121 T.C. No. 13
UNITED STATES TAX COURT
FEDERAL HOME LOAN MORTGAGE CORPORATION, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 3941-99, 15626-99. Filed September 29, 2003.
P was originally exempt from Federal income
taxation. However, on Jan. 1, 1985, P became subject
to taxation under the Deficit Reduction Act of 1984
(DEFRA), Pub. L. 98-369, sec. 177, 98 Stat. 709. P had
entered into certain financing arrangements before Jan.
1, 1985, the proceeds of which were used in P’s
mortgage business. As of Jan. 1, 1985, the contract
rates of interest on these financing arrangements were
less than the market rates of interest as of that date,
because of an increase in interest rates since the date
on which P entered into the respective arrangements. P
claims that the economic benefit of the below-market
financing as of Jan. 1, 1985, is an intangible asset
subject to amortization. P claimed amortization
deductions on the basis of the fair market value of
that alleged intangible asset as of Jan. 1, 1985,
pursuant to the special basis provisions that are
applicable to P under DEFRA sec. 177(d)(2)(A)(ii). The
issue presented by the parties’ cross-motions for
partial summary judgment is whether, as a matter of
law, the benefit of below-market borrowing costs from
- 2 -
P’s financing arrangements on Jan. 1, 1985, can be an
intangible asset that could be amortized for tax
purposes.
Held: The benefit attributable to P’s below-
market financing as of Jan. 1, 1985, can, as a matter
of law, constitute an intangible asset which could be
amortized if P establishes a fair market value and a
limited useful life.
Robert A. Rudnick, Stephen J. Marzen, James F. Warren, and
Neil H. Koslowe, for petitioner.
Gary D. Kallevang, for respondent.
OPINION
RUWE, Judge: Respondent determined deficiencies in
petitioner’s Federal income taxes in docket No. 3941-99 for 1985
and 1986, as follows:
Year Deficiency
1985 $36,623,695
1986 40,111,127
Petitioner claims overpayments of $9,604,085 for 1985 and
$12,418,469 for 1986.
Respondent determined deficiencies in petitioner’s Federal
income taxes in docket No. 15626-99 for 1987, 1988, 1989, and
1990, as follows:
- 3 -
Year Deficiency
1987 $26,200,358
1988 13,827,654
1989 6,225,404
1990 23,466,338
Petitioner claims overpayments of $57,775,538 for 1987,
$28,434,990 for 1988, $32,577,346 for 1989, and $19,504,333 for
1990.
Petitioner and respondent filed cross-motions for partial
summary judgment under Rule 1211 on the question of whether
petitioner is entitled to amortize the economic benefit of
certain debt obligations which had below-market interest rates on
January 1, 1985, the date petitioner became subject to Federal
income taxation. Petitioner claims entitlement to amortize its
favorable financing using a fair market value basis as of that
date. Petitioner determined the fair market value of the claimed
favorable financing to total $456,021,853 on January 1, 1985, and
claims the following amortization deductions for taxable years
1985 through 1990:
1
All Rule references are to the Tax Court Rules of Practice
and Procedure, and all section references are to the Internal
Revenue Code in effect for the taxable years in issue, unless
otherwise indicated.
- 4 -
Taxable Year Amortization Deduction
1985 $50,219,116
1986 48,702,457
1987 47,017,000
1988 45,835,556
1989 40,680,420
1990 38,028,084
In this Opinion, we decide whether the benefit of
petitioner’s favorable financing can, as a matter of law,
constitute an intangible asset for tax purposes.
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. At the time of filing the
petition, petitioner’s principal office was located in McLean,
Virginia. At all relevant times, petitioner was a corporation
managed by a board of directors.
Petitioner was chartered by Congress on July 24, 1970, by
the Emergency Home Financing Act of 1970, Pub. L. 91-351, title
III (Federal Home Loan Mortgage Corporation Act), 84 Stat. 451.
Petitioner was originally exempt from Federal income taxation.
However, Congress repealed petitioner’s Federal income tax
exemption status in the Deficit Reduction Act of 1984 (DEFRA),
Pub. L. 98-369, sec. 177, 98 Stat. 709. Pursuant to this Act,
petitioner became subject to Federal income taxation, effective
January 1, 1985.
- 5 -
Petitioner was established to purchase residential mortgages
and to develop and maintain a secondary market in conventional
mortgages.2 Since the time of its incorporation, petitioner has
facilitated investment by the capital markets in single-family
and multi-family residential mortgages. In the course of its
business, petitioner acquires mortgages from originators.
Petitioner either resells the acquired mortgages in
securitization transactions, principally by pooling the mortgages
and issuing participation certificates (PCs),3 or it holds them
to maturity in its retained mortgage portfolio, generally
financing this activity by the issuance of various debt
instruments. Petitioner is a profit-making business whose net
income (for book purposes) was approximately $208 million in
1985. In 1984, petitioner acquired 550,000 mortgage loans, sold
$20.5 billion in mortgage-related securities, and posted
corporate earnings of $267.4 million.
Petitioner claims that it held a certain intangible asset,
which it identifies as “favorable financing”, on January 1, 1985.
2
A “conventional mortgage” is a mortgage that is not
guaranteed or insured by a Federal agency. The “primary mortgage
market” is composed of transactions between mortgage originators
(lenders) and homeowners or builders (borrowers). The “secondary
market” generally consists of sales of mortgages by originators
and purchases and sales of mortgages and mortgage-related
securities by institutional dealers and investors.
