Rev. Rul. 74-27

The purpose of this Revenue Ruling is to update and restate, under the current statute and regulations, the position set forth in G.C.M. 12355, XII-2 C.B. 100 (1933).

The question presented is whether, under the circumstances described below, certain interest earned by the taxpayer is excludable from its gross income pursuant to the provisions of section 103 of the Internal Revenue Code of 1954, or is includible in its gross income under the provisions of section 61.

During the years 1970 to 1972, inclusive, the taxpayer, a bank, entered into transactions with certain of its customers which, it is purported, resulted in the "purchase and resale" of state or municipal bonds the interest on which is exempt from tax under section 103 of the Code. In such transactions, customers owning the bonds and desiring to secure temporary funds entered into written agreements with the bank providing as follows:

Agreement made the ___ day of ________, 19____, between [the customer] here in after referred to as the party of the first part, and [the bank], here in after referred to as the party of the second part,

WITNESSETH:

1. That the party of the first part, in consideration of the agreements hereinafter contained, to be performed by the party of the second part, agrees to sell and deliver to the said party of the second part on the day and year first above written the following securities: ___________________________________________________________________ ___ for which in consideration thereof the party of the second part agrees to pay to the party of the first part ___________________________________________________________________ ______________.

2. In consideration of the premises, the party of the first part agrees to repurchase and the party of the second part agrees to sell said securities on or before ___________________________________________________________________ ______________.

3. Upon failure of said party of the first part to accept delivery of said securities as provided for in clause 2 hereof, and to make payment therefor, then the party of the second part may immediately, without further notice to the party of the first part, sell the above-mentioned securities at public or private sale, at any broker's board or otherwise, and apply the proceeds of said sale as far as needed toward the above contract price, and of any or all other obligations or liabilities of the party of the first part to the party of the second part, accounting to the party of the first part for any surplus arising; the party of the first part remaining liable to the party of the second part for any deficiency remaining unpaid after such application.

4. In the event of failure of said party of the second part to deliver said securities and accept payment therefor under this repurchase agreement, then the said party of the first part may, without further notice of the party of the second part, "buy in" the party of the second part under terms and conditions corresponding to those described in the preceding paragraph.

5. Delivery and payment to be made at the office of the party of the _____________ part. * * *"

Section 61 of the Code provides, in part, that, except as otherwise provided in subtitle A, gross income includes interest.

From an examination of the agreement quoted herein, it is apparent (1) that the identical securities which are "sold" to the bank are required to be held by it for repurchase by the customer, and that the customer is entitled to demand and receive such identical securities when he performs his agreement to repurchase; (2) that upon the failure of the customer to repurchase the securities and to make payment therefor as stipulated, the bank may sell the securities, apply the proceeds of the sale upon the repurchase price, and either credit the customer with any excess or hold him liable for any deficiency; (3) that the customer is legally bound both to repurchase the securities and to pay any deficiency remaining unpaid after the application of the proceeds of sale (the customer not having a mere option to repurchase); (4) that the customer agrees to pay interest at a stipulated rate upon the amount advanced by the bank; and (5) that the value of the securities may or may not equal the amount advanced by the bank.

In the case of First American National Bank of Nashville, v. United States, 467 F. 2d 1098 (6th Cir. 1972), bond dealers orally agreed with a bank that it (bank) would buy tax exempt bonds from issuers and later sell them to the dealers at the price the bank had paid for them and the bank would accrue interest on the bonds until the latter sales occurred. In addition, arrangements were made whereby customers of the bank agreed that the bank would acquire bonds from dealers and later sell the bonds to the customers at the price it (bank) had paid with adjustments for accrued interest. The United States Court of Appeals held that the bank in substance never owned the bonds and was not entitled to tax exemptions for interest that accrued on the tax exempt bonds during the period held by the bank. See also American National Bank of Austin, v. United States, 421 F. 2d 442 (5th Cir. 1970), rev'g rem'g D. C., cert. denied, 400 U.S. 819.

Based on the foregoing, it is concluded that the "purchase and resale" agreements described in the instant case simply effect loans of money by the taxpayer upon collateral security and such agreements are not purchases by the taxpayer of securities for investment.

Accordingly, it is held that the taxpayer must include in its gross income, pursuant to section 61 of the Code, the entire amount of the interest charged on its customers' loans in such transactions. The taxpayer is not entitled to treat as income from tax exempt securities the interest payable by the obligors on such securities during the period they are held by it. Such tax-exempt interest is the income of the customer who submitted the securities to the bank for collateral.

G.C.M. 12355 is hereby superseded, since the position stated therein is restated under the current law in this Revenue Ruling.

¹ Prepared pursuant to Rev. Proc. 67-6, 1967-1 C.B. 576.