Rev. Rul. 60-145

Advice has been requested as to the treatment, for Federal income tax purposes, of interest on nonnegotiable savings certificates issued by a bank under the circumstances described below.

A bank issued savings certificates, designated as series `A' and series `B,' in multiples of $100. Both types of certificates are nonnegotiable and mature one year after date of issue with automatic renewals for successive six-month periods without further notice to the holder, unless the certificates are presented for payment within ten days after the original maturity date or any subsequent semiannual maturity date. Assignment of the certificates is effective only when registered on the books of the issuing bank.

Interest on the series `A' certificates when held to maturity is allowed at the rate of two and one-half percent per annum from the date of issue, compounded semiannually for each full semiannual period, and is paid only upon their redemption. If the certificates are presented and surrendered prior to the expiration of the first six-month period, no interest is paid. However, if the cerfificates are presented and surrendered for redemption prior to maturity, but after the first six-month period, interest will be allowed at one percent per annum for the first full semiannual period. On and after one year from the date of issue, interest will be allowed at the rate of two and one-half percent per annum on such certificates, compounded semiannually. For example, if a $100 certificate is held for seven months and then surrendered for redemption, the holder will receive only $100.50. If held for 12 months and then surrendered, the holder would receive $102.50.

Interest on series `B' certificates is paid by check at the rate of two and one-half percent annum for each full semiannual period from the date of issue. However, if the certificates are properly presented and surrendered for redemption before the expiration of the first six-month period, no interest is paid. If the certificates are presented and surrendered for redemption prior to maturity, but after the first six-month period, interest is allowed at the rate of one percent per annum, for that first full semiannual period. On or after one year from the date of issue, interest is paid at the rate of two and one-half percent per annum. Upon surrender prior to the original maturity date, the holder receives an amount which is less than the face amount of the certificate. For example, if such certificate is surrendered prior to the original maturity date and after six months from the issue date, he would receive only $99.25 for each $100 of face value of the certificate redeemed.

Section 446 of the Internal Revenue Code of 1954 provides, in part, `Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books' and, `* * * if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the option of the Secretary or his delegate, does clearly reflect income.'

Section 451 of the Code provides, in part, `The amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period.'

Section 1.451-2(a) of the Income Tax Regulations provides, in part, as follows:

Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account or set apart for him so that he may draw upon it at any time. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restriction. * * *

Since a holder of series `A' certificates, in order to obtain any interest earned before the expiration of one year after purchase, must forego the right to receive the full interest at the rate of two and one-half percent, he cannot be said to have accrued or constructively received any interest not paid to the holder during that period. However, at maturity (at the end of the first year), he is entitled to receive interest at the two and one-half percent rate, which is credited to him at that time and at the end of each succeeding seminannual period. Such interest is then accrued or constructively received by him in accordance with his method of accounting and is includible in his income for the year in which it is so credited. If a certificate is redeemed before the expiration of the first year after its purchase, the interest is includible in income when received, regardless of the method of accounting employed by the taxpayer.

Interest on series `B' certificates constitutes income when received or accrued depending upon the method of accounting employed by the taxpayer. Upon redemption of such certificates prior to maturity and after six months from the issue date, where there is paid over to the certificate holder only the fixed redemption value of $99.25, the holder, in effect, receives the full face value of certificate ($100) and simultaneously refunds previously realized interest to the extent of the difference between the face amount of the certificate and the net redemption value. Such a refund of interest is deductible as an ordinary loss under section 165 of the Code, incurred in a transaction entered into for profit, for the taxable year of such redemption and refund. Insofar as the certificate itself is concerned, a purchaser has no gain or loss, either capital or ordinary. The same principles are applicable here as were applied in I.T. 3504, C.B. 1941-2, 93, relating to United States savings bonds, Defense Series G. See also Rev. Rul. 59-271, C.B. 1959-2, 70.

Accordingly, it is held that interest on nonnegotiable savings certificates issued by a bank, which is credited periodically to a certificate holder but paid only upon redemption of the certificates and at a different rate prior to maturity, is includible in the holder's gross income for the taxable year in which such interest was received prior to the first maturity date or credited thereafter. Interest on such savings certificates which is paid periodically by check to a certificate holder is includible in his gross income for the taxable year in which received or accrued, depending upon the method of accounting employed by the holder.

A refund by the holder of any previously realized interest, effected by redemption of such certificates at an amount less than face value at maturity, constitutes an ordinary loss, incurred in a transaction entered into for profit, only for the taxable year of redemption and refund. A purchaser of such a certificate has no gain or loss upon its redemption.