
    NORTH CAROLINA NATIONAL BANK v. THE UNITED STATES
    [No. 451-60.
    Decided May 14, 1965]
    
      
      Gordon W. Gerber for plaintiff. Kenneth W. Gerrmdll and Dechert, Price <& Rhoads of counsel.
    
      Thomas A. Troyer, with, whom was Assistant Attorney General Louis F. Oberdorfer, for defendant. Edward 8. 8mith, Lyle M. Turner, and Earl L. Huntington were on the briefs.
    Before Laramore, Dureee, and Davis, Judges, and Jones* and Whitaker, Senior Judges.
      
    
    
      
      At the time this case was argued, March 4, 1964, Jones, Senior Judge, was Chief Judge of the court. The decision herein has been deferred pending decision in the Central Bank Co. and Pullman Trust <6 Sawings Bank cases cited infra.
      
    
   Whitaker, Senior Judge,

delivered the opinion of the court:

Plaintiff sues to recover the additional taxes assessed against it resulting from the disallowance of the addition to its reserve for bad debts claimed on its return.

Plaintiff succeeded to all the rights and obligations of the Security National Bant of Greensboro on June 30, 1960. The Security Bank had been organized on August 28, 1933. Until 1951 the Security Bank was engaged in the making of commercial loans only, but in that year it organized a Time Payment Department, which it continued to operate during and after the taxable years in question, which are the years 1953,1954, and 1955.

The business of the Time Payment Department consisted of the making of loans payable in installments over periods, normally, of from 24 to 36 months and secured frequently by liens or chattel mortgages on automobiles, household appliances, etc. It also purchased from automobile dealers and dealers in household appliances notes taken by such dealers from their customers, which were secured by liens on the appliances and, when purchased by the bank, were also secured by the endorsement of the dealer. It also made house improvement loans, payable in installments.

When the bank determined to enter the time-payment-loan field, it employed a person to manage this department who had not been previously connected with the bank and who was familiar with this type of loans. The manager organized a group of persons experienced in this field to handle this department of the bank’s business. Separate books of accounts were kept for this department, and separate balance sheets and profit and loss statements were prepared. No employee of the Commercial Department had anything to do with the business of the Time Payment Department, and vice versa.

Plaintiff’s experience and that of others engaged in this type of business showed that losses from bad debts were substantially greater than such losses on the commercial type of loans.

Beginning with the year 1947 the bank, with the consent of the Commissioner of Internal Revenue, began to avail itself of the provisions of section 166(c) of the Internal Revenue Code of 1954 in computing its deduction for bad debts. This section permitted, in the discretion of the Secretary of the Treasury or his delegate, the deduction of a reasonable addition to a reserve for bad debts.

When taxpayer came to compute its addition to its reserve for the years 1958,1954, and 1955, it computed a reasonable addition to its reserve for bad debts on account of the loans in the Time Payment Department separately from an addition on account of the loans in the Commercial Department, and it claimed a deduction for the sum of the two.

The Commissioner of Internal Revenue made a computation to determine what addition the bank was entitled to on the basis only of its experience in the commercial loan field, supplemented by the experience of other banks similarly situated,'and did not take into consideration the bank’s experience/’ or the experience of other banks similarly situated, .in tbe time-payment field. Since the bank’s reserve for bad debts thus computed already exceeded the maximum, he disallowed any addition to the reserve. However, if it is proper to compute the addition on loans in the Time Payment Department separately from the Commercial Department and add the two together, then the reserve did not exceed the limit for 1954 and 1955, but it did for 1953, and plaintiff would have been entitled to an addition thereto for 1954 and 1955.

Plaintiff says it filed its returns in compliance with the provisions of Mimeograph 6209,1947-2 Cum. Bull. 26, issued by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, and, since that is so, the burden is on the Commissioner of Internal Revenue to show that the provisions of this mimeograph should not be used .in this particular case. The Commissioner, on the other • ' hand, says that he computed the reserve in accordance with ' / this mimeograph, except that he did not compute the reserve "on loans in the Time Payment Department separately from "-loans in the Commercial Department, and that he had the ¿'discretion to do so or not as he saw fit. This is the issue ¿.which the case presents.

