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. e du/thir dc ir c uit_2000/103Filed May 19, 2000

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No. 99-6020

PNC BANCORP, INC., Successor to First National Pennsylvania Corporatio n

v.

COMMISSIONER OF INTERNAL REVENUE (Tax Court No. 95-16002)

PNC BANCORP, INC., Transferee of Assets of First National Pennsylvania Corporation

v.

COMMISSIONER OF INTERNAL REVENUE (Tax Court No. 95-16003)

PNC BANCORP, INC., Successor to United Federal Bancorp, Inc., and
Subsidiaries

v.

COMMISSIONER OF INTERNAL REVENUE (Tax Court No. 96-16109)

PNC BANCORP, INC., Transferee of Assets of United Federal Bancorp, Inc ., and
Subsidiaries

v.

COMMISSIONER OF INTERNAL REVENUE (Tax Court No. 96-16110)PNC Bancorp, Inc., as (i) Successor to First Nation al

Pennsylvania Corporation, (ii) Transferee of Assets of First National Pennsylvania Corporation, (iii) Successor to United Federal Bancorp, Inc., and Subsidiaries, and (iv) Transferee of Assets of United Federal Bancorp, Inc
., and Subsidiaries, Appellant

On Appeal from the Commissioner of Internal Revenue
, Decision of the United States Tax Court (Tax Court Nos. 95-16002, 95-16003, 96-16109, and 96-16110) Tax Court Judge: Honorable Robert P. Ruwe

Argued October 21, 1999

Before: SLOVITER, RENDELL, Circuit Judges, and BYRNE, District Judge*

(Filed: May 19, 2000)

Robert J. Jones, Esq. (ARGUED) Roger P. Colinvaux, Esq.

Arnold & Porter 555 12th Street, N.W. Washington, DC 20004 Attorneys for Appellant

Richard Farber, Esq. Annette M. Wietecha, Esq.
(ARGUED) U.S. Department of Justice
Tax Division

P.O. Box 502 Washington, DC 20044 Attorneys for Appellee

___________________________________________________ ______________

* The Honorable Wm. Matthew Byrne, Jr., United Stat es Senior District Judge for the Central District of California, sitti ng by designation.

2Michael F. Crotty, Esq.

American Bankers Association 1120 Connecticut Avenue, N.W. Washington, DC 20036 Attorney for Amicus-Appellant
American Bankers Association

Maureen E. Mahoney, Esq.
Latham & Watkins 1001 Pennsylvania Avenue, N.W.
Suite 1300 Washington, DC 20004 Attorney for Amicus-Appellant
National Association of

Manufacturers

Ronald W. Blasi, Esq. Georgia State University College of Law

P.O. Box 4037 Atlanta, GA 30302 Attorney for Amicus-Appellant
Ronald W. Blasi

OPINION OF THE COURT

RENDELL, Circuit Judge.

In this appeal from a decision of the Tax Court, we are asked to determine whether certain costs incurred b y banks for marketing, researching and originating lo ans are deductible as "ordinary and necessary expenses" as provided by section 162 of the Internal Revenue Cod e, 26 U.S.C. S 162 (1988), or whether these expenses must be capitalized under section 263 of the Code. Two bank s that were predecessors in interest of appellant PNC Banc orp, Inc. deducted these costs as ordinary business expe nses. The Internal Revenue Service disallowed the deducti ons and issued statutory notices of deficiency. PNC filed p etitions for
redetermination with the Tax Court. The Tax Court determined that the expenses in question were not deductible, but, instead, must be capitalized and a mortized

3over the life of the subject loans. PNC now appeals from

this determination.

We hold that the costs at issue were deductible as "ordinary and necessary" expenses of the banking bu siness within the meaning of Internal Revenue Code section 162, and that these costs do not fall within the purview of section 263. Accordingly, we will reverse the judgm ent of

the Tax Court.

I. Genesis of the Dispute

The costs that the banks seek to deduct are the int ernal and external costs that they incur in connection wi th the issuance of loans to their customers. These costs, discussed in more detail below, are a routine part of the banks' daily business, and the services procured wi th these outlays have been integral to the basic execution o f the banking business for decades.

The general contours of banks' involvement in makin g loans have not changed dramatically in recent years , and
the relevant sections of the Tax Code have remained largely unchanged. Historically, the costs at issue have be en deductible in the year that they are incurred; howe ver, the Commissioner rejected this tax treatment by PNC. Wh y is the Commissioner now insisting upon capitalization of

these costs?

There are two relatively recent developments that a ppear to have emboldened the Internal Revenue Service to pursue capitalization of such costs. One of these developm ents is the Supreme Court's opinion in INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992), in which the Cour t held that expenses incurred by a target corporation in t he course of its friendly acquisition by another entit y were not currently deductible. See id. at 90. INDOPCO, which signaled that the Supreme Court's previously announ ced tests for capitalization were not exhaustive, may w ell have been viewed by the IRS as a green light to seek capitalization of costs that had previously been co nsidered
deductible in a number of businesses and industries . This phenomenon has not escaped comment from observers. See, e.g., W. Curtis Elliott Jr., Capitalization of Operating

4Expenses After INDOPCO: IRS Strikes Again, S.C. Law
.,

Sept./Oct. 1993, at 29, 29, 30 (commenting on the I RS's "recently aggressive posture on capitalization" aft er INDOPCO, and noting that while the INDOPCO decisio n itself was not "necessarily troubling," the IRS's interpretation of it has stretched far beyond the s cenario presented in INDOPCO); IRS Loses Battle in INDOPCO War: Advertising Remains Deductible, Taxes on Parade, Ju ly 16, 1998, at 1 (describing the "IRS's INDOPCO-fueled juggernaut"). Thus, INDOPCO ushered in an era of ge nerally more aggressive IRS pursuit of capitalization.

