Home Loan Banks Shouldn’t Face EO Excise Tax, Group Says

April 1, 2019

Internal Revenue Service
CC-PA:LPD:PR (REG-107163-18)
Room 523
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Re: Applicability of Section 4960 of the Internal Revenue Code to the Federal Home Loan Banks

Dear Sir or Madame:

On behalf of the Federal Home Loan Banks of Atlanta, Boston, Chicago, Cincinnati, Dallas, Des Moines, Indianapolis, New York, Pittsburgh, San Francisco, and Topeka (collectively, the “Federal Home Loan Banks”), and the Federal Home Loan Banks' Office of Finance (“Office of Finance”) (hereinafter, the “Federal Home Loan Banks” and the “Office of Finance” will be referred to collectively as the

“FHLBanks”), we provide the following comments¹ with respect to Section 4960 of the Internal Revenue Code of 1986,² as amended (the “Code”), which was implemented as part of the Tax Cuts and Jobs Act and signed into law on December 22, 2017. The FHLBanks are financial institutions, statutorily organized and exempted from all taxation (except property taxes), which serve the public interest by enhancing the availability of residential housing finance and community lending credit through their member institutions.

INTRODUCTION

New Code Section 4960 imposes a 21% excise tax on applicable tax-exempt organizations that pay executive compensation considered to be excessive. Neither the express language of Section 4960 nor its legislative history addresses specifically whether the excise tax applies to the FHLBanks. By contrast, Section 13 of the Federal Home Loan Bank Act (“Bank Act”)³ expressly mandates that the FHLBanks “shall be exempt from all taxation now or hereafter imposed by the United States . . .” except for state property taxes. The plain meaning of Section 13 of the Bank Act is that the FHLBanks are exempt from the excise tax under Section 4960. This conclusion is also supported by well-established precedent that the general provisions of Section 4960 should be interpreted in a manner that will preserve the specific Congressional directive of the Bank Act to exempt the FHLBanks from taxation.

Accordingly, the FHLBanks respectfully request that the Internal Revenue Service (“Service”) clarify in subsequent guidance that the FHLBanks are not “applicable tax-exempt organizations” within the meaning of Code Section 4960 due to their tax-exempt status originating directly from the Bank Act. The FHLBanks believe such clarification is warranted because: (1) Section 13 of the Bank Act specifically provides that the FHLBanks are exempt from all taxation at the time of the Bank Act and in the future (with the exception of state property taxes); and (2) such guidance would be consistent with U.S. Supreme Court precedent which interprets later in time statutes that appear to differ, from earlier statutes in a manner that will preserve the authority of the more specific statute, in this case, the Bank Act, over the more general tax statute, Code Section 4960.⁴

BACKGROUND INFORMATION

The Federal Home Loan Banks are regional member-owned corporations created by Congress in 1932 pursuant to the Bank Act, to provide lending institutions with a liquidity resource to finance housing (including affordable housing) and economic development activities in the communities the Federal Home Loan Banks serve by promoting mortgage lending and other community investments.⁵ The Federal Home Loan Banks provide long-term and short-term secured loans, called “advances,” to their members. For collateral, Federal Home Loan Bank members primarily use residential mortgage loans, as well as government and agency securities. Community financial institutions may also pledge small business, small farm, small agri-business and community development loans as collateral for advances. The Federal Home Loan Banks play an essential role by helping member institutions meet the credit needs of communities everywhere in all economic cycles.⁶

Today, the FHLBank system is comprised of eleven federally chartered Federal Home Loan Banks operating in eleven distinct Federal Home Loan Bank Districts and the Federal Home Loan Banks' fiscal agent, the Office of Finance.⁷

The Federal Home Loan Banks are government-sponsored enterprises that are federally chartered but privately capitalized, and individually and independently managed. Each Federal Home Loan Bank is an independent legal entity with its own management and staff and its own board of directors elected by the Federal Home Loan Bank's members.⁸

Purpose of FHLBanks

Unlike other housing government-sponsored enterprises, Federal Home Loan Banks do not guarantee or insure mortgage loans. Instead, Federal Home Loan Banks accomplish their mission primarily by acting as “banks to banks,” providing services such as long-term and short-term loans (or “advances”) to their members, who, in turn, issue mortgage loans to consumers. The Federal Home Loan Banks are required to fulfill certain mandates by law, such as contributing at least ten percent of their net earnings to affordable housing efforts established through the Affordable Housing Program, through which each Federal Home Loan Bank provides grants and subsidized loans to its members to enable them to work with community organizations and affordable housing developers to create rental or homeownership opportunities for lower-income households.⁹

The Office of Finance is the fiscal agent of the Federal Home Loan Banks. Its primary function is to facilitate the issuance and service debt securities for the Federal Home Loan Banks while obtaining the most cost-effective terms based on the current market conditions. The Office of Finance also compiles and publishes combined financial statements of the Federal Home Loan Banks.¹⁰ The debt issued by the Office of Finance is the joint and several liability of the eleven Federal Home Loan Banks, but is not backed by the full faith and credit of the United States government.

