*2334 Held, under the circumstances as shown, it is not established that the petitioner received, during the years involved, the tax-exempt income in controversy.
*744 The respondent determined deficiencies of income taxes for the calendar years 1922 to 1927, inclusive, in the respective amounts of $15,962.75; $13,088; $12,016.19; $15,474.87; $14,818.42; and $7,218.27. In these petitions, which have been consolidated for hearing and determination, Docket No. 29675 seeks to review the respondent's *745 actions in respect to 1922, 1923, and 1924; and Docket No. 42106 seeks a similar review for the years 1925, 1926, and 1927.
In respect to these determinations the petitioner alleges that the respondent erred in adding to its taxable income for each of the years sums derived from interest upon tax-exempt Federal, state, and municipal securities.
FINDINGS OF FACT.
The petitioner is a national bank, organized under the laws of the United States, located at Wichita, Kans. During the taxable years a considerable*2335 portion of its business involved transactions in Federal, state, municipal and other tax-exempt bonds. These transactions took on various forms, including (1) the purchase outright at their market value of securities for investment purposes; (2) the making of collateral loans to its customers upon the pledging of such securities; and (3) the advancing to its customers the face or par value of securities assigned to it, upon being guaranteed against loss under a so-called repurchase agreement.
Typical of these transactions were those carried on with the Brown-Crummer Co., which was one of the petitioner's largest customers. That company, which transferred its account to the petitioner's bank some time in 1922, required for use in its business continuous heavy loans, which, on account of the lending limitation on national banks fixed by Federal law, the petitioner was unable to supply to the extent of its needs. To meet this situation, and to provide for its other customers similarly situated, the petitioner put into effect a system whereby it advanced to the Brown-Crummer Co. the par value of tax-exempt bonds, first assigned to it under an agreement reading as follows:
This*2336 agreement by and between and the First National Bank in Wichita, Kansas, chartered under the laws of the U.S. of America:
Witnesseth, that whereas the said has this day sold to the First National Bank in Wichita the following described bonds, namely, ,receipt of which is hereby acknowledged in consideration of the purchase price of , the receipt of which is hereby acknowledged, the said does hereby agree to reimburse said bank for any loss said bank may suffer when at its option it shall sell said bonds, or when said bonds are matured, and shall for any reason not be paid by the makers thereof, provided, however, the said shall be entitled to 30 days notice of the bank's intention to sell said bonds, provided further, that said shall have the privilege of purchasing said bonds from said bank upon the payment of $ and interest at from until paid.
In Testimony Whereof the said bank and said have caused these presents to be signed this day of , 192 .
FIRST NATIONAL BANK IN WICHITA.
By
By
*746 This form of agreement was adopted by the petitioner, after approval of the Comptroller of Currency, as expressed in a letter to the petitioner*2337 dated November 25, 1922, in the following language, to wit:
* * *
The copy of the agreement between the Brown Crummer Company and your bank is also received, under which the Company agrees to sell to your bank certain bonds and to reimburse the bank for any loss suffered by it in the event it shall dispose of the bonds, or at their maturity, but with the understanding that the Brown Crummer Company shall have the privilege of purchasing such securities so sold to the bank upon the payment of the principal and interest. This agreement is satisfactory inasmuch as the Brown Crummer Company merely has the privilege of repurchasing the bonds referred to and does not bind itself absolutely so to do. If the Brown Crummer Company could be compelled to repurchase these bonds, the transaction would then be a loan subject to the limit prescribed by Section 5200 U.S.R.S.
During the period involved, 90 per cent of all of the bond transactions carried on by the petitioner under the form of agreement, hereinabove set forth, was with the Brown-Crummer Co., whose aggregate advances made by the petitioner, in such connection, amounted to from $5,000,000 to $6,000,000. Preliminary to such advances, *2338 this company, when in need of money, tendered to the petitioner certain bonds. Upon inspection and approval of such bonds by the petitioner, it paid to the Brown-Crummer Co. their par value, without regard to their market value, upon being guaranteed against loss through the form of repurchase agreements, as hereinabove set forth. The amount advanced to the company on each bond was the amount written into the repurchase agreement as the price which said company would pay to the petitioner upon repurchase of such bond, and an interest charge at the current loan rate, in each instance, was agreed to be paid by the company upon such repurchase price to the date of repurchase, when made, without regard to the rate fixed in the coupon. In addition to the sums advanced by the petitioner to it upon repurchase sales contracts, the Brown-Crummer Co. carried additional continuous credit with this bank for $200,000, which was the maximum amount it could legally loan to a single customer. This loan or credit was secured by the company's collateral note and bore the current rate of interest, payable monthly.