An additional development may have prompted the IRS 's assertive posture in the more specific case of the loan origination costs at issue here. This second develo pment was the Financial Accounting Standards Board's promulgation of a new standard for financial accoun ting treatment of loan origination costs, Statement of F inancial Accounting Standards No. 91 ("SFAS 91").1 Beginning in the late 1980s, SFAS 91 required for the first time tha t, for financial accounting purposes, loan fee income and the costs incurred in connection with loan origination should be deferred and recognized over the life of the loa n, rather than being recognized in full in the year the loan closed.2 The FASB's authority extends only to financial acco unting standards and not to tax accounting standards. For the first few years of SFAS 91's existence, the IRS did not require capitalization of the loan origination cost s described in this financial accounting standard. However, the IRS apparently viewed INDOPCO as a reason to pursue capitalization of the costs that SFAS 91 requires t o be deferred.3 Thus, the stage for this litigation was set.

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1. The Financial Accounting Standards Board ("FASB" ) is an independent private sector organization that establishes standa rds for financial accounting and reporting. The Securities and Exchan ge Commission recognizes the FASB's financial accounting standard s as authoritative. See UAW Local No. 1697 v. Skinner Engine Co., 188 F .3d 130, 136 n.4 (3d Cir. 1999).

2. SFAS 91 became effective for accounting years th at began after December 15, 1987.

3. Although the Commissioner and the Tax Court both claimed that they were not relying on the financial accounting standa rds of SFAS 91 in

5II. Factual Background

PNC Bancorp, Inc. (PNC) is a bank holding company incorporated in Delaware. See A. at 102. Two smalle r banking entities, First National Pennsylvania Corpo ration (FNPC) and United Federal Bancorp, Inc. (UFB), were merged into PNC in 1992 and 1994, respectively, and PNC succeeded to the liabilities of both these companie s. See A. at 103, 105. The activities at issue in this case o ccurred before the mergers and were performed by FNPC and U FB
or their subsidiaries.4

The costs challenged in this appeal were incurred b y both banks in connection with the origination of loans. 5 There are two categories of such "loan origination costs, " as they have been called.6 The first category includes paym ents made to third parties for activities that help the bank determine whether to approve a loan (credit screeni ng, property reports, and appraisals) and for the recor ding of security interests when the bank decides to issue a secured

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determining the tax treatment of the costs at issue , the IRS appears to have imported the result of these financial account ing standards into the tax arena without engaging in independent analysis of why these costs should be subject to different tax treatment than t he majority of everyday business costs, and without considering th e secondary tax ramifications that would flow from a requirement of capitalization. See infra note 16; see also Tr. of Oral Argument at 27 (conceding that SFAS 91 effectively determined where the IRS would "draw the line" between deductibility and capitalization in this case).

4. For FNPC, the tax years at issue are 1988 and 19 90; for UFB, the years at issue are 1990, 1991, 1992 and 1993.

5. The IRS contested FNPC's claimed deductions for origination of both consumer and commercial loans, but contested UFB's deductions only for costs incurred in originating consumer loans. S ee A. at 137. The Tax Court opinion noted that it was unclear why the IRS pursued commercial loan activities only in the case of one of the two banks. See PNC Bancorp, Inc. v. Commissioner, 110 T.C. 349, 35 5 n.9 (1998).

6. The parties disagree as to the appropriate name for this collection of costs -- the Commissioner prefers "loan origination expenses," while PNC prefers "risk management and marketing costs." Howe ver, as there is no dispute about which costs are included in this grou p, the disagreement is largely semantic. In this opinion, we will use t he terms "loan origination costs" or "loan marketing costs" to den ote the costs at issue.

6loan. The second category consists of internal cost s, namely

that portion of employee salaries and benefits that can be attributed to time spent completing and reviewing l oan applications, and to other efforts connected with l oan marketing and origination.7 The Commissioner pursue d capitalization of loan origination costs only when those
costs were incurred in connection with a loan that was later approved; the Commissioner allowed the banks to ded uct origination costs expended in connection with loans that were not successfully approved. See PNC Bancorp, In c. v. Commissioner, 110 T.C. 349, 359, 362 (1998); see al so Tr. of Oral Argument at 7.

Loan interest constituted the largest source of rev enue for each bank during the relevant time period, and interest on deposits and other borrowing constituted the lar gest expense. See A. at 108.8 It is undisputed that bank s generally can be profitable only if they successful ly manage their "net interest margin" -- the difference betwe en interest earned and interest paid. A profitable ban k's net interest margin plus its revenues from fees and oth er sources must exceed its losses on loans and investm ents.
See A. at 108.

