Rev. Rul. 77-216

Advice has been requested whether, under the circumstances described below, certain loans are includible in the taxpayer's eligible loan base for purposes of computing additions to its bad debt reserve as provided in section 166(c) of the Internal Revenue Code of 1954.

In 1968, X, a domestic bank, along with other domestic banks, entered into an agreement to lend the New York Port Authority a specified sum. That loan was evidenced by promissory notes that were special obligations of the Authority payable as to principal and interest solely from the special funds designated in the loan agreement. The notes were not insured or guaranteed by the Authority or by the State of New York.

In 1968, X sold a piece of property to A, an individual, who in return gave X a purchase money mortgage. A sold the property on the same day to Y, an unrelated domestic bank. A was a nominee of Y; consequently, Y assumed the mortgage obligations of A.

The specific questions presented are whether the loans made to the New York Port Authority and the purchase money mortgage received from A are includible in the eligible loan base of X in 1968.

Section 166(a) of the Code provides that, as a general rule, there shall be allowed as a deduction (1) any debt that becomes worthless within the taxable year, and (2) a debt that is recoverable only in part in an amount not in excess of the part charged off within the taxable year.

Section 166(c) of the Code provides that in lieu of any deduction under section 166(a), there shall be allowed a deduction for a reasonable addition to a reserve for bad debts.

Rev. Rul. 65-92, 1965-1 C.B. 112, sets forth a uniform percentage for computing annual additions to reserves for bad debts of banks and provides that a bank will be allowed deductions for additions to its reserve for bad debts until the reserve equals 2.4 percent of loans outstanding at the close of the taxable year. This is the uniform reserve ratio method of computing annual additions to reserves for bad debts for banks.

Rev. Rul. 68-630, 1968-2 C.B. 84, clarifies certain questions regarding the eligibility of items for inclusion in the loan base by banks using the uniform reserve ratio method. Section 3 of that Revenue Ruling provides, in part, that a loan to a bank (as defined in section 581 of the Code) is not eligible for inclusion in the loan base irrespective of whether it takes the form of a repurchase agreement or a similar transaction.

Section 6 of Rev. Rul. 68-630 states, in part, that Rev. Rul. 65-92 provides that Government insured or guaranteed loans must be excluded from the loan base to the extent so insured or guaranteed. That section defines the term "Government insured or guaranteed loans" to include both direct loans to a Government as well as loans to a third party that are insured or guaranteed, directly or indirectly, by a Government. Section 6 of the above Revenue Ruling interpreted the term "Government" as having reference to the Federal Government and its instrumentalities, the District of Columbia, Territories or possessions of the United States, and State governments and political subdivisions thereof. Section 103 of the Code is cited in section 6 to aid in the interpretation of the term Government.

Although the New York Port Authority does not have any taxing power, it is a political subdivision of the States of New York and New Jersey for purposes of section 103 of the Code. Commissioner v. Shamberg's Estate, 144 F.2d 998 (2nd Cir. 1944), cert. denied, 323 U.S. 792 (1945); Wolkstein v. Port of New York Authority, 178 F. Supp. 209 (D. N. J. 1959).

Those entities that are political subdivisions under section 103 of the Code are also considered political subdivisions for purposes of Rev. Rul. 68-630. Therefore, loans to the New York Port Authority are direct loans to a Government as that phrase is used in Rev. Rul. 68-630, even though that entity does not have a taxing power.

As to the purchase money mortgage received by X from A, since A was acting merely as nominee for Y (a bank), the loan, in substance, was made to a bank. Therefore, since Rev. Rul. 68-630 provides that a loan to a bank is not includible in the taxpayer's eligible loan base, the purchase money mortgage in the instant case is not includible in the eligible loans outstanding of X.

Accordingly, the loan to the New York Port Authority and the purchase money mortgage are not includible in the eligible loan base of X for the purpose of computing additions to the bad debt reserve as provided in section 166(c) of the Code.

The holding in this Revenue Ruling is also applicable for taxable years beginning after July 11, 1969, the effective date of section 585 of the Code, relating to reserves for losses on loans of banks.

Rev. Rul. 68-630 is amplified to provide that the phrase Government insured or guaranteed loans includes loans to governmental subdivisions that do not have taxing power.