Opinion ID: 1835354
Heading Depth: 1
Heading Rank: 4

Heading: to what extent may the bad debt reserves and allowances of the parent bank and all its branches be excluded from calculation of the valuation constant used in determining the branches' intangible value?

Text: Appellee excluded from its taxable capital the sum of $2,048,223 which was carried on its books as Allowance for Loan Losses. The lower court held that this exclusion was proper. Appellant contends that there is no statutory authority for such exclusion and that bad debt reserves should be included in the taxable capital. Section 27-35-35 provides that the net worth ( i.e., valuation constant) of a bank is determined by adding its capital and reserves or accumulations of any sort and then deducting certain named liabilities and other similar items, constituting a debt against the reserves of the bank. Appellee argues that bad debt reserves are such other similar items contemplated by the statute as deductible from net worth. This argument, accepted by the trial court, is based upon analogy to Miss. Code Ann. § 27-13-9 (Supp. 1982) which sets forth the valuation formula for computing corporation franchise tax. That formula expressly excludes bad debt reserves from valuation. Appellee's theory is that because § 27-35-35 provides that special bank taxes be credited against the bank's corporation franchise tax liability, the purpose of special bank taxes such as the tax on branch banks is the same as the corporation franchise tax. Therefore, appellee reasons, deductions allowed under the franchise tax should also be allowed under the bank tax. We disagree. Section 27-35-35 specifically states that capital, prior to allowed deductions, shall include reserves or accumulations of any sort.  This would certainly encompass bad debt reserves. Deductions authorized under § 27-35-35 are: (1) due and unpaid taxes; (2) declared and unpaid dividends; (3) actual depreciation of personal property not entered on books; and (4) other similar items constituting debts against the reserves of the bank. All of these deductions represent actual, realized debts chargeable against the assets of the bank. But bad debt reserves, on the other hand, are not true debts but are contingency allocations for debts which may be realized, i.e., actually become worthless, at a later date. See I.R.C. § 166 (1988). See also Roth Steel Tube Co. v. Commissioner of Internal Revenue, 620 F.2d 1176 (6th Cir.1980); Loewi v. Commissioner of Internal Revenue, 232 F.2d 621 (7th Cir.1956); Milton Bradley Co. v. U.S., 146 F.2d 541 (1st Cir.1944); Hamlen v. Welch, 116 F.2d 413 (1st Cir.1940). Because bad debt reserves do not represent realized debts chargeable against the assets of the bank, we conclude that such reserves and allocations are not other similar items constituting debts entitled to deduction under § 27-35-35. Under federal tax law, a bank is not entitled to deduct the entire balance of its bad debt reserve but rather only that reasonable addition made to the reserve to reimburse the fund for actual bad debts covered during the taxable year. I.R.C. § 585 (1988); 1988 Fed.Tax Reg. § 1.585-1. This concept is consistent with our interpretation of § 27-35-35 suggested above. Additions made to the reserve to replenish the fund for bad debts actually covered would represent realized debts chargeable against the assets of the bank and would therefore be deductible under § 27-35-35 as other such items. Therefore, the trial court erred in holding that the entire balance of appellee's bad debt reserves was deductible. The clear intention of § 27-35-35 is to allow deduction of realized debts chargeable against the assets of the bank. Accordingly, only those disbursements from appellee's bad debt reserve made to cover actual bad debts realized during the taxable year are deductible; the remaining balance is merely a contingency reserve not representing actual debts chargeable against assets.