Bank personnel routinely undertook loan marketing activities in tandem with other marketing and custo mer service functions. Both tellers and "platform emplo yees" (those bank employees who have desks apart from the teller windows) were encouraged to "cross-sell," that is, to sell multiple products to existing and new customers who came to the bank in search of a particular product or se rvice. For example, if a new customer opened a checking and sa vings account, the bank representative might also suggest a certificate of deposit or a loan. Likewise, when a consumer applied for a loan, the employee taking the applica tion was

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7. The parties have stipulated to most of the facts concerning the loan origination activities and the role that loan origi nation plays in the banking business.

8. As the Tax Court put it, the banks' "principal b usinesses . . . consisted of accepting demand and time deposits and using the amounts deposited, together with other funds, to make loans ." PNC, 110 T.C. at

351.

7also expected to sell other bank products and servi ces

(such as checking accounts, credit lines, or ATM ca rds) during that same session. The banks provided financ ial incentives to their tellers and platform employees for each successful "cross-sale," see A. at 110, and such "c rosssales" were a routine part of each bank's daily bus iness.9

Before 1988, FNPC and UFB treated their loan origination costs in the same manner as their other routine expenses, both for tax accounting and financial acc ounting purposes. That is, they reported these costs for th e tax year (and the fiscal year) in which the costs were incur red. This practice was apparently standard in the banking ind ustry at that time. See A. at 169. In 1988, following the promulgation of SFAS 91, FNPC and UFB began to sepa rate out their loan origination costs for financial acco unting and reporting purposes in order to conform with SFAS 91 's requirements. However, both banks continued to dedu ct loan origination costs for tax purposes in the tax year in which the loan closed. See A. at 124, 134. It is th ese deductions that the Commissioner and the Tax Court
disallowed.

III. Jurisdiction and Standard of Review

The Tax Court had jurisdiction over PNC's petitions for redetermination pursuant to 26 U.S.C. SS 6213 and 7 442. We have appellate jurisdiction pursuant to 26 U.S.C

. S 7482(a)(1), which states that "[t]he United State s Courts of Appeals . . . shall have exclusive jurisdiction to review the
decisions of the Tax Court . . . in the same manner and to
the same extent as decisions of the district courts in civil actions tried without a jury." Thus, we have plenar y review over the Tax Court's findings of law, including its construction and application of the Internal Revenu e Code. See National Starch & Chem. Corp. v. Commissioner, 918 F.2d 426, 428 (3d Cir. 1990), aff 'd, INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992). We review the Tax Court's factual findings and inferences for clear e rror. See

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9. At UFB, the average number of products and servi ces sold to a new customer at a loan session was six, including the l oan. See A. at 53.

8id.; see also Pleasant Summit Land Corp. v. Commiss ioner,

863 F.2d 263, 268 (3d Cir. 1988).

IV. Discussion

There is a fundamental distinction between business expenses and capital outlays. The primary consequen ce of characterizing a payment as a business expense or a capital outlay "concerns the timing of the taxpayer 's cost recovery," INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 83 (1992): business expenses are deductible in the yea r in which they are incurred, whereas a capital outlay i s generally "amortized and depreciated over the life of the relevant asset, or, where no specific asset or usef ul life can be ascertained, is deducted upon dissolution of the enterprise," id. at 83-84.

Two sections of the Internal Revenue Code address t he deductibility vel non of expenditures such as those incurred by FNPC and UFB. Section 162 of the Internal Revenu e Code provides in pertinent part: "There shall be al lowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business . . ." 26 U.S.C. S 162(a). Section 263 of the Code states that capital expenditures, i.e.,"amount [s] paid out for new buildings or for permanent improvements or betterments made to increase the value of any prope rty or estate," cannot be currently deducted. 26 U.S.C.S 2 63(a)(1).
It is true that these two sections are neither all- inclusive nor mutually exclusive. See General Bancshares Corp . v. Commissioner, 326 F.2d 712, 716 (8th Cir. 1964) (wr itten by then-Judge Blackmun). For example, it is possibl e that an expense that might appear to be deductible under section 162(a) might instead be required to be capi talized because it also properly falls under the descriptio n provided by section 263(a). If an expense were to fall under the language of section 263(a), that section would "tru mp" the deductibility provision of section 162(a) and the e xpense would have to be capitalized. Thus, in order to be deductible, the expense must both be "ordinary and necessary" within the meaning of section 162(a) and fall outside the group of capital expenditures envisione d by

9section 263(a).10 Nonetheless, the two sections rep resent the

archetypes of the two opposing alternatives for tax treatment of expenditures -- deduction and capitali zation -- and, ordinarily, an expenditure will fall under one or the other section, not both.

The taxpayer bears the burden of showing that a giv en expenditure is deductible. See Interstate Transit L ines v. Commissioner, 319 U.S. 590, 593 (1943), quoted in INDOPCO, 503 U.S. at 84. In order to demonstrate deductibility under section 162(a) of the Code, the taxpayer must meet a five-part test. "To qualify as an allow able deduction under S 162(a) . . . , an item must (1) b e `paid or incurred during the taxable year,' (2) be for `carr ying on any trade or business,' (3) be an `expense,' (4) be a`n ecessary' expense, and (5) be an `ordinary' expense." Commiss ioner v. Lincoln Sav. & Loan Ass'n, 403 U.S. 345, 352 (1971) . It is clear that PNC's loan origination expenses can sati sfy the first four parts of this test.11 The question befor e us under S 162, then, is whether these expenses qualify as " ordinary" business expenses within the meaning of that sectio n.

