Rev. Rul. 70-385

Advice has been requested whether certain financial institutions described below qualify as "persons carrying on the banking business" as that phrase is used in section 955(c)(1)(B)(ii) and section 956(b)(2)(A) of the Internal Revenue Code of 1954.

A United States corporation has several wholly-owned foreign subsidiaries, some of which may qualify as "less developed country corporations" as that term is defined in section 955(c)(1) of the Code. From time to time these subsidiaries anticipate making certain temporary investments which consist of fixed deposits with foreign companies which are similar to United States finance companies and which would not qualify as banks under section 581 of the Code if they were United States companies.

Section 955(c)(1)(B)(ii) of the Code provides that money, and deposits with persons carrying on the banking business will be considered part of the qualifying assets of a less developed country corporation. Similarly, section 956(b)(2)(A) of Code provides that the term "United States property," as that term is defined in section 956(b)(1) of the Code, does not include obligations of the United States, money, or deposits with persons carrying on the banking business.

The phrase "persons carrying on the banking business" has not been defined for purposes of sections 955 and 956 of the Code. Hence, it is necessary to examine other Code sections and the interpretations given thereunder for guidance.

The term "banks," for domestic purposes, is defined by section 581 of the Code to mean a bank or trust company incorporated and doing business under the laws of the United States (including laws relating to the District of Columbia), of any State, or of any Territory, a substantial part of the business of which consists of receiving deposits and making loans and discounts, or of exercising fiduciary powers similar to those permitted to national banks under authority of the Comptroller of the Currency, and which is subject by law to supervision and examination by State, Territorial, or Federal authority having supervision over banking institutions. Such term also means a domestic building and loan association.

Section 861(a)(1)(A) of the Code, prior to 1967, provided that interest on deposits with persons carrying on the banking business would not be treated as income from sources within the United States. The phrase "persons carrying on the banking business," for purposes of section 861 of the Code, includes such institutions as mutual savings banks and certain savings and loan associations even though such institutions were not engaged in all of the activities normally conducted by a bank as defined in section 581 of the Code. See Rev. Rul. 58-34, C.B. 1958-1, 333; Rev. Rul. 54-623, C.B. 1954-2, 14; and Rev. Rul. 54-624, C.B. 1954-2, 16.

The Foreign Investors Tax Act of 1966, Public Law 89-809, Eighty-ninth Congress, C.B. 1966-2, 656, amended section 861(a)(1)(A) of the Code, effective after 1966, to provide that interest on amounts described in subsection (c) received by a nonresident alien individual or a foreign corporation, if such interest is not effectively connected with the conduct of a trade or business within the United States, shall not be treated as income from sources within the United States.

Section 861(c) of the Code provides that for purposes of subsection (a)(1)(A), the amounts described in this subsection are--

(1) deposits with persons carrying on the banking business,

(2) 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, and

(3) amounts paid by an insurance company under an agreement to pay interest thereon.

The Senate Finance Committee in its explanation of the above amendment took note of the Service's interpretation of section 861(a)(1)(A) of the Code and pointed out that although it found the entire exemption questionable, as long as bank deposit interest is to be treated as foreign source income, there is no justification for denying similar treatment for interest paid by savings and loan institutions generally as well as interest earned on the proceeds of an insurance policy that are left on deposit with an insurance company. These all represent interest income received on deposits and, therefore, it was felt that the competing businesses should be treated in the same manner for tax purposes. See Senate Report No. 1707, Eighty-ninth Congress, C.B. 1966-2, 1066.

From the foregoing it is evident that Congress recognized that the institutions mentioned in paragraph (2) and (3) of section 861(c) of the Code were not persons carrying on the banking business. Nevertheless, for reasons set forth above Congress decided to broaden the interest exemption without saying that the added institutions, in fact, constituted persons carrying on the banking business.

Thus, the several interpretations of the phrase "persons carrying on the banking business" for purposes of section 861 of the Code, noted above, will not be applied to sections 955 and 956 of the Code. Therefore, an entity which qualified as a bank under section 581 of the Code, without regard to the place in which it is doing business or the authority under which the business is carried on, is a person carrying on the banking business for purposes of sections 955 and 956 of the Code.

Accordingly, since the foreign companies in which deposits are to be made would not qualify as banks under section 581 of the Code if they were United States companies, they do not qualify as persons carrying on the banking business for purposes of sections 955(c)(1)(B)(ii) and 956(b)(2)(A) of the Code.