Rev. Rul. 64-123

Advice has been requested concerning the classification of a savings and loan association as a `domestic builing and loan association,' for Federal income tax purposes, for taxable years beginning before October 17, 1962.

For taxable years beginning before October 17, 1962, section 7701(a)(19) of the Internal Revenue Code of 1954 defined the term `domestic building and loan association' to mean a domestic building and loan association, a domestic savings and loan association, and a Federal savings and loan association, substantially all the business of which is confined to making loans to members. 68A Stat. 912.

Section 7701(a)(19) of the Code was amended by section 6(c) of the Revenue Act of 1962, P.L. 87-834, 76 Stat. 960, C.B. 1962-3, 111, at 131, and now contains a new definition of `domestic building and loan association,' applicable for taxable years beginning after October 16, 1962, and as so amended, is not here under consideration.

The definition of `domestic building and loan association,' contained in section 7701(a)(19) of the Code prior to the effective date of section 6(c) of the Revenue Act of 1962, is the same as that contained in section 3797(a)(19) of the Internal Revenue Code of 1939. That section was added to the 1939 Code by section 313(i) of the Revenue Act of 1951, 65 Stat. 452, at 491.

Prior to this amendment, the Federal taxing statutes had, since 1913, exempted the income of `domestic building and loan associations' from taxation. Section 231(a) of the Revenue Act of 1921, 42 Stat. 227, at 253, amended the language to exempt only `Domestic building and loan associations substantially all the business of which is confined to making loans to members * * *.' The language employed by the 1921 Act remained in effect until the exemption was eliminated by section 313(b) of the Revenue Act of 1951, for taxable years beginning after December 31, 1951.

Section 313(i) of the Revenue Act of 1951 further defined the term `domestic building and loan association' to include `a domestic building and loan association, a domestic savings and loan association, and a Federal savings and loan association.' However, the addition of these phrases by the Revenue Act of 1951 was of a clarifying nature and did not change the existing meaning of a domestic building and loan association. See S. Report No. 781, Eighty-second Congress, C.B. 1951-2, 458, at 564.

As contained in section 7701(a)(19) of the Code, prior to the effective date of section 6(c) of the Revenue Act of 1962, the definition of `domestic building and loan association' has two requirements. First the organization must be a domestic building and loan association, a domestic savings and loan association, or a Federal savings and loan association. Second, it must satisfy the limitation that substantially all of its business be confined to making loans to members.

When this requirement respecting substantially all the business was considered by Congress in the Revenue Act of 1921, the debate in the Senate indicated that the question of what constitutes `substantially all the business of making loans to members' was left to the Commissioner of Internal Revenue to determine. However, the debate indicated that the percentage of such business may vary between 80 and 91 percent, depending upon the circumstances. 61 Congressional Record 5822-5824. do so merely because it invests funds in assets that may be subsequently converted into cash for the purpose of making loans to members. Moreover, any portion of the funds of an association may be held in cash or invested in obligations of the United States or of a State or political subdivision thereof, in the stocks or bonds of a Federal Home Loan Bank, or in the obligations of the Federal National Mortgage Association. Any portion may also be invested in stock or obligations of any other corporation which is an instrumentality of the United States or of a State or political subdivision thereof, or in certificates of deposit in or obligations of, a corporation organized under a State law which specifically authorizes such corporation to insure the deposits or share accounts of member associations.

Furthermore, a domestic building and loan association, in order to be considered a bona fide association and one not engaged in a gross misuse of the name, should not have any substantial part of its business consisting of underwriting corporate securities, selling insurance, buying and selling real estate, or making loans other than passbook loans or loans on real estate authorized by the laws of the chartering authority. Nor should it make loans or enter into other transactions in which an officer, director, or employee representing the association or having a voice therein has business interests that actually conflict with the interests of the association in its capacity as a quasi-public institution. Thus, if the evidence indicates that more than 20 percent of the assets of the association are devoted to, or more than 20 percent of its income is derived from, the activities mentioned in this paragraph, a gross misuse of the name domestic building and loan association may have occurred.

2. Substantially all business not confined to making loans to members . Except as otherwise indicated herein, if substantially all the business of the association is not confined to investing in loans to members, as permitted by its chartering authority, the association does not qualify as a domestic building and loan association for Federal income tax purposes. Funds invested in loans to nonmembers who become members when the loans are made to them are not improperly invested. Nor are funds improperly invested if they are invested in cash and assets described in the third and fourth sentences, second paragraph of 1, above, or property acquired on defaults of permissible loans, or if they are used by the association to acquire property for use in the conduct of its affairs as a domestic building and loan association.

