The following article is adapted and reprinted from the M&A Tax Report, Vol. 10, No. 2, September 2001, Panel Publishers, New York, NY.

FDIC INSURANCE FEES DEDUCTIBLE, NOT INDOPCOED!

By Robert W. Wood

The Tax Court, in a divided opinion, has held that fees paid by a bank holding company subsidiary to the FDIC for switching insurance funds and paid incident to the acquisition of a failed savings association's assets and liabilities are currently deductible. See Metrocorp Inc. v. Commissioner; 116 T.C. No. 18; No. 19780-98 (April 13, 2001).

Just the Facts...

Metrocorp Inc., a bank holding company, has a wholly owned subsidiary, Metrobank. In 1990 Metrobank submitted a bid to the FDIC to acquire a portion of the assets of a failed savings association, Community, and assume a portion of the liabilities. Both banks insure their deposit liabilities through a different FDIC fund: Community is insured under the Savings Association Insurance Fund (SAIF) and Metrobank under the Banking Insurance Fund (BIF). Under Title 12 of the U.S. Code, the acquisition of Community's assets by Metrocorp is treated as a conversion because the banks are insured under different FDIC funds. Metrobank completed the transaction and the FDIC approved it. After the transaction all of Metrobank's deposit liabilities were insured by the BIF, and Metrobank paid exit fees (for Community's assets/liabilities leaving SAIF) to the FDIC over a five-year period and an entrance fee (for the assets/liabilities entering BIF) over the same period. Metrobank deducted the fees in the years paid.

The IRS issued a deficiency notice disallowing the fee deductions, determining that they are nondeductible capital expenditures and should be capitalized under the standard set forth in INDOPCO Inc. v. Commissioner, 503 U.S. 79 (1992) (92 TNT 44-1), because the payment of the fees will generate future benefits. The IRS argued that the benefits permit Metrobank to insure all of its deposit liability through one fund, minimizing compliance; to gain lower insurance premiums for the Community assets; and to gain entrance to the more stable fund. Metrocorp argues that Metrobank derived no significant long-term benefit from the payment of the fees.

To Deduct or Not to Deduct...

Tax Court Judge David Laro, writing for the majority, held that Metrocorp may deduct the fees. The court noted that the IRS failed to argue the capitalization of the fees because they were incurred in connection with the acquisition of another financial institution, and, because the theory wasn't raised before the case submission, the court chose not to rule on that issue. (This procedural point is important, and should not be lost on those hoping INDOPCO has breathed its last breath.)

Still, Judge Laro reviewed the history of banking reform and noted that Congress anticipated that banks would want to switch from SAIF and to BIF because of the lower rates, and added the fees for conversion. Also, the court noted there was a moratorium period on conversions, unless one of two exceptions was met. The first exception permits the FDIC to allow conversions involving the acquisition of a depository institution that was in default, such as Community. The second exception provides for conversions to be consummated through a merger or consolidation, and Metrobank could have also used this second exception but didn't.

Separate Asset Theory

The court next noted that when an expense creates a separate asset it must generally be capitalized, but if no separate asset is created, the courts look to the time period over which the taxpayer will derive a benefit from the expense and the significance to the taxpayer of the benefit. In this case, Judge Laro found that Metrobank's payment of the fees didn't produce a significant future benefit. Metrobank didn't pay the fees as a condition of obtaining the FDIC insurance in the first place, as it always had been covered by the BIF insurance. The payments were made to insure that its assumed deposit liabilities would be covered by BIF, rather than SAIF, a fund with which Metrobank was unfamiliar. If Metrobank severed its relationship with either fund, it would not recover any of the funds. The court interpreted the exit fees as compensation to the former insurer for loss of future income and the entrance fee as payment for the current year's insurance.

The court concluded that Metrobank's management made a business decision to pay the two fees to insure all of their liabilities under BIF rather than keep the acquired liabilities under SAIF until the end of the moratorium. Judge Laro concluded that the exercise of sound and reasonable business practice to minimize a recurring operating cost is not a significant future benefit requiring capitalization of the related non-asset-producing expenditures. The court dismissed the IRS's analogy of the fee payments to the purchase of a nontransferable membership interest and distinguished this case from Commissioner v. Lincoln Sav. & Loan Association, 403 U.S. 345 (1971), noting that the payments in that case created or enhanced a separate and distinct asset.

Division: Tax Court Judges Disagree

Judge Stephen J. Swift, concurring, noted that under INDOPCO, direct and indirect costs that are similar to routine expenses need not be capitalized. Judge Carolyn P. Chiechi, also concurring, noted that the nonrefundable fees should not be analogized to the premiums paid for insurance coverage.

Judge Robert P. Ruwe, dissenting, concluded that the fees should be capitalized, and that the majority misconstrued the deficiency notice to exclude the argument that the fees were incurred in connection with the acquisition of an asset. Judge James S. Halpern, also dissenting, noted that Metrocorp failed to prove that the fees were other but a cost incident to the purchase of a capital asset. Judge Renato Beghe, also dissenting, concluded that even normally deductible costs must be capitalized if they are related to the acquisition of a capital asset, and the IRS did sufficiently raise the asset acquisition issue.

INDOPCO, it seems to me, may have a half-life longer than DDT!

FDIC Insurance Fees Deductible, Not INDOPCOed!, Vol. 10, No. 2, The M&A Tax Report (September 2001), p. 1.