# Appendix — Commissioner v. Lincoln Savings & Loan Ass'n > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386413_0307%3A1 ## Record - **Collection:** Supreme Court brief - **Document type:** Appendix - **Published:** January 1, 1971 - **Citation:** 403 U.S. 345 ## Text IN THE Supreme Court of the United States OCTOBER TERM, 1970 No. 544 COMMISSIONER OF INTERNAL REVENUE, Petitioner, —V,—— LINCOLN SAVINGS AND LOAN ASSOCIATION ON WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT INDEX Page Docket entries in the Tax Court of the United States Relevant docket entries in the United States Court of - peals for the Ninth Circuit eR 10 Stipulation of facts _...________ 14 Stipulation Exhibit 4-D Letter and Revision of Uniform Classification of Ac- counts _ Stipulation Exhibit 14-N Insurance Premium Notices Stipulation Exhibit 15-0 Notice of Insurance Premium Prepayments —_..--.......- ii INDEX Stipulation Exhibit 16-P California Modification of Uniform Classification of Accounts for Section 404(d) Payments dinillnpesanidiitnse ss Stipulation Exhibit 27-AA Federal Home Loan Bank Board Instructions for Re- pairing Section 404(d) Payments... = Stipulation Exhibit 29-AC FSLIC’s Section 404(d) Payments Accounts for Lincoln Savings Loan Association a Stipulation Exhibit 30-AD Status of Insurance Premium Prepayment Account ___ Findings of fact and opinion of the Tax Court (Filed October ih: MENU clinlenstdclidiiadeiiniliatcigtdannidktadpa tiie ied item oe Decision of the Tax Court (Entered October 21, 1968) ____ Opinion of the United States Court of Appeals for the Ninth Circuit (Filed February 83,1970). s—s—t Judgment of the United States Court of Appeals for the Ninth Circuit (Filed and entered February 8, 1970) Order of the United States Court of Appeals for the Ninth Circuit denying petition for rehearing (Filed March 18, 1970) Order of thé Supreme Court of the United States granting a Writ of Certiorari (Filed November 9, DOD smipenandien TAX COURT OF THE UNITED STATES Docket No. 325-67 LINCOLN SAVINGS AND LOAN ASSOCIATION, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE£, RESPONDENT DOCKET ENTRIES Date Filings and Proceedings Jan. 16, 1967 PETITION FILED: FEE PAID Jan. 16, 1967; Served Jan. 17, 1967 Mar. 20, 1967 REQUEST by Resp. for trial at Los Angeles, Calif. Action, Granted 3/21/ 67; Served Mar, 23, 1967 Mar. 20, 1967 ANSWER filed by Resp. Served Mar. 23, 1967 Jan. 16, 1968 NOTICE of TRIAL April 8, 1968 at Los Angeles, Calif. Served Jan. 16, 1968 Mar. 4, 1968 MOTION by petr. for leave to file Amendment to Petition. Amendment to Petition Lodged. Action, Granted March 26, 1968; Served Mar. 27, 1968 March 6, 1968 NOTICE of filing of petr. motion for leave to file amendment to petition and hearing on March 27, 1968, if objection filed by March 22, 1968. Served March 6, 1968 March 26, 1968 Amendment to Petition filed; Served Mar. 27, 1968 Date Filings and Proceedings ee April 8, 9, 10, 1968 TRIAL before Judge Raum—Los Apn- April 24, 1968 April 29, 1968 May 27, 1968 May 29, 1968 May 29, 1968 June 24, 1968 June 26, 1968 geles, California Stipulation of Facts w/attached exhibits Respondent’s Amended Answer filed and served PARTIES shall file with the Court ex. hibits #42, 44, 45 and 29AC. BRIEFS due May 27, 1968 REPLY BRIEFS due June 26, 1968 SUBMITTED TO JUDGE RAUM UN- DER SUBMISSION TRANSCRIPT of Trial of Apr. 9 & 10, 1968, rec’d (2). TRANSCRIPT of Trial of Apr. 8, 1968, received. BRIEF for Respondent filed; Served May 29, 1968 BRIEF for Petitioner filed (20-P); Served May 29, 1968 ENTRY OF APPEARANCE for petr. by Victor L, Walch; Served June 7, 1968 JOINT MOTION to extend time from June 26, 1968 to July 10, 1968 to file Reply Briefs, Action, Granted 6/25/ 68; Served Jun 26, 1968 MOTION by Cyrus A. Neuman for leave to file Amicus Curiae Brief. Action, Granted 6/26/68; Served Jun 27, 1968 Filings and Proceedings July 10, 1968 July 11, 1968 Oct. 21, 1968 Oct. 21, 1968 Jan. 13, 1969 Jan. 14, 1969 Jan. 14, 1969 Jan. 24, 1969 AMICUS CURIAE BRIEF filed by Cyrus A. Neuman. (Brief was served on both petr. ard resp. by Cyrus A. Neuman.) REPLY BRIEF for Respondent filed. Served July 11, 1968 REPLY BRIEF for Petitioner filed. (Permission to file); Action (20-P. copies); Served July 11, 1968 FINDINGS OF FACT AND OPINION filed Judge Raum Decision will be entered for the respond- ent; Served Oct 21, 1968 DECISION enteref, Judge Raum. Served Oct. 21, 1968 APPELLATE PROCEEDINGS NOTICE of Appeal to USCA, Ninth Cir., filed by petitioner. Served Jan. 14, 1969 NOTICE with copy of notice of appeal sent to Lester R. Uretz, Chief Coun- sel. Served Jan. 14, 1969 NOTICE, to parties, of assembling and date for transmission of record. Served Jan. 14, 1969 MOTION filed by Resp. to withdraw Exs. 1-A, 2-B, & 3-C & substitute copies. Action, Granted 1/27/69; Served Jan. 27, 1969 UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT Docket No. 23923 [Caption Omitted | RELEVANT DOCKET ENTRIES Date Filings and Proceedings 1969 Feb. 25 FILED FEB. 20, 1969, CERTIFIED TYPED TRANSC. OF REC. (PLEADINGS, VOL I) FILED ORIG. REPTR. TRANSC. IN THREE VOLS (VOLS 2, 3, & 4 OF REC.) FILED ORIG. EXHIBITS IN RM. 219 * * * DOCKETED CAUSE & ENTERED APPEAR- ANCES OF COUNSEL a = * Oct. 10 Argued and submitted to E[Ely]-Hu[Hufsted- ler], CJJ & Thompson, DJ + * * 1970 Hufstedkr, CJ dis. Feb. 2 ORDERED OPINION (THOMPSON) FILED & JUDG. FILED & ENT. eo a Filed opinion. Decision of Tax Ct. rev. OF ne Filed & ent. judgment Feb. 16 Recvd. appellee motion for ext of time in which to file en banc petition for rehearing (panel) Feb. 19 Filed order (E) extding time to 2/24 in which appellee may file petition for rehearing Filings and Proceedings FILED 25 OF APPELLEES PETITION FOR REHEARING EN BANC Recvd. prae & entered appearance of counsel for appellee-CIR Filed order (E Hu & Thompson) denying petition for rehearing rejecting suggestion for rehearing en banc. ISSUED JUDGMENT TO CLERK OF DIS- TRICT COURT oo TAX COURT OF THE UNITED STATES {Caption Omitted} PETITION (Filed January 16, 1967) The above-named petitioner hereby petitions for a re determination of the deficiency set forth by the Commis. sioner of Internal Revenue in his notice of defici dated October 20, 1966 (Service symbols Form L-50, Code 411:90D: PWK), and as the basis of its case alleges as follows: 1. Petitioner is a corporation organized and existing under the laws of the State of California with its prin- cipal office at 630 West Sixth Street, Los Angeles, Cali- fornia 90017. The return for the period involved here was filed with the District Director of Internal Revenue at Los Angeles, California. 2. The notice of deficiency (a copy of which is at- tached and marked Exhibit A) was mailed to the peti- tioner on October 20, 1966. 8. The deficiency as determined by the Commissioner is in income tax for the calendar year 1963 in the sum of $461,454.38, of which approximately $458,971.17 is in dispute. 4. The determination of tax set forth in the notice of deficiency is based upon the following errors: (a) The Commissioner erred in disallowing a por- tion of the federal insurance premium expense paid and deducted on petitioner’s income tax return for the calen- dar year 1968, namely, the sum of $882,636.86 out of a total of $1,018,397.388 of federal insurance premium ex- pense paid and claimed for the year 1963. (b) The Commissioner erred in determining any deficiency in petitioner’s income tax liability for the cal- endar year 1963 in excess of the sum of $2,483.21. 5. The facts upon which petitioner relies as the basis of this case are as follows: 7 (a) Petitioner is a stock corporation, organized and existing under the laws of the State of California, en- in the savings and loan business. (b) Petitioner is a member of the Federal Home Loan Bank system (referred to herein as “FHLB”). Such membership is a necessity from a competitive busi- ness standpoint in the sevings and loan business. As a member of the FHLB system petitioner is required to insure the savings accounts of its depositors with the Federal Savings and Loan Insurance Corporation (re- ferred to herein as “FSLIC”), in accordance with the laws enacted by Congress. (ec) The FSLIC was organized in 1934 to provide stability to the savings and loan industry through insur- ance of savings accounts. Prior to January 1, 1962 each insured member was required to pay to the FSLIC an annual premium of 1/12 of 1 percent of the total of its savings accounts and creditor obligations, for insurance by the FSLIC of its depositors’ savings accounts. Such insurance premiums have created what is known as the primary reserve on the books of the FSLIC, and have con- sistently been deducted as ordinary and necessary busi- ness expenses in carrying on the savings and loan busi- ness. Petitioner paid such insurance premiums during the year 1963 in the sum of $135,760.52, and the deduc- tion thereof has been allowed by the Commissioner in the notice of deficiency. (d) On September 8, 1961, Congress enacted Pub- lice Law 87-210, which, among other provisions, amended Section 404 of the National Housing Act by adding sub- sections “(d)”, “(e)”, “(f)”, and “(g)” to Section 404, effective January 1, 1962. The Act as amended requires each insured member to pay to the FSLIC annually an additional insurance premium equal to 2 percent of the net increase in all savings accounts of the insured mem- ber during the preceding calendar year less the amount, if any, of required additional investment in FHLB stock. The additional insurance premium is credited on the books of FSLIC to a so-called secondary reserve account. Petitioner paid such additional insurance premium dur- ing the taxable vear 1963 in the sum of $882,636.86 and deducted such sum on its return for that year as an ordinary and necessary business expense. The Commis- sioner has disallowed such de*: ction, with the explana- tion in the notice of deficiency that “you have failed to establish that you are entitled to deductions in excess of the amounts allowed.” (e) The additional insurance premium thus disal- lowed was an expense necessarily incurred by petitioner as a condition to its continuing to engage in the savings and loan business during the year 1963. It was an ordinary expense of carrying on such business. Such ad- ditional premium was therefore an allowable deduction as an ordinary and necessary business expense under Section 162 of the Internal Revenue Code. The Commissioner’s proposed disallowance thereof is erroneous and illegal. (f) Petitioner is informed and believes, and there- fore alleges, that the payment of the additional insurance premium of the character involved here was required by Congress in order to strengthen the FSLIC, because, due to rapid growth of insured members, the ratio of the FSLIC’s reserves to its potential liability had dropped and it was deemed necessary that its reserves be built up at a faster rate than was occurring under the Act prior to its amendment in 1961. From petitioner’s standpoint there was and is no practical difference between the prem- ium payment under the original Act and the additional insurance premium. Both were expenses incurred in carrying on its business, and neither resulted in the ac- quisition by petitioner of say asset having any ascertain- able fair market value. Any possibility of the return to petitioner of any portion of the additional insurance premium was and is so remote, indefinite, and contingent as to be negligible. (g) The deduction of the additional insurance premium should accordingly be allowed as claimed on pe- titioner’s return for the taxable year 1968. — 9 WHEREFORE, petitioner prays that this Court may try the case, determine that the Commissioner erred as alleged above, and grant such other and further relief as may be proper in the premises. /s/ A Calder Mackay A. CALDER MACKAY /s/ Adam Y. Bennion ADAM Y. BENNION /s/ Richard N. Mackay RICHARD N. MACKAY 523 West Sixth Street, Suite 828 Los Angeles, California 90014. COUNSEL FOR PETITIONER [Jurat Omitted] —— 10 TAX COURT OF THE UNITED STATES [Caption Omitted] ANSWER (Filed March 20, 1967) THE RESPONDENT, in answer to the petition filed in the above-entitled case, admits, denied and alleges as follows: 1 and 2. Admits the allegations of paragraphs 1 and 2 of the petition. 8. Admits that the deficiency as determined by the Commissioner is in income tax for the calendar year 1963 in the sum of $461,454.38 but denies the remaining allegations of paragraph 3 of the petition. Alleges that the entire deficiency is in dispute. 4. Denies the allegations of paragraph 4 of the peti- tion and all subparagraphs thereunder. 5 (a). Admits the allegations of subparagraph (a) of paragraph 5 of the petition. (b). Admits that petitioner is a member of the Fed- eral Home Loan Bank system (referred to herein as “FHLB”) and that as a member of the FHLB system petitioner is required to insure the savings accounts of its depositors with the Federal Savings and Loan Insurance Corporation (referred to herein as “FSLIC’”), in accord- ance with the laws enacted by Congress. Denies the re- maining allegations of subparagraph (b) of paragraph 5 of the petition. (c). Admits the alle «ns of subparagraph (c) of paragraph 5 of the petition. (d). Admits the allegations of subparagraph (d) of paragraph 5 of the petition except denies that the pay- ments referred to as “additional insurance premiums” constituted insurance premiums during the taxable year 1963. (e)-(g), inclusive. Denies the allegations of sub- paragraphs (e)-(g), inclusive, of paragraph 5 of the petition. ll 6. Denies generally each and every allegation of the petition not hereinbefore specifically admitted, qualified or denied. WHEREFORE, it is prayed that the deficiency deter- mined by the respondent be in all respects approved. /s/ Lester R. Uretz/DPC LESTER R. URETZ Chief Counsel Internal Revenue Service OF COUNSEL: MELVIN L. SERRS Regional Counsel JAMES A. THOMAS Attorney Internal Revenue Service JAT/emb (C) TAX COURT OF THE UNITED STATES {Caption Omitted] AMENDED ANSWER (Filed March 9, 1968) THE RESPONDENT, in answer to the petition and Amendment to Petition filed in the above-entitled case, admits, denies and alleges as follows: 1 and 2. Admits the allegations of paragraphs 1 and 2 of the petition. 8. Admits that the deficiency as determined by the Commissioner is in income tax for the calendar year 1963 in the sum of $461,454.38 but denies the remaining allegations of paragraph 3 of the petition. Alleges that the entitre deficiency is in dispute. 4. Denies the allegations of paragraph 4 of the petition and subparagraphs (b) and (c) thereunder; * * * * * * @ 5 (a). Admits the allegations of subparagraph (a) of paragraph 5 of the petition. 