3
PCs are securities representing beneficial ownership of the
principal and interest payments on a pool of mortgages.
- 6 -
The “favorable financing” consisted of a number of financing
arrangements, the interest rates payable on which were below
those currently prevailing in the financial markets on January 1,
1985, because of an increase in interest rates since the date on
which petitioner entered into the respective arrangements. Those
financing arrangements consisted essentially of issuances of:
(1) Notes and bonds payable; (2) subordinated debt (capital
debentures and zero coupon bonds); (3) collateralized mortgage
obligations (CMOs); and (4) guaranteed mortgage certificates
(GMCs). Petitioner claims that the net present value of future
cashflows computed at market rates as of January 1, 1985,
exceeded the net present value of future cashflows for each
respective instrument at its contract rate. It is this
difference that petitioner claims as its favorable financing
asset as of January 1, 1985. Petitioner has not reported its
favorable financing as an asset on its books or on any financial
statement. Petitioner did not acquire its favorable financing in
any purchase transaction.
Under DEFRA section 177(d)(2)(A)(ii), 98 Stat. 711, Congress
provided a specific adjusted basis for determining gain on the
sale or other disposition of property held by petitioner on
January 1, 1985. DEFRA section 177(d)(2)(A)(ii) provides that
the adjusted basis of any asset of petitioner shall “for purposes
of determining any gain, be equal to the higher of the adjusted
- 7 -
basis of such asset or the fair market value of such asset as of
such date.” Section 167(g), which forms the basis for
amortization deductions, provides that “The basis on which
exhaustion, wear and tear, and obsolescence are to be allowed in
respect of any property shall be the adjusted basis provided in
section 1011, for the purpose of determining the gain on the sale
or other disposition of such property”. In a prior Opinion, Fed.
Home Loan Mortgage Corp. v. Commissioner, 121 T.C. ___ (2003), we
held that, under section 167(g), petitioner’s adjusted basis for
purposes of amortizing intangible assets held on January 1, 1985,
is determined under the specific adjusted basis rule in DEFRA
section 177(d)(2)(A)(ii). Pursuant to DEFRA section
177(d)(2)(A)(ii), petitioner claims entitlement to amortize its
favorable financing using a fair market value basis as of January
1, 1985.
Discussion
I. Standards for Partial Summary Judgment
Summary judgment is intended to expedite litigation and
avoid unnecessary and expensive trials. FPL Group, Inc. v.
Commissioner, 116 T.C. 73, 74 (2001). Either party may move for
summary judgment upon all or any part of the legal issues in
controversy. Rule 121(a); FPL Group, Inc. v. Commissioner, supra
at 74. A decision will be rendered on a motion for partial
summary judgment if the pleadings, answers to interrogatories,
- 8 -
depositions, admissions, and other acceptable materials, together
with the affidavits, if any, show that there is no genuine issue
as to any material fact and that a decision may be rendered as a
matter of law. Rule 121(b); Elec. Arts, Inc. v. Commissioner,
118 T.C. 226, 238 (2002). The moving party has the burden of
proving that no genuine issue of material fact exists and that
moving party is entitled to judgment as a matter of law.
Rauenhorst v. Commissioner, 119 T.C. 157, 162 (2002).
II. Amortization of Intangible Assets
Section 167(a) provides:
SEC. 167(a). General Rule.--There shall be
allowed as a depreciation deduction a reasonable
allowance for the exhaustion, wear and tear (including
a reasonable allowance for obsolescence)--
(1) of property used in the trade or
business, or
(2) of property held for the production of
income.
Section 1.167(a)-3, Income Tax Regs., which interprets section
167(a), provides:
If an intangible asset is known from experience or
other factors to be of use in the business or in the
production of income for only a limited period, the
length of which can be estimated with reasonable
accuracy, such an intangible asset may be the subject
of a depreciation allowance. Examples are patents and
copyrights. An intangible asset, the useful life of
which is not limited, is not subject to the allowance
for depreciation. No allowance will be permitted
merely because, in the unsupported opinion of the
taxpayer, the intangible asset has a limited useful
- 9 -
life. No deduction for depreciation is allowable with
respect to goodwill. * * *
For an intangible asset to be amortizable under section 167(a),
the taxpayer must prove with reasonable accuracy that the asset
is used in the trade or business or held for the production of
income and has a value that wastes over an ascertainable period
of time. Newark Morning Ledger Co. v. United States, 507 U.S.
546, 566 (1993); FMR Corp. v. Commissioner, 110 T.C. 402, 430
(1998). The taxpayer must prove that the intangible asset has a
limited useful life, the duration of which can be ascertained
with reasonable accuracy, and the asset has an ascertainable
value separate and distinct from goodwill and going-concern
value. S. Bancorporation, Inc. v. Commissioner, 847 F.2d 131,
136-137 (4th Cir. 1988), affg. T.C. Memo. 1986-601. In this
Opinion, our primary concern is whether, as a matter of law,
petitioner’s asserted favorable financing can constitute an
“asset” for purposes of section 167(a).
III. Analysis
Petitioner argues that its favorable financing represented a
valuable economic benefit on January 1, 1985, and is an
intangible asset subject to amortization. Petitioner claims that
the fair market value of this “asset” is measured by the
difference between the market cost of using the borrowed money
and its below-market cost. Respondent argues that petitioner’s
- 10 -
favorable financing arose from fortuitous interest rate
fluctuations, is not an asset, and is not amortizable as a matter
of law.
