No EO Excise Tax for Federal Home Loan Banks, Firm Says

August 6, 2020

Internal Revenue Service
CC:PA:LPD:PR (REG–122345–18)
Room 5203
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 Madam:

On behalf of the Federal Home Loan Banks of Atlanta, Boston, Chicago, Cincinnati, Dallas, Des Moines, Indianapolis, New York, Pittsburgh, San Francisco, and Topeka, and the Federal Home Loan Banks' Office of Finance¹ (collectively, the “Federal Home Loan Banks” or “Banks”), we provide the following comments on the proposed regulations under section 4960 of the Internal Revenue Code of 1986,² as amended (the “Code”), which was enacted as part of the Tax Cuts and Jobs Act and signed into law on December 22, 2017. These comments incorporate the Banks' April 1 and November 1, 2019 comments to the Service concerning section 4960, and are submitted in response to the request in the preamble to the proposed regulations for “comments regarding the application of section 4960 to [ ] Federal instrumentalities” like the Federal Home Loan Banks, i.e., financial institutions statutorily organized and exempted from all taxation (except state and local real property taxes) by virtue of their enabling statute. See Tax on Excess Tax-Exempt Organization Executive Compensation, 85 Fed. Reg. 35,746, 35,748 (June 11, 2020).

Introduction

In their April 1, 2019 comments, the Federal Home Loan Banks provided to the Service a detailed background of the Federal Home Loan Bank System, the legislative history and congressional purpose behind the creation of the Federal Home Loan Banks, and the language in their enabling statute granting the Federal Home Loan Banks an exemption from “all taxation now or hereafter imposed” (except for state and local real property taxes) that furthers that congressional purpose. The Banks hereby refer the Service to the April 1, 2019 comments for that background.³

In those April 1, 2019 comments, the Banks explained that neither the express language of section 4960 of the Code nor what limited legislative history is available addresses specifically whether the new excise tax applies to the Federal Home Loan Banks. Meanwhile, the Federal Home Loan Bank Act (“Bank Act”) expressly mandates that the Federal Home Loan Banks “shall be exempt from all taxation now or hereafter imposed by the United States” except for state and local real property taxes, as codified in 12 U.S.C. § 1433 (hereinafter “section 1433”). Therefore, the Banks explained that section 4960 must be reconciled with section 1433 so as not to impair the Federal Home Loan Banks' explicit tax exemption. The November 1, 2019 comments provided further support for the Banks' position, noting that the Service had, in a prior Revenue Ruling, followed the clear language of section 1433 and held that the Banks were exempted from a later-enacted excise tax.

The proposed rules, however, failed to fully grapple with the plain language of the statutory provisions at issue. The preamble to the proposed regulations relies on an inference drawn from comparing section 4960 to an income tax provision in the Code that makes reference to federal instrumentalities described in section 501(c)(1), but does not address the specific language of the Bank Act and its prior application by the Service to exempt the Banks from later-enacted excise taxes, nor the language or history of section 501(c)(1). In light of the invitation for further comment, and the importance of respecting the statutory exemption afforded by Congress to the Federal Home Loan Banks that remains in full force and effect and of interpreting the new section 4960 excise tax in the specific context of the Code, we explain below how a careful consideration of the language, context, purpose, and history of section 1433, section 501(c)(1) of the Code, and section 4960 of the Code compel the conclusion that the Federal Home Loan Banks are exempt from the new section 4960 excise tax by virtue of the broad exemption from “all taxation now or hereafter imposed” afforded in their enabling statute. The Banks hereby incorporate their prior comments and provide further elaboration as follows:

(1) section 1433 specifically provides that the Federal Home Loan Banks are exempt from all taxation existing at the time of the Bank Act and enacted in the future (with the exception of state and local real property taxes), as recognized by both the Supreme Court and the Service itself in two previous Revenue Rulings, as well as a private letter ruling;