On maturity of the coupons attached to the bonds held under repurchase agreements*2339 with this company, the petitioner first credited to the current interest account of such company the amount called for in the coupons, and then clipped and forwarded them to it for collection. It also forwarded to this company all other matured coupons from bonds purchased outright through it, to simplify the process of collection through a single agency. The Brown-Crummer Co., after receiving and collecting these coupons from the issuing municipalities, *747 remitted to the bank by its single check the proceeds of the coupons from bonds belonging wholly to the bank, plus whatever further amount, if any, was due from it upon its current monthly account. No adjustments were made between the petitioner and the company, either at the initial sale of the bonds or upon their repurchase for any unmatured coupons; but in each and every case all bonds were delivered in their then state to the transferee.
Except in certain special transactions which involved large issues of bonds; and, in which a lower interest rate was charged on the amount advanced, the company was permitted to withdraw, from time to time, any bonds placed by it with the bank under repurchase agreements, and*2340 substitute other bonds of a like character and value in their place. Under this arrangement the company was able to continuously offer for sale the bonds in the hands of the petitioner, as well as those on deposit in its own vault, and to make deliveries, in case of sales, by withdrawals from the bank through the process of substitution. These exchanges and substitutions were frequent, and in cases of an active issue of bonds which found ready sale, were made several times each day. At no time were any bonds placed by this company with the bank under repurchase agreements ever sold to anyone other than the company; and in no case did the company ever fail to so repurchase such bonds for the amount advanced with interest. In the majority of cases, the interest rate charged by the bank to this company and its other customers for money advanced upon bonds under repurchase agreements was less than the coupon rate of the bonds involved, and, in the period under consideration, the bank collected by way of such interest an aggregate of $3,050.77, less than was paid upon coupons clipped from such securities and credited back or delivered to its customers.
The petitioner made no report*2341 in its income and profits-tax returns of the amounts paid to it by way of interest upon the repurchase agreements, as hereinabove set forth, claiming that such amounts represented interest received as a result of tax-exempt securities owned by it. Upon audit of the petitioner's returns for the years considered, the respondent determined that the amounts in dispute constituted taxable income to it and added them to its income for the years received.
OPINION.
LANSDON: The petitioner claims that the several amounts added to its gross income by the respondent for each of the years involved represented tax-exempt income derived by it from interest in Federal, state and municipal securities acquired and held by it under the circumstances set forth in the findings of fact.
*748 At the outset it is clear that the transactions involving the year 1922 must be eliminated from our consideration, since there is nothing definite in the record to show what deals, if any, were carried on during that year to which the repurchase contract, in evidence, might apply. The evidence shows that prior to sometime during 1922 the bank carried on its transactions under a form of agreement differing*2342 from the one in evidence; that sometime late during 1922 it adopted the form used during the remainder of the years in controversy, but it fails to establish the time such new contract was put into effect. The form submitted to the Comptroller of Currency was approved by him on November 25, 1922, and the witness testifying as to the actual date when it was put into use stated that it was sometime during 1922 or 1923. In the absence of evidence to show how the petitioner's business for 1922 was conducted, we are unable to say that the respondent erred in his determination for that year. His conclusion, therefore, for such year must be sustained.
In respect of the petitioner's transactions wherein, during the years involved, it acquired, held, and resold certain tax-exempt securities in accordance with repurchase agreements as shown, the petitioner states that this plan was evolved to enable it to supply its customers with money in amounts in excess of the legal loan limit allowed to national banks to single customers, and that this plan had the full and complete approval of the Comptroller of Currency.