The parties in these cases stipulated that petitioner’s
favorable financing “consisted of a number of financing
arrangements, the interest rates payable on which were below
those currently prevailing in the financial markets on January 1,
1985, owing to an increase in interest rates since the date on
which Petitioner entered into the respective arrangements.”4
Simply put, favorable financing represents a right to use
borrowed money at below-market interest rates.5
It is beyond doubt that the right to use money represents a
valuable property interest. Indeed, in Dickman v. Commissioner,
465 U.S. 330, 337 (1984), the U.S. Supreme Court stated that “The
4
Respondent disputes that petitioner’s favorable financing
has been substantiated as to original cost, or as to value
(whether fair market value, book value, or salvage value) as of
any date, including Jan. 1, 1985, or as to useful life.
Respondent does not dispute that the CMOs and the GMCs are debt
for Federal income tax purposes but disputes that the CMOs and
the GMCs are debt of petitioner for purposes of the favorable
financing, and he contends that any claimed favorableness
resulting from higher comparable market rates on the CMOs and the
GMCs would not accrue to, nor be to the benefit of, petitioner.
We express no view as to these matters in this Opinion.
5
In computing the fair market value of its favorable
financing, petitioner does not include any offset for unfavorable
debt; i.e., those debt obligations of petitioner that carried
above-market interest rates as of Jan. 1, 1985. Respondent
alludes to this fact in his memoranda but provides no argument as
to its bearing on the legal issue before us.
- 11 -
right to use money is plainly a valuable right, readily
measurable by reference to current interest rates”.6 See also
Catalano, Inc. v. Target Sales, Inc., 446 U.S. 643, 648 (1980);
Rev. Rul. 81-160, 1981-1 C.B. 312; cf. sec. 7872. It is also
clear that the right to use borrowed money is interrelated with
its corresponding interest cost.
Interest represents the cost of using borrowed money. See,
e.g., Snyder v. Commissioner, 93 T.C. 529, 546 (1989). For
example, in Albertson’s, Inc. v. Commissioner, 95 T.C. 415, 421
(1990), affd. 42 F.3d 537 (9th Cir. 1994), we stated:
Interest is “the amount which one has contracted
to pay for the use of borrowed money.” (Emphasis
added.) Old Colony Railroad Co. v. Commissioner, 284
U.S. 552, 560 (1932). Interest is also commonly
defined as “compensation for the use or forbearance of
money.” (Emphasis added.) Deputy v. du Pont, 308 U.S.
488, 498 (1940). Interest is the equivalent of “rent”
for the use of funds. Dickman v. Commissioner, 465
U.S. 330, 339 (1984). Implicit in these three
definitions of interest is the concept that interest is
a payment for the use of money that the lender had the
legal right to possess, prior to relinquishing
possession rights to the debtor. [Fn. ref. omitted.]
Thus, there is a correlative relationship among the right to use
borrowed money, interest paid for the use of borrowed money, and
the intangible value of this right to use borrowed money. For
example, if current market rates of interest fluctuate to a rate
6
In Dickman v. Commissioner, 465 U.S. 330, 338 (1984), the
U.S. Supreme Court held that the interest-free loan of funds was
a transfer of property; i.e., a gift of the reasonable value of
the use of the money lent, for purposes of the gift tax.
- 12 -
which is lower than the contract rate of interest, the obligor is
paying essentially a higher cost for the use of the borrowed
money. Alternatively, if current market rates of interest
fluctuate to a rate which is higher than the contract rate of
interest, the obligor is paying essentially a lower cost for the
use of the borrowed money. In this circumstance, the obligor
stands in a better position than other borrowers that finance at
the current market rates of interest. The important point to be
made is that an obligor’s right to use borrowed money under an
existing debt obligation may be more or less valuable depending
on the current market rates of interest. See, e.g., Dickman v.
Commissioner, supra at 337. Thus, we agree with petitioner that
the right to use borrowed money at below-market interest rates
represents a valuable economic benefit in terms of the cost
savings that can be achieved in financing income-producing
activities. It is a benefit for which a third party would pay a
premium if the favorable financing were included as a part of a
purchase transaction. Following this analysis, since
petitioner’s favorable financing involves a right to use borrowed
money at below-market rates as of January 1, 1985, we have no
trouble concluding that petitioner’s favorable financing
arrangements represented something of value as of that date.
Respondent agrees that “there is a measurable economic value
associated with the right to use money.” However, respondent
- 13 -
claims that “Once the debtor enters into a debt obligation for a
fixed rate, a subsequent increase in market rates of interest
over the obligation’s fixed contract rate does not create an
asset, amortizable or otherwise.” Respondent claims that
petitioner’s favorable financing involves only the differential
between market rates of interest and the contract rates of
interest stated in petitioner’s debt obligations. Respondent
argues that this differential is not an asset, it is
“fortuitous”, and it is “not a function of an expenditure”.
Respondent’s contentions are similar to the arguments the
Commissioner made in Ithaca Indus., Inc. v. Commissioner, 97 T.C.