3 Section 166 of the Internal Revenue Code of 1954 permits *' the deduction, as a general rule, of debts that become worth-i less within the taxable year, but in subsection (c) it permits, ' in lieu thereof, “a deduction for a reasonable addition to a reserve for bad debts”; but a taxpayer was only entitled to use the latter method within “the discretion of the Secretary or his delegate.” Undoubtedly, the Commissioner of Internal Revenue and the Secretary of the Treasury had the discretion to allow or not to allow a deduction of an addition to a reserve for bad debts. The taxpayer as a matter of right could deduct all debts that became worthless within the taxable year, but it could only deduct an addition to a reserve for bad debts within the discretion of the Commissioner.

This alternate method was allowed after the Bevenue Act of 1943, but it was not until 1947 that the Commissioner of Internal Bevenue promulgated any rulings to inform banks as to when they might be permitted to deduct an addition to their reserve for bad debts and how this reserve should be computed. In Mimeograph 6209, dated December 8, 1947, the Commissioner of Internal Bevenue, with the approval of the Acting Secretary of the Treasury, stated in paragraph 1: “The Bureau has given careful and extended consideration to the situation of banks in general with respect to the use of reserves for bad debts, the proper measure of such reserves, and the amounts to be allowed as deductions.” (Emphasis added.) In paragraph 2 it was statéd: “In determining a reasonable annual addition to a reserve for bad debts by a bank it is believed to be fair and sufficiently accwrate to resort to the average annual bad-debt loss of the bank over a period of twenty years, to include the taxable year, as constituting a representative period in the bank’s history and to accept the equivalent percentage of presently outstanding loans as indicative of the probable annual accruing loss. * * *” (Emphasis added.)

The other relevant provisions of the mimeograph will be referred to later. What has been quoted so far is only for the purpose of showing that after “careful and extended consideration,” the Commissioner adopted a plan which he “believed.to be fair and sufficiently accurate.”

This mimeograph, although signed by the Commissioner and approved by the Secretary of the Treasury, still has not the force and effect of a regulation, but we are of opinion that it was issued as the exercise of the discretion reposed in the Secretary of the Treasury and his delegate by section 166 (c) of the Bevenue Act of 1954 and the comparable provisions of the Bevenue Act of 1939, and that banks are entitled to the benefit of its provisions.

Again, on April 8, 1954, nearly seven years after the issuance of Mimeograph 6209, the Commissioner of Internal Bevenue, with the approval of the Acting Secretary of the Treasury, issued Bev. Bul. 54-148, 1954-1 Cum. Bull. 60, which set forth an alternative method of computing the addition to the reserve. But in that ruling it was said, “Banks which are now using the moving average method provided in Mimeograph 6209 may continue to use that method if they so desire, * * Thus, after Mimeograph 6209 had been in existence for nearly seven years, it was reaffirmed by this ruling.

Since this mimeograph and the later ruling do not have the binding effect of a regulation, we think that, in extraordinary or unusual circumstances, the Commissioner might refuse to permit use of the mimeograph, but in the absence of such conditions, we think a bank is entitled to an addition to its reserve according to its provisions, and the Commissioner of Internal Revenue may not deny its use, unless he shows that unusual or extraordinary circumstances in the particular case make its use improper.

There has been much confusion in prior decisions of the courts over this question, but the most recent decisions are in accord. In Pullman Trust and Savings Bank v. United States, 235 F. Supp. 317 (1963), opinion by Judge Will, the burden was squarely placed on the Commissioner of Internal Revenue to show why Mimeograph 6209 should not be applied to the case at hand. The Court of Appeals for the Seventh Circuit, in a per curiam opinion, 338 F. 2d 666 (1964), affirmed the decision of the District Court and adopted its opinion as its own.

Judge Will’s opinion carefully reviewed prior opinions in the Tax Court and other courts. He stated that the Tax Court in Miners National Bank of Wilkes-Barre, 33 T.C. 42 (1959), had held that the Commissioner was not bound by Mimeograph 6209 and, despite its provisions, could allow or disallow an addition to a reserve in his discretion. On the contrary, it was held in Boardwalk National Bank of Atlantic City, 34 T.C. 937 (1960), that the Commissioner of Internal Revenue and the Secretary of the Treasury had already exercised their discretion when they issued Mimeograph 6209 and that the Commissioner of Internal Revenue was bound by it. Then still later the Tax Court in 1963 had held in Central Bank Company, 39 T.C. 856, that the Commissioner had the discretion to disregard Mimeograph 6209.