(2) the Banks are not “applicable tax-exempt organizations” under section 4960 because, notwithstanding the fact they are federal instrumentalities described in section 501(c)(1), they are not “exempt from taxation under section 501(a),” but rather exempt under section 1433;

(3) Supreme Court precedent requires an express repeal of the section 1433 tax exemption to impose any federal tax on the Banks, a repeal that section 4960 does not provide; and

(4) in any event, the specific tax exemption for the Federal Home Loan Banks provided by section 1433 governs over the general provision in section 4960 referencing organizations exempt from tax under section 501(a), which cannot be read to have impliedly repealed the explicit exemption afforded to the Banks under section 1433.

For the reasons set out below, therefore, the Banks again ask the Service to clarify that the new section 4960 excise tax does not apply to the Federal Home Loan Banks.

Text of the Bank Act

The “analysis begins with the text”⁴ of the statutory exemption afforded to the Federal Home Loan Banks. Section 1433 provides:

The bank, including its franchise, its capital, reserves, and surplus, its advances, and its income, shall be exempt from all taxation now or hereafter 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 of 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.

12 U.S.C. § 1433 (emphasis added). The language is unequivocal: except for state and local real property taxes, Congress exempted the Federal Home Loan Banks from all taxation, whether existing at the time of the Bank Act or enacted thereafter. There is no ambiguity in the text — as one Court of Appeals put it when interpreting an identically worded exemption, “a straightforward reading of the statute leads to the unremarkable conclusion that when Congress said 'all taxation,' it meant all taxation.”⁵ Because the text is clear, “the duty of [the Service] is to follow its commands as written.”⁶

The Supreme Court confirmed this broad understanding of section 1433 in Laurens Federal Savings & Loan Ass'n v. Tax Commission.⁷ There, the Court concluded that the Banks remained exempt from all taxation, despite a provision contained in the later-enacted Home Owners' Loan Act of 1933 that could have been read to authorize subjecting the Banks to all nondiscriminatory state taxes.⁸ The Court rejected that reading of the later-enacted statute, however, holding that “there is no express language providing for such a 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.”⁹ That reading was confirmed by the legislative history, as the Supreme Court noted that there was not “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.”¹⁰ Thus, in Laurens Federal Savings & Loan Ass'n, the Supreme Court required an express repeal of section 1433 before the Banks could be subjected to taxation, even under the purported authority of a later-enacted federal statute.¹¹

The Service echoed this understanding of section 1433 in a 1971 Revenue Ruling, as the Banks previously set out in their November 1, 2019 comments. The question there was whether the Federal Home Loan Banks were subject to the interest equalization tax, enacted in 1964.¹² The Service held that “based on section 13 of the Federal Home Loan Bank Act of 1932 [codified at 12 U.S.C. § 1433], the [Federal Home Loan Banks] will not be subject to the interest equalization tax imposed by section 4911(a) of the Internal Revenue Code of 1954.”¹³ In other words, based on the clear and specific language contained in section 1433, the interest equalization tax found in the Internal Revenue Code itself, which otherwise applied by its terms to “acquisition by a United States person . . . of a debt obligation of a foreign obligor,”¹⁴ could not be applied to the Federal Home Loan Banks.¹⁵ Notably, the interest equalization tax was an excise tax.¹⁶ The Service again reiterated that reading of section 1433 in 1989 when it issued a private letter ruling to an entity created under the Federal Home Loan Bank Act, concluding that it was exempt from another excise tax — the communications tax in section 4251(a) of the Code — by virtue of section 1433.¹⁷ And one year after issuing this private letter ruling and nineteen years after the 1971 Revenue Ruling, the Service in another Revenue Ruling recognized the source of the Banks' tax exemption as follows: “A[ ] [Federal Home Loan Bank] is exempt from federal, state, and local income tax. 12 U.S.C. section 1433 (1988).”¹⁸