253 (1991), affd. 17 F.3d 684 (4th Cir. 1994). In that case, the
taxpayer sought to amortize the value of certain favorable raw
material contracts that it had purchased as part of a stock
acquisition. We held that the favorable raw material contracts
constituted an intangible asset subject to amortization. Id. at
275. We stated in that case:
Respondent argues that the life of the contracts
is indefinite because any value inhering in the
contracts exists only so long as the favorable price
spread is predicted to exist. Respondent argues that
because yarn prices fluctuate, it is impossible to
predict with any accuracy the length of time the spread
would exist. We find this argument unpersuasive. The
favorable spread of the contracts is not the asset
being amortized. The asset is the contracts
themselves. The favorable spread is used only to
determine the value of the contracts. [Id. at 274.]
- 14 -
Similarly, in these cases, petitioner seeks to amortize the right
to use borrowed money provided for in its various debt
obligations. The differential between the market rate of
interest and the contract rate of interest serves as a measure of
the economic value of that right as of January 1, 1985. Thus, we
cannot agree with respondent’s attempt to analyze petitioner’s
right to use borrowed money separately from the comparable cost
of that use. For the reasons discussed above and in Dickman v.
Commissioner, 465 U.S. 330 (1984), the right to use borrowed
money is interrelated with the corresponding interest cost of
that right, in much the same way that the right to use property
is interrelated with its corresponding rental cost.
Petitioner’s interest in its favorable financing is in many
respects analogous to a bank’s interest in its “deposit base” or
“core deposits”, which we have held to be an intangible asset
amortizable for tax purposes. “The term ‘deposit base’ describes
‘the intangible asset that arises in a purchase transaction
representing the present value of the future stream of income to
be derived from employing the purchased core deposits of a
bank.’” Newark Morning Ledger Co. v. United States, 507 U.S. at
561 n.11 (quoting Citizens & S. Corp. v. Commissioner, 91 T.C.
463, 465 (1988), affd. 919 F.2d 1492 (11th Cir. 1990)). “The
value of the deposit base rests upon the ‘ascertainable
probability that inertia will cause depositors to leave their
- 15 -
funds on deposit for predictable periods of time.’” Id. at 562
(quoting Citizens & S. Corp. v. Commissioner, supra at 500); see
also Colo. Natl. Bankshares, Inc. v. Commissioner, T.C. Memo.
1990-495, affd. 984 F.2d 383 (10th Cir. 1993).
Core deposits typically consist of low-cost accounts such as
regular savings accounts, deposit transaction accounts (e.g.,
regular checking accounts), time deposit open accounts, etc., see
Citizens & S. Corp. v. Commissioner, supra at 465, but do not
typically include “Adjustable rate deposit accounts”, such as
certificates of deposit, money market deposit accounts, and super
NOW (negotiable order of withdrawal) accounts, which are designed
to be sensitive to market interest rates, see IT&S of Iowa, Inc.
v. Commissioner, 97 T.C. 496, 517 (1991); Peoples Bancorporation
& Subs. v. Commissioner, T.C. Memo. 1992-285. In Citizens & S.
Corp. v. Commissioner, supra at 465-466, we described core
deposits as:
a relatively low-cost source of funds, reasonably
stable over time, and relatively insensitive to
interest rate charges. A bank typically invests the
funds from deposits in loans and other income-producing
assets, and receives fees for services rendered to its
depositors. A bank also incurs expenses in
establishing, processing, and maintaining deposit
accounts. The excess of the income generated over the
associated costs represents the profit attributable to
core deposits. * * *
In Citizens & S. Corp., the seminal case involving deposit
base, the taxpayer sought to amortize the deposit base that it
- 16 -
acquired in a purchase of a number of banks. The taxpayer sought
to amortize the present value of the income that it expected to
derive from the use of the core deposits which it had acquired in
those transactions. The Commissioner argued that deposit base
was not a separate and distinct asset from the goodwill of the
acquired banks since deposit base involved terminable-at-will
customer relationships. We held that deposit base represents an
intangible asset subject to amortization under section 1.167(a)-
3, Income Tax Regs., where a taxpayer can prove that core
deposits have an ascertainable value separate and distinct from
the goodwill and going-concern value of the bank acquired:
The evidence in the instant case establishes that
the acquisition of core deposits was the primary reason
petitioner purchased the Acquired Banks and that
petitioner paid a premium in order to obtain the core
deposits. In Banc One Corp. v. Commissioner, * * * [84
T.C. 476, 490 (1985)], we stated that “Often the
assumption of the deposit liabilities, rather than the
purchase of the assets, represents the economic purpose
behind the acquisition of a bank.” These core deposits
are a low-cost source of funds and are an important
factor contributing to the profitability of a
commercial bank. Moreover, the economic value
attributable to the opportunity to invest the core
deposits can be valued. The value is based solely upon
the core deposits acquired in the purchase. * * * The
value of deposit base rests upon the ascertainable
probability that inertia will cause depositors to leave
their funds on deposit for predictable periods of time.
* * * [Id. at 498-500; fn. ref. omitted.]
We have reiterated that holding in a number of cases following
our holding in Citizens & S. Corp. See, e.g., IT&S of Iowa, Inc.
v. Commissioner, supra; First Chicago Corp. v. Commissioner, T.C.
- 17 -
Memo. 1994-300; Trustmark Corp. v. Commissioner, T.C. Memo. 1994-
184; Peoples Bancorporation v. Commissioner, supra; Colo. Natl.