Board and Agency Oversight

The Federal Home Loan Banks each have an independent board of directors which includes representatives of members of that particular bank as well as independent directors. The directors' expertise is broad and includes areas such as banking, accounting, housing and community development.¹¹

The Federal Home Loan Banks are also overseen and their activities restricted by their federal regulator, the Federal Housing Finance Agency (the “Agency”), an entity created by Congress under the Housing and Economic Recovery Act of 2008¹² to ensure the Federal Home Loan Banks stay true to their mission of providing their members with financial products and services to assist members' financing of housing, including affordable housing and community lending. The Agency's purpose is to ensure that the Federal Home Loan Banks operate in a safe and sound manner so they can serve as a reliable source of liquidity.¹³ To carry out its purpose, the Agency has rulemaking authority under which it issues regulations applicable to the Federal Home Loan Banks. The Agency also conducts annual on-site examinations and continuous off-site monitoring of the Federal Home Loan Banks.

Under its rulemaking authority, the Agency issued rules¹⁴ pursuant to Section 1113 of the Housing and Economic Recovery Act of 2008¹⁵ setting requirements and procedures governing executive compensation, prohibiting the payment of compensation that is not “reasonable and comparable”¹⁶ and regulating golden parachutes.¹⁷

Legislative History

The legislative history of the Bank Act reflects the importance which Congress attached to the specific tax immunity about the Federal Home Loan Banks. There is extensive evidence in the legislative history of detailed discussion of the constitutionality of the tax-exempt status along with the examination of the societal and economic effects of such a status.¹⁸

For example, Mr. John O'Brien, Assistant Counsel from the Office of the Legislative Counsel of the House of Representatives, explained that the “capital, surplus, and income of Federal home loan banks shall be exempt from taxation, both Federal, State, municipal, and local taxation, except, of course, real estate held, purchased, or taken by the bank is to be taxed.”¹⁹ Additionally, Mr. Nathan William MacChesney, General Counsel of the National Association of Real Estate Boards, testified that the proposed Bank Act would result in the entities being classified as U.S. government instrumentalities and depositories, thus making them tax-exempt.²⁰

Congress, ultimately, decided that the goals of assisting society to obtain home loans and furthering the economy would best be met if the Federal Home Loan Banks were created as tax-exempt instrumentalities of the federal government.²¹ Thus, Congress passed Section 13 of the Bank Act with the following clear and strongly worded tax-exempt mandate language:

“The bank, including its franchise, its capital, reserves, and surplus, its advances, and its income, shall be exempt from all taxation now or hereinafter imposed by the United States, by any Territory, dependency, or possession thereof, or by any State, county, municipality or local taxing authority, except that in any real property and the bank shall be subject to State, Territorial, county, municipal, or local taxation to the same extent according to its value as other real property is taxed.” (Emphasis added.)

After the enactment of the Bank Act, the U.S. Supreme Court rejected interpreting a more recently enacted federal law to impair or diminish the Federal Home Loan Banks' tax-exempt status.²² Specifically, in Laurens Fed. Sav. & Loan Ass'n, the Supreme Court rejected an argument of an implied repeal of the tax exemption on the FHLBanks by the Home Owners' Loan Act of 1933. The Court held that “[c]learly there is no express language providing for such repeal, and it is significant that when other provisions of the 1932 Act were to be superseded by the 1933 Act they were repealed expressly and not by implication . . . Nor is there even an intimation in the legislative history of the 1933 Act of any intention to reduce the scope of the exempt status of Home Loan Banks.”

For the reasons discussed below, there is no reason to impair the FHLBanks' tax exemption here.

PRINCIPLES OF STATUTORY CONSTRUCTION DICTATE THAT CODE SECTION 4960 DOES NOT APPLY TO THE FHLBANKS

Code Section 4960 imposes an excise tax on an extremely broad range of tax-exempt entities and does not target a specific industry or type of tax-exempt entity. The legislative history of Code Section 4960 is sparse. By contrast, the Bank Act was specifically targeted to create and govern the FHLBanks, including a discussion of tax status.