In determining what expenditures qualify as "ordina ry," we must look to the particular facts of the case be fore us, including the particular puzzle posed by the circum stances of the banking industry. As Justice Cardozo stated nearly seventy years ago in interpreting an earlier versio n of this long-standing Code provision, ordinariness is "a va riable affected by time and place and circumstance." Welch v. Helvering, 290 U.S. 111, 113-14 (1933). In interpre ting the

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10. Section 161 of the Code provides the appropriat e method for reading the two provisions in sequence: "In computing taxab le income [ ], there shall be allowed as deductions the items specified in this part, subject to the exceptions provided in part IX (sec. 261 and following, relating to items not deductible)." 26 U.S.C. S 161. Therefore, an expense that is judged ordinary and necessary under section 162 can be deducted only if it also does not trigger any of the capitalizati on provisions beginning
in section 261.

11. The requisite showing that an expense is"necess ary" is a minimally burdensome one; to meet it, a taxpayer need show on ly that the expenditures were "appropriate and helpful." Welch v. Helvering, 290 U.S. 111, 113 (1933) (citing McCulloch v. Maryland, 17 U.S. (4 Wheat.) 316 (1819)).

10Code, we should not stray from the moorings of the

"natural and common meaning" of the term "ordinary, " id. at 114, and in doing so must examine the nature of the day-to-day operations of the particular business be ing considered. See also Deputy v. du Pont, 308 U.S. 48 8, 495- 96 (1940) (stating that each case "turns on its spe cial facts," and that an expense that is ordinary-- "nor mal, usual, or customary" -- in one business may not be ordinary in another). Justice Cardozo's oft-quoted words regarding the heavily case-specific nature of this inquiry are no less appropriate today than they were in 1933:

Here, indeed, as so often in other branches of the law, the decisive distinctions are those of degre e and not of kind. One struggles in vain for any verbal f ormula that will supply a ready touchstone. The standard set up by the statute is not a rule of law; it is rath er a way of life. Life in all its fullness must supply the ans wer to the
riddle.

Welch, 290 U.S. at 114-15; see also Commissioner v. Lincoln Sav. & Loan Ass'n, 403 U.S. 345, 353 (1971). Accord ingly, we pursue a real-life inquiry into whether the expe nditures associated with loan marketing and origination are "ordinary" expenses incurred in the day-to-day
maintenance of a bank's business.

The Commissioner has conceded that loan interest wa s the banks' largest revenue source during the period in question, and that interest payments on deposits an d other borrowing were their largest expense. There is no r eason to suppose that this time period was any different fro m any other in this regard. Further, maximizing the "net interest margin" -- the difference between interest received and interest paid out -- is the principal manner in whi ch banks earn their keep. As the Tax Court stated, "[t]he pr incipal businesses of [the banks] consisted of accepting de mand and time deposits and using the amounts deposited, together with other funds, to make loans." PNC, 110 T.C. at 351. Modern banks are essentially dealers in money. See United States v. Philadelphia Nat'l Bank, 374 U.S. 321, 326, 327 n.5 (1963).

Given this context, the ordinary nature of the cost s at issue, routinely incurred in the banks' businesses, would

11seem clear. In order to ensure deductibility, howev er, we

must also ascertain whether these costs were expend ed for betterments to increase the value of property in a way that would require these costs' capitalization underS 26 3. We cannot conclude that in performing credit checks, appraisals, and other tasks intended to assess the profitability of a loan, the banks "stepped out of [their] normal method of doing business" so as to render th e expenditures at issue capital in nature. Encyclopae dia Britannica, Inc. v. Commissioner, 685 F.2d 212, 217 (7th Cir. 1982). As we stated in National Starch, an imp ortant determination is whether given expenditures "relate to the corporation's operations and betterment into the in definite future," indicating the need for capitalization, or are instead geared toward "income production or other current n eeds," suggesting deductibility. National Starch & Chem. C orp. v. Commissioner, 918 F.2d 426, 433 (3d Cir. 1990), aff 'd, INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992). The facts before us demonstrate that loan operations ar e the primary method of income production for the subject banks. We have no doubt that the expenses incurred in loan origination were normal and routine "in the pa rticular business" of banking. See Deputy v. du Pont , 308 U .S. at
496.