5 (b). Admits that petitioner is a member of the Fed- eral Home Loan Bank system. Denies the remaining al- legations of subparagraph (b) of paragraph 5 of the petition. (c). Admits the allegations of subparagraph (c) of paragraph 5 of the petition. (d). Admits the allegations of subparagraph (d) of paragraph 5 of the petition except denies that the pay- ments referred to as “additional insurance premiums” constituted insurance premiums during the taxable year 1963. (e)-(g), inclusive. Denies the allegations of sub- paragraphs (e)-(g), inclusive, of paragraph 5 of the peti- tion. 13 6. Denies generally each and every allegation of the petition and amendment to petition not hereinbefore spe- cifically admitted, qualified or denied. WHEREFORE, it is prayed that the deficiency deter- mined by the respondent be in all respects approved. /s/ Lester R. Uretz LESTER R. URETZ Chief Counsel Internal Revenue Service OF COUNSEL: AARON S. RESNIK Acting Regional Counsel JAMES A. THOMAS Attorney Internal Revenue Service 14 TAX COURT OF THE UNITED STATES {Caption Omitted] STIPULATION OF FACTS (Filed April 9, 1968) It is hereby stipulated that, for the purpose of this case, unless otherwise provided, the following statements may be accepted as facts and the exhibits attached as true copies of the original documents; provided, however, that either party may object to the admission of such facts or exhibits or both on the grounds of materiality and relevancy; and that either party may introduce other and further evidence not inconsistent with the facts herein stipulated: 1. Lincoln Savings and Loan Association (herein- after—“petitioner” or “Lincoln Savings”) is a corpora- tion organized and existing under the laws of the State of California, having been incorporated on February 6, 1925. Its name, originally Lincoln Building & Loan As- sociation, was changed on August 5, 1943 to Lincoln Say- ings and Loan Association. At the date of the filing of the petition in the instant case, petitioner’s principal office was located at 630 West Sixth Street, Los Angeles, Cali- fornia. Petitioner filed its tax returns for the calendar years 1962, 1963 and 1964 with the District Director of Internal Revenue at Los Angeles, California, copies of which are attached hereto and marked Exhibits 1-A, 2-B and 3-C, respectively. 2. All of petitioner’s outstanding stock (consisting of 2,500 shares with a par value of $100.00 per share) has been owned since 1964 by First Lincoln Financial Cor- poration, which is a corporation organized under the laws of the State of California with its principal office in Los Angeles, California. During 1962 and 1963, First Lincoln Financial Corporation owned 98.88% of petitioner’s out- standing stock. On December 31, 1963, First Lincoln Financial Corporation had 1,402,654 shares of stock out- standing, without par value, owned by approximately 15 2,800 shareholders. The stock of First Lincoln Financial Corporation is traded over-the-counter. 8. On February 6, 1925, petitioner was licensed as a savings and loan association by the Savings and Loan Commissioner of the State of California, and since that date at all times petitioner has been and remains a licensed savings and loan association under the laws of the State of California, transacting business in the Los Angeles area. California licensed savings and loan associations are regulated by Division II of the California Financial Code (West’s Annotated California Codes, Financial Code, Section 5,000, et seq.), and by regulations of the Califor- nia Savings and Loan Commissioner, being Chapter 2 of Chapter 10 of the California Administrative Codes, which law and regulations are incorporated herein by reference. Attached hereto and marked Exhibit 4-D is a copy of a letter dated December 4, 1962, by the California Savings and Loan Commissioner issued to all California licensed savings and loan associations with an attached order revising Subchapter 1 of Chapter 2 (the “Uniform Classi- fication of Accounts”) of his regulations, effective Jan- uary 1, 1963. 4. Upon application by it, petitioner on March 4, 1936, became a member of the Federal Home Loan Bank of Los Angeles (hereinafter—“FHLB”), and since that date at all times petitioner has been and remains a member of such bank. (Now the Federal Home Loan Bank of San Franciso). Attached hereto and marked Exhibit 5-E is a copy of petitioner’s certificate of membership dated March 4, 1936. 5. Upon application by it, petitioner on June 6, 1938, became an insured institution of the Federal Savings and Loan Insurance Corporation (hereinafter—“FSLIC”) as provided in Title IV of the National Housing Act, as amended. Attached hereto and marked Exhibit 6-F is a copy of the petitioner’s certificate of insurance. 6. Attached hereto and marked Exhibits 7-G and 8-H, respectively, are copies of the petitioner’s Articles of In- corporation and By-Laws. 7. Attached hereto and marked Exhibit 9-I is a copy of the annual license under which petitioner was licensed nag 16 and authorized to transact the business of a savings and loan association in the State of California during the calendar year 1963. Similar annual licenses have au- thorized petitioner to transact such business during years prior and subsequent to 1963. 8. The FSLIC is a corporation created by the laws of the United States under the National Housing Act of 1934, (12 U.S.C.A. § 1724, et seq.). The FSLIC operates under the direction of the Federal Home Loan Bank Board (hereinafter—“FHLB Board’). 9. By statute, the FSLIC had an original capital stock of $100,000,000, all of which was subscribed for originally by the Home Owners Loan Corporation. This stock was eventually transferred to the Secretary of the Treasury of the United States. By amendments in 1950 to the National Housing Act, the FSLIC was authorized and directed to pay off and retire annually at par an amount of its capital stock equal to 50% of its net income for the fiscal year. On July 1, 1958, the FSLIC completed retirement of its outstanding capital stock. 10. Prior to January 1, 1962, each insured institution was required by Section 1727(a) of Title 12 of the United States Code (12 U.S.C.A. § 1727(a)) to pay to the FSLIC an annual premium of 1/12 of 1% of the total amount of all savings accounts and creditors’ obligations, for insur- ance by the FSLIC of its depositors’ savings accounts. Such annual payments have consistently been deducted as ordinary and necessary business expenses in carrying on the savings and loan business. 11. On Sepember 8, 1961, Congress enacted Public Law 87-210 which, among other provisions, amended Sec- tion 404 of the National Housing Act. A copy of Public Law 87-210 is attached hereto and marked Exhibit 10-J. Hereinafter, payments made by the petitioner pursuant to Section 1727(b) (1) of Title 12, United States Code (12 U.S.C.A. § 1727(b) (1) ) as amended will be referred to as “Section 1727(b) payments,’ and payments made by the petitioner pursuant to Section 1727(d) of Title 12 (12 U.S.C.A. § 1727(d)) will be referred to as “Section 1727 (d) payments.” 12. Attached hereto and marked Exhibits 11-K and 12-L, respectively, are copies of Senate Report No. 778 17 and House Report No. 823, both of the 87th Congress, 1st Session, which reports accompanied the legislation re- sulting in Public Law 87-210. Attached hereto and marked Exhibit 13-M are copies of 5 schedules (identified as Ex- hibit A, Exhibit B, Exhibit C, Schedule 1 and Schedule 2) which were prepared in the Office of the Comptroller of the FSLIC and submitted to the Senate Committee of Banking and Currency subsequent to the printing of Senate Report No. 778. These exhibits and schedules use the same “assumptions” used in Exhibits A through E of Senate Report No. 778. 13. During the calendar years 1962 through 1967, the petitioner made payments to the FSLIC as follows: Year § 1727(b) Payments § 1727(d) Payments 1962 $ 93,258.58 $ 126,759.48 1963 135,760.52 882,636.86 1964 196,412.86 450,829.68 1965 271,477.00 1,095,089.00 1966 317,427.60 1,226,064.76 1967 373,025.38 None 14. On its Federal income tax returns for the above years, petitioner deducted all sums paid by it to the FSLIC as listed above under both Section 1727(b) and Section 1727(d) under “other deductions” as “Federal insurance premiums.” Interest credited by the FSLIC to petitioner’s pro rata share of the secondary reserve pur- suant to Section 1727(e) (hereinafter—‘Section 1727 (e) interest”) was not reported on petitioner’s returns. Upon examination of its returns for the taxable years 1962, 1963 and 1964, the Commissioner allowed the de- duction for the amounts paid under Section 1727(b), but disallowed the deduction for the amounts paid under Section 1727(d). 15. Attached hereto and marked Exhibit 14-N are copies of “Insurance Premium Notices” received by peti- tioner from the FSLIC for the payment due under Sec- tion 1727(b) for the calendar years 1962 through 1967. Attached hereto and marked Exhibit 15-0 are copies of “Notice of insurance premium prepayment” received by 18 petitioner from the FSLIC for the payments due under a 1727(d) for the calendar years 1962 through 1967. 16. Attached hereto and marked Exhibit 16-P is a copy of a memorandum dated May 21, 1962, which was issued by the State of California, Division of Savings & Loan, to all California licensed savings and loan associations. This ruling was modified and incorporated into the “Uniform Classification of Accounts” effective January 1, 19638, as set forth in Exhibit 4-D at page 54 under the heading “Contributions to the Secondary Reserve-FSLIC.” All sub- sequent “Uniform Classification of Accounts” published by the California Savings and Loan Commissioner have required identical treatment of the “Contributions to the Secondary Reserve-FSLIC” as set forth at page 54 of Exhibit 4-D. 17. Attached hereto and marked Exhibits 17-Q, 18-R, 19-S, 20-T and 21-U, respectively, are copies of the peti- tioner’s “Financial Statements” and “Accountant’s Re- port” for each of the calendar years 1962 through 1966. On petitioner’s balance sheet for the year 1962, the pay- ments made pursuant to Section 1727(d) and the Section 1727(e) interest credited to petitioner’s account by the FSLIC were included in “Other Assets.” Beginning with 1963, the Section 1727(d) payments and the Section 1727 (e) interest have been shown on the asset side of the balance sheet as “Prepaid Federal Savings and Loan In- surance Corporation Premiums.” The Section 1727 (d) payments were not included as expense on any of the “Statement of Operations” for the period 1962 through 1966. The interest credited to petitioner’s account pur- suant to Section 1727(e) by the FSLIC for each of the years 1962 through 1966 was included in miscellaneous income on each of the “Statement of Operations” for the year in which the interest was credited to petitioner’s account by the FSLIC. 18. Attached hereto and marked Exhibits V, W, X, Y and Z, respectively, are “Consolidated Financial State- ments” for each of the years 1962 through 1966 for First Lincoln Financial Corporation and subsidiaries. With re- spect to the petitioner, the same financial figures set forth 19 on Exhibits 17-Q through 21-U were used in these consoli- dated financial statements. For the calendar years 1962 through 1964, the Section 1727(d) payments by peti- tioner together with its Section 1727(e) interest were included on the asset side of the consolidated balance sheets in “Other Assets.” For the calendar years 1965 and 1966, the Section 1727(d) payments and Section 1727(e) interest of petitioner is shown as “Prepaid Fed- eral Savings and Loan Insurance Corporation premiums.” 19. The regulations of the FHLB Board require each savings and loan association, which is a member of the Federal Home Loan Bank system, to file, on forms pro- vided by the Board, a semiannual report of its affairs as of the end of each semiannual period. Printed instruc- tions for the preparation of such reports are published and distributed to each member. The “Introduction” to these instructions provide “These instructions are pro- vided to assist in the completion of monthly and semian- nual reports by members of the Federal Home Loan Bank system. Each reporting institution is urged to carefully follow these instructions . . .” The instructions further provide that the reports may be submitted on either a cash or accrual basis, in conformity with the accounting method used by the institution in keeping its books. At- tached hereto and marked Exhibit 27-AA is a copy of the FHLB Board instructions for reporting “Other As- sets,” as in effect during the years 1962 through 1966. Attached hereto and marked Exhibit 28-AB is a copy of the report filed by petitioner with the FHLB Board for the close of business December 31, 19638. In all of its reports to the FHLB Board since 1962, the petitioner has reported its pro rata share of the “Secondary Reserve” in the same manner as set forth on Exhibit 28-AB. 20. Payments made by insured institutions pursuant to Section 1727(d) have been credited on the books and records of the FSLIC directly to an account entitled “Sec- ondary Reserve.” Effective with the first payments pur- suant to Section 1727(d) made by insured institutions, the FSLIC has maintained separate accounts for each insured institution showing, among other things, the amount of payment pursuant to Section 1727(d), the in- — 20 terest credited by the FSLIC to the account pursuant to Section 1727(e), and the insured institution’s pro rata share of the secondary reserve. Attached hereto and marked Exhibit 29-AC is a copy of the account main- tained by the FSLIC for the petition. Attached hereto and marked Exhibit 30-AD are copies of “Status of In- surance Premium Prepayment Account” as of December 31, 1963; December 31, 1965; December 31, 1966; and December 31, 1967; received by petitioner on the FSLIC. Petitioner believes that a similar document was received from the FSLIC as of December 31, 1962 and December 31, 1964, but cannot locate such in its files and records at the present time. 21. Attached hereto and marked Exhibits 31-AE, 32- AF, 33-AG, 34-AH and 35-AlI, respectively, are copies of the financial statements distributed by the FSLIC for the fiscal year ended June, 1963, and calendar years 1964- 1967. 22. Attached hereto and marked Exhibit 36-AJ is a copy of the “Rules and Regulations for Insurance of Ac- counts’ issued by the FSLIC, which were in effect in 1963. 