If any doubt remained as to the plain meaning of the text of section 1433 and the broad exemption it affords the Federal Home Loan Banks from all taxation (including excise taxes), one need only look at the numerous Court of Appeals cases that over the years have interpreted virtually identically worded statutory provisions. The Banks discussed one such case in their April 1, 2019 comments, and cited to many others. That discussion is incorporated herein by reference, and the relevant cited cases are included in these comments for easy referral.¹⁹ In addition to the cases concerning Fannie Mae and Freddie Mac, the Banks point to decisions concerning the Federal Credit Unions, to which Congress granted broad tax exemption using language almost identical to that contained in section 1433.²⁰ These cases too have reached what should be an uncontroversial conclusion: when Congress exempted these entities from all taxation, it meant that they were exempted for all taxation unless and until that exemption was repealed explicitly by another act of Congress.

Importantly, nothing has changed in the text of section 1433 since the Supreme Court decision in Laurens Federal Savings & Loan Ass'n or the 1971 and 1990 Revenue Rulings that respect the scope and effect of the tax exemption under section 1433. The Federal Home Loan Banks thus remain exempt from “all taxation now or hereafter imposed” (except for state and local real property taxes) as was recognized in those authorities.²¹ This includes an exemption from later-enacted excise taxes, as recognized by the Service in its 1971 Revenue Ruling and the 1989 private letter ruling. As the Supreme Court instructed in Laurens Federal Savings & Loan Ass'n, only an express repeal will subject the Federal Home Loan Banks to new taxation. Therefore, to conclude that, despite no changes in the language of section 1433, the Federal Home Loan Banks are now subject to the new excise tax under section 4960 requires reading section 4960 as having repealed the exemption from “all taxation” afforded in section 1433. For the reasons set forth below, the language of section 4960 cannot bear that weight.

The General Language of Section 4960 Does Not Repeal the Specific Exemption in Section 1433

In contrast to this clear and specific language in section 1433 concerning the tax status of the Federal Home Loan Banks, section 4960 defines an “applicable tax-exempt organization” for purposes of the new excise tax only generally, and does not address the status of federal instrumentalities such as the Federal Home Loan Banks at all. In relevant part, section 4960(c)(1) defines an applicable tax-exempt organization that is subject to the tax as including an organization that “is exempt from taxation under section 501(a).”²² This reference to a category covering more than a million organizations composed of many types does not subject the Federal Home Loan Banks to the new excise tax for at least four reasons.

First, the Federal Home Loan Banks are not “exempt from taxation under section 501(a)” as required for application of the new excise tax set out in section 4960. Careful consideration of the “language, context, history, and purposes”²³ of the provisions at issue supports this conclusion. Beginning with the language, section 501(a) provides that organizations “described in [501](c) or (d) or section 401(a) shall be exempt from taxation under this subtitle unless such exemption is denied under section 502 or 503.” In turn, section 501(c) is a broad provision listing numerous categories of organizations that are exempt from paying income tax, the majority of which derive that tax-exempt status from section 501(a) itself. Take, for example, the most well-known of these categories, section 501(c)(3). The text of that provision nowhere provides that the nonprofit charitable organizations described therein are exempt from taxation.²⁴ Instead, these section 501(c)(3) organizations derive their tax-exempt status “under section 501(a)” solely by virtue of the reference to section 501(c) contained in section 501(a) itself. These organizations are thus “exempt from taxation under section 501(a)” and consequently subject to the new section 4960 tax.²⁵