The Commissioner argues, and the Tax Court found, t hat the Supreme Court's decision in Lincoln Savings re quires a different result. We disagree. In Lincoln Savings, the Supreme Court concluded that payments made by Linco ln Savings and Loan Association into a "Secondary Rese rve" fund at the Federal Savings and Loan Insurance Corporation (FSLIC) were not deductible as ordinary business expenditures. See Lincoln Savings, 403 U.S . at 354, 359. In so holding, the Court upheld the IRS's distinction between payments that Lincoln made into the FSLIC's "Primary Reserve," which the IRS had found to be deductible as ordinary and necessary expenses, and those payments made into the "Secondary Reserve," found t o be capital expenditures. The Court engaged in an exten sive analysis of the nature of each reserve fund and the premium payments made into each by Lincoln Savings and other similarly situated FSLIC-insured institutions . The Court noted that the "only concern" was whether the

12premium payment to the Secondary Reserve "was an

expense and an ordinary one within the meaning ofS 162(a) of the Code." Lincoln Savings, 403 U.S. at 354. The Court noted that the fact that many institutions were req uired to make such a Secondary Reserve premium did not rende r that premium an ordinary expense, see id. at 358; n or did the fact that the premium could have some ensuing b enefit to Lincoln Savings, in and of itself, render the pr emium a capital expenditure, see id. at 354 ("many expenses concededly deductible have prospective effect beyon d the taxable year"). Rather, the Court focused on what t he payment represented in the context of Lincoln Savin gs' business and of the "structure and operation of FSL IC's

reserves":

What is important and controlling, we feel, is that the [Secondary Reserve] payment serves to create or enhance for Lincoln what is essentially a se parate and distinct additional asset and that, as an in evitable consequence, the payment is capital in natur e and not an expense, let alone an ordinary expense, d eductible under S 162(a) in the absence of other facto rs not
established here.

Id.12 Whereas Lincoln Savings and the other insured institutions had no property interest in the Primar y Reserve, each did have an earmarked property intere st in the Secondary Reserve that was carried as an asset on each institution's books, was enhanced by each instituti on's contribution, and was refundable to that institutio n in
certain circumstances.

In the case at bar, the Tax Court concluded without any elaboration that the consumer and commercial loans "clearly" were separate and distinct assets of the banks, see PNC, 110 T.C. at 364, and that the costs incurred i n originating and processing the loans "created" thes e

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12. Interestingly, while the Court did not discuss the issue in terms of the provisions of S 263, in determining that the as set was "capital in nature," the Court necessarily engrafted its thinki ng on the meaning of capital assets under that section of the Code. In f act, the Supreme Court has subsequently described Lincoln Savings' holding as stemming from an analysis of S 263 as well as S 162. See INDOPCO, 503 U.S. at 86-87.

13separate and distinct assets, see id. at 366. We be lieve that

the Tax Court took too broad a reading of what Linc oln Savings meant by "separate and distinct assets," as well as an overbroad reading of what can be said to "create " such

assets.

The Secondary Reserve fund in Lincoln Savings was a "separate and distinct asset" in two important ways that distinguish it from FNPC's and UFB's loans, the ass ets in question here. First, the Secondary Reserve fund wa s an asset that existed quite apart from Lincoln's main daily business of taking deposits and making loans; secon d, the fund was an asset that, although it existed within the FSLIC, was nonetheless separate from the FSLIC's ot her revenues and distinctly earmarked as Lincoln's prop erty. The Tax Court's broad reading of Lincoln Savings e ssentially treats the term "separate and distinct asset" as if it extends to cover any identifiable asset. We do not subscrib e to this reading of Lincoln Savings.

Furthermore, we do not agree that the marketing and origination activities actually "created" the banks ' loans in the same way that the activities in Lincoln Savings created the Secondary Reserve fund. In the instant case, th e Tax Court proceeded from the clearly accurate premise t hat the expenses in question were associated with the loans
, incurred in connection with the acquisition of the loans, or "directly related to the creation of the loans," PN C, 110 T.C. at 368, to the faulty conclusion that these expense s themselves created the loans. See id. at 364-68. We

conclude that the term "create" does not stretch th is far. In Lincoln Savings, it was the payments themselves tha t formed the corpus of the Secondary Reserve; therefo re, it naturally follows that these payments "created" the reserve fund. In PNC's case, however, the expenses are mere ly costs associated with the origination of the loans; the expenses themselves do not become part of the balan ce of the loan. PNC argues persuasively that the Tax Cour t's interpretation of the Lincoln Savings language is inappropriately expansive:

While purporting to apply the Lincoln Saving s language, both the Tax Court and the governm ent effectively have transformed that language, by subtle

14but significant degrees, from a test based o n whether

a cost "creates" a separate and distinct ass et, into a much more sweeping test that would mandate capitalization of costs incurred "in connect ion with" or "with respect to" the acquisition of an asse t.

PNC Reply Br. at 4. We decline to follow the Tax Co urt's broad interpretation, for to do so would be to expa nd the type of costs that must be capitalized so as to dra stically limit what might be considered as "ordinary and nec essary" expenses. We conclude, therefore, that the loan ori gination expenses were ordinary expenses and that they did n ot "create or enhance a separate and distinct asset" w ithin the meaning of Lincoln Savings.

