Rev. Rul. 62-183

Advice has been requested whether a qualified employees' profit-sharing trust, established by a state bank, will be engaging in a prohibited transaction, within the meaning of section 503(c) of the Internal Revenue Code of 1954, by depositing trust funds in a savings account with the employer-grantor.

A state bank established a profit-sharing trust for the benefit of its employees. The trust meets the requirements of section 401(a) of the Code and is held to be exempt from Federal income tax under section 501(a). Funds of the trust have been placed on deposit in a savings account with the employer-grantor bank in an amount in excess of the amount for which insurance is provided by the Federal Deposit Insurance Corporation. The bank pays a reasonable rate of interest on savings accounts. While withdrawals may generally be made at any time without prior notice, the bank reserves the right to require 30 days' notice.

Under the provisions of section 503(a)(1) of the Code, an organization described in section 401(a) is not exempt from taxation under section 501(a) if it has engaged in a prohibited transaction after March 1, 1954. Section 503(c) of the Code provides, in part, that where an exempt trust lends any part of its income or corpus to the creator of such trust without the receipt of adequate security and a reasonable rate of interest, or where it engages in any other transaction which results in a substantial diversion of its income or corpus to the creator, the trust shall be considered as engaging in a prohibited transaction.

When the "prohibited transaction" provisions of the Internal Revenue Code were first considered by the Congress of the United States, it was stated by the Senate Finance Committee, in dealing with section 331 of the Revenue Act of 1950, that there is no objection to engaging in transactions with donors if these transactions are carried out at arm's length. It was also stated that the only type of loan that would not be at arm's length is one in which the organization lends any part of its income or corpus without adequate security or at an unreasonable rate of interest to donors, etc. Section 331 of the Revenue Act of 1950 added section 3813(b)(1) to the 1939 Code which was the predecessor of section 503(c)(1) of the 1954 Code. See Senate Report No. 2375, 81st Cong., C.B. 1950-2, 483, at 510 and 569. Thus, the situation presented by the facts in the instant case is not one of the type intended to be covered by the legislation enacted in 1950.

Having determined that the instant situation does not violate the spirit of the statute, the question arises whether this type of "loan" is actually a loan within the meaning of the statute. Generally speaking, the judicial view tends to support treating a deposit as not being a loan to the financial institution, whether the deposit be a savings deposit bearing interest and requiring 30 to 60 days' notice for withdrawal or some other form of deposit, such as a checking account requiring no withdrawal notice. Although it is well established that such a transaction does create a debtor-creditor relationship (Schumacher v. Eastern Bank & Trust Company, 52 Fed. (2d) 925 (1931)), this fact alone is not determinative that a deposit in a savings account is a loan. However, a time deposit, that is, a deposit made for a fixed period of time is considered to be a loan. Thus, a deposit of this kind is distinguishable from deposits in ordinary checking and savings accounts of the type described above and for the purposes of section 503(c)(1) the Service would treat such a deposit as being a loan.

The concept of what constitutes a deposit and the basic distinction between a deposit and a loan can be found in the decision of the Supreme Court of the United States in Texas & Pacific Railway Company v. Pottorff, 291 U.S. 245 (1933), and, among others, in the decision of the Circuit Court of Appeals for the Fourth Circuit in the Eastern Bank & Trust Company case. The courts there stated that the modern deposit grew out of the older form of deposit in which the fund was held separate and intact and the sole purpose of the deposit was safekeeping. Safekeeping is still a very important function of deposit banking and, from the viewpoint of most depositors, the chief one. A loan is primarily for the benefit of the bank while a deposit is primarily for the benefit of the depositor.

In the instant case, the deposit is made primarily for the benefit of the depositor, that is, safekeeping of the funds and the return of interest thereon. It may or may not be for the bank's benefit depending on whether the deposited funds could, at the time, be placed in loans or suitable investments yielding a sufficient return to the bank. Even if the bank can so place the funds and is benefited thereby, the basic motive of the depositor is the overriding factor in denominating the transaction as a deposit rather than as a loan.

In view of the above, it is held, in the instant case, that the placing of funds by the exempt employees' trust in a savings account with the employer-grantor bank is a deposit and, as such, it does not represent a loan within the meaning of section 503(c)(1) of the Code. Therefore, the trust is not engaging in a prohibited transaction within the meaning of section 503(c) of the Code.

The above conclusion is applicable to national banks, state banks, savings and loan associations, or building and loan associations, properly chartered and subjected to the usual Federal or state regulatory requirements, whose deposits are covered by insurance issued by the Federal Deposit Insurance Corporation or the Federal Savings and Loan Insurance Corporation, or their state equivalents. This is true even though the amount on deposit is in excess of the amount for which insurance is provided.

The provisions of Part 2(r) of Revenue Ruling 61-157, C.B. 1961-2, 67, govern the manner in which the savings account is to be conducted in order to be consistent with the exemption requirements under section 401(a) of the Code. It is there pointed out that the primary purpose of benefiting employees or their beneficiaries must be maintained with respect to the investment of trust funds as well as in other activities of the trust.

See Revenue Ruling 59-29, C.B. 1959-1, 123, with respect to the deposit of funds of an exempt employees' trust in a checking account with the employer-grantor bank.