Court Opinion

ID: 9739654
Source: CourtListenerOpinion
Date Created: 2023-08-26 20:19:05.53225+00
Date Added: 2024-06-11T07:24:13.362448
License: Public Domain

*91Caporale, J.,
dissenting.
I dissent; for when stripped to their essence, the transactions in question are nothing more than ones in which the plaintiffappellee, John Loewenstein, participated as a lender in loans secured by various governmental obligations. Therefore, state taxation of the income Loewenstein earned through those participations is not precluded by the Supremacy Clause of the U.S. Constitution through the provisions of 31 U.S.C. § 3124 (1988), and Nebraska Department of Revenue Ruling 22-85-1, issued by the defendant-appellant, State of Nebraska, Department of Revenue, is valid.
Loewenstein is an investor in funds operated by Massachusetts Business Trusts, a regulated investment company as defined in the Internal Revenue Code, I.R.C. § 851(a) (1988), which funds are commonly known as mutual funds. Under the “General Repurchase Agreement” which controls the transactions in question, a seller of governmental securities to the trusts is obligated to repurchase them by a fixed date, and the trusts are obligated to resell them at a fixed price. In exchange, the trusts receive a fixed rate of return which bears no relationship either to the value of the securities which make up the trusts’ funds or to the income the securities produce for the seller, or more accurately, the seller-repurchaser. In short, the seller-repurchaser bears the entire market risk. Moreover, until the repurchase date, the seller-repurchaser has the right to substitute one governmental security for another. Further, the seller-repurchaser and the trusts each have remedies against the other in the event of a default in the respective obligations of either.
Nine of the 10 other appellate courts which have considered this issue have held that under such circumstances, the income to the investors is subject to state taxation: Hammond Lead Products v. Tax Com’rs, 575 N.E.2d 998 (Ind. 1991); Everett v. Dept. of Revenue and Finance, 470 N.W.2d 13 (Iowa 1991); Comptroller v. First United Bank, 320 Md. 352, 578 A.2d 192 (1990); Borg v. Dept. of Rev., 308 Or. 34, 774 P.2d 1099 (1989); Department of Revenue v. Page, 541 So. 2d 1270 (Fla. App. 1989); Massman Const. v. Director of Revenue, 765 S.W.2d 592 (Mo. 1989); Capital Preservation v. Rev. Dept., 145 Wis. 2d *92841, 429 N.W.2d 551 (Wis. App. 1998); In re Sawyer Estate, 149 Vt. 541, 546 A.2d 784 (1987); Andras v. Department of Revenue, 154 Ill. App. 3d 37, 506 N.E.2d 439 (1987), cert. denied 485 U.S. 960, 108 S. Ct. 1223, 99 L. Ed. 2d 424 (1988). The only decision other than that of the majority holding to the contrary is that of an intermediate court of appeals in Matz v Dep’t of Treasury, 155 Mich. App. 778, 401 N.W.2d 62 (1986). However, the Matz court was construing a state statute defining ownership.
While the fact that nine other courts have reached a contrary result to that reached by the majority is not, in and of itself, particularly persuasive, the reasoning illustrated by Andras v. Department of Revenue, 154 Ill. App. 3d at 43-44, 506 N.E.2d at 443-44, is:
In reviewing similar transactions involving municipal bonds, Federal courts have consistently held that the Federal income tax exemption provided for income received from State or municipal obligations (26 U.S.C. sec 103(a) (1982)) is available only to the taxpayer who actually owns the securities — i.e., the taxpayer who has the right to dispose of them and who bears the risk of a profit or loss. (See American National Bank v. United States (5th Cir. 1970), 421 F.2d 442, 451 (and cases cited therein).) Plaintiffs have cited no authority holding that section 742 requires immunizing from State taxation the income of anyone other than the owner of Federal government securities, nor have we found any authority supporting plaintiffs’ position.