Judge Will then quoted what was called Technical Information Bolease (TIB 499), published by tlie Internal Beve-nne Service on August 7,1963, which reads as follows:

In response to numerous inquiries about the recent Tax Court decision in Central Bank Company, 39 T.C. No. 90 [856] (on appeal to C.A. 6th), Internal Bevenue Service announced that the discretion specifically granted the Secretary or his delegate in section 166(c) of the Internal Bevenue Code of 1954 to determine reasonable additions to a reserve for bad debts was exercised in the promulgation of Mimeograph 6209, C.B. 1947-2,26, and Bevenue Bulings supplementary thereto, and that it will continue to allow additions to bank bad debt reserves when the reserves are properly computed in accordance therewith. [235 F. Supp. 317,323.]

Judge Will concluded his opinion on this phase of the case as follows:

If the position espoused by the Technical Information Belease was not accepted by the Service and the courts, every bank which elects to use the reserve method and Mimeo 6209 would find that its calculation of its reserve for bad debts would be subject to annual review for reasonableness despite fastidious compliance with the Commissioner’s directive with respect thereto. Such a result would be intolerable. The Court concludes that Mimeo 6209 is the product of the Commissioner’s exercise of discretion as authorized by section 166(c) of the Internal Bevenue Code and that a computation in accordance therewith is presumed to be reasonable. Accordingly, the defendant would have the burden of disproving its reasonableness. [235 F. Supp. 317, 323.]

As stated above, this opinion was adopted by the Court of Appeals as its own.

The Tax Court’s determination in the Central Bank Company case, supra, was appealed to the Court of Appeals for the Sixth Circuit. In a per curiam opinion, the Tax Court was reversed. In its opinion the Court of Appeals said:

Presumably to indicate how the Commissioner’s discretion would be exercised in relation to the problem related above, on December 8,1947, George J. Schoeneman, then Commissioner of Internal Bevenue, published Mimeograph Bulletin 6209, the first sentence of which reads as follows:
“1. The Bureau has given careful and extended consideration to the situation of banks in general with respect to the use of reserves for bad debts, the proper measure of such reserves, and amounts to be allowed as deductions.” [329 F. 2d 581 (1964).]

It also said that while the case was pending before it, the Commissioner of Internal Revenue issued Rev. Rul. 63-267, 1963-2 Cum. Bull. 99, which it quoted as follows:

In connection with the implementation of section 166(c) of the Code with respect to banks, there is set forth in Mimeograph 6209, C.B. 1947-2,26, and Revenue Rulings supplementary thereto, guidelines for computing a reasonable addition to a reserve for bad debts. The Service will continue to 'allow additions to bank bad debt reserves when the additions are determined by the Commissioner to be properly computed in accordance with the formula set forth in the foregoing publications. [329 F. 2d 581, 582.]

It then said that [at p. 583] : “In view of this action, counsel for respondent Commissioner changed his position in a Supplemental Brief and at oral argument; and, abandoning reliance on his first argument, urged affirmance solely on the second ground of his contention before the Tax Court, namely, that the taxpayer bank had not properly applied the provisions of Mim. 6209.” The case was therefore remanded to the Tax Court for its decision on the second ground advanced by the Commissioner, which had not been decided in its former opinion, since it had disposed of the case on the ground that the Commissioner had the discretion to disregard Mimeograph 6209.

The decision in the Pulhnan case is in apparent conflict with American State Bank v. United States, 279 F. 2d 585 (1960), cert. denied, 364 U.S. 881 (1960), decided by the same court, but not necessarily so, since in that case the court, after quoting Mimeograph 6209, said:

The real controversy arises because the Commissioner disallowed deductions from income tax to the extent that these deductions for the reserve account for bad debts were based upon substituted loss ratio for the years the Bank was in actual existence. * * * (Emphasis added.) [279 F. 2d 585,587.]

No one would deny that the Commissioner had the discretion to disallow an addition computed in a way unauthorized by the mimeograph or as the result of a misapplication, of its provisions. We also agree with the court that:

[S] lavish adherence to a formula might, under certain conditions, result in an unreasonable addition to a bad debt reserve, or a failure to make any addition * * *. [279 F. 2d 585, 589.]

But we do say that Mimeograph 6209 is to be applied in the absence of unusual or extraordinary circumstances, and that the burden is on the defendant to show that the circumstances are unusual or extraordinary.