Bankshares, Inc. v. Commissioner, supra. In doing so, this Court
and the Courts of Appeals have rejected the Commissioner’s
argument that deposit base is not amortizable as a matter of
law.7
We believe the cases involving core deposits support
petitioner’s position that favorable financing is an intangible
asset subject to amortization. Petitioner’s favorable financing
is in many respects similar to the core deposits considered in
the above cases. Like the core deposits in those cases,
favorable financing involves the use of borrowed money at below-
market rates. Like core deposits, below-market financing
arrangements provide a less expensive means of generating income
and contribute to the profitability of a business.
Respondent claims that the cases involving core deposits are
distinguishable because “The core deposits at issue were
customer-based intangibles representing stable deposits that
7
We also point out that the U.S. Supreme Court discussed our
holding in Citizens & S. Corp. v. Commissioner, 91 T.C. 463
(1988), affd. 919 F.2d 1492 (11th Cir. 1990), favorably in its
opinion in Newark Morning Ledger Co. v. United States, 507 U.S.
546, 561-562 (1993). See Trustmark Corp. v. Commissioner, T.C.
Memo. 1994-184 (“the Supreme Court has cited Citizens & Southern
Corp. with approval and has rejected respondent’s underlying
legal argument that as a matter of law core deposits * * * are
inseparable from goodwill/going concern value and thus
nondepreciable”).
- 18 -
banks expect to retain for extensive lengths of time.”
Respondent contends that “Petitioner has nothing comparable to a
core group of depositors who, through their inertia and their
focus on savings accumulation instead of market-based returns,
are willing to leave funds on deposit at below-market rates for
extended periods of time.”
We agree with respondent that deposit base involves what we
might term a “customer-based intangible”. See, e.g., sec.
197(d)(2)(B). However, we cannot agree that this effectively
distinguishes the above cases. Indeed, the customer
relationships in the cases involving core deposits formed the
basis for the Commissioner’s objections to the taxpayer’s
amortization deductions for deposit base. However, apart from a
customer-based relationship, deposit base, like the favorable
financing in the instant cases, involves a debtor-creditor
relationship. Also, like petitioner’s favorable financing, core
deposits represent a relatively low-cost source of funds, see
Citizens & S. Corp. v. Commissioner, 91 T.C. at 465, which carry
below-market interest rates, and which support the obligor’s
financing of its profit-making activities. Also, in the same
manner that an acquirer of a bank with an established deposit
base would pay a premium for deposit base of the target bank, we
believe that the hypothetical buyer would pay a premium for the
acquisition of a company with below-market indebtedness.
- 19 -
Respondent also argues that the cases involving core
deposits are distinguishable because “The core deposits in those
cases were acquired as part of a larger acquisition, unlike
petitioner’s self-created ‘asset.’” Respondent’s argument
perhaps represents a broader criticism of petitioner’s position
with respect to its favorable financing because, admittedly,
petitioner’s favorable financing was not acquired in any purchase
transaction, and both parties seem to agree that petitioner has
not incurred any costs with respect to its favorable financing
such that it would have an adjusted cost basis in that alleged
intangible asset.
In IT&S of Iowa, Inc. v. Commissioner, 97 T.C. 496, 507-508
(1991), we stated:
To qualify for a depreciation deduction,
petitioners must show that the deposit core acquired
from the * * * bank (1) had an ascertainable cost basis
separate and distinct from the goodwill and going-
concern value of such bank, and (2) had a limited
useful life, the duration of which could be ascertained
with reasonable accuracy. Donrey, Inc. v. United
States, 809 F.2d 534, 537 (8th Cir. 1987); Houston
Chronicle Publishing Co. v. United States, 481 F.2d
1240, 1250 (5th Cir. 1973); Citizens & Southern Corp.
v. Commissioner, 91 T.C. at 479. * * * [Fn. refs.
omitted; emphasis added.]
See also Trustmark Corp. v. Commissioner, T.C. Memo. 1994-184
(“The core deposit intangible asset may be amortized upon a
proper showing by petitioner of its cost basis and a reasonably
accurate estimate of its useful life.”). However, the primary
- 20 -
import of this statement is that an intangible asset must have an
identifiable, separate, and distinct value apart from
nonamortizable goodwill or going-concern value to be amortizable
under section 1.167(a)-3, Income Tax Regs. Since the deposit
base cases involved asset acquisitions, mergers, or stock
acquisitions with a section 338 election,8 and the taxpayers’
positions in those cases were that they paid an allocable portion
of the overall purchase price for the value of the deposit base
of the target bank, this allocable portion represented their
“ascertainable cost basis” for amortization under section
167(g).9
In the instant cases, we are dealing with a unique
situation. Congress provided a specific adjusted basis for
8
Sec. 338 allows an election in certain stock purchases by a
corporation. Under this election, the corporation whose stock
was acquired is treated: (1) As having sold all its assets at
the close of the acquisition date at fair market value in a
single transaction, and (2) as a new corporation which purchased
all those assets as of the beginning of the day after the
acquisition date. Sec. 338(a). Under sec. 338(b), the basis
allocated to the “acquired” assets is determined by reference to
the purchase price of the stock. First Chicago Corp. v.
Commissioner, T.C. Memo. 1994-300.
9
Sec. 167(g) provides that “The basis on which exhaustion,
wear and tear, and obsolescence are to be allowed in respect of
any property shall be the adjusted basis provided in section 1011
for the purpose of determining the gain on the sale or other
disposition of such property.” Sec. 1011 generally provides an
adjusted cost basis for purposes of determining gain or loss.
