The Fifth Circuit, in an unpublished opinion (MoneyGram International Inc. et al. v. Comm'r) (No. 15-60527) (5th Cir.), remanded to the US Tax Court its finding in MoneyGram v. Comm'r, 144 T.C. 1 (2015), that MoneyGram International, Inc. (MoneyGram) did not qualify as a "bank" for purposes of Section 581 (see Tax Alert 2015-491 for an analysis of the Tax Court opinion). The appeals court found that the Tax Court properly defined "bank," but applied definitions for "deposits" and "loans" that were too narrow.

Facts

During the financial crisis, MoneyGram realized large losses on investment securities. Under Section 166(e), taxpayers typically must account for losses on certain debt securities under Section 165 rules and are thereby prevented from claiming bad debt deductions as ordinary losses. Banks, however, are exempt from Section 166(e) by way of Section 582(a). To avail itself of these rules and the accompanying ordinary bad debt deductions, MoneyGram asserted that it was a bank under the three-part definition contained in Section 581.

Tax Court Analysis

The Tax Court found that MoneyGram was not a bank within the meaning of Section 581. The Court spent the majority of its analysis on whether MoneyGram met the first requirement of Section 581, which states that "the term bank means a bank or trust company incorporated and doing business under the laws of the United States … or of any State." The Tax Court drew heavily on the Fourth Circuit's 1941 decision in Staunton Industrial Loan Corp. v. Comm'r, 120 F.2d 930 (4th Cir. 1941), where the Fourth Circuit had to determine whether an industrial loan company (ILC) organized under Virginia law would qualify as a bank under the predecessor to Section 581 (Section 104 of the Revenue Act of 1936). In Staunton, the Fourth Circuit argued that bank classification under a federal taxing statute should not literally require that a company be formed under a state's banking code so long as the company possesses the essential characteristics of a bank. Following Staunton, the Tax Court in MoneyGram explained that "an incorporated entity will satisfy the first requirement of the Section 581 definition, even though it is not chartered as a bank under State law, if it possesses the essential characteristics of a bank."

The Tax Court concluded that MoneyGram failed to possess the essential characteristics of a bank. In its analysis, the Tax Court referred to five features that it found were essential characteristics of a bank, none of which MoneyGram possessed: (1) the receipt of deposits from the general public repayable on demand or at a fixed time, (2) the use of deposit funds for secured loans, (3) a debtor-creditor relationship between the bank and its depositor, (4) regulation by the Federal Reserve, the OCC or the FDIC, and (5) eligibility for membership in the Federal Reserve System. The Tax Court did not rely on any existing banking law definition to determine whether MoneyGram was a bank for purposes of federal tax law, such as the Federal Reserve Act of 1913 (12 U.S.C. Section 221), the Federal Deposit Insurance Act of 1950 (12 U.S.C. Section 1813(a)(1)), or the Bank Holding Company Act of 1956 (12 U.S.C. Section 1841(c)), instead crafting a narrower definition.

According to the Tax Court, MoneyGram did not satisfy Section 581 because "receiving deposits and making loans do not constitute any meaningful part of MoneyGram's business, much less 'a substantial part.'" In making its determination, the Tax Court came up with its own definition for deposits as "funds that customers place in a bank for the purpose of safekeeping," that are "repayable to the depositor on demand or at a fixed time," and which are held "for extended periods of time." The Tax Court felt that funds received by MoneyGram as part of its money order and financial services segments were not held for safekeeping or for an extended period of time.

Similarly, the Tax Court crafted its own definition of a loan as an agreement, "memorialized by a loan instrument" that "is repayable with interest," and that "generally has a fixed (and often lengthy) repayment period." The Court found that MoneyGram enters into Master Trust Agreements with its agents and these are not loans. Specifically, the Court said this type of agreement is a trust agreement (by name) and not a loan agreement, and MoneyGram does not charge interest.

Appellate Court Analysis

The Fifth Circuit Court of Appeals first noted that the Tax Court properly defined "bank" using its common meaning and that the essential characteristics of a bank as described in the Staunton case on which the Tax Court relied were correct.

The appeals court disagreed, however, with the way the Tax Court defined "deposits" and "loans," finding the qualifications added by the lower court were too restrictive. With respect to "deposits," the Fifth Circuit found fault with the inclusion of the requirement that the funds be held "for extended periods of time." The Tax Court relied on the decision in AmSouth Bancorporation & Subsidiaries v. United States, 681 F. Supp. 698 (N.D. Ala. 1988), to support its holding.¹ The appeals court found that the AmSouth decision focused on deposit relationships and did not address whether an entity receives deposits, nor did it address the duration of the deposit. It concluded, therefore that the AmSouth decision does not support a finding that deposits must be held for an "extended period of time."

With respect to the definition of a "loan," the Fifth Circuit disagreed that repayment "with interest" is required. The Court cited a number of cases to support its assertion that the main requirement is that the parties intend for the loan to be repaid. Whether a loan is intended to be repaid is a question of fact determined using seven factors as set out in Todd v. Comm'r, 486 F. App'x 423, 426 (5th Cir. 2012).²

Further, the Appeals Court noted that Section 581 provides that a substantial part of the taxpayer's business must consist of "making loans and discounts." In the view of the Fifth Circuit, the conjunctive use of the word "and" indicates that each aspect of the phrase must be considered. The Appeals Court found that neither the Tax Court nor MoneyGram presented arguments regarding "discounts." So, on remand, the Tax Court is directed to also consider whether MoneyGram makes "discounts."

One judge dissented, saying that it is obvious that MoneyGram's clients do not deposit funds for safekeeping. He said MoneyGram did not bear its burden of proof as to whether it is a bank and nitpicking definitions doesn't excuse the failure.

Implications

Depending on how the Tax Court rules on remand, an expansion of the definition of "bank" may allow other entities that have not previously asserted their status as a bank to avail themselves of the benefits conferred on entities that meet the Section 581 bank definition, including ordinary character charge-offs on debt securities, the bad debt reserve method under Section 585, and a separate regime for computing foreign tax credit limitations under Section 864(e)(5).

The decision on remand could also have a FATCA implication. The guidance under FATCA makes it reasonably clear that an institution that carries on a "banking or similar business," as defined, can accept "deposits" for FATCA purposes even though it is not a "bank" within the meaning of Section 581. Treas. Reg. Section 1.1471-5(e)(2). The guidance under FATCA does not contain a definition of a "deposit." The decision on remand could affect the analysis of the nature of a "deposit."

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ENDNOTES

¹ The Tax Court quoted the following in the AmSouth decision: "In the commercial banking industry, deposit relationships represent the most favorable source of funds and are one of the most important factors with respect to the profitability of a commercial bank. Deposit relationships tend to be the focal point for other bank customer relationships. Since the ability of a bank to attract and retain core deposits is the main factor in the size and scope of its business, most banking services are designed to keep and develop those deposit relationships. Once a deposit relationship is established, it generally will be retained, all things being equal, for a period of time with little, if any, need for the bank to engage in further direct marketing efforts."

² The seven factors cited in Todd are: (1) whether the promise to repay is evidenced by a note or other instrument; (2) whether interest was charged; (3) whether a fixed schedule for repayments was established; (4) whether collateral was given to secure payment; (5) whether repayments were made; (6) whether the borrower had a reasonable prospect of repaying the loan and whether the lender had sufficient funds to advance the loan; and (7) whether the parties conducted themselves as if the transaction were a loan.