A line of federal appellate opinions subsequent to Lincoln Savings, involving factual scenarios not that diffe rent from the one before us, supports our finding that Lincol n Savings does not compel a conclusion that FNPC's and UFB's costs should be capitalized. These cases, from the Fourth , Eighth and Tenth Circuit Courts of Appeals, address the deductibility of costs incurred in connection with credit
card issuance. In Iowa-Des Moines National Bank v. Commissioner, 592 F.2d 433 (8th Cir. 1979), the Eig hth Circuit Court of Appeals found that payments by ban ks to third parties who provided the banks with credit information on prospective credit card customers we re deductible expenses under S 162. See id. at 436. T he court found that "[p]erhaps the most significant factor i s that the payments were for a service (credit screening) that could have been performed by personnel employed by the [banks]." Id. Because "[c]redit screening is a nece ssary and ordinary part of the banking business . . . not a c apital expenditure," the Eighth Circuit Court of Appeals f ound that fees paid to third parties for credit screenin g were deductible. Id. The Iowa-Des Moines court seemed to assume that such expenditures would a fortiori be deductible if the bank's personnel were to perform the
credit screens themselves.13 The Fourth and Tenth C ircuit

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13. The Eighth Circuit Court of Appeals also emphas ized the "short
useful life" of this credit information as a factor weighing in favor of deductibility. Iowa-Des Moines, 592 F.2d at 436.

15Courts of Appeals have reached similar conclusions. In First

National Bank of South Carolina v. United States, 5 58 F.2d 721 (4th Cir. 1977) (per curiam), the Fourth Circui t Court of Appeals permitted the taxpayer bank to deduct st art-up assessments paid to a nonprofit association formed to enable banks to combine their efforts in entering t he credit
card field. See id. at 723. The association was cha rged with centralizing billing and recordkeeping for the bank s. The Fourth Circuit Court of Appeals characterized the c redit card accounts that were the focus of this activity as being a type of loan. See id. at 722. In Colorado Springs National Bank v. United States, 505 F.2d 1185 (10th Cir. 197 4), the Tenth Circuit Court of Appeals allowed the deductio n of pre-operation expenditures for a nonprofit credit c ardrelated association that would cover expenses such as computer costs, advertising, credit screening, and clerical services. See id. at 1193. The Colorado Springs cou rt found that these expenses did not "create or enhance . . . a separate and distinct additional asset," reasoning as follows:

The start-up expenditures here challenged di d not create a property interest. They produced no thing corporeal or salable. They are recurring. At the most they introduced a more efficient method of c onducting
an old business. . . .

. . . [T]he use of bank credit cards in con sumer transactions is a normal part of the banking business. The challenged expenditures were for the con tinuation of an existing business and for the preserva tion and improvement of existing income. Hence, they were ordinary expenses.

Id. at 1192-93.

In the case before us, the Tax Court distinguished these "credit card" cases, stating that they were inappos ite to our fact pattern because in those cases, no "separate a nd distinct asset" was created, while in PNC's case, s uch an asset was created. As we have discussed above, we d o not agree that the loan origination expenditures create d distinct assets, any more so than did the expenditures incur red in entering into the credit card business. In fact, we find that

16PNC's situation presents an even stronger case for

deductibility than do the credit card cases. In the credit card cases, the taxpayers were starting up new prog rams within their businesses, or at the very least, new methods of performing old tasks. In contrast, FNPC and UFB incurred the challenged costs in their routine sell ing and marketing of normal loans in the traditional ways t hat banks have been using for many decades.14 Thus, FN PC's
and UFB's costs bear far more of the indicia of "ordinariness," and fewer of the indicia of"creatin g" something, than do the start-up costs described in the
credit card cases.

The remaining question, then, is whether either the Financial Accounting Standards Board's adoption of SFAS 91 or the Supreme Court's pronouncement on deductib ility in INDOPCO, both of which developments occurred aft er the decisions in Lincoln Savings and the credit card ca ses, would alter the calculus of deductibility versus capitalization in PNC's case. We conclude that the existence of SFAS 91 has little, if any, bearing on the appro priate tax analysis, and that the Supreme Court's decision in INDOPCO, while clearly relevant, does not change th e result
in the case at bar.

The Supreme Court has held that financial accountin g standards such as SFAS 91 do not dictate tax treatm ent of income and expenditures. See Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 542-43, 544 (1979) (discussing the "vastly different objectives thatfi nancial and tax accounting have" and stating that "[g]iven this diversity, even contrariety, of objectives, any presumptive eq uivalency between tax and financial accounting would be unacceptable" and would "create insurmountable difficulties of tax administration"). The IRS conce des that "financial accounting rules are not controlling for federal

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14. As the Tax Court decision that was affirmed by the Eighth Circuit Court of Appeals in Iowa-Des Moines stated, costs t hat are "merely related to the active conduct of an existing busine ss and [do] not create or enhance a separate and distinct asset or propert y interest" are appropriate for deduction. Iowa-Des Moines Nat'l Ba nk v. Commissioner, 68 T.C. 872, 879 (1977), cited in PNC, 110 T.C. at 365.