While we recognize that section 742 is a constitutionally mandated immunization from taxation (see, e.g., Memphis Bank & Trust Co. v. Garner (1983), 459 U.S. 392, 397, 74 L. Ed. 2d 562, 567, 103 S. Ct. 692, 695-96) rather than a legislative exemption from a particular tax, the scope of the immunity it affords is not unlimited. In First National Bank v. Bartow County Board of Tax Assessors (1985), 470 U.S. 583, 84 L. Ed. 2d 535, 105 S. Ct. 1516, the Supreme Court held that section 742 did not require a State to permit a bank to deduct the full value of its government securities from its gross assets. The court *93recognized that, because the bank may have incurred liabilities, the interest on which was also deductible, to acquire the securities, the statute was satisfied by the State’s allowing only a pro rata deduction from the bank’s net worth for the securities. The court concluded that the bank should not be allowed to use Federal obligations to shelter otherwise taxable assets. (470 U.S. 583, 593, 84 L. Ed. 2d 535, 545, 105 S. Ct. 1516, 1523-24.) If the Trust is not the true owner of these securities, but is merely loaning the sellers the securities’ purchase price and thereby earning otherwise taxable interest income, we conclude that it may not shelter that income from State taxation by allowing the borrowers to secure the loans with tax-exempt Federal securities.
In determining whether or not a repurchase transaction is actually a loan, Federal courts consider the entire transaction and look to the following specific factors, which, if present, tend to indicate that the transaction is a loan: (1) whether the seller could require the purchaser to resell the securities; (2) whether the purchaser could require the seller to repurchase them; (3) whether the agreement provides either party a specific remedy in the event that the other defaults; (4) whether the seller agreed to pay interest at a stipulated rate between the sale and resale; and (5) whether the amount advanced does not necessarily equal the fair market value of the securities sold. (See Citizens National Bank v. United States (Ct. Cl. 1977), 551 F.2d 832, 842.) Other indications of a loan are: (6) whether the identical securities are bought and sold, and (7) whether the purchaser may sell the securities for the seller’s account in the event of a default. See I.R.S. Rev. Rul. 74-27, 1974-1 C.B. 24. See also I.R.S. Rev. Rul. 82-144, 1982-2 C.B. 34 (transaction held to be purchase where the purchaser could sell the securities at will); I.R.S. Rev. Rul. 77-59, 1977-1 C.B. 196 (transaction was found to be loan only and the purchaser’s assets were found not to be the securities themselves, but the seller’s obligation to repay the funds loaned).
Loewenstein argues that repurchase agreements are essential *94in order to allow the Federal Reserve to adjust the nation’s money supply and points to 12C.F.R. § 32.103(a) (1993), which provides that U.S. Treasury notes subject to a repurchase agreement do not constitute a loan or the extension of credit. However, as noted in Hammond Lead Products v. Tax Com’rs, supra, that regulation relates to commercial banks and the general scheme of lending limits; it has no bearing on the Internal Revenue Code or the judicial interpretation of repurchase agreements.
Loewenstein also argues that repurchase agreements are necessary to increase the liquidity of mutual funds dealing in government obligations in order to satisfy those investors who wish to avoid inflexible terms in their investments. But government securities are, in and of themselves, very liquid; they can be sold readily, albeit with some short-term market risk. Also, a mutual fund could achieve even greater liquidity by borrowing against the government securities it holds. And a fund could also enhance its liquidity by diversifying the maturity dates of the government securities it acquires. The point is that there are other means to achieve liquidity without the use of repurchase agreements, which take exposure to market risks and other incidents of ownership away from the investor and give them to the seller-repurchaser.
As stated in Everett v. Dept. of Revenue and Finance, 470 N.W.2d 13, 15 (Iowa 1991):
The State’s tax did not consider, either directly or indirectly, the federal obligations or the interest paid on them in calculating the Everetts’ tax. Instead, the tax was based on the interest paid by private seller-repurchasers pursuant to a private sector loan agreement in which federal obligations served as collateral. In such a situation, neither the federal obligations nor the interest thereon is considered in calculating the state income tax. Borg, 308 Or. at 38-39, 774 P.2d at 1102; In re Thomas Sawyer Estate, 546 A.2d at 786. We hold that neither the supremacy clause nor 31 U.S.C. section 3124(a) prevents the State from taxing the income derived from the repurchase agreements.
Accordingly, I would reverse the judgment of the district *95court and remand the cause with the direction that the district court declare Revenue Ruling 22-85-1 to be valid.
Grant, J., Retired, joins in this dissent.