Opinion ID: 2736936
Heading Depth: 3
Heading Rank: 1

Heading: The Plain Meaning of the Statute

Text: RCW 82.04.4292 limits the deduction to interest received on investments or loans primarily secured by first mortgages or trust deeds on nontransient residential properties. The statute is concerned with interest received by the taxpayer-bank; it follows inexorably in this case that the investments or loans must be investments or loans made by Cashmere. It also follows that the same investments or loans made by Cashmere must be primarily secured by first mortgages or trust deeds. The statute clearly allows Cashmere to deduct interest earned on any loan made by Cashmere directly to a home buyer in return for a promissory note and deed of trust because the loan would be primarily secured by a deed of trust. By allowing this deduction to the B&O tax, the legislature apparently intended to encourage banks to make loans to home buyers. In addition, the statute allows Cashmere to deduct interest earned on investments backed primarily by first mortgages and trust deeds. Parties dispute what constitutes a qualifying investment. By the plain language of the statute, a qualifying investment must be primarily secured by first mortgages. The statute does not define secured, but it is a familiar legal term so we give it its familiar legal meaning. Rasor v. Retail Credit Co., 87 Wn.2d 516, 330, 554 P.2d 1041 (1976). Black's Law Dictionary defines secured as supported or backed by security or collateral. BLACK's LAW DICTIONARY 1475 (9th ed. 2009). A secured creditor is protected by a pledge, mortgage, or other encumbrance of property that helps ensure financial soundness and confidence. /d. Under the Uniform Commercial 12 Cashmere Valley Bank v. Dep't of Revenue, No. 89367-5 Code, a secured creditor has the right, on the debtor's default, to proceed against collateral and apply it to the payment of the debt. BLACK's LAW DICTIONARY, supra, at 425 (citing UCC § 9-1 02-(a)(72)). Thus, a secured party obtains two related benefits: leverage for payment or performance of the obligation and the ability to proceed against specific property if the debtor defaults. See RUSSELL A. HAKES, THE ABCs OF THE UCC: ARTICLE 9: SECURED TRANSACTIONS 2 (3d ed. 2013); see also Cashmere Valley Bank, 175 Wn. App. at 417 (a secured party necessarily has some recourse to collateral securing its investment). Cashmere did not receive any interest in mortgages or deeds of trust to back its investment. The REMICs created contractual obligations or perhaps obligations on the part of the REMIC trustees, but Cashmere received no security for the investments. While it is true that the interest received by Cashmere from the REMICs ultimately comes from promissory notes secured by mortgages and deeds of trust, Cashmere has no interest in the underlying mortgages and deeds of trust and is not a beneficiary of those instruments. Cashmere's investments merely gave Cashmere the right to receive specific cash flows generated by the assets of the trust at specific times. But if the REMIC trustee failed to pay Cashmere according to the terms of the investment, Cashmere had no right to sell the mortgage loans or the residential property or any other asset of the trust to satisfy this obligation. Cf. Dep't of Revenue v. Sec. Pac. Bank of Wash. Nat'/ Ass'n, 109 Wn. App. 795, 808, 38 P.3d 354 (2002) (deduction allowed because mortgage companies transferred ownership of loans to taxpayer who could sell the loans in event of default). Cashmere's only recourse would be to sue the trustee for 13 Cashmere Valley Bank v. Dep't of Revenue, No. 89367-5 performance of the obligation or attempt to replace the trustee. The trustee's successor would then take legal title to the underlying securities or other assets of the related trust. At no time could Cashmere take control of trust assets and reduce them to cash to satisfy a debt obligation. Thus, we hold that under the plain language of the statute, Cashmere's investments in REMICs are not primarily secured by mortgages or deeds of trustY B. The Department of Revenue's 1990 Determination The Department of Revenue has similarly determined that investments in REMICs do not qualify for the deduction. DORis charged with enforcing the tax code and hence has the authority to interpret it. Ass'n of Wash. Bus. v. Dep't of Revenue, 155 Wn.2d 430, 440, 120 P.3d 46 (2005) (holding that DOR has implied authority to adopt interpretive rules); RCW 82.32.300 (administration of chapters 82.04 through 82.27 RCW of this title is vested in DOR). Although a DOR determination is not binding on this court, an agency's adjudicatory action is generally granted some deference. See Leonard v. City of Bothell, 87 Wn.2d 847, 557 P.2d 1306 (1976); lmpecoven v. Dep't of Revenue, 120 Wn.2d 357, 363, 841 P.2d 752 (1992) (considerable deference given to interpretation by agency charged with enforcing 12 Cashmere argues that the investments are secure because the trustee is obligated to protect the investors' interests and the trustee has the right to foreclose. But, this is not always the case. The underlying mortgages back all of the tranches, and a trustee must balance competing interests between investors of different tranches. Thus, a default in one tranche does not automatically give the holders of that tranche a right to force foreclosure. We hold that if the terms of the trust do not give beneficiaries an investment secured by trust assets, the trustee's fiduciary obligations do not transform the investment into a secured investment. 