However, section 501(c)(1) contains language not found in other subsections of section 501(c) that recognizes that the exemption for some of the federal instrumentalities described therein originates not in section 501(a), but elsewhere in the U.S. Code, namely their enabling statutes. Specifically, section 501(c)(1)(A)(i) describes a “corporation organized under Act of Congress which is an instrumentality of the United States” that is “exempt from Federal income taxes . . . under such Act as amended and supplemented before July 18, 1984” (emphasis added). That text unambiguously recognizes that the source of the exemption for that subset of organizations described in section 501(c)(1)(A)(i) is not section 501(a), but rather an “Act of Congress” that granted that tax-exempt status prior to 1984. The Federal Home Loan Banks are one such category of tax-exempt federal instrumentalities. By contrast, section 501(c)(1)(A)(ii) refers to federal instrumentalities that are exempt from federal income tax “under this title.” Thus, although the Federal Home Loan Banks are described in section 501(c)(1)²⁶ and their tax-exempt status recognized therein, they are not “exempt from taxation under section 501(a)” as required for application of the new section 4960 excise tax. Instead, the Federal Home Loan Banks have always been, and remain, exempt from taxation under section 1433.

The purpose and legislative history of section 501(c)(1) confirm that this provision was enacted to serve as a convenient shorthand for referring to federal instrumentalities that were granted tax-exempt status under their enabling statutes without having to refer to each such statute individually, and was never intended to replace those enabling statutes as the source of the exemption for those organizations.²⁷ At the time that the predecessor to section 501(c)(1) was added to the Internal Revenue Code, the House and Senate Reports explained that “a general provision has been inserted” into the Code “to bring the section [concerning tax-free interest under the general gross income section of the Code] into accord with the acts authorizing such exemptions and to avoid the necessity of referring to all such acts.”²⁸ The language, which largely mirrors the language in section 501(c)(1)(A)(i) today, described “Corporations organized under Act of Congress, if such corporations are instrumentalities of the United States and if, under such Act, as amended and supplemented, such corporations are exempt from Federal income taxes.”²⁹ The Deficit Reduction Act of 1984 amended section 501(c)(1) to add what is now section 501(c)(1)(A)(ii), which describes a set of federal instrumentalities that are exempt from tax under section 501(a). Both the plain language and legislative history make clear that section 501(c)(1)(A)(ii) and section 501(c)(1)(B) served to require federal instrumentalities not already exempt under their enabling statutes as of July 18, 1984 to be listed in section 501(l) of the Code in order to be exempt from income tax. The legislative history confirms that the change was prospective only, and that nothing changed the status of section 501(c)(1)(A)(i) organizations as exempt under their enabling statutes.³⁰ Thus, section 501(c)(1) was created as a convenient shorthand, and nothing at the time of its enactment or in the amendments to section 501(c)(1) since suggest that Congress superseded the enabling statutes as the source of the tax-exempt status for these federal instrumentalities.

That the Federal Home Loan Banks are not “exempt from taxation under section 501(a)” is further confirmed by the scope of the exemption the Banks enjoy. Namely, whereas section 501(a) affords an exemption from income taxes only,³¹ section 1433 affords the Federal Home Loan Banks an exemption from “all taxation now or hereafter imposed” except state and local real property taxes.³² This section 1433 exemption includes not only income taxes, but also excise taxes, as the Service itself recognized in its 1971 Revenue Ruling and 1989 private letter ruling.³³ Therefore, the income-tax-only exemption found in section 501(a) cannot possibly be the source of the broad tax exemption afforded to the Federal Home Loan Banks. Instead, the source of that broad exemption is found in the text of section 1433.

In sum, the Federal Home Loan Banks are exempt from taxation under section 1433. Although listed as section 501(c)(1) federal instrumentalities, section 501(a) is not (and cannot be) the source of their tax-exempt status. The Federal Home Loan Banks are therefore not “exempt from taxation under section 501(a)” and consequently do not qualify as an “applicable tax-exempt organization” for purposes of the new excise tax.³⁴