See also secs. 1012 (cost basis), 1016 (adjustments); Fed. Home
Loan Mortgage Corp. v. Commissioner, 121 T.C. ___ (2003).
- 21 -
petitioner for purposes of determining its gain on the sale or
other disposition of property held on January 1, 1985. See DEFRA
sec. 177(d)(2)(A)(ii). In Fed. Home Loan Mortgage Corp. v.
Commissioner, 121 T.C. ___ (2003), we held that since section
167(g) requires the use of the basis for determining gain as the
basis for amortization of intangible assets and since DEFRA
section 177(d)(2)(A)(ii), 98 Stat. 711, replaced the regular
adjusted cost basis rule of section 1011 for purposes of
determining gain, petitioner’s basis for amortizing any
intangibles it held on January 1, 1985, is the higher of the
regular adjusted cost basis or fair market value of petitioner’s
intangible assets as of that date. Given this special
circumstance, we do not find the cases involving core deposits
distinguishable for the reason that respondent claims. It
follows from our previous Opinion regarding the application of
DEFRA section 177(d)(2)(A)(ii) that petitioner’s failure to
establish a “cost basis” does not prevent it from claiming a
higher fair market value basis in its favorable financing. Thus,
we do not believe an acquisition or an allocable cost is
essential to petitioner’s claim that it held an asset of value in
the form of its favorable financing as of January 1, 1985.10
10
Further, although relevant to the general question whether
a taxpayer has an adjusted cost basis in an asset upon which
amortization deductions can be based, adjusted cost basis is not
determinative of whether there is in fact an intangible asset.
See, e.g., Bartolme v. Commissioner, 62 T.C. 821, 830 (1974).
- 22 -
We also cannot distinguish the cases involving deposit base
for the reason that those cases involved an acquisition of
deposit base in conjunction with a larger acquisition of assets
of a company. We might agree that, as a practical matter, a
debtor’s position with respect to its favorable financing would
not be transferred, except as a part of a larger acquisition of a
company or property. However, this is not, in our view,
determinative of the question of whether there exists an
amortizable asset of value. Indeed, in Citizens & S. Corp. v.
Commissioner, 91 T.C. at 492-493, we stated:
Petitioner argues in the alternative that separate
sales are not required to establish that an asset has a
determinable value separate from goodwill. In a case
involving the purchase of a professional football team,
the Fifth Circuit in Laird v. United States, * * * [556
F.2d 1224 (5th Cir. 1977)], held:
“the [players’] contracts had an ascertainable
value separate and distinct from the value of the
franchise (which thus has the same significance in
this case as goodwill had in Houston Chronicle) *
* * the valuation figure set by the district judge
for the players’ contracts was supported by the
evidence, and reflected their own particular
value, notwithstanding the fact that they were
acquired in a bundle of rights and intangibles. *
* *
* * * * * * *
“It does not matter for purposes of
amortization if individual assets only have
economic significance in the context of an
integrated transaction involving the sale of a
number of assets. [556 F.2d at 1233-1234. Fn.
refs. omitted.]”
- 23 -
Applying this analysis to deposit base, it is
irrelevant for purposes of depreciation that deposit
base cannot be separately transferred and only has
economic significance in the context of a bank.
Accordingly, the separate transferability of deposit
base is not required in order to establish that deposit
base has a determinable value separate and distinct
from goodwill. [Citations omitted.]
We believe a similar analysis applies with respect to
petitioner’s favorable financing. See also Peoples
Bancorporation & Subs. v. Commissioner, T.C. Memo. 1992-285.
Thus, the meaningful question is whether the favorable financing
had a separate and distinct value as of January 1, 1985.11
Because we are dealing with a specific adjusted basis rule
provided by Congress in a statute which is applicable only to
petitioner and which provides an adjusted basis that is in some
cases different from the regular adjusted cost basis in an asset,
our analogy to the cases involving core deposits, or any other
situation for that matter, can never be perfect. But, we believe
the principles developed in those cases do indeed support
petitioner’s treatment of its favorable financing as an
intangible asset on January 1, 1985.12
11
Respondent does not argue that petitioner could never
transfer its favorable financing. Indeed, in his memorandum in
support of his cross-motion for summary judgment at page 25,
respondent points out that “Some of the Intangibles in question *
* * are not likely to be disposed until petitioner itself is
liquidated or acquired.”
12
We observe that petitioner’s claimed favorable financing
appears to present a better case, in some respects, for “asset”
(continued...)
- 24 -
Petitioner’s favorable financing is also comparable to an
interest in a favorable leasehold, which is without doubt an
asset. Similar to petitioner’s favorable financing, an interest
in a favorable leasehold involves a lease obligation with a
rental rate less than the current fair rental value of that
particular interest. “There is no question that a leasehold may
have a value in the hands of the lessee when the fair rental
value exceeds the rent established by the lease”, New Orleans La.
Saints v. Commissioner, T.C. Memo. 1997-246 (citing KFOX, Inc. v.