The District Court for the Northern District of Ohio, in an exhaustive and well-reasoned opinion by Battisti, District Judge, in Union National Bank of Youngstown v. United States, 237 F. Supp. 753 (1965), held that “Mimeograph 6209 is an expression of the Commissioner’s discretion” and, following Pullman Trust and Savings Bank v. United States, supra, it said:

Hopefully, the Pullman Trust case laid the issue to rest by concluding that a computation in accordance with mimeograph 6209 is presumed reasonable, and the burden of disproving its reasonableness rests upon the Commissioner. For the Court to have found otherwise would return banks to their pre-1947 position when calculations of their bad debt reserves subjected banks to annual reviews for reasonableness despite complete compliance with the Internal Revenue Service’s directions.
Therefore, this Court concludes that mimeograph 6209 is the Commissioner’s exercise of the discretion authorized by Section 166(c) of the Code; and that although the mimeograph does not have the force and effect of law, it is a rule of general application binding on the Commissioner, and binding on the taxpayer as well by way of rebuttable presumption. * * * [237 F. Supp. 753, 761.]

So, it would seem that our opinion, that the burden is on the defendant to show that Mimeograph 6209 should not be applied in any particular case, is in accord with both the Seventh Circuit and the Sixth Circuit, and that defendant itself admits that it is controlling, and, indeed, purported to use it in the case at bar.

Nor do we think that the opinion we have expressed is in conflict with our prior decision in Paramount Finance Co. v. United States, 157 Ct. Cl. 824, 304 F. 2d 460 (1962). Mimeograph 6209 was not involved in that case; instead, plaintiff relied upon an agreement between it and the Commissioner of Internal Revenue. Mimeograph 6209 was not mentioned since it applied only to “banks,” and in paragraph 8 of the mimeograph it is provided that the term “banks” means “banks or trust companies incorporated under the laws of the United States, of any State or of any Territory, a substantial part of the business of which consists of receiving deposits and making loans and discounts.” The Paramount Finance Company does not appear to be such an institution.

Also our decision in the Paramount Finance Compamy case was issued prior to Rev. Rul. 63-267, quoted by the Court of Appeals in the Central Bank Company case, supra, and also prior to the Technical Information Release published by the Service on August 7, 1963; so that even if the Paramount Finance Company had been a bank, our decision might have been different in the light of these rulings.

Mimeograph 6209 provides for the computation of an addition to a bad debt reserve by taking “a moving average of losses to outstanding loans over a period of twenty years, including the taxable year,” and for applying the percentage to the loans outstanding at the end of the taxable year. This is to be continued year by year, dropping the first year in the former period and including always the taxable year. In paragraph 5 it is provided that a bank without twenty years’ experience “will be permitted to set up a reserve commensurate with the average experience of other similar banks with respect to the same type of loans, preferably in the same locality, subject to adjustment after a period of years when the bank’s own experience is established.”

Plaintiff bank and its predecessor were not in existence over a period of twenty years and, to supply the missing years, it adopted the experience of the banks in the Fifth Federal Reserve District, in which plaintiff bank was situated, in computing its reserve on its commercial business. The Commissioner of Internal Revenue makes no objection thereto.

Rev. Rul. 5A-148, supplementing Mimeograph 6209, provided in section 4, paragraph .01, “In lieu of the moving average experience factor provided in paragraph 3 of Mimeograph 6209, which is determined on a basis of 20 years including the taxable year, a bank may use an average experience factor based on any 20 consecutive years of its own experience after the year 1927.” And if a bank was not in existence throughout the twenty-year period it selected, it was permitted to fill in such years with the experience of other banks in the same locality with respect to the same type of loans.

Plaintiff bank availed itself of the provisions of Rev. Rul. 5A-148 and selected the years 1928 to 1947, inclusive, during a part of which period it was not in existence, and so it borrowed the experience of banks in the Fifth Federal Reserve District to fill in the years in which it was not in existence in computing its reserve on its commercial loans. The Commissioner of Internal Revenue does not question this.

As stated, plaintiff computed its addition to its reserve on the loans in the Commercial Department separately from its loans in the Time Payment Department. It bases its right to do this on the provisions of paragraphs 4 and 5 of Mimeograph 6209 and also on the provisions of section 4, paragraph .03, of Rev. Rul. 54 — 148. In paragraph 4 of Mimeograph 6209 it is provided that “in computing the moving average percentage of actual bad debt losses to loans, the average should be computed on loans comparable in their nature and rish iwool/oed to those outstanding at the close of the current taxable year involved.'1'1 (Emphasis added.) Also, in paragraph 5 providing for the borrowing of the experience of other banks, it limits the banks to those with experience “with respect to the same type of loans.” Paragraph .03 of section 4 of Rev. Rul. 54-148 also speaks of borrowing the experience of similar banks “with respect to tihe same type of loans.”