Second, even if one were to overlook the fact that the Federal Home Loan Banks do not qualify as “applicable tax-exempt organizations” because they are not “exempt from taxation under section 501(a),” the general language contained in section 4960 comes nowhere near the “express language” required by the Supreme Court in Laurens Federal Savings & Loan Ass'n to overcome the specific exemption afforded to the Federal Home Loan Banks under section 1433.³⁵ Reconciliation of the new tax created under section 4960 with the pre-existing exemption under section 1433 can be done here with the rare benefit of a Supreme Court decision directly addressing precisely the question at issue in these comments, and there is no reason to stray from its reasoning. Like in Laurens Federal Savings & Loan Ass'n, “there is no express language [in section 4960] providing for . . . [a] repeal” of the exemption afforded by section 1433.³⁶ And, also like in Laurens Federal Savings & Loan Ass'n, nothing in the scant legislative history of section 4960 contains “even an intimation . . . of any intention to reduce the scope of the exempt status of Home Loan Banks.”³⁷ The Supreme Court decision in Laurens Federal Savings & Loan Ass'n is therefore fully on point, and dictates that the Service conclude that the new excise tax under section 4960 does not repeal the broad exemption afforded to the Federal Home Loan Banks under section 1433. Section 4960 may not be interpreted solely in the context of the Code. Other provisions of U.S. law, including most especially section 1433 of the Bank Act, must be taken into account. The Service has done this before. The interest equalization tax applied to the “acquisition by a United States person . . . of a debt obligation of a foreign obligor”³⁸ and, without the application of section 1433, could have been read as applying to the Banks. However, the 1971 Revenue Ruling recognized that provisions in the Code cannot be read in isolation. Other federal statutes must be taken into account, and where that statute is section 1433, as the Supreme Court has held, its exemption overrides the application of a tax that might otherwise apply if the Code were read by itself.

We observe that in response to the Banks' prior comments which pointed to the necessity of applying the law in section 1433 in accordance with Supreme Court precedent, the preamble to the proposed regulations says that the Banks' “reasoning, if accepted, would exempt many or most Federal instrumentalities from tax under section 4960, both as ATEOs and as related persons or governmental entities.”³⁹ Although we cannot say how many federal instrumentalities beyond the entities in the Federal Home Loan Bank System are exempt from federal taxes under their enabling statutes, the number is irrelevant where a federal instrumentality is subject to precise statutory language that compels this result. The statute must be applied consistent with its language, structure, and history. There is no legislative history for section 4960 to describe the intended scope of its application, and even if there were, the clear statutory language of section 1433 controls.⁴⁰ In other words, the statutory language of section 4960 and section 1433 must be followed regardless of whether the application of that language results in an outcome that some may not expect.

Third, and relatedly, principles of statutory construction compel the conclusion that section 4960 does not control over the specific exemption found in section 1433.⁴¹ “It is a basic principle of statutory construction that a statute dealing with a narrow, precise, and specific subject is not submerged by a later enacted statute covering a more generalized spectrum.”⁴² Here, section 1433 “deal[s] with a narrow, precise, and specific subject” by expressly providing an exemption from “all taxation now or hereafter imposed” specifically and only to the Federal Home Loan Banks. In contrast, section 4960 defines “applicable tax-exempt organization” by reference to another provision, section 501(a), an expansive provision that provides exemption from income tax for more than a million different organizations. Under the “basic principle of statutory construction” set out above, section 1433, a statute that deals with the “narrow, precise, and specific subject” of affording tax exemption to the Federal Home Loan Banks, “is not submerged by [the] later enacted” section 4960 “covering a more generalized spectrum.”⁴³

Fourth, “repeals by implication are not favored, and are a rarity. Presented with two statutes, the Court will regard each as effective — unless Congress' intention to repeal is clear and manifest, or the two laws are irreconcilable.”⁴⁴ Here, application of this “cardinal principle of statutory construction”⁴⁵ eliminates any lingering argument that section 4960 repealed the specific tax exemption afforded to the Federal Home Loan Banks in section 1433. Congress expressed no “clear and manifest” intention to repeal section 1433, and the two statutes can be easily reconciled by recognizing that the Federal Home Loan Banks remain, as always, exempt from “all taxation” until explicitly provided otherwise by Congress. Section 4960 will not be rendered ineffective by this exemption. To the contrary, it will continue to apply to a huge array of other tax-exempt organizations.⁴⁶

