary to preserve the trust property or any part thereof covered at any time by this instrument, or in which they have any rights, title, or interest whatsoever, * * * 8. Under date of June 4, 1940, the state banking department made the following ruling: To the Reorganized Bank and/or The Trustees of Segregated Assets Addressed Gentlemen: Re: Determination of income and excess profits taxes on operations of segregated trusts Reference is hereby made to our circular to you under date of January 19, 1940, concerning filing of income and excess profits tax returns and the fact that the Commissioner of Internal Revenue has ruled that banks reorganized under Act 32 of the Public Acts of 1933 should file a joint return with the segregated trust for each taxable year combining the income, losses, and all deductions of the bank and of the segregated trust. In connection with any disposition*1092 of claims of the Bureau of Internal Revenue, growing out of assessments for income and excess profits tax, it is requested that - when a claim is made against a reorganized bank involving the income of a segregated trust and when such claim has been finally established by the Bureau - the portion of the tax applicable to income of the segregated trust must be paid by the trustees and charged as operating expense of the trust.*668 After giving this problem much consideration, it is our conclusion that the establishment of any claim against segregated or trusteed assets of a reorganized bank on the earnings of the trust is a proper charge under the terms of the plan of reorganization, and trust agreement. In all such instances, where the payment of such a tax would diminish assets otherwise available and necessary for full payment of creditors' claims, it is requested that claim for immunity from the tax be made and that a protest be filed so that any rights respecting non-payment, or to recover the amount paid, may be preserved. When and if any tax claims are presented by the Bureau of Internal Revenue for payment, such claims should immediately be submitted to this*1093 office together with complete information, for our review and approval prior to payment. The trust operated entirely independently of the petitioner. It had an office separate from that of the petitioner. The petitioner exercised no control whatever over the activities of the trust. 9. The depositors have been paid 80 percent of their principal claims against the trust. Inasmuch as they received 50 percent of their old deposits when the bank reopened and have now received 80 percent of 50 percent of the remainder, they have received an aggregate of 90 percent of the principal amount of their deposits when the bank closed. They have been paid no interest on their claims, although under paragraph 7 of the trust agreement of September 19, 1933, they are entitled to such interest at a rate to be determined by the state banking commissioner. 10. Up to the time of the hearing of this proceeding (April 7, 1941), the remaining assets of the trust showed a book value of $867,469.41, which included uncollected stock assessments of $140,244.10, of which it was believed only $2,056.25 was collectible. The appraised value of all such assets was only $307,911.30. At the same time*1094 the unpaid claims of the depositors for unpaid principal amounted to $342,550.97. This leaves a deficiency in assets of $34,639.67 below the claims of the depositors for principal. As stated above, no interest has been paid on the depositors' claims. Computed at the rate of two percent per annum up to the close of business on March 24, 1941, this interest would amount to approximately $186,000. The excess of liabilities over assets as of March 24, 1941, including claims for principal and interest so computed, is $220,639.67. 11. For the calendar year 1934 the petitioner did not include in its income tax return any transactions relating to the trust. All of the bookkeeping connected with the segregated assets was done by the trustees. The segregated assets were not carried as assets of the petitioner; the leabilities of the trust were not liabilities of the petitioner. 12. The net income of the petitioner for 1934, as shown by its return filed for that year, was $55,663.92. The income of the trust for 1934 was $59,018.30. *669 In the determination of the deficiencies for 1934 the respondent added to the net income reported by the petitioner the income of the*1095 trust and made other adjustments which increased the petitioner's adjusted net income. Of the asserted deficiencies, $8,063.09 income tax and $2,950.91 excess profits tax were attributable solely to the income of the segregated assets and the balance to the income of the unsegregated assets. OPINION. SMITH: The respondent has determined deficiencies in income and excess profits taxes against petitioner for 1934. To the extent that the taxes are attributable to income in respect of its unsegregated assets, the petitioner now concedes liability; in other words, it concedes that it is liable for deficiencies in income and excess profits taxes for 1934 in the respective amounts of $310.33 and $112.85, which it claims already to have paid. The sole question in issue is whether the petitioner is liable to income tax for 1934 in respect of the income of a trust of segregated assets which were held by three trustees for the benefit of its depositors. The petitioner claims that it is exempt from tax upon such income under the provisions of section 3798 of the Internal Revenue Code, as amended by section 406 of the Revenue Act of 1939. That section, as amended, provides, so far*1096 as material, as follows: (b) Whenever any bank or trust company, a substantial portion of the business of which consists of receiving deposits and making loans and discounts, has been released or discharged from its liability to its depositors for any part of their claims against it, and such depositors have accepted, in lieu thereof, a lien upon subsequent earnings of such bank or trust company, or claims against assets segregated by such bank or trust company or against assets transferred from it to an individual or corporate trustee or agent, no tax shall be assessed or collected, or paid into the Treasury of the United States on account of such bank, or trust company, such individual or corporate trustee or such agent, which shall diminish the assets thereof which are available for the payment of such depositor claims and which are necessary for the full payment thereof. (c) (1) Any such tax collected, whether collected before, on, or after the date of enactment of the Revenue Act of 1938, shall be deemed to be erroneously collected, and shall be refunded subject to all provisions and limitations of law, so far as applicable, relating to the refunding of taxes. (2) Any*1097 tax, the assessment, collection, or payment of which is barred under subsection (a) of this section, or any such tax which has been abated or remitted after May 28, 1938, shall be assessed or reassessed whenever it shall appear that payment of the tax will not diminish the assets as aforesaid. (3) Any tax, the assessment, collection, or payment of which is barred under subsection (b) of this section or any such tax which has been refunded after May 28, 1938, shall be assessed or reassessed after full payment of such claims of depositors to the extent of the remaining assets segregated or tranferred as described in subsection (b). The respondent contends that the trust set up in 1933, principally out of the segregated assets of the petitioner, is not a separate taxable *670 entity, but that the gains and losses and net income of the trust must be incorporated in the petitioner's income tax return for 1934. The petitioner, although not having any control over the trust, and although its assets are not the assets of the petitioner and its liabilities are not the liabilities of the petitioner, and although its bookkeeping is not reflected in the petitioner's books of account, *1098 does not combat the contention of the respondent that the trust is not a separate tax entity. It contends, nevertheless, that it is not liable to income tax in respect of any net income of the trust for 1934 by reason of the fact that the payment of the tax would reduce the assets of the trust available for the payment of claims of depositors. At the hearing of this case counsel for the respondent stated: In this case, in the year 1934, the bank made a profit of some fifty-five thousand dollars and the profits from what he called the segregated assets, amounted to about fifty-nine thousand dollars. There is one taxable entity, and the deficiency is asserted against the Alpena Savings Bank, which is a going concern, making money each year, and has plenty of free assets and also sufficient income to pay these taxes, which would not in any way, diminish the amount that the depositors would be entitled to. That is really the issue in this case. * * * He further stated: Naturally, if the taxes are paid out of these segreated assets, it would diminish the assets, so that there would not be as much available for the depositors, as you can see, but, on the other hand, if we collect*1099 the taxes from whom the deficiency is asserted, there is no harm done to the depositors in any way, shape, or form, except what they have done by their own legal arrangement. The respondent further contends that the Board has no jurisdiction in the determination of the deficiency to consider the effect of section 3798 of the Internal Revenue Code, which relates to "Exemption of Insolvent Banks from Tax." The respondent asserts that it is the function of the Board merely to determine the deficiency and that section 3798 of the Internal Revenue Code pertains only to the collection. This contention of the respondent must be denied upon the authority of West Town State Bank,32 B.T.A. 531; Republic Bank & Trust Co.,36 B.T.A. 680; Valuation Service Co.,41 B.T.A. 811. By the trust agreement of September 19, 1933, in accordance with the terms of which the trust was set up, it is provided that the trust shall pay all of its own expenses, including taxes. The trust fund was managed in accordance with the instructions of the state banking commissioner. He has ruled that if the bank is subjected to any Federal income tax in respect*1100 of the income of the trust the trust shall pay it. Since the respondent admits that the payment of the tax by the trust would reduce the assets necessary for the payment of claims of the depositors, both the assessment and collection *671 of the tax are clearly prohibited by section 3798 of the Internal Revenue Code. In Valuation Service Co., supra, which is cited herein for comparison, we stated: As respondent points out, it is not the purpose of the relevant legislation to relieve those having a proprietary interest in the bank from their appropriate tax liability. Jackson v. United States,20 Ct.Cls. 298. But even if there were a possibility under the facts here that such a result might eventuate, the danager is eliminated by the provisions of the 1938 Amendment, leaving open the ultimate liability of those governed by the statute until the outcome of liquidation is apparent. The same is true here. Reviewed by the Board. Decision will be entered under Rule 50.