23. Attached hereto and marked Exh’bits 37 through 41, respectively, are copies of the annual reports of the Federal Home Loan Bank Board for the calendar years 1962 through 1966, which were submitted to the Con- gress of the United States pursuant to Section 1727(b) of the Federal Home Loan Bank Act. 24. Members of the Federal Home Loan Bank system are not required to insure the savings accounts of its de positors with the FSLIC. 25. The petitioner concedes the correctness of all of the adjustments made by respondent for the taxable year ended December 31, 1963 (page 5 of the statutory notice), with the exception of the adjustment (b) entitled “Fed- eral Insurance Premuium Expense.” 26. Attached hereto and marked Exhibit 42 is a copy of a report to the Congress of the United States by the Comptroller General of the United States dated October 1964 regarding the audit of the FSLIC for the year ended June 30, 1963. Attached hereto and marked Ex- 21 hibit 43 is a copy of a report to the Congress of the United States by the Comptroller General of the United States dated May 1967 regarding the audit of the FSLIC for the period July 1, 1963 through December 31, 1965. Respondent stipulates only to the authenticity of Exhibits 42 and 48, and reserve all other objections to the admis- sion of these exhibits as evidenced in this case. 27. Attached hereto and marked Exhibit 44 in a copy of the statement of John E. Horn, Chairman, Federal Home Loan Bank Board, before the Subcommittee on Financial Institutions of the Committee of Banking and Currency, United States Senate, regarding S. 3158, 89th Cong., April 4, 1966, together with a transmittal letter by John E. Horn dated April 12, 1966, transmitting a copy of such testimony to each insured savings and loan association. Respondent stipulates only to the authenticity of Exhibit 44, and reserves all other objections to the ad- mission of this exhibit as evidence in this case. 28. Attached hereto and marked Exhibits 45, 46 and 47, respectively, are copies of the annual reports of the California Savings and Loan Commissioner for the cal- endar years 1959, 1963 and 1966. 29. Attached hereto and marked Exhibit 48 is a copy of a report to the Congress of the United States by the Comptroller General of the United States dated Decem- ber 1961 regarding the audit of the FSLIC for the fiscal year ended June 30, 1961. Attached hereto and marked Exhibit 49 is a copy of a report to the Congress of the United States by the Comptroller General of the United States dated January 1963 regarding the audit of the FSLIC for the fiscal year ended June 30, 1962. Respond- ent stipulates only to the authenticity of Exhibits 48 and 49, and reserves all other objections to the admission of these exhibits as evidence in this case. /s/ Adam G. Bennion Counsel for Petitioner /s/ Lester R. Uretz LESTER R. URETZ Chief Counsel Internal Revenue Service STIPULATION EXHIBIT 4-D Letter and Revision of Uniform Classification of Accounts 540 Van Hess Avenue San Francisco 2 PRESTON N. SILBAUGH 8460 Wilshire Blvd. COMMISSIONER Los Angeles 5 EDMUND G. BROWN GOVERNOR STATE OF CALIFORNIA DIVISION OF SAVINGS AND LOAN Los Angles December 4, 1962 TO: All State-Licensed Savings and Loan Associations RE: Uniform Classification of Accounts Attached is a copy of the Savings and Loan Commis- sioner’s order in the above matter. It was filed with the Secretary of State on November 29, 1962, and will become effective on January 1, 1963. The principal revisions made since the preceding Uniform Classification of Accounts was filed on May 2, 1956, are as follows: Uniform Classification of Accounts #2 7. The following additional accounts have been pro- vided : Additions Account Number 197 Contributions to Secondary Reserve—F.S.L.1.C. * . a * — Uniform Classification of Accounts #4 Questions of interpretation may be submitted to the office of the Savings and Loan Commissioner, 3460 Wilshire Boulevard, Los Angeles 5, or 540 Van Ness Avenue, San Francisco 2. We wish to thank those who offered suggestions to our staff during the long course of revision. We especially acknowledge the contributions of the California Savings and Loan League, the Society of Savings and Loan Con- trollers, the Committee for Savings and Loan of the Cali- fornia State Society of Certified Public Accounts and the many individual accounts, whose thoughtful comments did much to enrich the product. /s/ Preston N. Slibaugh PRESTON N. SILBAUGH Savings and Loan Commissioner Enclosure Ty STATE OF CALIFORNA DEPARTMENT OF INVESTMENT DIVISION OF SAVINGS AND LOAN ORDER ADOPTING, AMENDING, OR REPEALING REGULATIONS OF THE SAVINGS AND LOAN COMMISSIONER After proceedings had in accordance with the provi- sions of the Administrative Procedure Act (Gov. Code, Title 2, Div. 3, Part 1, Chapter 4) and pursuant to the authority vested by Section 5255 of the Financial Code, and to implement, interpret, or make specific Section 8701 of the Financial Code, the Savings and Loan Com- missioner hereby repeals, amends, revises and adopts his regulations in Title 10, California Administrative Code, as follows: Adopts new Subcapter 1 of Chapter 2 to read: a a ae J CLASSIFICATION OF ACCOUNTS ASSET ACCOUNTS Account No. Account Name FHLBB Annual Report Exhibit “A” Line No. * _ e e OTHER ASSETS * a + eo 194 Prepaid Expenses and Deferred Charges 194-1 Assessments (State License, League Dues, etc.) 14 194-2 Surety Bond Premiums ) ) ) ) 194-3 Federal Savings and Loan ) Insurance Corporation ) Premiums ) ) 194-4 Other Insurance Premiums ) ) 14 194-5 Taxes ) ) 194-6 Acquisition Cost of Loans ) ) 194-7 Other Prepaid Expenses ) and Deferred Charges ) * * * * 197 Contribution to Secondary Reserve—F.S.L.I.C 15 * * * EXPLANATORY TEXT OF BALANCE SHEET AND PROFIT AND LOSS ACCOUNTS e * a * 26 194 Preferred Expenses and Deferred Charges This account, if carried, shall reflect that portion of expenses paid or accrved applicable to future periods and shall indicate the proper segregation thereof in the ledger according to the subaccounts set forth in the Uniform Classification of Accounts under Account No 194. * * * * 197 Contributions to the Secondary Reserve— FSLIC This account shall be debited for the annual prepay- ment to the FSLIC Secondary Reserve. Interest earned on the prepayments is recorded by a debit to this account and a credit to Account No. 407. Transfer to the Primary Reserve is recorded by crediting this account and debiting Account No. 511. Both the interest and transfer entries are made at the time of notification by the insurer. 27 STIPULATION EXHIBIT 14-N INSURANCE PREMIUM NOTICES SOUPS TOG) 321440 ONIANINE ANTINNETAOU 6 ON 1" "2° ‘ST voiturysomy "M ‘CN ‘anusay vueipuy for *uOssVs0d 40!) 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JL MOA SITLIMNIAS INAWNYZANG ‘£1006 .WINdOSIIV) S3739NV $07 «SIAM IS GILING NT SIP AWIS FANT L3IYLS HLXIS 453M Oy Sit yA MOTLYYOdYAN GH. SL ed VOULVISOSSY .VOT ChY SONTAVS KIOINIT - “34 4P 3LWe WONNY 29eNI4y INL 9902 OL Weezy 3ive v tv GalNawod cr NHNLIM MIML e471 AG CIMNTINAG owe $79S Ow! 19517 Le y79S UO? OU LYSE *VI9S Ulorul] seprpout (e)_ ase ee jal pe BY iy a 9 gmesunteze’y ¢ dtyse*6si t Sudezestn = ¢ (@) <é* ose" zed"n ; we is eILwy NMALSM MIL IY erence mer cree menwwens?, NYNLIN 94043 SEATE, PT VND Ee de CL CILIAIAD MMILIM c9/LE/2T Bt: L96T STE M3AWADIA AC ~W INGCTIW LNINAWASNA WOEWIdd JINYYASNI 49 SNLYLS ENDED NOVEMBER 10, 1906 TAX COURT OF THE UNITED STATES 51 T.C. No. 10 [Caption Omitted] FINDINGS OF FACT AND OPINION (Filed October 21, 1968) Petitioner, a California savings and loan association, insures the accounts of its depositors with the Federal Savings and Loan Insurance Corporation (FSLIC). It pays regular annual premiums for such insurance cover- age, which are deductible. Such premiums are part of FSLIC’s gross income, available to meet all current ex- penses and losses, and to the extent not so used are trans- ferred to FSLIC’s “Primary Reserve” to meet losses of future years. Since 1962, petitioner has also been required to make additional annual payments “in the nature of * * * prepayment[s] with respect to future premiums.” Such “prepayments” immediately become part of the FSLIC’s “Secondary Reserve,” which is available to a limited extent to meet future losses in the event of de- pletion of all other resources of the FSLIC. Although petitioner has no interest in the Primary Reserve, it has a pro rata interest in the Secondary Reserve. That in- terest is reflected in an account which is rendered to it annually by the FSLIC showing the amount of the “pre- payments” made by petitioner together with an annual “return” computed upon the balance in the account at the end of each year. The balance in such account is to be used to discharge petitioner’s obligation to pay its regu- lar insurance premiums in future years after the total of FSLIC’s Primary Reserve and Secondary Reserve reaches a certain level, but petitioner may transfer its account (its pro rata interest in the Secondary Reserve) to another insured institution in the event of merger, consolidation or bulk sale, and may recover any unused | balance in its account in cash if it terminates insurance : with the FSLIC or liquidates. Petitioner’s pro rata share | of the Secondary Reserve appears on its financial state- © 40 ments and the consolidated statements of its parent as an asset, and both State and Federal regulatory agencies require that the “prepayments” be capitalized and not expensed until used to pay premiums or cover losses. Held the “prepayments” are also capital expenditures for Fed- eral income tax purposes, deductible only in the years and to the extent used to discharge petitioner’s obligation to pay regular insurance premiums or to meet actual losses of the FSLIC. Adam Y. Bennion, A. Calder Mackay and Richard N. Mackay, for the petitioner. James A. Thomas, for the respondent. The Commissioner determined a deficiency in petition- er’s income tax of $461,454.38 for the year 1963. Peti- tioner disputes so much of that deficiency as is based upon the Commissioner’s disallowance of a deduction in the amount of $882,636.86, which petitioner claimed as a “Federal Insurance Premium” expense in that year. Peti- tioner paid this amount to the Federal Savings and Loan Insurance Corporation in 19638, as well as its regular annual insurance premium for that year, as it was re- quired to do by 12 U.S.C. sec.1727(d), which section characterized the payment as an “additional premium in the nature of a prepayment with respect to future pre- miums.” The issue for decision is whether such payment was an ordinary and necessary expense of petitioner’s business in 1963, or whether it was a capital expenditure deductible, if at all, only when actually used to discharge petitioner’s obligation to pay regular annual insurance premiums or to meet insurance losses of the Federal Savings and Loan Insurance Corporation. FINDINGS OF FACT Some of the facts have been stipulated and, as stipu- lated, are incorporated herein by this reference together with accompanying exhibits. Lincoln Savings and Loan Association (hereinafter sometimes referred to as “petitioner”) is a corporation organized under the laws of the State of California, in- corporated on February 6, 1925. It’s name, originally Lincoln Building & Loan Association, was changed on — 41 August 5, 1943 to Lincoln Savings and Loan Association. At the date of the filing of the petition in this case, peti- tioner’s principal office was located at 630 West Sixth Street, Los Angles, California. It filed its tax returns for the calendar years 1962, 1963 and 1964 on the cash re- ceipts and disbursements basis of accounting with the district director of internal revenue, Los Angeles, Cali- fornia. All of petitioner’s outstanding stock (consisting of 2,500 shares with a par value of $100 per share) has been owned since 1964 by First Lincoln Financial Corporation, which is a corporation organized under the laws of the State of California with its principal office in Los Angeles, California. During 1962 and 19638, First Lincoln Financial Corporation owned 98.88 percent of petitioner’s outstand- ing stock. On December 31, 1968, First Lincoln Financial Corporation had 1,402,654 shares of stock outstanding, without par value, owned by approximately 2,800 share- holders. Its stock is traded over-the-counter. Petitioner was licensed as a savings and loan associa- tion by the Savings and Loan Commissioner of the State of California on February 6, 1925, and since that date has been and remains a licensed savings and loan asso- ciation under the laws of the State of California, trans- acting business in the Los Angeles area. As such, it is regulated by Division II of the California Financial Code (West’s Annotated California Codes, Financial Code, Section 5000, et seg.) and by regulations of the California Savings and Loan Commissioner, which law and regula- tions are incorporated herein by reference. Petitioner is a member of the Federal Home Loan Bank of San Francisco, one of twelve regional district banks established and supervised by the Federal Home Loan Bank Board (hereinafter sometimes referred to as the FHLB Board) under authority of the Federal Home Loan Bank Act of 1982. See 12 U.S.C. sec. 1428. These banks provide additional liquidity and funds for mortgage lending by making advances to member institutions as needed to meet unusual or heavy withdrawal and credit demands. As a condition of membership, each member institution is required to purchase capital stock in its bank ——_ equal to one percent of its outstanding “unpaid loan principal,” and to invest in such amounts of stock there- after as is necessary to maintain this percentage. 12 U.S.C. sec. 1426(c). Prior to 1962 the statutory level was two percent but thereafter, as part of a comprehensive legislative plan calling for certain additional payments by “insured institutions” to the Federal Savings and Loan Insurance Corporation, as hereinafter set forth, the level was reduced to one percent. Since 1938, petitioner has been an “insured institution” of the Federal Savings and Loan Insurance Corporation (hereinafter sometimes referred to as the FSLIC), a cor- poration created by the laws of the United States under Title IV of the National Housing Act of 1934, 12 U.S.C. sec. 1724 et seqg., and operated under the direction of the FHLB Board, which is required by statute to insure the accounts of all Federal savings and loan associations, and is permitted to insure the accounts of qualified state chartered savings and loan associations, such as petitioner. 