17tax purposes," IRS Br. at 28 n.4 (citing PNC , 110 T.C. at

364 n.15), and states that "[n]either the Commissio ner's deficiency determination nor the Tax Court decision was based on the provisions of SFAS 91," id. Although S FAS 91 may have served as a catalyst for the IRS's desire to seek capitalization of the costs at issue here, and may have been considered by the IRS in determining where to draw the line between current-year and deferred costs, see s upra note 3, the IRS disavows any argument that the fina ncial accounting standards should dictate tax treatment, see IRS Br. at 27-28 & n.4. Further, as with the financial accounting standards at issue in Thor Power, it is clear that the reasons for SFAS 91's requirement that loan ori gination costs be deferred are reasons wholly specific to th e realm of financial accounting,15 and thus those financial ac counting standards do not affect our tax analysis.16

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15. SFAS 91 was motivated by a concern that the str ucture of certain banks' loan agreements could lead to the illusion t hat these banks and
their customers were in better financial condition than they actually were. Specifically, SFAS 91 was designed to address the practices of banks that charged unusually high fees up front as conditions for the closing of a loan (e.g., high "points" on a mortgag e) in exchange for

lower interest rates later on; these practices were known as "teaser" rate financing. See A. at 173. These practices"arguably allowed individuals to qualify for loans in greater amounts than they w ould otherwise be able to secure," id., and also overstated the incom e from a loan in its first year and understated its income in later year s. The Financial Accounting Standards Board, concerned about these r amifications, therefore required companies to defer fees over the life of the loan. SFAS
91 was worded to include the deferral of costs onl y after industry representatives protested that it would be unfair t o the industries to have to defer the fees they received without also b eing allowed to defer the costs they incurred. See A. at 174.

16. In fact, we conclude that the IRS's wholesale i mportation of the line drawn by the financial accounting standards creates tax consequences that the Commissioner appears not to have considere d. For example, if the loan origination costs were required to be capi talized, it would seem
to follow that these costs would have to be include d in the basis of each loan. Such inclusions would apparently be a departu re from current practice. Cf. Rev. Rul. 89-122, 1989-2 C.B. 200 (ap parently assuming that the bank's basis in a loan is equal to the mon ey advanced by the bank, without any adjustments for origination costs ). The calculations

18Nor do we view the Supreme Court's decision in INDO PCO

as requiring a different result regarding the deduc tibility of the banks' costs. In INDOPCO, the Supreme Court req uired capitalization of the expenditures incurred by the target corporation during a planned friendly takeover by a nother company. See INDOPCO, 503 U.S. at 90. The Supreme Court was careful to emphasize in INDOPCO, as it ha d in Lincoln Savings, that the capitalization versus ded uctibility inquiry was heavily fact-based. See id. at 86 (citi ng Welch v. Helvering, 290 U.S. 111, 114 (1933) and Deputy v . du Pont, 308 U.S. 488, 496 (1940)). The Supreme Court in INDOPCO downplayed the importance of the "creation of a separate and distinct asset" described in Lincoln S avings, clarifying that it was not an exclusive test:

Lincoln Savings stands for the simple propos ition that a taxpayer's expenditure that "serves to cre ate or enhance . . . a separate and distinct" asset should be capitalized under S 263. It by no means foll ows, however, that only expenditures that create or enhance separate and distinct assets are to be capit alized under

S 263.

INDOPCO, 503 U.S. at 86-87. The Court reasoned that
, while in the Lincoln Savings setting the Court had seemed to attach limited significance to the concept of"be nefit," see INDOPCO, 503 U.S. at 87 (quoting Lincoln Savings, 4 03 U.S. at 354), in the merger situation presented in INDOPCO a "future benefit" analysis was relevant and approp riate since the "resource-related benefits" to be reaped from the merger were of considerable importance, INDOPCO , 5 03 U.S. at 88. In the INDOPCO context of a friendly ta keover,

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involved would presumably complicate the transfer o f loans from one lending institution to another. However, the IRS co nceded at oral argument that a requirement of capitalization of lo an origination costs would probably mean that these complex basis adjust ments would need to be made. See Tr. of Oral Argument at 34. The IRS 's apparent failure
to consider these and other tax ramifications of ca pitalization suggests that the IRS's borrowing of the line that the SFAS 91 standards draw between current-year costs and deferred costs was n ot based on any independent tax analysis, but was simply a "bootstr apping" of the financial accounting standards into the tax arena.

19the Court found that one key inquiry was whether th e

money that the target corporation had spent on take overrelated expenditures was spent primarily for a "fut ure benefit" extending beyond the tax year, rather than for the needs of current income production. The Court state d:

Although the mere presence of an incidental future benefit -- "some future aspect" -- may not w arrant capitalization, a taxpayer's realization of benefits beyond the year in which the expenditure is incurred is undeniably important in determining whether the appropriate tax treatment is immediate deduc tion or capitalization.

Id. at 87.

As was recognized in several of the "credit card" c ases discussed above, these circumstances are simply not presented by a bank's credit-issuing activities. Th e Eighth Circuit Court of Appeals in Iowa-Des Moines, antici pating
the "future benefit" concerns later stated in INDOP CO, emphasized the "short useful life" of credit inform ation as a reason for deductibility. Iowa-Des Moines, 592 F.2d at 436. The Iowa court stated that the prospective future b enefit that could accrue beyond the taxable year as a resu lt of credit screening was "very slight," and thus capita lization was "not easily supported." Id. In National Starch, the decision that the Supreme Court affirmed in INDOPCO , we found that these credit card cases contained the se ed of the "future benefit" analysis, citing these cases as ev idence that several Courts of Appeals "look[ed] to whether an e nsuing benefit was created to determine whether the expens e was ordinary and necessary," National Starch, 918 F.2d at 431,
and that these courts found that future benefit was not
substantial in situations similar to the case at ba r. See id. (citing Iowa-Des Moines and Colorado Springs). We c onclude that the credit card cases not only continue to hav e vitality after INDOPCO, but in fact anticipated some of the concerns addressed by INDOPCO.