14 Cashmere Valley Bank v. Dep't of Revenue, No. 89367-5 statute). In addition, we accord deference to an interpretation of law in matters involving the agency's special knowledge and expertise. Chi. Title Ins. Co. v. Office oflns. Comm'r, 178 Wn.2d 120, 133, 309 P.3d 372 (2013). In a 1990 determination, DOR explained why interest earned from investments in REMICs does not qualify for the mortgage tax deduction. See Wash. Dep't of Revenue, Determination No. 90-288, 10 Wash. Tax Dec. 314 (1990). A savings and loan association sought a refund of B&O taxes assessed on interest earned from investments in REMICs. The taxpayer argued that because interest received from investments in pass-through securities is deductible, interest received on REMICs should be too. DOR rejected the deduction, explaining that with pass-through securities, the issuer holds the mortgages in trust for the investor. In the event of individual default, the issuer, as trustee, will foreclose on the property to satisfy the terms of the loan. In other words, the right to foreclose is directly related to homeowner defaults-in the event of default, the trustee can foreclose and the proceeds from foreclosure flow to investors who have a beneficial ownership interest in the underlying mortgage. Thus, investments in pass-through securities are primarily secured by first mortgages. By contrast, with REMICs, a trustee's default may or may not coincide with an individual homeowner default. So, there may be no right of foreclosure in the event a trustee fails to make a payment. And if a trustee can and does foreclose, proceeds from the sale do not necessarily go to the investors. Foreclosure does not affect the trustee's obligations vis-a-vis the investor. Indeed, the Washington Mutual REMIC here contains a commonly used form of guaranty: For any month, if the master 15 Cashmere Valley Bank v. Dep't of Revenue, No. 89367-5 servicer receives a payment on a mortgage loan that is less than the full scheduled payment or if no payment is received at all, the master servicer will advance its own funds to cover the shortfall. The master servicer will not be required to make advances if it determines that those advances will not be recoverable in the future. At foreclosure or liquidation, any proceeds will go first to the servicer to pay back any advances it might have made in the past. Similarly, agency REMICs, like the Fannie Mae REMIC Trust 2000-38, guarantee payments even if mortgage borrowers default, regardless of whether the issuer expects to recover those payments. Moreover, the assets held in a REMIC trust are often MBSs, not mortgages. So, if the trustee defaults, the investors may require the trustee to sell the MBS, but the investor cannot compel foreclosure of individual properties. DOR also noted that it has consistently allowed the owners of a qualifying mortgage to claim the deduction in RCW 82.04.4292. But the taxpayer who invests in REMICs does not have any ownership interest in the MBSs placed in trust as collateral, much less any ownership interest in the mortgage themselves. By contrast, a pass-through security represents a beneficial ownership of a fractional undivided interest in a pool of first lien residential mortgage loans. Thus, DOR concluded that while investments in pass-through securities qualify for the tax deduction, investments in REMICs do not. We should defer to DOR's interpretation because it comports with the plain meaning of the statute. C. Our Interpretation of RCW 82.04.4292 inHomeStreet In HomeStreet, 166 Wn.2d 444, we interpreted RCW 82.04.4292 and applied the statute to allow a deduction. HomeStreet originated mortgage loans to 16 Cashmere Valley Bank v. Dep't of Revenue, No. 89367-5 homeowners and then sold the loans on the secondary market. /d. at 447-48. It either sold whole loans (servicing released) or sold a portion of the loans while • retaining the right to service the loans and receive a portion of the interest (servicing retained). /d. at 448. For the loans sold on a service-retained basis, borrowers continued to make principal and interest payments to HomeStreet because HomeStreet still owned a portion of the loan and serviced the loans for the secondary market lenders. /d. HomeStreet collected the payments from borrowers, paid the investors the principal and a portion of the interest, and retained a portion of the interest as a servicing fee. /d. We held that income earned from the service-retained loans could be deducted because this revenue came directly from homeowners' interest