In the preamble to the proposed regulations, however, the Service argues that Congress' failure to specifically exempt section 501(c)(1) organizations from the new section 4960 excise tax demonstrates an intent to subject those entities to taxation.⁴⁷ In particular, the Service notes that section 511(a)(2)(A) of the Code⁴⁸ “specifically exclude[s] section 501(c)(1) organizations” but that “a similar exclusion was not included in section 4960 even though section 4960 applies to section 501(c)(1) organizations through reference to entities exempt under section 501(a).”⁴⁹ But the Service here turns Supreme Court precedent on its head, reading an intent to repeal into Congress' silence and requiring Congress to specifically exempt the Banks every time a new tax provision is enacted, rather than respecting the blanket exemption already afforded to the Banks under section 1433. Whatever reason Congress had for specifically referencing section 501(c)(1) organizations when it came to the unrelated business income tax under section 511,⁵⁰ the failure to do so here says nothing about whether Congress intended to repeal the blanket exemption afforded to the Banks under section 1433. And the Supreme Court has been unequivocal that a “clear and manifest” intent is needed before a statute is read to have repealed a previous act of Congress. Simply put, the silence here does not convey a “clear and manifest” intent to repeal section 1433.

Importantly, Congress knew exactly how to express such a “clear and manifest” intent to repeal tax exemptions in enabling statutes. Take, for instance, the FICA tax. When Congress wanted to make otherwise-exempt federal instrumentalities subject to the FICA tax (which is not an income tax), it did not do so impliedly. Instead, it explicitly provided in section 3112:

Notwithstanding any other provision of law (whether enacted before or after the enactment of this section) which grants to any instrumentality of the United States an exemption from taxation, such instrumentality shall not be exempt from the tax imposed by section 3111 unless such other provision of law grants a specific exemption, by reference to section 3111 (or the corresponding section of prior law), from the tax imposed by such section.⁵¹

That “clear and manifest” intention in section 3112 to make entities like the Federal Home Loan Banks — which, under “other provision of law” had been afforded “an exemption from taxation” — subject to the FICA tax stands in sharp contrast to the ambiguous and general reference to organizations “exempt from taxation under section 501(a)” contained in section 4960. Section 3112 demonstrates conclusively that Congress was well aware that there were blanket exemptions like the one found in section 1433, and that if it wanted to change that blanket exemption, it had to do so clearly and specifically to survive the presumption against implied repeals.⁵² No such express repeal can be found in section 4960, and without that “clear and manifest” intention to eliminate the Banks' tax-exempt status, the Federal Home Loan Banks remain exempt from the new excise tax.

Summarized Comments/Requests

For the reasons discussed in this letter, and the Banks' previous comments, section 1433 affords the Federal Home Loan Banks an exemption from all taxes (except state and local real property taxes), and that exemption includes later-enacted excise taxes such as the section 4960 excise tax. In addition, the Banks are not “applicable tax-exempt organizations” under section 4960 because their exemption derives from their enabling statute, not from section 501(a) of the Code. The Federal Home Loan Banks therefore respectfully ask the Service to confirm in the final regulations under section 4960 that the Federal Home Loan Banks are not applicable tax-exempt organizations under section 4960, and thus that the Federal Home Loan Banks of Atlanta, Boston, Chicago, Cincinnati, Dallas, Des Moines, Indianapolis, New York, Pittsburgh, San Francisco, and Topeka, and the Federal Home Loan Banks' Office of Finance, are exempt from the excise tax imposed by that provision.

Sincerely

Catherine E. Livingston

Gerald M. Griffith
Jones Day
Washington, DC