United States, 206 Ct. Cl. 143, 510 F.2d 1365, 1373-1374 (1975);
A.H. Woods Theatre Co. v. Commissioner, 12 B.T.A. 827 (1928)),
and, presumably, a hypothetical buyer would pay a premium to
obtain the lessee’s favorable position in the leasehold. It is
this correlative value and premium which give rise to
amortization deductions:
A leasehold is an intangible asset that is gradually
exhausted by the passage of time. Its cost is
recoverable ratably by way of amortization deductions
over the period of exhaustion in the same manner that
costs of tangible assets are recoverable by way of
depreciation deductions. Of course, the amortization
12
(...continued)
status than deposit base. For example, whereas deposit base
consists of deposit accounts which have no fixed termination date
and which are terminable-at-will, petitioner’s debt obligations
presumably have stated terms with fixed maturity dates. See
Colo. Natl. Bankshares, Inc. v. Commissioner, 984 F.2d 383, 396-
397 (10th Cir. 1993) (the Commissioner attempted to distinguish
core deposits on the basis that those intangibles do not involve
fixed-term loans with a definite life span) affg. T.C. Memo.
1990-495.
- 25 -
deductions are in addition to those for rent required
to be paid under the lease. See Washington Package
Store, Inc. v. Commissioner, T.C. Memo. 1964-294.[13]
[Id.14]
We see no principled difference in the tax treatment under
section 167(a) of favorable financing and a favorable leasehold.
We have no problem equating a right to use money at a below-
market interest rate with a right to use property at a below-
market rental rate. Indeed, in Dickman v. Commissioner, 465 U.S.
at 337, the U.S. Supreme Court similarly equated such rights in a
case involving interest-free demand loans, stating:
The right to the use of $100,000 without charge is
a valuable interest in the money lent, as much so as
the rent-free use of property consisting of land and
buildings. In either case, there is a measurable
economic value associated with the use of the property
transferred. The value of the use of money is found in
what it can produce; the measure of that value is
interest--“rent” for the use of the funds. We can
assume that an interest-free loan for a fixed period,
especially for a prolonged period, may have greater
value than such a loan made payable on demand, but it
would defy common human experience to say that an
intrafamily loan payable on demand is not subject to
accommodation; its value may be reduced by virtue of
its demand status, but that value is surely not
eliminated.
13
Sec. 1.162-11(a), Income Tax Regs., provides: “If a
leasehold is acquired for business purposes for a specified sum,
the purchaser may take as a deduction in his return an aliquot
part of such sum each year, based on the number of years the
lease has to run.”
14
Indeed, in New Orleans La. Saints v. Commissioner, T.C.
Memo. 1997-246, the Commissioner stipulated that the favorable
leasehold interest in that case was an intangible asset with a
limited useful life equal to the term established in the lease.
- 26 -
As previously stated, this Court has also equated the use of
borrowed money and interest with the use of property and rent.
See Albertson’s Inc. v. Commissioner, 95 T.C. at 421.
Respondent argues that petitioner’s favorable financing
represents a “liability”, not an “asset”. Respondent claims that
petitioner is “attempting to adjust, for tax purposes, the asset
side of its balance sheet to account for an overstatement in fair
market value terms of its liabilities.” We cannot agree with
respondent’s proposed characterization of petitioner’s favorable
financing as a liability. Indeed, as petitioner points out,
there is a valuable economic benefit associated with the below-
market interest rates on its financing arrangements as of January
1, 1985. It is this economic benefit which petitioner claims as
an intangible asset and upon which it bases its claimed
amortization deductions.
Respondent appears to make the same argument that he made in
the context of the core deposits cases. For example, in Peoples
Bancorporation & Subs. v. Commissioner, T.C. Memo. 1992-285,
respondent argued that core deposits are “liabilities” rather
than “property” for purposes of section 167 and the regulations
thereunder. We rejected that argument, stating that “Similar
arguments were considered in Citizens & Southern Corp. v.
Commissioner, 91 T.C. at 490 and 492. These arguments simply
- 27 -
fail in the face of Citizens & Southern Corp. v. Commissioner,
supra, and IT&S of Iowa, Inc. v. Commissioner, 97 T.C. 496
(1991).” Peoples Bancorporation & Subs. v. Commissioner, supra.
Similarly, we believe respondent’s attempts to characterize the
economic benefit inherent in petitioner’s below-market financing
as a liability is misplaced, and for similar reasons we cannot
accept that characterization.
Respondent also argues that petitioner’s claiming of
amortization deductions with respect to its financing
arrangements constitutes an impermissible “loop” around the
interest deductions rules of section 163 and the rules applicable
to original issue discount (OID). Respondent argues:
Petitioner claims a deduction based on the net
present value differential as of January 1, 1985,
between the hypothetical future cash flows at market
rates over prospective future cash flows based on the
actual contract rates on the relevant instruments.
This differential, in effect, is analogous to discount,
which is a substitute for interest. Therefore, the
petitioner is claiming deductions under I.R.C. § 167
for what is inherently an interest item–discount or
interest subject to the rules for deductibility under
I.R.C. § 163. [Fn. ref. omitted.]
We are not persuaded that petitioner’s treatment of its favorable
financing implicates section 163 or the OID rules. Petitioner’s
favorable financing is an economic benefit which arises from the
below-market rates of interest on January 1, 1985, and the
expectation of cost savings from its existing financing
arrangements. Again, this economic benefit is not a liability;
- 28 -
it is, in our view, an asset which is subject to amortization.
Permitting amortization deductions on the basis of this
intangible asset does not run afoul of the interest deduction
rules of section 163 or the OID rules. We cannot agree with
respondent that petitioner’s claimed amortization deductions are
in effect a substitute for interest.