12 U.S.C. sec. 1726. Members of the Federal Home Loan Bank system are not required to insure the savings ac- counts of their depositors with the FSLIC, unless they are also Federally-chartered savings and loan associations. Similarly, except for Federal savings and loan associa- tions, any insured institution of the FSLIC may volun- tarily terminate such insurance, provided adequate notice is given to depositors and other technical requirements are met; the FHLB Board may, however, direct an in- voluntary termination of the insurance of any insured in- stitution under certain conditions, though it has done so only once in the history of the FSLIC. Petitioner placed a great deal of emphasis in its advertising upon the fact that it was a Federally insured institution and, in the opinion of its management, loss of its insured status with the FSLIC would cause a mass withdrawal of savings by its depositors. Prior to January 1, 1962, each insured institution was required by section 1727(a) of Title 12 of the United States Code (sec. 404(a) of the National Housing Act) to pay an annual insurance premium to the FSLIC equal to 1/12 of 1 percent of the total amount of its savings Z 43 accounts and creditor obligations. Such premiums were to be continued until the FSLIC’s reserve for losses equalled or exceeded five percent of the insured accounts and creditor obligations of all insured institutions (its potential liabilities), and at such intervals thereafter as might be required to keep the reserve fund at this level. Public Law 87-210, 75 Stat. 482, pertinent parts of which are set forth in the margin,’ amehded section 1727 of * Public Law 87-210 amended section 404 of the National Housi Act (12 U.S.C, sec. 1727) to read as follows. e Sec. 1727. Primary and secondary reseryeg (a) Establishment. The Corporation shall establish a Primary Reserve which shall be the general reserve of the Corporation ang’ . Secondary Reserve to which shall be credited the amounts of tl, prepayments made by insured institutions pursuant to subsectior, (d) of this section and the credits made pursuant to the first 8@hiance of subsection (e) of this — Rae vy" (b) Premiums for insurance; amount; t; 5 ’ rules and regulations time of payment; waiver (1) Each institution whose application rance roved by the Corporation shall pay to the Corp’ inst in rag oa as it shall prescribe, a premium for such jp surance equal to one- twelfth of 1 per centum of the total aMOUnt of all accounts of the insured members of such institution plus ®ny creditor obligations of such institution. Such premium shall by paid at the time the certificate is issued by the Corporation Ur gor section 1726 of this title, and thereafter annually, except thay under regulations pre- scribed by the Corporation such premium Muay be paid semiannually. (2) If, at the close of any December 31, the Primary Reserve equals or exceeds 2 per centum of the tots)’, mount of all accounts of insured members and creditor obligatio,., of all insured institu- tions as of such close, no premium unde paragraph (1) of this subsection shall be payable by any insureg institution with respect to its premium year beginning during the year commencing on May 1 next succeeding such December 31, except that the foregoing provisions of this sentence shall not be Applicable to any insured institution with respect to any of the twerty premium years begin- ning with the premium year commencing. with the date on which such — is issued. nial (8) e Corporation is authorized to | regulations at is may determine to be n ace te cerns accomplish the purposes and provisions of this subsection. [ Footn ote continued on page 44] meer a aren SANNA ta da 1 [Continued] (d) Prepayments; amount; credit to Secondary Reserve; amount for newly insured institutions. Each insured institution, except as otherwise provided in this section, shall annually pay to the Corporation, at such time and in such manner as the Corporation shall by regulations or otherwise prescribe, an additional premium in the nature of a prepayment with respect to future premiums of such institution under subsec- tion (b) of this section equal to 2 per centum of the net increase in all accounts of its insured members during the next preceding calendar year, less an amount equal to any requirement, as of the end of such calendar year, for the purchase of stock of the Federal Home Loan Bank of which such institution is a member, calculated in accordance with the provisions of subsection (c) of section 1426 of this title and without regard to any net increase during such calendar year in its holdings of such stock, and such prepayments shall be credited to the Secondary Reserve * * *. (e) Credits to Secondary Reserve; availability for losses; as- signment or transfer of share of Reserve. The Corporation, in accordance with such regulations as it may prescribe, shall credit to the Secondary Reserve, as of the close of each calendar year a return on the outstanding balances of the Secondary Reserve during such calendar year, as determined by the Corporation, at a rate equal to the average annual rate of return to the Corporation during the year ending at the close of November 39 of such calendar year, as determined by the Corpora- tion, on the investments held by the Corporation in obligations of, or guaranteed as to principal and interest by, the United States. Except as provided in subsections (f) and (g) of this section, the Secondary Reserve shall be available to the Corporation only for losses of the Corporation and shall be so available only to such extent as other accounts of the Corporation which are available therefor are insufficient for such losses. No right, title, or interest of any institution in or with respect to its pro rata share of the Secondary Reserve shall be assignable or transferable, whether by operation of law or otherwise, except to such extent as the Corpora- tion may by regulation or otherwise provide for transfer of such pro rata share in cases of merger or consolidation transfer of bulk assets as defined by the Corporation by regulation or otherwise for the purposes of this sentence, and similar transactions as so defined. (f) Cessation of prepayments; distribution of share of Sec- ondary Reserve; reinstatement of reserve share; payment; waiver, or other treat of accruals. If (i) the status of an insured institution as an insured institution is terminated pursuant to any provision of section 1730 of this title or the insurance of accounts of an insured institution is otherwise terminated, (ii) a conservator, receiver, or other legal custodian is appointed for an insured institution under the circumstances and 45 for the purpose set forth in subsection (d) of section 1724 of this title, or (iii) the Corporation makes a determination that for the purposes of this subsection an insured institution has gone into liquidation, the obligation of such institution to make prepayments under subsection (d) of this section, including any prepayments as to which such institution is obligated at the time of such termi- nation, appointment, or determination, shall cease, and the Corpora- tion shali pay in cash to such institution its pro rata share of the Secondary Reserve, in accordance with such terms and conditions as the Corporation may prescribe by regulations or otherwise, or, at the option of the Corporation, the Corporation may apply the whole or any part of the amount which would otherwise be paid in cash toward the payment of any indebtedness or obligation, whether matured or not, of such institution to the Corporation, then existing or arising before such payment in cash * * *. (g) Suspension of prepayments, resumption of obligation upon insufficiency of aggregate reserves; cash distribution of shares of Secondary Reserve. If, at the close of any December 31, the aggregate of the Pri- mary Reserve and the Secondary Reserve equals or exceeds 2 per centum of the total amount of all accounts of insured members and creditor obligations of all insured institutions but the Primary Reserve does not equal or exceed such 2 per centum, no insured institution shall be obligated to make any prepayment under sub- section (d) of this section during the year beginning with May 1 next succeeding such close, and each insured institution’s pro rata share of the Secondary Reserve shall be used to the extent available, to discharge such institution’s obligation for its premium under subsection (b) of this section for the premium year beginning in such year; and the suspension of obligation to make such prepay- ments and the use of such pro rata shares as provided in this sentence shall continue unless and until the next sentence or the last sentence of this subsection shall become operative. If, at the close of any December 31 occurring before the last sentence of this subsection shall become operative, the aggregate of the Primary Reserve and the Secondary Reserve is not at least equal to 1534 per centum of the total amount of all accounts of insured members and creditor obligations of all insured institutions (i) the obligation of insured institutions to make prepayments under subsection (d) of this section shall resume on May 1 next following such December 31 and shall continue unless and until the first sentence or the last sentence of this subsection shall become operative, and (ii) the use of any insured institution’s pro rata share of the Secondary Re- serve under the first sentence of this subsection shall terminate with respect to its premium under subsection (b) of this section for the premium year beginning during the calendar year commencing on May 1 next succeeding such December 31, and such termination shall continue unless and until the first sentence of this subsection shall become operative. If, at the close of any December 31, the Primary Reserve equals or exceeds such 2 per centum, the Corpora- enc AE SO A RN a —— 46 Title 12 of the United States Code, effective January 1, 1962, to its present form. An annual insurance premium at the rate of 1/12 of one percent is still required of all insured institutions (provision for which is now made in section 1727(b)(1)), though the point at which such premiums are to cease and the level at which the FSLIC’s general reserve is to be maintained has been lowered from five to two percent of total insured savings and creditor obligations of insured institutions. (Section 1727 (b) (2)). But insured institutions are now required under the amended provisions of section 1727, to make further annual payments to the FSLIC (provided for in 12 U.S.C. sec. 1727(d) and hereinafter sometimes referred to as tion shall, at such time (which shall be the same for all insured institutions and shall not be later than May 1 next succeeding such close) and in such manner as the Corporation shal] determine, pay in cash to each insured institution its pro rata share of the Secondary Reserve and shall not, after such time, accept or receive further prepayments under subsection (d) of this section. Public Law 87-210 also amended section 6 of the Federal Home Loan Bank Act (12 U.S.C. sec. 1426) to read as follows: Sec. 1426. Capital stock. am * * * (c) Minimum subscriptions; retirement of oversubscriptions; limitations; cancellation of oversubscriptions; aggregate unpaid loan principal; reports and information. (1) The original stock subscription of each institution eligi- ble to become a member under section 1424 of this title shall be an amount equal to 1 per centum of the subscriber’s aggregate unpaid loan principal, but not less than $500. The bank shall annually, as of the close of the calendar vear, adjust, at such time and in such manner and upon such terms and conditions as the Federal Home Loan Bank Board may by regulations or otherwise prescribe, the amount of stock held by each member so that such member shal! have invested in the stock of the Federal Home Loan Bank at least an amount calculated in the manner provided in the next preceding sentence (but not less than $500). If the bank finds that the in- vestment of any member in stock is greater than that required under this subsection it may, unless prohibited by said Board or by the provisions of paragraph (2) of this subsection, in its discretion and upon application of such member retire the stock of such member in excess of the amount so required. Said Board, in its discretion, may, by regulations or otherwise, provide for adjust- ments in amounts of stock to be issued or retired in order that stock may be issued or retired only in entire shares. - “section 1727(d) payments”) equal to two percent of any net increase in the total amount of its insured ac- counts during the previous year, reduced, however, by an amount equal to any requirement, as of the end of such year, for the purchase of stock in a Federal Home Loan Bank of which the insured institution is a member. Public Law 87-210 also amended section 6 of the Federal Home Loan Bank Act (12 U.S.C. sec. 1426), to reduce the per- centage of stock which a member of a Federal Home Loan Bank is required to hold in relation to its outstand- ing home mortgage loans, with certain exceptions relating to stock already purchased, from two to one percent. It was contemplated that, for most member institutions, the section 1727(d) “prepayment requirement would be ap- proximately offset” by the resulting reduction in outlays for Federal Home Loan Bank stock which a member in- stitution was theretofore (prior to 1962) required to make. H. Rept. No. 828, 87th Cong., 1st Sess., p. 2. Under the terms of section 1727, as amended by Public Law 87-210, the FSLIC is directed to establish a “Pri- mary Reserve,” and a “Secondary Reserve”. (Section 1727(a)). The Primary Reserve is credited annually with the net incorae of the FSLIC, and thus represents its “re- tained earnings.” Regular insurance premiums paid by insured institutions under section 1727(b) (1) constitute one of the major items of the FSLIC’s gross income, and, to the extent that such premiums exceed expenses and in- surance losses in any given year, they are thus trans- ferred as part of FSLIC’s net income to the Primary Reserve. Section 1727(d) payments, on the other hand, though described in the statute as “additional pre- mium[s] in the nature of * * * prepayment[s] with respect to future premiums,” are not regarded as an item of income by the FSLIC, which is required by sec- tion 1727(a) to credit all such payments directly to the “Secondary Reserve.” The FSLIC is also required to credit the “Secondary Reserve” with an annual “return” on the outstanding balances in that account at the end of each year, computed “at a rate equal to the average an- nual rate of return to the Corporation * * * on the invest- ments held by the Corporation in obligations of, or guar- anteed as to principal and interest by, the United States.” 