As indicated previously, what percentage constitutes `substantially all' was left to the discretion of the Commissioner to be determined on the basis of the facts and circumstances of the individual case, and no fixed percentage was established. However, due to the uncertainty of the meaning of this term, the Service will not challenge the classification of a domestic building and loan association for Federal income tax purposes for years beginning before October 17, 1962, assuming that there are no other disqualifying factors, if at least 80 percent of its business is comprised of investments in loans to members, even though in many other circumstances the term `substantially all' would require a much higher percentage. The term

It is, of course, not enough that substantially all of the business of the association is confined to making loans to members. It must still be a domestic building and loan association, a domestic savings and loan association, or a Federal savings and loan association. It is well established that, in determining the classification of a building and loan association, if an association is a domestic building and loan association under the law of the state in which it is chartered, it is such for Federal income tax purposes `unless there is a gross misuse of the name.' United States v. Cambridge Loan and Building Company , 278 U.S. 55 (1928), T.D. 4252, C.B. VII-2, 290 (1928).

In determining whether an organization is a bona fide domestic building and loan association, other factors are to be considered. In general, these factors relate to the control and management of the association and its business and assets and to the opportunity and means it affords the public for saving and borrowing primarily for residential purposes. The case of Perpetual Building and Loan Association of Columbia v. Commissioner , 34 T.C. 694 (1960) acquiescence, C.B. 1961-2, 3, affirmed per curiam, 291 Fed.(2d) 831 (1961), is a clear example of some of the factors which disqualify an association as a domestic building and loan association for Federal income tax purposes.

In accordance with the foregoing, it is held that for an association to qualify as a domestic building and loan association, for Federal income tax purposes, for taxable years beginning before October 17, 1962, the association must be organized as a building and loan association or savings and loan association pursuant to, and operated in all material respects as such in accordance with, the law of the chartering authority. If this requirement is met, the association qualifies as a domestic building and loan association for Federal income tax purposes, provided it is not operating contrary to one or more of the following principles:

1. Gross misuse of the name . It is understood that a domestic building and loan association engages primarily in the promotion of thrift and residential financing. Though an organization is chartered as a building and loan association or savings and loan association, it is not a domestic building and loan association for Federal income tax purposes if the organization's activities are such that to denominate the organization a building and loan association is a gross misuse of the name. Cambridge Loan and Building Company, supra . For example, an organization that in reality is a mortgage brokerage company or investment company operating under the guise of a building and loan association is not a domestic building and loan association for Federal income tax purposes. Compare H.R. Report No. 350, Sixty-seventh Congress, C.B. 1939-1 (Part 2), 168, at 178, relating to the Revenue Act of 1921.

In applying this test, the Internal Revenue Service will give weight to changes in economic conditions as they may relate to a particular association. Thus, for example, in times of small demand for loans on residential property which are permitted by the chartering authority, an association, which otherwise qualifies as a domestic building and loan association for Federal income tax purposes, will not fail to at least 80 percent of its business as used herein means that 80 percent of its assets (exclusive of the assets mentioned in the last sentence of the immediately preceding paragraph) is invested in such loans or 80 percent of its gross income (exclusive of the gross income from the assets mentioned in the last sentence of the immediately preceding paragraph) is derived from such loans.

In determining who are members, the Service recognizes that an association has the right to determine the qualifications of its members for itself, through its charter or bylaws, so long as such action is in conformity with the requirements prescribed by the law, rules and regulations of the chartering authority. Thus, although a person has deposited only a nominal amount in his share or credit account, he is a member if provision for him to be such is allowed or required by the law of the chartering authority. Likewise, a borrower may become a member on account of a permitted loan made to him, if it is lawfully provided that he shall be one.

It is appropriate, in determining whether an association is a domestic building and loan association, to consider, under either of the foregoing requirements, the manner in which its profits and assets are shared as well as the manner in which its business has been conducted. Unless the law of the chartering authority clearly requires that all members of a building and loan association shall share in the profits of the association on substantially the same footing, the rule, for Federal income tax purposes, does not embrace such a requirement. Nor, in the absence of a law of the chartering authority to the contrary, is an association any less a domestic building and loan association because it has different classes of members with different rights and liabilities. Moreover, without a requirement by the law and regulations of the chartering authority, that in the event of dissolution of a building and loan association, all of the members shall be entitled to share on a mutual basis in the assets of the association in proportion to their relative share or account credit, such requirement is not a prerequisite to qualification as a domestic building and loan association. Guaranty Building and Loan Company of Marion, Indiana v. Commissioner , 27 B.T.A. 754 (1933), acquiescence, C.B. XII-1, 6 (1933); see also G.C.M. 11653, C.B. XII-1, 121 (1933).

On the other hand, an association does not qualify as a domestic building and loan association for Federal income tax purposes if (1) the method of sharing profits, or the method of sharing the assets in the event of dissolution, is contrary to the law and regulations of the chartering authority, or (2) the association authorizes an excessive and grossly disproportionate sharing by one class of members, a majority of which is composed of one or more persons who are directors, officers, or controlling shareholders of the association, members of the immediate families of such persons, or a corporation owned or controlled by one or more such persons. The foregoing shall not be construed to deny qualification to permanent stock associations by reason of appreciation of value of its stock, or allocation to reserves required or permitted by the chartering authority, or regular or liquidating dividends paid on nonwithdrawable shares.

¹ Also released as Technical Information Release 566, dated April 7, 1964.