payments. /d. at 453. We explained that RCW 82.04.4292 has five elements; at issue in HomeStreet was the second-whether the amount deducted was derived from interest received. /d. at 449. Looking to the plain language of the statute, we reasoned that it is not essential to determine why the money is received or taken from a source. The statute requires only that the amount be 'derived from interest.' /d. at 454 (citation omitted) (quoting RCW 82.04.4292). Thus, even though HomeStreet retained the interest as a servicing fee, the income could nevertheless be deducted because the source of the income was homeowner's interest payments. Notably, the amount of the servicing fee was not set but rather change[d] with the size and length of the loans, interest rate fluctuations, and the borrowers' ability to pay back the loan. /d. at 453. Cashmere relies on language in Home Street taken out of context to argue that its interest income qualifies for the deduction because the income was traceable to 17 Cashmere Valley Bank v. Oep't of Revenue, No. 89367-5 interest payments borrowers made on first mortgages. But, the issue here is not whether this is income derived from interest received. It is whether the investments were primarily secured by a first mortgage or trust deed (the fourth element). As explained above, Cashmere's investments were not. Moreover, this case is factually distinct. Borrowers making the payments that eventually end up in Cashmere's REMIC investments do not pay Cashmere, nor do they borrow money from Cashmere. The borrowers do not owe Cashmere for use of borrowed money, and they do not have any existing contracts with Cashmere. Unlike HomeStreet, Cashmere did not have an ongoing and enforceable relationship with borrowers and security for payments did not rest directly on borrowers' promises to repay the loans. Indeed, REMIC investors are far removed from the underlying mortgages. Interest received from investments in REMICs is often repackaged several times and no longer resembles payments that homeowners are making on their mortgages. Cashmere also argues that requiring a taxpayer to show that it has some legal recourse to the underlying mortgages or trust deeds conflicts with HomeStreet by adding a sixth element to the statute. DOR counters that whether a taxpayer has legal recourse to the assets in the REMIC trust addresses a fact that supports the legal conclusion that the investments are primarily secured by the mortgages or deeds of trust. We agree with DOR. Under the statute, there is no requirement that the taxpayer have direct recourse in order for an investment to be considered secure. However, as explained above, a secured party necessarily has some recourse to collateral securing its 18 Cashmere Valley Bank v. Dep't of Revenue, No. 89367-5 investment. For example, in Security Pacific, Security Pacific required mortgage companies to assign residential loans to Security Pacific in return for loaning money to those companies to make the loans. 109 Wn. App. at 798-99. The assignments transferred ownership of the loans to Security Pacific such that Security Pacific stood in the shoes of the mortgage companies. /d. at 808. If a mortgage company defaulted on its line of credit, Security Pacific resorted to the underlying loans, selling them on the secondary market. /d. at 809. Thus, the Court of Appeals held that Security Pacific could deduct any interest earned from the time of the assignment until it sold the loan on the secondary market. /d. at 810-11. Accordingly, we hold that a secured investment must be backed by collateral and the investor must have some recourse against that collateral. Here, REMIC issuers offered no interests in mortgages or trust deeds to back their promises to pay investors. Relatedly, Cashmere has no direct or indirect legal recourse to the mortgages that underlie its REMIC investments in the event of default. Thus, we hold that Cashmere cannot claim the tax deduction. D. Policy Arguments We reject Cashmere's argument that RCW 82.04.4292 should be broadly construed because these deductions have a beneficial impact on the residential housing market. See HomeStreet, 166 Wn.2d at 454 (holding that purpose of RCW 82.04.4292 'was to stimulate the residential housing market' (internal quotation marks omitted) (quoting Sec. Pac., 109 Wn. App. at 804)). No evidence was presented that allowing the deduction actually stimulates the housing market in Washington or benefits consumers by lowering transaction costs. Indeed, a legislative 19 Cashmere Valley Bank v. Dep't of Revenue, No. 89367-5 committee tasked with evaluating the effectiveness of various tax deductions recently expressed doubt whether the deduction in RCW 82.04.4292 has achieved these public policy objectives. State of Wash., Joint Legis. Audit & Review Comm., 2011 Tax Preference Performance Reviews, Report 12-2, at 97 (2012). Thus, we reject Cashmere's policy arguments because they rest on unsupported assumptions and, instead, we construe the statute narrowly and according to its plain language.