47 nar rene a 48 Section 1727 (e). Finally, whereas the “Primary Reserve” is “the general reserve of the Corporation [i.e, the FSLIC],” the “Secondary Reserve” is available “only for losses of the Corporation and shall be so available only to such extent as other accounts of the Corporation which are available therefor are insufficient for such losses.” Section 1727 (e). Each insured institution maintains an interest in a pro rata share of the “Secondary Reserve,” and though its “right, title or interest” therein is not generally trans- ferable or assignable, the FSLIC has authority to pro- vide for the transfer of such pro rata share “in cases of merger or consolidation transfer of bulk assets * * * and similar transactions.” Section 1727(e). Moreover, an insured institution is entitled to a cash refund of its pro rata share in the event that (1) its status as an insured institution is terminated, or (2) a conservator, receiver, or other legal custodian is appointed for the purpose of liquidating the assets of the institution, or (3) the FSLIC determines that such institution has gone into voluntary liquidation. Section 1727 (f). When, at the close of any December 31, the aggregate of the Primary Reserve and the Secondary Reserve equals or exceeds two percent of the total amount of all insured accounts and creditor obligations of all insured institu- tions, the obligation of insured institutions to make sec- tion 1727(d) payments will be suspended for the fol- lowing year and all succeeding years; the obligation to make section 1727(d) payments is to resume in the year following any December 31 on which such aggregate amount falls below 134 percent of all insured accounts and creditor obligations, and is to terminate permanently when the amount in the Primary Reserve alone equals or exceeds two percent of such accounts and obligations. In any year in which the obligation to make section 1727 (d) payments is suspended, as described above, the pro rata share of each insured institution in the Secondary Reserve will be used, to the extent available, to dis- charge its obligation to pay the regular insurance pre- mium for that year. After the Primary Reserve alone reaches the two percent level, each insured institution is — il 49 entitled to the return of its pro rata share of the Sec- ondary Reserve, if any, in cash. Section 1727(g). A schedule appearing shortly hereinafter sets forth estimates of the reserve position of the FSLIC in terms of the expected ratio of the Primary Reserve, the Sec- ondary Reserve, and the aggregate of the Primary and Secondary Reserves to the total of all accounts and credi- tor obligations of all insured institutions for the years 1962-1995. These estimates, prepared in the Office of the Comptroller of the FSLIC and submitted to the Senate Committee on Banking and Currency in connection with that Committee’s consideration of the bill which became Public Law 87-210, were based upon certain assumptions, viz: 1. No insurance losses.* 2. Premium income computed on annual billing basis of one-twelth of 1 percent. 8. Investment income based on annual average rate of return of 3 percent. 4. Operating expenses based on current rate of ex- penditure equal to 3.7 percent of premium income. 5. Mortgage loans held estimated at 96 percent of total savings capital. 6. Net home mortgages estimated at 90 percent of mortgage loans held. 7. Annual growth in savings of $7 billion plus divi- dends at an annual rate of 3 percent. In addition to the foregoing estimates, the schedule also shows the actual percentage of the aggregate of the Pri- mary and Secondary Reserves to the total amount of all accounts and creditor obligations of insured institutions during the years 1963-1967, as shown on the financial statements of the FSLIC for those years. The schedule described above is as follows: 2 The FSLIC, during the 27 years of its existence prior to June 30, 1961, had incurred net insurance losses of only $5.1 million, approxi- mately 1.1 percent of its cumulative gross income. eee oa] ASRS AR AOS Ae TA a a oe ee ee ae 50 —- of Primary Secondary any ae reserve— reserve— sooeneary want estimated estimated Estimated Act December 31 ratio ratio ratio rat 1962 0.642 0.227 0.869 1963 0.661 0.417 1.078 *] 1964 0.685 0.581 1.266 1 1965 0.712 0.723 1.435 1 1966 0.741 0.849 1.590 1 1967 0.773 0.963 1.736 1 1968 0.807 1.067 1.874 1969 0.842 1.148 1.990 1970 0.879 1.177 2.056 1971 0.917 1.052 1.969 1972 0.956 0.985 1.891 19738 0.996 0.825 1.821 1974 1.036 0.720 1.757 1975 1.078 0.620 1.699 1976 1.121 0.667 1.787 1977 1.164 0.710 1.874 1978 1.208 0.752 1.960 1979 1.252 0.792 2.045 1980 1.298 0.696 1.994 1981 1.343 0.603 1.946 1982 1.390 0.512 1.902 1983 1.487 0.424 1.860 1984 1.484 0.338 1.822 1985 1.532 0.258 1.785 1986 1.580 1.171 1.751 1987 1.629 0.218 1.848 1988 1.679 0.264 1.943 1989 1.729 0.309 2.088 1990 1.779 0.226 2.005 1991 1.830 0.145 1.975 1992 1.881 0.074 1.955 19938 1.982 1.982 1994 1.984 1.984 1995 2.037 2.037 * As of June 30, 1963. ' ) } - 51 In summary, according to the FSLIC projections in 1961, the aggregate of the Primary Reserve and the Secondary Reserve would equal or exceed two percent of all insured accounts and creditor obligations of all insured institutions by 1970, and all section 1727(d) payments, together with all amounts credited thereon, would be consumed in discharging the obligation of in- sured institutions to pay regular insurance premiums by the time that the Primary Reserve itself reaches the two percent level in 1995. During the years 1962 through 1967, petitioner re- ceived annual “Insurance Premium Notices” from the FSLIC charging it with “Annual Premium[s] at rate of 1/12 of 1%” (of its insured accounts and creditor obliga- tions) in the following amounts: Year: Premiums 1962 $ 98,258.58 1963 135,760.52 1964 196,413.86 1965 271,477.00 1966 $17,427.60 1967 373,025.38 All such sums were paid by petitioner to the FSLIC in the year assessed. During each of those same years, petitioner also re- ceived from the FSLIC a separate “Notice of Insurance Premium Prepayment.” which set forth the amounts due from petitioner, and the manner in which computed, gen- erally as follows: Increase in accounts of petitioner’s insured Gross pre- members payment (depositors) (2% of during pre- __ increase in FHLbank Net amount Year ceding year prior year) stock credit due Junel 1962 $ 6,387,974 $ 126,759.48 0 $ 126,759.48 1963 44,131,843 882,636.86 0 882,636.86 1964 61,746,484 1,234,929.68 $784,100.00 450,829.68 1965 71,489,450 1,429,789.00 $34,700.00 1,095,089.00 1966 61,808,288 1,226,064.76 0 1,226,064.76 1967 (1,944,138) 0 0 0 —— 52 All such section 1727(d) payments billed to petitioner were paid by it to the FSLIC in the year due. All section 1727(d) payments have been credited on the books and records of the FSLIC directly to its “Secondary Reserve.” Effective with the first of such payments, the FSLIC has maintained separate accounts for each in- sured institution and annually forwards statements to such institutions showing, among other things, the total amount of section 1727(d) payments made to that time, the interest credited annually by the FSLIC to the ac. count pursuant to section 1727(e), and the insured in- stitution’s pro rata share of the Secondary Reserve. Peti- tioner’s account, No. 2066, reflects the following: Annual return Pro rata share of secondary reserve Sec. 1727 (d) Date payment Rate Amount Debit Credit Balance May $81, 1962 $ 126,759.48 $ 126,759.48 $ 126,759.48 Dec. 31, 1962 3.151488% $ 2,242.10 2,342.10 129,101.58 May 31, 1968 82,636.86 882,636.86 1,011,788.44 Dec. 31, 1963 3.549594% 22,951.42 22,951.42 1,034,689.86 May 28, 1964 450,829.68 450,829.68 1,485,519.54 Dec. 31, 1964 (1) 44,864.25 44,864.25 1,580,383.79 June 1, 1965 1,095,089.00 1,095,089.00 2,625,472.79 Dec. 31, 1965 3.555086 % 77,231.97 77,231.97 2,702,704.76 June 1, 1966 1,226,064.76 1,226,064.76 $,928,769.52 Dec. 31, 1966 3.837323 % 131,295.86 131,295.86 4,060,065.38 June 1, 1967 0 0 4,060,065.38 Dec. 31, 1967 4.232271% 171,832.97 171,882.97 4,231,898.85 Dec. 31, 1967 2690,217.11 4,922,115.46 2 Not in record. a Transferred from the account of another savings and loan association due to merger. Section 8701 of the California Financial Code authorizes the Savings and Loan Commissioner to establish a uni- form classification of accounts for savings and loan asso- ciations and to prescribe the manner in which such ac- counts are to be kept. On May 21, 1962, the California Savings and Loan Commissioner issued an order pre- scribing the procedure for accounting for section 1727 (d) payments, which order was modified and incorporated into the “Uniform Classification of Accounts” effective January 1, 1963, and, as modified, has remained effective for all subsequent periods. The “Uniform Classification of Accounts” requires each California savings and loan as- sociation to treat section 1727(d) payments as an asset, 53 in an account entitled “Contributions to Secondary Re- serve—FSLIC;” to treat the return credited to its pro rata share of the Secondary Reserve as income when noti- fied by the FSLIC that such return has been credited to its account; and to treat transfers made from its pro rata share of the Secondary Reserve to discharge its ob- ligation to pay regular annual premiums as expenses when notified of such transfer. On petitioner’s balance sheet for the year 1962, its sec- tion 1727(d) payment for that year, and the statutory interest credited thereon, were included in “Other Assets a beginning in 1963, all section 1727(d) payments have been shown, on the asset side of the balance sheet, as “Prepaid Federal Savings and Loan Insurance Corpora- tion Premiums.” Such payments were not included as an expense on any of its income statements for the periods 1962 through 1966. The interest credited to petitioner’s account pursuant to section 1727(e) by the FSLIC for each of the years 1962 through 1966 was included in mis- eellaneous income for the year in which the interest was credited to petitioner’s account by the FSLIC. These items were similarly treated on the Consolidated Financial Statements of petitioner’s parents, First Lincoln Finan- cial Corporation, and its subsidiaries. All of petitioner’s financial statements for the years 1962 through 1966, and all consolidated financial statements of its parent for those years, were audited by the firm of Peat, Mar- wick, Mitchell & Co., certified public accountants, which submitted accompanying “Accountant’s Reports” stat- ing that the financial position of petitioner (or its parent) had been presented fairly therein, “in conformity with generally accepted accounting principles applied on a basis consistent with that of the preceding year.” The regulations of the FHLB Board require each sav- ings and loan association which is a member of the Fed- eral Home Loan Bank system to file, on forms provided by the Board, a semi-annual report of its affairs as of the end of each semiannual period. Printed instructions for the preparation of such reports are published and distributed to each member. The “Introduction” to these instructions states that: “These instructions are provided — to assist in the completion of monthly and semiannual rts by members of the Federal Home Loan Bank Sys- tem. Each reporting institution is urged to carefully foj- low these instructions * * *.” Under the heading “Sched- ule D, Other Assets,” each institution insured by the FSLIC is instructed to report in that category ‘ amount of its pro rata share in the Secondary Reserve established by the Corporation from the premium pre payments.” In all of its reports to the FHLB since 1962 petitioner has reported its pro rata share of the Sec ondary Reserve .@8 an asset under the heading “Other On its Federal income tax returns for the years 1962, 1963 and 1964, petitioner deducted both its section 1727 (b) (1) regular premium payments and its section 1727 (d) payments under “other deductions” as “Federal in- surance premiums.” Upon examination of its returns for those years, the Commissioner allowed the deduction for amounts paid under section 1727(b) (1), but disallowed a deduction for all section 1727(d) payments. In its peti- tion to this Court, petitioner put in issue the greater part 54 by the Commissioner for 1963 with the exception of his disallowance of a deduction of $882,636.86, the amount of the section 1727(d) payment made by petitioner in that year. OPINION RauM, Judge: Petitioner, a Savings and loan asso- ciation licensed by the State of California and doing busi- ness in the Los Angeles area, has since 1938 insured the savings accounts of its depositors with the Federal Say- ings and Loan Insurance Corporation (the “FSLIC”), pursuant to the provisions of Title IV of the National Housing Act, as amended. (12 U.S.C. sec. 1724 et seq.) It pays an annual “premium for such insurance” in an amount equal to 1/12 of one percent of the total amount * There was no deficiency in petitioner’s income tax in the other years. --™ of all its savings accounts and creditor obligations, as provided in section 1727(b) (1). Since 1962, as the result of amendments made to the National Housing Act, peti- tioner has been required to make further annual pay- ments to the FSLIC under section 1727(d), hereinafter sometimes referred to as “Sec. 1727(d) payments”, equal to two percent of any net increase in its insured accounts during the previous year, but reduced in the case of an insured institution, such as petitioner, which is also a member of a Federal Home Loan Bank, by the amount of any required purchase of stock in such Bank for that year. These section 1727(d) payments are described in the statute as “additional premium([s] in the nature of * * * prepayment[s] with respect to future premiums.” In 1963, the only year here in issue, petitioner paid its annual insurance premium for the year in the amount of $135,760.52, and made its section 1727(d) payment in the amount of $882,636.86. Both sums were deducted on its 1963 Federal income tax return as “Federal insurance premiums.” The Commissioner, while not disputing peti- tioner’s right to deduct its regular annual insurance pre- mium, disallowed in full the’ deduction of $882,636.86 claimed for the additional section 1727(d) payment. The sole issue for decision is whether this latter payment was an ordinary and necessary expense of petitioner’s business in 1963, or a capital expenditure deductible, if at all, only in later years to the extent that it ceased to be an asset of petitioner. Although described in the statute as “an additional premium in the nature of a prepayment with respect to future premiums,” the section 1727(d) payment is neither an “additional premium,” in the sense of being a mere increase in the annual insurance premium as contended by petitioner, nor a “prepayment with respect to future pre- miums,” at least insofar as the ordinary prepaid insurance premium is taken as a standard. The National Housing Act is not, of course, a revenue statute, and the label at- tached to section 1727(d) payments therein is not, and was not intended to be, conclusive in the determination of how these payments should be treated for Federal tax purposes. See McMillan Mortgage Company, 36 T.C. 924, a 56 928. The label is at any rate ambiguous, though if we were to give it binding effect here, we should most cer- tainly adopt the characterization of “prepayment” as controlling, and would therefore have to deny petitioner 4 current deduction for its section 1727 (d) payment under a long line of decisions by this Court holding that prepaid insurance premiums are capital expenditures to be ex- 20 T.C.M. 78, 86. See and compare Commissioner y, Boyl- ston Market Ass’n., 181 F. 2d 966 (C.A. 1), affirming a Memorandum Opinion of the Board of Tax Appeals, with Waldheim Realty and Investment Company v. Commis. sioner, 245 F. 2d 823 (C.A,. 