Whether Code Section 4960 applies to the FHLBanks turns on well-established principles of statutory construction. Given the unique characteristics of the FHLBanks, Code Section 4960 cannot be considered in isolation, but must instead by viewed in conjunction with the more specific statutory language set forth in the Bank Act, which expressly mandates that the FHLBanks are “exempt from all taxation now or hereinafter imposed” (except for state real estate taxes).²³ Simply stated, this is a clear case of two federal statutes addressing a common topic between them, which requires courts to read Code Section 4960 and the Bank Act in a compatible manner.²⁴ To reconcile statutes in a compatible manner, courts must employ canons of statutory interpretation. Relevant to this particular issue are:

(1) the plain meaning rule; and (2) the rule that implicit repeals are not favored, and specific provisions control over general ones.²⁵ As discussed below, resort to these canons dictates that the Bank Act's unequivocal exemption of the FHLBanks from all future taxation must control in this situation.

The Plain Meaning of the Bank Act Dictates that the FHLBanks are Exempt from “All Taxation”

It is axiomatic that courts use the “plain meaning” of a statute to interpret its meaning.²⁶ “When interpreting a statutory provision, [courts] begin with the language of the statute.”²⁷ “Every exercise in statutory construction must begin with the words of the text.”²⁸ “If the statutory terms are unambiguous, [courts] construe the statute according to the plain meaning of its words.”²⁹ The U.S. Supreme Court stated in SAS Institute, Inc. v. Iancu³⁰ that the plain meaning interpretation of a statute controls and “[w]here a statute's language carries a plain meaning, the duty of an administrative agency is to follow its commands as written.” Similarly, the Second Circuit in Tyler v. Douglas³¹ noted that “[i]n determining the proper interpretation of a statute, [it would] look first to the plain language of a statute and interpret it by its ordinary, common meaning. If the statutory terms are unambiguous, [its] review generally ends and the statute is construed according to the plain meaning of its words” (note that internal citations, quotation marks, and alteration omitted).

Indeed, the U.S. Supreme Court has increasingly instructed courts to focus on the words in the statute, including grammar, sentence structure, and general definitions of the words used.³² Departure from the plain language of a statute is disfavored and “appropriate only in rare cases in which the literal application of the statute will produce a result demonstrably at odds with the intentions of its drafter or when the statutory language is ambiguous.”³³

Here, as previously indicated, Code Section 4960 imposes a tax on certain remuneration paid to certain executives by “applicable tax-exempt organizations.” The definition of “applicable tax-exempt organizations” under Section 4960 includes any organization that is exempt from taxation under Code Section 501(a). Code Section 501(a), in turn, cross-references to Code Section 501(c) to include entities exempt under Code Section 501(c).

However, even assuming that the FHLBanks (among many other entity types) fall within the expansive definition of tax-exempt organizations under Code Section 501(c)(1) does not conclusively establish that the FHLBanks are subject to the excise tax based solely on the language of Code Section 4960. In stark contrast to Code Section 4960, Section 13 of the Bank Act, which applies specifically and exclusively to the FHLBanks, expressly provides that the FHLBanks are exempt from all taxation, including taxes “now or hereinafter imposed by the United States” (except state property taxes).

Numerous opinions concerning Freddie Mac and Fannie Mae are instructive as to how courts would apply the plain meaning principle to the application of Code Section 4960 and the Bank Act in this situation.³⁴ These cases involved the interpretation of Congressional Acts exempting Freddie Mac and Fannie Mae from “all taxation now or hereafter imposed by any State . . .” except for property taxes, using language that is virtually identical to the language in the Bank Act. The courts consistently held that the plain meaning of the phrase exempt from “all taxation” means exactly what it says — that the entities were exempt from paying all taxes.

For example, in County of Oakland v. Federal Housing Finance Agency, the state of Michigan argued that the congressional exemption of Freddie Mac and Fannie Mae did not include property transfer taxes.³⁵ In interpreting the statutory intent, the Sixth Circuit Court of Appeals considered the plain meaning of the words “all” and “taxes” in the Oxford English Dictionary, and ultimately concluded that “when Congress broadly exempts an entity from taxation or all taxation it means all taxation (emphasis added).”³⁶ As the court aptly observed, “the common sense, non-technical interpretation of 'all taxation' has to include the State and County real estate transfer taxes here . . . [because] a straightforward reading of the statute leads to the unremarkable conclusion that when Congress said 'all taxation,' it meant all taxation.”³⁷ (emphasis original). As such, the property transfer tax that the states and counties were attempting to impose in the various Freddie Mac and Fannie Mae cases could not be imposed on these tax-exempt entities. In short, as stated by the Eighth Circuit of Appeals, “all means all.”³⁸

The same principle applies to the issue here. Section 13 of the Bank Act expressly provides in everyday, unequivocal terms that the FHLBanks are exempt from all taxation, including taxes “now or hereinafter imposed by the United States.” The plain meaning of the phrase “all taxation” can only be read as including (and therefore negating) the excise tax set forth in Code Section 4960. Accordingly, the IRS should issue guidance clarifying that Congress did not intend to impose the excise tax under Section 4960 on the FHLBanks.