We also conclude that the Tax Court erred in its interpretation of the "future benefit" analysis by relying on the fact that the loan itself was usually of severa l years' duration and by reasoning that the loan origination costs

20were, thus, essentially directed at future benefit. The Tax

Court stated: "While the useful life of a credit re port and other financial data may be of short duration, the useful life of the asset they serve to create is not." PNC, 110 T.C. at 371. However, that analysis depends on the Tax Cour t's earlier assumption that the loan origination expens es actually created a "separate and distinct asset." S tripped of this assumption, the Tax Court's analysis is not supportable.17

In addition, we must remember that the "future bene fit" analysis adopted in INDOPCO is not meant as a talis manic, bright-line test. See A.E. Staley Mfg. Co. v. Commi ssioner, 119 F.3d 482, 489 (7th Cir. 1997) ("[T]he Court did not purport to be creating a talismanic test that an ex penditure must be capitalized if it creates some future benef it."). Rather, the INDOPCO analysis demonstrates the conte xtual, case-by-case approach to determining whether an expenditure better fits under the "ordinary and nec essary" language of section 162(a) or the "permanent improv ements or betterments" language of 263(a). We conclude tha t the loan origination expenses incurred by UFB and FNPC have the characteristics of the former, rather than the latter, statutory language.

As described above, the loan marketing activities a t issue here lie at the very core of the banks' recurring, routine day-to-day business. The Commissioner has not been able to articulate a principled reason why these normal costs of doing business must be capitalized, while other ord inary banking costs need not be. Instead, the Commissione r relies on the line drawn by SFAS 91, a standard who se rationale we conclude is far removed from the conce rns of the tax system. See, e.g., IRS Br. at 27 ("It shoul d be noted

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17. The Tax Court's "future benefit" discussion als o reflects another problematic assumption, i.e., that the capitalizati on requirement is contingent on the loan's ultimately being approved. It cannot possibly be true, as the Tax Court and the Commissioner would h ave it, that the existence of a subsequent loan-derived revenue stre am is the trigger for the capitalization requirement. (If a company were to undertake research and development to investigate new product lines, w ould it have to capitalize only those R&D costs that led to product lines that were ultimately successful and profitable? We think not. )

21. . . that SFAS 91 itself, which the banks have fol lowed,

expressly distinguishes direct loan origination cos ts, which must be deferred, from all other loan-related costs , such as advertising, soliciting potential borrowers, and se rvicing existing loans, which may be currently deducted for financial accounting purposes."); Tr. of Oral Argum ent at 27 (statement by IRS's counsel that "[w]here we dra w the line is -- actually the Financial Accounting Standa rds Board made it very easy for us."). Similarly, the T ax Court, while professing not to find the financial standard s dispositive, see PNC, 110 T.C. at 364 n.15, id. at 368 n.18, used SFAS 91 as the sole source of an explanation a s to why these loan origination costs, but not other cos ts associated with the banks' lending business, must b e capitalized, see id. at 368-69. We remain unconvinc ed that the line drawn by the FASB in SFAS 91 has any relev ance here for tax purposes.

The Supreme Court has noted that "capitalization prevents the distortion of income that would otherw ise occur if depreciation properly allocable to asset a cquisition were deducted from gross income currently realized. " Commissioner v. Idaho Power Co., 418 U.S. 1, 14 (19 74). In the case of the costs at issue here, there need be no concern about a distortion of income because of the regularity of these expenses.

Finally, we emphasize that the key to the deductibi lity inquiry remains the statutory language of sections 162(a) and 263(a). See Erwin N. Griswold, Cases and Materi als on Federal Taxation, at 15 (5th ed. 1960) ("There is n o use in thinking great thoughts about a tax problem unless the thoughts are firmly based on the controlling statut e."). The analyses set forth in INDOPCO and Lincoln Savings p rovide us with two applications of that statutory language . Like the Supreme Court in INDOPCO and Lincoln Savings, w e do not here attempt to define once and for all a brigh t line between deduction and capitalization that will hold true for all factual situations. We can only heed Justice Ca rdozo's admonition that we should always keep the factsfirm ly in view, as well as Dean Griswold's advice that we rem ain cognizant of the language of the Code. Resorting to that language, we find the case before us today to be mu ch

22farther from the heartland of the traditional capit al

expenditure (a "permanent improvement or betterment ")
than are the scenarios at issue in INDOPCO and Linc oln Savings. We will not mechanistically apply phrases from those precedents in ignorance of the realities of t he facts before us. We see no principled distinction between the
costs at issue here and other costs incurred as"ord inary expenses" by banks.

V. Conclusion

For the foregoing reasons, we find that the loan origination expenses are deductible as "ordinary an d necessary business expenses" under section 162(a) o f the Internal Revenue Code, and are not subject to the capitalization provision of section 263(a). Accordi ngly, we will reverse the judgment of the Tax Court.

A True Copy:

Teste:

Clerk of the United States Court of Appeals
for the Third Circuit

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