The petitioner solicited the business of the Brown-Crummer Co., the bulk*2343 of which, prior to late in 1922, had been carried with another bank, which had gone into liquidation. Witness Chandler, chairman of petitioner's board of directors, states that Brown-Crummer's transactions in bonds amounted to, at times, $5,000,000 to $6,000,000, and that "we asked them to let us have them," inasmuch as he explained "they had carried them with somebody else; * * * with terms of purchase, and we were carrying this money."
It seems clear that at the time the petitioner solicited this business from the Brown-Crummer Co. it had on hand a large surplus of unemployed funds and that that company was in the market for loans. The maximum amount of credit the petitioner could extend to this company by way of a direct loan, under the law, was $200,000; this credit it readily gave to the company upon its collateral note. The company, however, required amounts greatly in excess of this; and, since it was dealing in large issues of municipal securities which constituted approved banking investments, the sale with repurchase agreement was evolved and brought into play. The petitioner contends that through this process it acquired a complete title to these bonds which the repurchase*2344 agreement in no way impaired, and that, because of that fact, the interest payments were its income, *749 and being tax-exempt, it was entitled to exclude them from its income-tax returns. We think there could be no question as to the soundness of the petitioner's contention had it taken title to these securities subject to no conditions other than is evidenced by the repurchase agreements; however, other established facts show that other considerations formed the motives of the parties to the transactions.
The question here, as we view it, is not dependent upon who held the bare legal title to the bonds during the dates of sale and repurchase, but rather upon the broader issue as to whom, under the understanding between the bank and its customers, was entitled to receive, and who, as carried out, did receive the interest payments made by the issuing authorities of such bonds when collected and paid. The record shows that the true relationship between the petitioner and its customers, in these transactions, was that of a lender of money in consideration for the legal rate of interest payable on the amount advanced, and not that of an investor in the securities assigned*2345 to it by such customers. The history of these transactions and the manner in which they were carried out can lead to no other conclusion.
In explaining how these transactions were initiated and carried out, Gillespie, vice president of the Brown-Crummer Co., said:
When it was necessary to borrow money we would take to the First National Bank bonds or securities and lodge them there under what we called a repurchase agreement. The repurchase agreement bore a stated rate of interest irregardless of the coupon rate of their maturity or market value of when they were payable. We were permitted to substitute from time to time and place other bonds of equal value in the repurchase agreement. When we would want to liquidate them we would pay off our loan and take down our bond.
Upon this subject, the petitioner's president Carson, in his deposition, stated that the company paid the loan rate of interest upon the amount advanced, monthly; also that:
We delivered the coupons to them and rather than take two checks for them, one for the amount of coupons and another for the amount of the excess interest, we took one check once a month. In the case of bonds which we had purchased*2346 outright from them which were not on the repurchase agreement, they, of course, gave their own check payable the date the coupon was due.
When further asked as to how the bank handled the unmatured coupons, the witness said:
I should say that they were not handled - in most of these cases - in all of them I should judge - we let the coupons go. If they took the bond in the meantime they took the coupons - they paid us interest, discount interest.
Witness Mrs. Young, bond teller for petitioner, stated that she kept a record of the date of each coupon when due, that she personally *750 clipped all coupons, and that in respect to these bonds with repurchase agreement attached "they are always delivered to our customer or credited to his account"; that this was done "to simplify matters" and do away with "extensive bookkeeping."
The true relationship between the petitioner and the customer, in these transactions, was that of borrower and lender, in which the securities were employed as a mere convenience. In these circumstances, the ad interim ownership of the bare legal title to the bonds would not affect the character of the transactions between the parties or*2347 change their true relationship. ; ; ; and see also .
In view of the facts hereinabove set forth and of the further circumstances that the entire record fails to show any instance in which the petitioner ever benefited by the excess interest paid on coupons over the rate charged its customers for the use of the money advanced on the bonds from which they were clipped, we are unable to now say that the respondent erred in holding that the petitioner did not in fact receive such payments as claimed. The action of the respondent is, therefore, affirmed.
Reviewed by the Board.
Decision will be entered for the respondent.
SMITH and TRAMMELL dissent.