Implicit Repeals are Not Favored, and the Specific Provisions of the Bank Act Control

If Code Section 4960 is read to impose an excise tax on the FHLBanks, it would operate as an implicit repeal of the Bank Act's express mandate that FHLBanks are exempt from all taxation “now or hereinafter imposed.” That cannot be the result Congress intended. There is no mention in the legislative history that Congress even considered the FHLBanks or the Bank Act in passing the legislation.

It is also a “cardinal rule [of statutory construction] that repeals by implication are not favored.”³⁹ Rather, “[t]he intention of the legislature to repeal [a particular statute] must be 'clear and manifest.'”⁴⁰ “In the absence of some affirmative showing of an intention to repeal, the only permissible justification for a repeal by implication is when the earlier and later statutes are irreconcilable.”⁴¹ Because repeals by implication are not favored, courts often reconcile the statutes in question by categorizing them as “general” or “specific” in nature. The statutes are then read, if possible, in a manner that prevents the general statute from negating a specific statute.⁴² “It is a well-settled rule of statutory interpretation that where there is no clear intention otherwise, a specific statute will [not be] controlled or nullified by a general one, regardless of the priority of enactment.”⁴³

The seminal case applying this principle, Morton v. Mancari,⁴⁴ is instructive. In Morton, the U.S. Supreme Court examined a similar tension between the Indian Reorganization Act of 1934 and the Equal Employment Opportunities Act of 1972. The court first acknowledged its disfavor for the implicit repeal of statutes: “In the absence of some affirmative showing of an intention to repeal, the only permissible justification for a repeal by implication is when the earlier and later statutes are irreconcilable.”⁴⁵ The court held that “[w]here there is no clear intention otherwise, a specific statute will not be controlled or nullified by a general one, regardless of the priority of the enactment.”⁴⁶ From this, the court found that “the Indian preference statute is a specific provision applying to a very specific situation . . . [while the] 1972 Act . . . is of general application.”⁴⁷ Ultimately, the more specific provision in the Indian Reorganization Act controlled.⁴⁸

Applying the well-established holding articulated in Morton and its progeny to the issue here, it is clear that Congress expressed no affirmative intention to repeal the Bank Act, and the earlier and later statutes are not irreconcilable – the two statutes can be easily reconciled by concluding that Code Section 4960 was not intended to, and does not, apply to the FHLBanks. This conclusion should be reached because the Bank Act is a more specific statute pertaining only to the Federal Home Loan Banks, unlike Code Section 4960, which is a much broader statute pertaining to almost all tax-exempt entities. To decide otherwise would effectively repeal a portion of the Bank Act by implication, which is highly disfavored in statutory interpretation, especially in a case such as this one, where the affirmative Congressional intent required to establish implicit repeal is entirely lacking. Indeed, had Congress intended to reverse its previous mandate that the FHLBanks are “exempt from all taxation now or hereinafter imposed by the United States,” it could easily have added organizations exempt from taxation under the Bank Act to the list of tax-exempt entity types listed under Code Section 4960(c)(1). It did not do so. Given that Congress neither listed organizations exempt from taxation under the Bank Act as one of the applicable tax-exempt organizations, nor discussed the FHLBanks in connection with its consideration of Section 4960, it follows that Congress did not intend Code Section 4960 to operate as a repeal of the protections of the Bank Act as applied to taxation of the FHLBanks.

SUMMARIZED COMMENTS/REQUESTS

For the reasons discussed in this letter, the FHLBanks are exempt from all taxes, including taxes imposed in the future (except state property taxes), based on the Bank Act enacted by Congress in 1932, which has not been repealed. The FHLBanks therefore respectfully ask the Service to issue guidance confirming that the newly enacted Code Section 4960 does not apply to the FHLBanks; thus the FHLBanks will not be subject to the excise tax imposed by Code Section 4960.

Sincerely,

Sharon B. Hearn

Tiffany A. Hofmeister

KRIEGDEVAULT
Carmel, IN

Enclosures

cc:
Jonathan R. West