8), reversing 25 T.C. 1216. But regardless of whether the section 1727(d) payment analysis of the substantive provisions of section 1727 convinces us that this payment, however labeled, is in the nature of a capital outlay and is therefore not deductible as an expense in the year that it is made. so used, they are transferred, as part of the FSLIC’s net income for the year, to the “Primary Reserve,” the FSLIC’s general reserve which contains its cumulative net income or “retained earnings” and which is available to meet the FSLIC’s insurance losses if its income in any year is insufficient for this purpose. Section 1727(d) payments, on the other hand, are not considered as in- come by the FSLIC, and are not ordinarily available to meet the annual expenses and losses of the Corporation. 57 Instead, the FSLIC is required by statute to credit all such payments directly to a “Seconary Reserve,” which is to be used “only for losses of ‘he Corporation and shall be so available only to such ext:nt as other accounts of the Corporation which are availible therefor are im- sufficient for such losses.” Section 1727(e). (Emphasis added.) Thus, instead of being takea into income, freely available to meet expenses and losses of the current year, the section 1727(d) payment is credited directly to an ac- count, rather like a capital account, which may be applied against losses only in the event that the regular insur- ance premiums for the year, the corporation’s other in- come, and its retained earnings of prior years have all been depleted. It cannot, therefore, be accurately termed a premium for insurance coverage in the year of payment, but, at least initially, is in reality a capital investment in the FSLIC, part of a pool or capital available to the FSLIC for the payment of losses in the event of emer- gency. Furthermore, when the regular insurance premiums paid by insured institutions under section 1727(b) (1) are received by the FSLIC, they lose their distinctive character as premiums and become merely part of the gross income of the corporation; the insured institution retains no rights in respect of such sums, other than the right to insurance coverage for the current year, and its premium, once paid, is lost to it forever. Payments made under section 1727(d), however, stand on quite a dif- ferent footing. Such payments, as noted ab ve, are im- mediately segregated in the “Secondary Reserve,” and the FSLIC is directed by statute to credit the outstand- ing balance in this account, on am annual basis, with a “return” computed “at a rate equial to the average an- nual rate of return to the Corporatiion * * * on the invest- ments held by the Corporation jn obligations of, or guaranteed as to principal and imterest by, the United States.” Section 1727(e). What iis more, each insured institution maintains an interest ijn a pro-rata share of the Secondary Reserve, and is amnually furnished with a statement of its account by the FSLIC, which keeps a separate account for each insured ifnstitution. That annual 5 POTEET er 58 statement discloses all section 1727(d) payments made by the insured institution, the interest or return earned by the account, any debits that may have been charged against the account, and, finally, the new balance in the account as of the end of the year. Thus, for the years 1962-1967, petitioner’s account, set forth in our findings, reflects various credits (section 1727(d) payments and interest or return), no debits, and a balance of $4,922. 115.46 in its favor, representing its pro rata share in the Secondary Reserve as of December 31, 1967. While petitioner's pro rata share of the Secondary Reserve is not, as a general rule, assignable or trans- ferable, “by operation of law or otherwise,” the value of such share may be fully realized through its transfer to another insured institution in a merger, consolidation or bulk sale; petitioner may even receive the value of its share from the FSLIC in cash if (1) its insured status is terminated, either voiuntarily or involuntarily, (2) it goes into liquidation, voluntarily are involuntarily, or (3) the obligation to make section 1727(d) payments is per- manently terminated and the Secondary Reserve dis- tributed before the value of its share has otherwise been‘ fully recovered. See p. ——, infra. Moreover, assuming petitioner does not realize the value of its pro rata share in one of the above ways, it is reasonably assured of receiving full value therefor in the form of insurance coverage in future years when its share of the Secondary Reserve is used to pay its regular section 1727(b) (1) premiums. To the extent that the petitioner’s share is so used, entries will undoubtedly be made in the debit column of its account which will be reflected in the balance ap- pearing as of the end of each such year. Also, to the ex- tent that any losses may be charged in any year against the Secondary Reserve, petitioner’s pro rata share thereof should similarly appear in the debit column, thereby also adversely affecting its balance as of the end of such year. And to the extent that any such debits are charged against petitioner’s balance in any particular year, whether for regular section 1727(b) (1) premiums or for losses, it would seem that petitioner would be entitled to deductions in those amounts for any such year. Cf. Rev. Rul. 66-49, 1966-1 C.B. 36, 37. — 59 As already noted, the Secondary Reserve is available for the payment of losses, but only to a very limited ex- tent. It has, however, never been used for this purpose, nor, on the basis of the FSLIC’s past loss experience, does such use appear to be likely. At the time that Congress considered Public Law 87-210, in 1961, net insurance losses of the FSLIC had absorbed only 1.1 percent of its income over its entire existence, H. Rept. No. 828, 87th Cong. Ist Sess. p. 2 (1961); S. Rept. No. 778, 87th Cong. Ist Sess. p. 2, and the financial statements of the FSLIC put in evidence by the parties, covering all the thereafter through December 31, 1967, reveal no year in which the net insurance losses of the FSLIC ex- ceeded even its investment income, much less the annual premiums for the year and/or the Primary Reserve, both of which must be fully consumed before the Secondary Reserve can be utilized. The Primary Reserve alone stood at $921,669,395 on December 81, 1967, while the cumula- tive net losses of the FSLIC from June 27, 1934 through December 31, 1967, totalled only $105,610,365. Of course, an event of catastrophic proportions, another Great De pression, could conceivably wipe out the Secondary Re- serve, but the probability that such an event will occur is simply incalculable. It is certainly not an event that could reasonably be anticipated as of any particular time, and if any event should occur requiring a charge against the Secondary Reserve in respect of any loss, petitioner’s pro rata share thereof would then be deductible, as has already been pointed out. But there do not appear to be any greater hazards in this respect than attach to the capital investment made by a stockholder in a commercial bank or an insurance company. Though it is clear that “prepayments” under section 1727(d) are not really insurance premiums, at least not in the year in which they are paid, a further examina- tion of the provisions of Public Law 87-210 also reveals sharp differences between such “prepayments” and the | ordinary prepaid insurance premium. While the average | prepaid insurance premium gives rise to an obligation on the part of the insurer to provide coverage for some definitely ascertainable period of time, usually not more than two or three years from the date of the policy, the FSLIC incurs no such obligation upon its receipt of a section 1727(d) payment. The obligation to provide in- surance coverage does not arise until the section 1727 (d) payment is actually used to discharge the obligation of the insured institution to pay a regular section 1727 (b) (1) insurance premium, which event is contingent upon the ratio of the FSLIC’s reserves to its potential lia- bilities attaining certain levels. Moreover, since the sec- tion 1727(d) payment credited to the Secondary Reserve is subject to accretion through the annual “return” credited annually by the FSLIC on the outstanding balance in such reserve, and at least theoretically to depletion in the event the reserve is used to meet losses in an emergency situation, and since the regular annual premium required by section 1727(b) (1) is itself a percentage of the in- sured institution’s accounts and creditor obligations, and thus varies from year to year, there is no way of predict- ing with certainty the number of years of insurance cov- erage which will be procured by each section 1727(d) payment, much less the precise years which will be cov- ered. Thus, unlike the common prepaid insurance pre- mium, the section 1727(d) payment is not simply “an exhaustible asset with a determinable life’ whose value may be allocated “ratably over the term for which the premium is paid,” see George S. Jephson, supra, 87 B.T.A. 1117, 1120; Higginbotham-Bailey-Logan Co., supra, 8 B.T.A. 566, 577, the life of the asset created by the section 1727(d) payment is not determinable on the date of payment, and its usefulness will not be ratably spread over the period of that life. For the period of time prior to its use to discharge the obligation of the payor institution to pay regular annual premiums required by section 1727(b) (1), the section 1727(d) payment will simply constitute part of the capital of the FSLIC. Under the terms of the statute, section 1727(g), the pro rata share of each insured institution in the Secondary Reserve will be used to pay its regular annual premiums, and the obligation of insured institu- tions to make section 1727(d) payments will concurrently be suspended, only after the aggregate of the FSLIC’s _ 61 Primary and Secondary Reserves equals or exceeds two percent of the total amount of all savings accounts and creditor obligations of institutions insured by the FSLIC. The obligation to make section 1727 (d) payments will, however, resume, if the aggregate of the two reserves subsequently falls below 134 percent of the FSLIC’s po- tential liabilities, and, until such aggregate again reaches the two percent level, the use of the pro rata share of each insured institution to pay its regular annual pre- miums must also cease. It is not until the FSLIC’s Pri- mary Reserve alone equals or exceeds two percent of its potential liabilities that the obligation to make section 1727(d) payments will permanently terminate, at which time insured institutions are entitled to the refund of their pro rata share of any amount remaining in the Sec- ondary Reserve. Clearly then, the effect of these provisions is to require insured institutions to make and keep capital investments in the FSLIC, until it has retained enough of its own earnings (in the Primary Reserve) to provide in the opinion of Congress, adequate protection for in- sured savers. To be sure, the asset acquired by petitioner by vir- tue of its section 1727(d) payments, i.e., its pro rata share of the FSLIC’s Secondary Reserve, differs in many respects from the usual capital investment. Petitioner is required by law to make the investment, at least as long as it wishes to insure its accounts with the FSLIC, cf. Hotel Sulgrave, Inc., 21 T.C. 619, the amount of the in- vestment is determined by the growth of its business, i.e, the increase in its savings accounts, and the asset so ac- quired is ordinarily not transferable to others. But these differences, though perhaps not insignificant for other than tax purposes, cannot alter the fact that the section 1727(d) payment does not actually provide insurance coverage for petitioner in the year of payment, and is not an ordinary and necessary expense of that year; it results in the acquisition of an asset which, if held to “maturity” and not transferred in a merger, consolidation or bulk sale, and not refunded in the event of a termination of insurance or liquidation, will result in benefits, in the form of insurance coverage, in future years. In these — a. 62 circumstances, it is a matter of no consequence whether petitioner is a cash or accrual basis taxpayer, for the rule is the same for both that: “If an expenditure results in the creation of an asset having a useful life which extends substantially beyond the close of the taxable year, such an expenditure may not be deductible, or may be deductible only in part, for the taxable year in which made.” Regs. sec. 1.461-1(a) (1) and (2). Moreover, we need not look far to find a similar investment which, though possessing many of these same peculiar attributes, is nevertheless a capital expenditure. An example readily at hand lies in the payment by petitioner of amounts re- quired by section 6 of the Federal Home Loan Bank Act, 12 U.S.C., section 1426(c), for the acquisition of capital stock in its Federal Home Loan Bank, a payment which we think is closely analogous to the section 1727 (d) pay- ment here, and which petitioner has consistently capi- talized rather than expensed in the year of payment. Membership in a Federal Home Loan Bank entitles a savings and loan association to obtain advances from such Bank, up to certain limits, upon the security of its home mortgages and obligations of or guaranteed by the United States, 12 U.S.C. section 1430(a); it thus serves the im- portant function of providing members with a source of additional liquidity and funds for mortgage lending. As a condition of membership, the savings and loan associa- tion must initially purchase stock in one of twelve regional Home Loan Banks, depending upon the district in which it is located, equal to one percent of such association’s “aggregate unpaid loan principal,” * and must purchase such additional amounts of stock thereafter as is necessary to maintain this ratio at the close of each succeeding calendar year. 12 U.S.C. sec. 1426(c) (1). Amounts so invested are not ordinarily transferable, and, in general, are returnable to the member only upon its withdrawal from membership. Also, if at the time of withdrawal the FHLB Board finds that the paid-in capital of the member’s Federal Home Loan Bank is or is likely to be * Defined as the aggregate unpaid principal of its home mortgage loans, home-purchase contracts, and similar obligations, 12 U.S.C. sec. 1426(c) (4). | 63 impaired as a result of losses in or depreciation of the assets held by such Federal Home Loan Bank, the amount to be paid the member in retirement of its stock is re- duced by its pro rata share of the amount of the impair- ment. 12 U.S.C. sec. 1426(i). The similarities between the mandatory payments made by petitioner to its Fed- eral Home Loan Bank and those made to the FSLIC are thus strikingly apparent.’ True, petitioner did not re ceive any pieces of paper to evidence its pro rata share of the Secondary Reserve, though one could imagine a redeemable preferred stock which incorporated all the provisions of sections 1727(d), (e), (f) and (g) as described above, which might have been issued in exchange for such payments. But it acquired an asset nevertheless, if evidenced only by the annual statements sent to peti- tioner every year showing the status of such pro rata share. That the section 1727(d) payment made to acquire that asset was mandatory and based upon the volume of petitioner’s business, and that the asset itself was non- transferable and subject to a limited extent to the losses 5’ Petitioner argues that the legally compelled investments made in its Federal Home Loan Bank are fundamentally distinguishable from the section 1727(d) payments here by virtue of the fact that it is entitled to dividends on its Federal Home Loan Bank stock which are immediately available for its use, and the further fact that the Federal Home Loan Bank may, “in its discretion,” retire the stock of any member to the extent that it exceeds the required ratio. Although these are distinctions, they are neverthe- less distinctions without a difference here. We do not consider it significant thaf petitioner’s annual dividends on its Federal Home Loan Bank stock are distributed to it rather than being credited to its account, nor do we think it important that petitioner may receive some of the funds invested in the Federal Home Loan Bank before it begins to receive, actually or constructively, its section 1727(d) payments. Moreover, assuming that it remains a member of both the Federal Home Loan Bank and the FSLIC indefinitely, petitioner will certainly receive its total investment in the FSLIC before it receives the money it has invested in its Federal Home Loan Bank, for while there is a definite limit on petitioner’s com- mitment to the FSLIC, there is none on its commitment of funds to the Federal Home Loan Bank. At any rate, the question of when such investments or the return thereon, will be redeemed is simply a questicn of timing; the important point is that both are in fact capital in vestments. as ane 64 of the corporation in which the funds were invested, does not make it any more an ordinary and necessary expense, nor less a capital expenditure, than the required invest- ments made by petitioner in its Federal Home Loan Bank, Moreover, the section 1727(d) payments, which are measured by the net increase of the institution’s insured accounts during the preceding year, were in fact regarded by Congress, in part at least, as being a substitute for investments in the capital stock of the Federal Home Loan Banks which member institutions were theretofore re quired to make. A member institution was formerly ob- ligated to purchase and hold such capital stock equal to two percent of its outstanding home mortgage loans, but when its obligation to make the section 1727(d) payments commenced in 1962, the two percent level in respect of the capital stock was simultaneously reduced to one per- cent. It is clear that Congress regarded these as interre- lated events,* and in our judgment the 1727(d) payments represented capital outlays by the member institution just as much as its investment in the stock of its regional Federal Home Loan Bank. The legislative history of Public Law 87-210, which amended section 1727 to its present form in 1961, does not of course deal with the manner in which section 1727(d) payments should be treated for Federal tax pur- poses, but it is certainly not inconsistent with anything we have said here. The decade preceding the enactment of the bill witnessed a tremendous increase in the growth of institutions insured by the FSLIC, and a concomitant growth in the total amount of savings insured by the Cor- poration. But, in that same decade, the FSLIC was re- quired by Congress to use its income to retire all of its captal stock, in the amount of $100,000,000, from the United States Treasury. The result was a decline in the ratio of the reserves of the FSLIC to its potential liabilities during this period from 0.848 percent to 0.661 percent. See S. Rept. No. 778, 87th Cong., 1st Sess., pp. 2, 12; Hearings Before Subcommittee No. 1 of the Committee on Banking and Currency, House of Representatives, 87th Cong., 1st Sess., on H.R. 7108 and H.R. 7109, pp. 10, 39. * See infra, p. ——. 65 Public Law 87-210 was “designed to add new strength” to the FSLIC by requiring insured institutions to make so-called “premium prepayments” which, it was hoped, “would result in a marked acceleration in building up the Corporation’s reserves.” H. Rept. No. 823, 87th Cong., 1st Segs., p. 2 (1961); S. Rept. No. 778, supra, pp. 1-2. Petitioner emphasizes that Congress spoke in terms of building up the FSLIC’s reserves, that section 1727 (d) payments are in fact credited to a “Secondary Reserve,” and concludes that a necessary corollary is that payments made to a reserve must be insurance premiums. This is no more than semantic word play. The truth of the mat- ter is that, for the reasons outlined at the beginning of this opinion, section 1727(d) payments cannot be con- sidered merely additional insurance premiums. Had Con- gress felt that the premium income of the FSLIC was inadequate to meet expenses and losses, it could easily have increased the regular annual premium to what it considered a more realistic level, without enacting all the complicated provisions which govern section 1727(d) payments. But, in fact, during the entire life of the cor- poration its total expenses had, to 1961, amounted to only 3.7 percent of its gross income while net insurance losses had absorbed “a mere 1.1 percent of the gross in- come.” Hearings, supra. p. 10. Cf. H. Rept. No. 823, supra, p. 2, S. Rept. No. 778, supra, p. 2. What was needed was additional capital, not additional premium income, which would serve as a buffer until the FSLIC had accumulated enough of its own income to bring its “Primary Reserves,” the true insurance reserve, to the desired two percent level.’ True, Congress called the ac- 7 Compare the statement of Everett C. Sherbourne, vice-chairman, Federal Legislation Committee, National League of Insured Sav- ings Associations, Hearings, supra p. 45. “From the standpoint of the loss experience of the Corporation, we do not believe the reserve would be inadequate * * *. There is, however, an inadequacy of working capital.” This witness went on to explain that the FSLIC does not “sit idk by, wait for a loss to occur, and then pay out insurarce * * *”, Lut hag authority to take steps, such as the making of loans to institutions in danger of failing, which “may involve substcrtial cash disbursements without ultimate loss to the Corpo- ration,” The savings and loan industry supported Public Law 87-210, see © Rept. No, 778, 87th Cong., 1st Sess., pp. 5, 12-18, in line with cg 66 count to which this additional capital was credited a “Secondary Reserve,” but since such “reserve” served the same function as a capital account, and was available for losses “only to such extent as other accounts of the Corporation which are available therefor are insufficient for such losses,’ Congress’ use of the terminology of the insurance industry should not confuse the issue. And what, after all, is the capital account of any corporation if not a “Secondary Reserve,” a pool of capital available to creditors in the event that the corporation’s current income and retained earnings are not sufficient to satisfy their claims? As has previously been pointed out, at the same time and in the same measure directing insured institutions to make these additional section 1727(d) payments to the FSLIC, Congress reduced the ratio of stock which mem- bers of a Federal Home Loan Bank were required t hold against their “unpaid loan principal” from two to one percent. It was contemplated that “[f]or most institu- tion, this prepayment requirement [i.e., section 1727(d) payments] would be approximately offset by reducing the stock the institution must purchase in its Federal home loan bank.” See H. Rept. No. 823, supra, p. 2; S. Rept. No. 778, supra, pp. 1-2. In essence, then, Public Law 87- 210 provided that furids which would otherwise have gone into the capital structure of the Federal Home Loan Banks, which already had “more than sufficient [amounts invested in capital stock] to meet the criterion of ade- quate capitalization,” see Hearings, supra, p. 9, would be channeled instead to the FSLIC’s Secondary Reserve, which is itself essentially a capital account, though more temporary in nature. Moreover, to the extent that an in- sured institution is required to purchase additional stock in its Federal Home Loan Bank, its section 1727(d) payment to the FSLIC is reduced by the amount of stock so purchased. Clearly, if the section 1727(d) payments represented actual insurance premiums needed by the —— ooo its “longstanding position” that savings and loan associations should finance “their Insurance Corporation” rather than “rely on taxpayer funds for this purpose.” See S. Rept. No. 378, 89th Cong., 1st Sess., pp. 71-72 (1965). -— FSLIC to meet its expenses and losses, rather than mere- ly a capital cushion for the FSLIC, this arrangement would not have been feasible. The fungibility of capital stock payments to the Federal Home Loan Bank and sec- tion 1727(d) payments to the FSLIC under Public Law 97-210 strongly suggests that Congress thought of both as serving roughly the same purpose. The conclusion then, is inescapable that section 1727 (d) payments result in the creation of an asset in the nature of a capital investment which should, however, eventually be used to provide insurance coverage in fu- ture years, and that for Federal income tax purposes at least, such payments must be capitalized and deducted from gross income only in the years and to the extent actually used to provide such insurance coverage or ac- tually drawn upon to meet losses. Regs. section 1.461-1 (a), supra. Nor are we convinced by petitioner’s argu- ment and the testimony of its expert witnesses, that even as a matter of general accounting practice a section 1727(d) payment should be written off immediately be- cause of uncertainty as to whether and when it will bene- fit the insured institution. We have already demonstrated that, for all practical purposes, these payments will definitely be used to discharge the obligation of the in- sured institution to pay regular annual premiums in fu- ture years, assuming it has not previously transferred its pro rata share of the Secondary Reserve or received a cosh payment in respect thereof from the FSLIC. Even the years in which the Secondary Reserve will be avail- able for such use are not wholly a matter of conjecture, for the Office of the Comptroller of the FSLIC has made projections in this regard, showing, inter alia, that the aggregate of the Primary and Secondary Reserves of the FSLIC will equal or exceed two percent of the FSLIC’s potential liabilities by 1970, and will thereafter be avail- able for payment of regular annual premiums in subse- quent years (except those in which the aggregate of the reserves falls below 134 percent of the FSLIC’s potential liabilities, as disclosed in the projection) until 1995, when the Primary Reserve is expected to equal or exceed the 67 68 two percent ratio by itself.