In support of his argument that petitioner is attempting to
circumvent the rules for deducting interest and OID, respondent
directs our attention to section 197 where Congress specifically
expressed its intent that below-market financing be addressed
under present law. Section 197, which was enacted after the
years in issue and does not apply to the years before us,
provides rules for the amortization of certain “amortizable
section 197 intangibles”.15 Under section 197(e)(5)(B), the term
“section 197 intangible” does not include any interest under any
15
Sec. 197 is generally effective with respect to property
acquired after Aug. 10, 1993. Omnibus Budget Reconciliation Act
of 1993, Pub. L. 103-66, sec. 13261(g), 107 Stat. 540. Sec. 197,
by reason of its effective date, does not apply to the instant
cases. Under sec. 197(a), a taxpayer is entitled to an
amortization deduction with respect to “any amortizable section
197 intangible.” The deduction under sec. 197 is determined by
amortizing the adjusted basis (for purposes of determining gain)
of the intangible ratably over a 15-year period beginning with
the month in which the intangible was acquired. Sec. 197(a). An
“amortizable section 197 intangible” is any “section 197
intangible” acquired by a taxpayer after Aug. 10, 1993, and held
in connection with the conduct of a trade or business or an
activity described in sec. 212. Sec. 197(c)(1); Frontier
Chevrolet Co. v. Commissioner, 116 T.C. 289, 292 (2001), affd.
329 F.3d 1131 (9th Cir. 2003).
- 29 -
existing indebtedness. Section 1.197-2(c)(9), Income Tax Regs.,
interprets this “exception” from section 197 treatment as
follows:
(9) Interests under indebtedness--(i) In general.
Section 197 intangibles do not include any interest
(whether as a creditor or debtor) under an indebtedness
in existence when the interest was acquired. Thus, for
example, the value attributable to the assumption of an
indebtedness with a below-market interest rate is not
amortizable under section 197. * * *
The legislative history to section 197(e)(5)(B) states that
“the value of assuming an existing indebtedness with a below-
market interest rate is to be taken into account under present
law rather than under * * * [section 197].” H. Conf. Rept. 103-
213, at 672 (1993), 1993-3 C.B. 393, 560. Respondent claims that
this reference to present law refers to the rules applicable to
debt; i.e., the interest deduction rules and the OID rules. On
the contrary, we read this legislative history to state that the
treatment of any intangible asset which might arise from below-
market financing is determined under section 167(a), section
1.167(a)-3, Income Tax Regs., and the caselaw interpreting that
Code section and regulation. This encompasses the legal question
that we are deciding in the instant cases. We cannot agree with
respondent’s argument that the reference to present law refers to
the rules relating to interest deductions (section 163) or the
OID rules. There is no support for that argument in the
legislative history.
- 30 -
Finally, we are not concerned that our holding is
inconsistent with petitioner’s treatment of its alleged favorable
financing on its financial statements. Admittedly, petitioner
did not report its alleged favorable financing as an intangible
asset on its books or records, and it is not at all clear whether
reporting this claimed intangible as an asset would be in
accordance with Generally Accepted Accounting Principles.
However, we have previously indicated that a failure to report a
claimed intangible asset on financial statements or regulatory
reports is not an impediment to a taxpayer’s entitlement to
amortization deductions. IT&S of Iowa, Inc. v. Commissioner, 97
T.C. at 511; see also Bartolme v. Commissioner, 62 T.C. 821, 830-
832 (1974).16 Our resolution of the legal question in these
cases is, in any event, not dependent upon accounting principles
or whether the claimed intangible asset was or was not reported
as an asset on petitioner’s books or records.
Our holding regarding below-market financing is supported by
at least one notable treatise. In an analysis of the treatment
of interests in debt obligations under postsection 197 law, 1
Ginsburg & Levin, Mergers, Acquisitions, and Buyouts, par.
16
We also point out that in Peoples Bancorporation & Subs.
v. Commissioner, T.C. Memo. 1992-285, the Commissioner advocated
the position that the treatment of core deposits as an asset for
financial and regulatory accounting purposes should be irrelevant
for tax purposes.
- 31 -
403.4.4.3, at 4-102 to 4-103 (June 2003 ed.), concludes that the
value attributable to below-market indebtedness is amortizable:
Code §197 never applies to the interest of a borrower
or lender in an existing debt obligation (even when
acquired as part of a larger business). [Fn. ref.
omitted.] Thus, according to the * * * [January 2000]
Regulations [interpreting section 197], “the value
attributable to the assumption of an indebtedness with
a below-market interest rate” is not amortizable under
Code §197 * * *
* * * * * * *
EXAMPLE 7. P Assumes T’s Borrower Position
P purchases all of T’s assets and assumes T’s
liabilities, including T’s debt to a third party
bearing a below-market interest rate. P may amortize
the portion of the purchase price allocable to the
favorable financing over the remaining term of the
debt.
IV. Conclusion
Favorable financing involves the right to use borrowed money
at below-market interest rates. The right to use the proceeds of
financing arrangements with below-market interest rates
constitutes an economic benefit. The benefit of petitioner’s
below-market financing can, as a matter of law, constitute an
intangible asset which could be amortized if petitioner
establishes a fair market value and a limited useful life as of
January 1, 1985.
An appropriate order
will be issued.