Fifth Circuit and Tax Court Disagree on Whether Money Services Business Is a Bank

If a taxpayer ends up with a worthless security, the loss from writing off that security is treated as a capital loss.  While, generally, to have a capital gain or loss there must be a sale, IRC §165(g) provides a special rule for worthless securities.  The section provides:

(g) Worthless securities

(1) General rule

If any security which is a capital asset becomes worthless during the taxable year, the loss resulting therefrom shall, for purposes of this subtitle, be treated as a loss from the sale or exchange, on the last day of the taxable year, of a capital asset.

(2) Security defined

For purposes of this subsection, the term "security" means--

(A) a share of stock in a corporation;

(B) a right to subscribe for, or to receive, a share of stock in a corporation; or

(C) a bond, debenture, note, or certificate, or other evidence of indebtedness, issued by a corporation or by a government or political subdivision thereof, with interest coupons or in registered form.

As well, no loss is allowed unless the item becomes worthless or the taxpayer disposes of the security in a taxable transaction.

However, the above rule does not apply to banks.  IRC §582(a) provides an exception to the application of §166(g) cited above for securities held by a bank:

(a) Securities

Notwithstanding sections 165(g)(1) and 166(e), subsections (a) and (b) of section 166 (relating to allowance of deduction for bad debts) shall apply in the case of a bank to a debt which is evidenced by a security as defined in section 165(g)(2)(C).

In the case of Moneygram International, Inc. and Subsidiaries v. Commissioner, 144 TC No. 1, reversed CA5 Case No. 15-60527, the question was whether the money transfer service Moneygram (which is the largest issuer of money orders, as well as providing immediate transfers of cash from location to location) qualified as a bank.  But the Tax Court and the Fifth Circuit did not agree on how to determine if Moneygram was a bank.

Tax Court Decision

Moneygram is generally regulated under state law, most often by a banking commission or similar office.  These state regulations impose capital requirements on the entity which can be satisfied by holding highly rated debt instruments.

During the financial crisis during 2007-2008 many of the asset backed securities that Moneygram held (and they held over $4 billion of such assets) were downgraded from A or higher ratings to junk status.  Not surprisingly, the value of those investments also dropped dramatically.  This caused Moneygram to fall out of compliance in many cases with state laws for minimum capital and permissible investments. 

To deal with that problem, Moneygram underwent a recapitalization and either wrote off or wrote down a large volume of such securities.  On its corporate return Moneygram claimed that these represented bad debt losses that gave rise to ordinary loss deductions.

The IRS claimed that such losses could be treated as ordinary bad debt losses only if Moneygram qualified as a bank under IRC §582.  Moneygram argued that, in fact, it should be treated as bank for federal tax purposes, arguing that it met the requirements of IRC §582.

A bank is defined for these purposes in IRC §581, which provides:

For purposes of sections 582 and 584, the term “bank” means a bank or trust company incorporated and doing business under the laws of the United States (including laws relating to the District of Columbia) or of any State, a substantial part of the business of which consists of receiving deposits and making loans and discounts, or of exercising fiduciary powers similar to those permitted to national banks under authority of the Comptroller of the Currency, and which is subject by law to supervision and examination by State or Federal authority having supervision over banking institutions. Such term also means a domestic building and loan association.

The Tax notes that Moneygram did not claim to be a building and loan association, nor does it exercise fiduciary powers.  Thus, the question becomes whether the organization is a bank where a substantial part of the business consists of receiving deposits and making loans subject to supervision an examination by the proper governmental authorities.

The Tax Court decided that there were two tests that Moneygram had to meet—first it must meet the general definition of a bank and, second, it must show that a substantial part of its business consists of receiving deposits and making loans, despite Moneygram arguing that, in fact, the section defines a bank as any entity that is subject to the proper supervision and meets the substantial part test.

The Court notes:

The statute’s text makes clear that this first requirement--that an entity be a “bank” as the term is commonly understood--is a distinct requirement, separate from the requirements that it accept deposits, make loans, and be subject to banking regulation. These latter requirements are set forth in a pair of restrictive relative clauses that follow the principal clause. These clauses specify two features that an entity must have, apart from being a “bank” as commonly understood, in order to be a “bank” within the meaning of section 581: a substantial part of its business must consist of receiving deposits and making loans, and it must be subject to regulation by Federal or State banking authorities. Basic rules of English syntax require that the principal clause of a sentence be given meaning independent from that of succeeding subordinate clauses. And elementary rules of statutory construction require that we interpret section 581 so that no clause, sentence, or word is rendered superfluous, void, or insignificant. See Duncan v. Walker, 533 U.S. 167, 174 (2001); Sophy v. Commissioner, 138 T.C. 204, 211 (2012).

Looking at whether Moneygram qualified as a bank as the term is commonly understood, the Court concluded that Moneygram did not meet that test.  Citing the Fourth Circuit’s opinion in Staunton Indus. Loan Corp. v. Commissioner, 120 F.2d 930 (4th Cir. 1941), rev'g 42 B.T.A. 1030 (1940) the Tax Court concluded that, to be a bank, Moneygram had to meet three tests:

·       The receipt of deposits from the public, repayable to the depositors on demand or at a fixed time;

·       The use of deposit funds for secured loans; and

·       The relationship of debtor and creditor between the bank and depositor.

The Court found that Moneygram met none of these tests. 

