Rev. Rul. 83-175

ISSUE

Whether interest on certificates of deposit paid by a state- chartered credit union to a nonresident alien, which interest is not effectively connected with the conduct of a trade or business in the United States, is excepted from income from sources within the United States under section 861(a)(1) of the Internal Revenue Code and thereby not subject to Federal income taxation.

FACTS

A is a nonresident alien individual not engaged in a trade or business in the United States and is a member of a state-chartered credit union. A purchased an interest bearing certificate of deposit from that credit union.

LAW AND ANALYSIS

Section 871(a)(1)(A) of the Code imposes on a nonresident alien individual for each taxable year a tax of 30 percent of the amount received from sources within the United States as interest that is not effectively connected with the conduct of a trade or business within the United States.

Section 1441(a) of the Code provides for the withholding of tax at a 30 percent rate on certain income, from sources within the United States, of nonresident alien individuals.

Section 1441(b) of the Code lists interest as an item of income subject to the withholding of tax under section 1441 (a).

Section 861(a)(1)(A) of the Code provides that interest on amounts described in section 861 (c) received by a nonresident alien individual shall not be treated as income from sources within the United States if such interest is not effectively connected with the conduct of a trade or business within the United States.

Section 861(c)(2) of the Code provides that for purposes of section 861(a)(1)(A), the amounts described include deposits or withdrawable accounts with savings institutions chartered and supervised as savings and loan or similar associations under Federal or State law, but only to the extent that amounts paid or credited on such deposits or accounts are deductible under section 591 (determined without regard to section 265) in computing the taxable income of such institutions.

A credit union is not a savings and loan association but may be a "similar association" for purposes of section 861(c)(2) of the Code. In order for a credit union to be considered a "similar association" under section 861(c)(2) all the facts and circumstances must be examined to determine if a state-chartered credit union is similar to a savings and loan association, chartered and supervised under federal or state law.

The original purpose of savings and loan associations was to provide local thrift institutions in which people could invest their funds in order to provide financing for their homes. See G. Munn, Encyclopedia of Banking and Finance 813 (7th Ed. 1973). Savings and loan associations continue to invest in home mortgages, and also now provide consumers with checking accounts, consumer loans, and trust services. See generally The Depository Institutions Deregulations and Monetary Control Act of 1980, Pub. Law 96-221, 94 Stat. 132. Savings and loan associations are taxable entities and are either state or federally-chartered. The state-chartered savings and loan associations are supervised by state banking departments, and the federally-chartered ones are supervised by the Federal Home Loan Bank Board.

A credit union is a democratically controlled, cooperative nonprofit society organized for the purpose of encouraging thrift and self-reliance among its members by creating a source of credit at a fair and reasonable rate of interest in order to improve the economic and social conditions of its members. A growing number of states now permit their credit unions to offer checking accounts or similar types of demand deposits and long-term real estate mortgages. See LaCaisse Populaire Ste. Marie (St. Mary's Bank) v. United States, 563 F.2d 505 (1st Cir. 1977). State-chartered credit unions are tax exempt organizations pursuant to section 501(c)(14)(A) of the Code provided they are organized without capital stock and operated for mutual purposes and without profit. State-chartered credit unions are supervised by state banking departments.

Thus, both state-chartered credit unions and state or federally- chartered savings and loan associations are thrift institutions, chartered and supervised under federal or state law and provide many similar services.

One distinction between these institutions is that a credit union is a tax exempt organization and a savings and loan is a taxable entity. However, this distinction is not of such magnitude as to preclude similar treatment for these entities under section 861(c)(2) of the Code. This is especially true in light of the underlying legislative history. As part of the Foreign Investors Tax Act of 1966, Congress broadened the exemption from United States source income for bank deposit interest to include interest earned on deposits from all savings and loan associations and similar associations because such amounts represent interest income on deposits and competing businesses should be treated in the same manner for tax purposes. See H.R. Rep. No. 1450, 89th Cong., 2d Sess. 7-8 (1966), 19662 C.B. 971-972, and S. Rep. No. 1707, 89th Cong., 2d Sess. 11 (1966), 19662 C.B. 1065-1066. Credit unions must be viewed as financial institutions competing with banks and savings and loan associations for deposits.

Accordingly, state-chartered credit unions are similar to savings and loan associations for purposes of section 861 (c)(2) of the Code.

The second requirement of section 861(c)(2) of the Code is that interest paid by the savings and loan associations or similar associations be deductible by such institutions under section 591. Under section 591 amounts paid to, or credited to the accounts of, depositors or holders of accounts as dividends or interest on their deposits or withdrawable accounts are deductible by the association if the depositor or holder of the account is entitled to withdraw such amounts on demand subject only to customary notice of intention to withdraw. While section 591 does not literally apply to credit unions because they are tax exempt organizations, the amounts described in section 591 would be deductible if the credit unions were taxable. Moreover, the purpose of adding the section 591 requirement was to insure that section 861(c)(2) did not apply to amounts paid by savings and loan or similar associations on or with respect to its non-withdrawable capital stock of the associations, or on or with respect to funds held in restricted accounts which represent a proprietary interest in the associations. See section 1.861-2(b)(1)(ii) of the Income Tax Regulations and H.R. Rep. No. 1450, at 52, 1966-2 C.B. 1003. The abuse which the section 591 requirement was designed to prevent does not arise in the case of credit unions, since under section 501 (c)(I 4)(A) in order to be a tax exempt organization the credit union must have no capital stock. Thus, the inapplicability of section 591 does not prevent credit unions from qualifying under section 861 (c)(2).

HOLDING

Interest on certificates of deposit paid by a state-chartered credit union to a nonresident alien, which interest is not effectively connected with the conduct of a trade or business in the United States, is foreign source income and therefore is not subject to tax under section 871(a)(1) of the Code and is not subject to withholding under section 144 1.

The holding of this revenue ruling is equally applicable to any federally chartered credit union supervised by the National Credit Union Administration, and is applicable with respect to interest paid to a foreign corporation that is a member of a credit union.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 54-623, 1954-2 C.B. 14 and Rev. Rul. 58-34, 1958-1 C.B. 333, which deal with the interpretation of section 861(a)(1)(A) prior to its amendment by the Foreign Investors Tax Act of 1966, are obsoleted.