* See Findings of Fact, p. — supra. Moreover, the fact of the matter is that both the Cali- fornia Savings and Loan Commissioner and the FHLB Board require that section 1727(d) payments be capi- talized and shown on the financial statements of insured institutions as an asset, to be expensed only in the years in which actually used to satisfy the insured institution’s obligation to pay a regular section 1727(b) insurance pre mium. It is, of course, well established that methods of accounting prescribed by regulatory agencies are not con- trolling for Federal tax purposes. Old Colony R. Co. vy. Commissioner, 284 U.S. 552, 562; Bellefontaine Federal Savings and Loan Association, 33 T.C. 808, 811-812, but where, as here, the accounting treatment prescribed for a particular expenditure appears to be prompted not by any particular statutory or regulatory requirements (in- deed, it would seem that agencies charged with the super- vision of financial institutions would be quite anxious that the assets and net income of such institutions not be over- stated) but rather to be based upon sound accounting principles, it should not be wholly disregarded. Further- more, the financial statements of both petitioner and its parent, the First Lincoln Financial Corporation reported the section 1727(d) payments here in issue as assets, not expenses, and the firm of certified public accountants which audited such financial statements was able to state, in the Accountant’s Report preceding such financial state- ments, that they presented fairly the financial position of 8 The projections made by the FSLIC are, of course, based on a number of assumptions, and are not infallible. Still, they have been proven relatively accurate for the first five years since the enact- ment of Public Law 87-210, and, in its annual report for 1966, the FHLB Beard (which administers the FSJIC) stated that it ex- pected the aggregate of the Primary and Secondary Reserves to reach the two percent level by 1971, as compared to the prediction of 1970 in the original FSLIC estimate. To be sure, these estimates will not allow an insured institution to compute with pinpoint accuracy the years in which its section 1727(d) payments will be used to provide insurance coverage, but they do at least allow it to make a rough approximation. —_ ; ee | 69 petitioner and its parent “in conformity with generally accepted accounting principles * * *.” We are aware that the same issue that confronts us here was raised, and recently decided in favor of the tax- payer, in First Federal Savings & Loan Ass’n of St. Joseph v. United States, 22 AFTR 2d 5238 (W.D. Mo. 1968),° the only case in which the issue herein has been adjudicated. The District Court there refused to follow Rev. Rul. 66-49, 1966-1 C.B. 35, in which it was stated that section 1727(d) payments were not deductible as ordinary and necessary expenses. The court held that section 1727(d) payments were deductible in the year of payment, relying on the fact that insured institutions are “subject to the basic liability” to make such payments, that the funds were “paid with respect to insurance cov- erage and * * * [were] based, to a certain extent, upon the risk of loss,” and “of even more significance,” upon the fact that such payments “were subject to being com- pletely consumed in the event of a loss.” We have al- ready expressed our opinion on these matters, and, being of the view that section 1727(d) payments are nonde- ductible capital expenditures, we respectfully decline to follow the holding of the District Court. Though we prefer to rest our holding upon the reasons set forth in this opin- ion, we do agree with the conclusion reached in Rev. Rul. 66-49 that section 1727(d) payments are not ordinary and necessary expenses in the year of payment and are not deductible until they are used to pay regular premiums or losses, or the possibility of their return to the institutions ®* That case involved a Federal savings and loan association which, unlike petitioner, a state-chartered association, was required and not merely permitted to insure its accounts with the FSLIC. Thus, it did not have the option, available to petitioner, of termi- nating its insured status without going into liquidation, while petitioner, theoretically at least, could cease being an insured institution of the FSLIC, receive its pro rata share of the Secon- dary Reserve in cash, and still remain in business. We need not discuss further whether this alternative was open to petitioner as a practical matter, and do not express any opinion as to the significance of this distinction, for our disagreement with the District Court’s opinion goes to the more basic issue of the inherent nature of the section 1727(d) payment. 70 is otherwise precluded. Rev. Rul. 66-49, su 19 C.B. 36, 37." ea ae Because of the unusual nature of the section 1727(d) payments in issue, the remaining cases and rulings cited by both petitioner and respondent are, for the most part, distinguishable on their facts. Thus, cases cited by peti- tioner for the proposition that an ordinary and neces- sary business expense is not rendered nondeductible be cause there remains after payment a contingent possibility of future recovery, e.g., Alleghany Corporation, 28 T.C. 298, 305; Electric Tachometer Corp., 37 T.C. 158; and ef. I.T. 2764, XIII-1 C.B. 45, IT. 3632, 1943 C.B. 114" Rev. Rul. 62, 1953-1 C.B. 71, are of no help to petitioner here since it failed to establish the necessary initial foun- dation required by these® cases; i.e., that the amount of $882,636.86 paid by it to the FSLIC in 1963 pursuant to section 1727(d) constituted an ordinary and n expense of that year. Cf. Harry W. Williamson, 37 T.C. 941, 944. Nor, on the other hand, were these payments 2°Tt was also held in Rev. Rul. 66-49 that the annual return credited to each insured institution on amounts in its pro rata share of the Secondary Reserve does not constitute taxable income to an inaured institution on the cash basis until actually or constructively received by it, either by way of refund or by its use to discharge the insured institution’s obligation to pay annual premiums. Peti- tioner, while of course not disparaging the Commissioner’s position on this matter, claims it is inconsistent with his position on the deductibility of the section 1727(d) payments. The question of when this annual “return” must be included in the income of a cash basis taxpayer is not now before us, and we express no opinion thereon. We do note, however, that the position we take here, that section 1727(d) payments are nondeductible capital expenditures, is not inconsistent with the Commissioner’s position as to the time for inclusion of the annual return on income. 11].T. 2764, relied upon by petitioner, was declared obsolete in Rev. Rul. 68-100, 1968-9 I.R.B. 24. It involved payments made to a temporary insurance fund set up by the Federal Deposit Insurance Corporation in the first days of its creation, and relied upon G.C.M. 8474, IX-2 C.B. 281, which was shortly thereafter revoked by the Commissioner. G.C.M. 18290, XIII-2 C.B. 318. See text concerning the Texas State Depositor’s Guaranty Fund, p. ——, infra. I.T. 3632, another ruling cited above upon which petitioner relies, cited as its only authority I.T. 2764. Both I.T. 2764 and I.T. 3632, however, are also distinguishable on their facts, as is noted above. — 71 merely security deposits in the natatyre of a reserve for contingent liabilities as suggested.q by respondent. Cf. Spring Canyon Coal Co. v. Comminissioner, 48 F. 2d 78 (C.A. 10), certiorari denied 284 Uys. 654; Wayne Title & Trust Co. v. Commissioner, 195 5 F 94 401 (C.A. 8); Wolfington Body Co. v. Smith, 999 pF Supp. 788 (E.D. Pa.). Compare Weber Paper ComPonany v. United States, 204 F. Supp. 394 (W.D. Mo.) affirmed, 820 F. 2d 199 (C.A. 8), with Rev. Rul. 60-275, 19(960-2 C.B. 43. Perhaps most closely approximating the ‘SitUéyation in this case are those cases and rulings involving P8Yayments made by Texas State banks during the 1920’s to the Texas State De positor’s Guaranty Fund, which, be,..ayse they shed some light on the section. 1727(d) payments involved herein, we now set forth in some detail. Texas statutes required every statate bank to protect its depositors either by a bond or policiiey of insurance, or by becoming a contributor to the Deposi,.i+o.. Guaranty Fund. If the latter method was elected, the... pank was required to make annual contributions to the . Fund based upon its average deposits, one-fourth in cash h to the State Treasury on which the bank was entitled to int nterest, though not pay- able until its liquidation or withdr; rawal from the Fund, and three-fourths as a deposit on i! i+. pooks to the credit of the State Banking Board. Thes,.., “regular contribu- tions” were to continue until the Fupind contained five mil- lion dollars. If a contributing bank fi ¢, 5) ed, whatever money was needed to pay its depositors ., a.’ taken from the Fund, which was then immediately ly reimbursed by a spe- cial cash assessment levied on thq},, contributing banl Such “special assessments” could not ot exceed two t of a bank’s total average daily depos)... in any -seongened so that, in any year in which losses es exceeded this amount, recourse was had to the Fund its¢t self, sah the @ we contributions” to the Fund would DD vememe wate it °s — reached five million dollars. Each ch participating bank’s pro rata share of the Fund was ret turn able to it upon its withdrawal from the Fund or UPON on its liquidation. The proper treatment to be acCO, worded the ie ats tributions to the Fund for Federal) tania cg became a matter of some controv. ersy. The Fs ape a 72 Internal Revenue first held that they were deductible as “necessary business expenses,” I.T. 1258, I-1 C.B. 281, but soon revoked this ruling in I.T. 2208, IV-2 C.B. 81, The position was then taken that the contributions were not deductible since they “remain assets of such partici- pating banks. Each participating bank retains at all times an interest in the fund equal to the unexpended portion of its contributions thereto, the amount whereof is readily determinable * * *”. S.M. 3877, IV-2 C.B. 79. The Board of Tax Appeals did not agree with this approach, holding in First State Bank of Bracketville, 9 B.T.A. 975, fol- lowed in First State Bank of Weimar, 10 B.T.A. 396, that such contributions were deductible since they were paid “pursuant to a definite liability fixed by law.” First State Bank of Bracketville, 9 B.T.A. 975, 980. The Bureau thereupon modified its position to conform to that of the Board of Tax Appeals. G.C.M. 8474, IX-2 C.B. 281. However, the Board was again confronted with this issue in Wichita State Bank & Trust Co., 27 B.T.A. 822. In that case, the taxpayer bank had withdrawn from the Fund and had received its pro rata portion thereof, and the issue raised was whether such amount was includible in its income. The Commissioner said it was, relying on his newly revised position on this matter following the Bracketville and Weimar cases, contending that since the regular contributions to the fund were deductible, their return to the taxpayer constituted taxable income. The Board, following its prior decisions, agreed. On appeal, in an opinion which we now think correctly disposed of this matter, the Fifth Circuit reversed the Board on this issue, holding that the regular contributions were not ordi- nary and necessary expenses but nondeductible capital expenditures. Wichita State Bank & Trust Co. v. Com- missioner, 69 F. 2d 595 (C.A. 5). Keeping in mind the similar characteristics of these “regular contributions” and the section 1727(d) payments here in issue, the fol- lowing comments of the Fifth Circuit are instructive (69 F. 2d at 596): * * * That fund [i.e., the permanent five million dollar Guaranty Fund] is not intended to be lost or consumed, but is to stand as a reservoir drawn on — 73 to provide prompt payment to depositors, but to be at once replenished by the special assessments. It is analogous to the capital of an insurance company. Each bank owns its pro rata part in it, which it ought ultimately to get back. * * * We think the contribu- tions to the $5,000,000 Guaranty Fund, while made annually instead of in a lump sum, were essentially capital investments and ought to be dealt with as such. Here the matter of the “regular contributions” was finally settled, the Commissioner indicating agreement with the Fifth Circuit’s opinion by reinstating S.M. 3877. G.C.M. 13290, XITII-2 C.B. 313. We hold that the section 1727(d) payment of $882,- 636.86 made by petitioner in 1963 was a nondeductible capital expenditure, that the Commissioner correctly dis- allowed a deduction for this sum, and that the deficiency determined in petitioner’s income tax for 1963 in respect of that disallowance was proper. Petitioner has made an alternative argument that the Commissioner’s attempt to assess and collect the deficiency here violated its constitutional rights under either Article II, section 8 (directing the President to “take care that the laws be faithfully executed”) or the Fifth Amend- ment to the Constitution (the due process clause). Peti- tioner relies on the fact that in the First Federal Savings & Loan Ass’n of St. Joseph case, discussed above, a tax refund suit in which the taxpayer savings and loan association sued to recover taxes which it alleged were erroneously paid for 1963, 1964 and 1965 due to its fail- ure to deduct section 1727(d) payments made in those years, the Government tried to settle by offering to pay the amount sought by the taxpayer and to dismiss the action with prejudice, though it did not wish the terms of the settlement to be included in the final stipulation. It should be noted that the taxpayer refused this offer, and the District Court went to extraordinary lengths in ruling that the refund suit had not become moot. The District Court thereupon adjudicated the issue on the merits in the taxpayer’s favor. Petitioner nevertheless contends that the mere fact that the offer of settlement 74 was made to the taxpayer in the St. Joseph casé is fata] to the determination of the deficiency herein on Consti- tional grounds. We think that the point is without merit, The position taken by the Commissioner in this case in respect of section 1727(d) payments made to the FSLIC is the same as that in Rev. Rul. 66-49, published in Cumulative Bulletin 1966-1, p. 36. We have carefully examined that position, as it relates to the facts of this case, and have found the deficiency determined by the Commissioner in petitioner’s income tax for 1963 was justified by the provisions of the Internal Revenue Code of 1954. We cannot and will not go further and examine the Commissioner’s reasons and motives for determining the deficiency in this case and defending his position in response to the petition for a redetermination filed by petitioner in this Court. See Charles Crowther, 28 T.C. 1298, 1801, affirmed 269 F. 2d 292, 293 (C.A. 9). Peti- tioner has no ground to object merely because some other taxpayer may have been offered a windfall as a result of the Government’s litigation strategy. Whatever may have been the Government’s litigation strategy in attempt- ing to dispose of the St. Joseph case, it is not a matter about which the petitioner herein has any standing to complain. The history of litigation over the years has been marked by efforts of private litigants as well as the Government to select test cases in such manner as may be thought to further their respective best interests, and the refusal to press some other case has never been thought to create any rights in favor of parties to a case where similar concessions have not been made. Petitioner has been accorded due process of law in the review of the deficiency determined against it by the Commissioner herein and the fact that it has not been offered a windfall, if indeed the offer of settlement in the St. Joseph case was such, does not rise to the level of an infringement of its constitutional rights. Reviewed by the Court. Decision will be entered for the respondent. _— TAX COURT OF THE UNITED STATES WASHINGTON [Caption Omitted] 75 DECISION (Entered October 21, 1968) Pursuant to the determination of the Court, as [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386413_0307%3A1. Public record. Not legal advice.