Moneygram argued that it received funds from its customers from the sale of money orders and other transfer services, for which it held the funds in temporary investment funds until the funds were claimed, which it found to be deposits.  The Tax Court disagreed, finding that Moneygram did not receive deposits from the general public (the funds came from Moneygram customers who sold money orders and similar items) and the funds were not held to be reclaimed by those individuals, but rather by the party to whom the money order or similar item had been issued.

Moneygram also did not use those deposits to make secured loans.  Moneygram pointed out that organizations who sold money orders had funds due to Moneygram that would be paid at a later (albeit only a few days later) date.  But the Court pointed out that the agreement with those customers made clear the funds were held in trust for Moneygram and, unlike bank loans, no interest was charged on these advances unless the customer failed to transfer the funds back to Moneygram at the time provided for in the agreement—a bank generally charges interest from the initiation of the loan until the date of repayment. 

Moneygram also classified these amounts as accounts receivable and not loans on its books.  As well, Moneygram doesn’t make use of what it claimed to be the “deposits” it received to make these “loans” as the funds were obtained from the buyers of the money orders and similar instruments by MoneyGram’s customers, not by Moneygram issuing cash from its investment funds.

Moneygram also is not subject to regulation as a bank—federal specifically treated Moneygram as “money services business” (MSB) which provided that such services are not a bank.  Moneygram was not eligible for membership in the Federal Reserve and while it is often regulated by state banking departments, it is licensed and regulated in such states as a money transmitter and not a bank.

Even though, as the Court notes, its finding that Moneygram fails to meet the common definition of a bank would preclude treating these losses as ordinary, the Court goes on to note that even if the Court accepted MoneyGram’s view that the statute should be read as defining any organization that meets the two tests as a bank, Moneygram would fail because a substantial portion of its business is not the receiving of deposits and making loans.

A deposit, in the view of the Tax Court, generally refers to funds placed with a financial institution for safekeeping, repayable to the depositor on demand or at a fixed date in the future.  As was noted earlier, the “depositor” (be it either the buyer of the money order or the customer of Moneygram that sold the money order) is not the party that will reclaim the funds in the future—rather it is a third party to whom funds are being transferred. 

The Court notes:

MoneyGram’s business consists of moving its customers’ money from point A to point B as quickly as possible. The funds it holds pending completion of that service are not placed with it for safekeeping and are not held for any meaningful period of time. Its money order customers are explicitly told that they are not making “deposits,” and these funds are reflected on its financial statements not as “deposits” but as “payment service obligations.” Because “receiving deposits” does not constitute any meaningful part, much less “a substantial part,” of MoneyGram’s business, it does not qualify as a “bank” under section 581.

The Tax Court also finds that Moneygram did not make loans as the term is commonly understood.   The Court notes:

Most corporations have, among the assets on their balance sheet, accounts receivable from customers, agents, and other persons. Any company having accounts receivable must specify the period within which it expects its customers to pay such accounts. Some invoices may say that they are payable immediately upon receipt; other invoices may afford the customer 30 days to pay. MoneyGram’s “deferred remittance agreements” simply specify the period--generally, half a week--within which its agents are expected to transmit to MoneyGram the sums they owe MoneyGram. These agreements do not give rise to “loans” within the meaning of section 581, any more than garden variety payment terms specified by any business give rise to “loans.” Were that not so, any company that has accounts receivable on its balance sheet could plausibly contend that it satisfies this requirement for “bank” status.

Thus, Moneygram did not qualify for ordinary loss treatment for these items.

While capital loss treatment is available, that did Moneygram no good—as the Tax Court pointed out, Moneygram had no capital gains against which to offset capital gains and, as a C corporation, capital losses can only be used to offset capital gains.  As well, unlike individuals, for C corporations such losses may not carried forward indefinitely—rather, the losses can be first carried back three years against any capital gains those years, then carried forward five years.  [IRC §1212(a)] If there are insufficient gains to offset the losses in those years, the capital losses go unused.

Fifth Circuit Reversal

Moneygram appealed the decision of the Tax Court and the Fifth Circuit, in a 2-1 split decision (Case No. 15-60527), reversed the Tax Court’s decision, holding that Moneygram should be treated as a bank for these purposes.

The Court agreed generally with the Tax Court’s view that bank should be given its common meaning, rejecting MoneyGram’s argument for a different holding.  But, the majority held:

While we agree with the Tax Court in this regard, we disagree with the manner in which it defined "deposits" and "loans" as relevant both the to this inquiry and § 581's later requirement that a substantial part of the taxpayer's business consist of receiving deposits and making loans.

The majority disagreed with the Tax Court’s view that in order to “take deposits” they must remain in place for an extended period, holding that the case the Tax Court cited (AmSouth Bancorporation & Subsidiaries v. United States, 681 F. Supp. 698 (N.D. Ala. 1988) did not mention any specific period of time such deposits had to remain with the entity.

The majority also did not accept the view that a loan was an instrument repayable with interest with a fixed and often lengthy repayment period, rather looking at whether there was an intent for the amount to be repaid. 

The majority found, based on these revised definitions, Moneygram was a bank for tax purposes and entitled to the ordinary, rather than capital, loss deduction.

In a dissenting opinion, Judge Wiener found that regardless of any technical distinctions on the definition the Tax Court used, Moneygram simply fell short of showing that it was a bank under either definition.