It would be manifestly unfair in arriving at the “moving average” to include in the outstanding loans in previous years Government secured loans (the example used in the mimeograph) , because, presumably, there were no bad debt losses on such loans. By the same token, it would be unfair to apply a “moving average,” computed on loans on which the bad debt losses were small, to loans on which the losses were much larger. . .

The bank’s own comparative bad debt experience on its commercial loans and on its time-payment loans, as set out in Finding 18, shows a loss ratio on commercial loans of 0.0106 percent and on time-payment loans of 0.0766 percent— more than seven times as much. This is equally as unfair as the inclusion of Government secured loans, and it is not in accord with the provisions of Mimeograph 6209 and Bev. Bul. 54 — 148, which provide the exclusion of loans not comparable and for borrowing the experience of other banks “with respect to the same type of loans.”

Since the average for prior years used by the Eevenue agent in auditing plaintiff’s returns was computed only on commercial loans, it cannot be applied to time-payment loans, because they are not at all comparable. Some other basis for comparison must be found.

The trial commissioner offers four alternative bases for comparison. One is the banks in the Fifth Federal Beserve District; second, the Bank of Georgia; third, the Bank of Delaware, and fourth, the Banks of Georgia and Delaware combined. We cannot use the banks in the Fifth Federal Beserve District as a basis for comparison since the evidence does not show how these banks computed the ratk> to be applied. But, presumably, it was based primarily on commercial loans, since banks generally did not enter the time-payment-loan field until 1945.

The Bank of Georgia furnishes perhaps the best basis for comparison, except for the fact that we are reluctant to use only one bank as a basis for comparison. The Bank of Delaware offers some basis for comparison, but not quite so good as the Bank of Georgia because further removed geographically and perhaps operating under somewhat different economic conditions. Both the Bank of Georgia and the Bank of Delaware had been engaged in so-called consumer loans, as distinguished from commercial loans, for many years. Both, of them were outgrowths of a Morris Plan Bank, but the evidence does not specify the exact type of loans other than as consumer loans.

If we use the Bank of Georgia as a basis for comparison, we arrive at a factor for 1953 of 0.2355 percent and for 1954 and 1955 of 0.598 percent. (The big difference between the factors for the two periods is due to the fact that in 1953 the factor was computed on the basis of the experience for the prior twenty years, including the taxable year, whereas for

1954 and 1955 it was computed upon the basis of any twenty years after 1927 selected by the taxpayer, which, of course, included the years of the Great Depression.)

If we use the Bank of Delaware as a basis for comparison, we arrive at a factor of 0.7065 percent for 1953 and 1.1185 percent for 1954 and 1955. It will be noted that the bad debt experience of the Bank of Delaware was considerably worse than that of the Bank of Georgia.

If we compare the experience of the Bank of Georgia on its consumer loans with all the banks in the Fifth Federal Beserve District on all types of loans, we find that for the year 1953 the factor for the banks in the Fifth Federal Be-serve District was 0.3 percent, whereas the factor for the Bank of Georgia was only 0.2355 percent. For 1954 and

1955 the factor for the banks in the Fifth Federal Beserve District was 0.7 percent, whereas the factor for the Bank of Georgia was 0.598 percent.

So, if we use the experience of either the Bank of Georgia or the banks in the Fifth Federal Beserve District, our error will not be great. Since the two figures are so close, we have less reluctance to use the experience of only one bank in computing the reserve on the time-payment loans. We have decided to use tihe experience of the Bank of Georgia as a basis for comparison, rather than the banks in the Fifth Federal Beserve District, because of the very definite provisions of Mimeograph 6209 and Bev. Bul. 5N-148 requiring that there be taken into consideration in applying the ratio “the same type of loans” only.

We are aware that the method of computing the addition to the reserve, as outlined above, may be cumbersome and ill-adapted to the bookkeeping system of some banks, but it cannot be avoided in this case as long as this bank’s experience and the experience of the other banks in the Fifth Federal Beserve District in the time-payment field encompasses less than twenty years. As soon as this length of experience of either or both has been reached, it may be that an average of bad debt losses on the aggregate of all loans of all types could be computed and this average applied to the outstanding loans, both commercial and time-payment, at the end of the taxable year. But the average for the twenty-year period computed only on loans with a low bad debt experience, cannot be applied to loans of a high bad debt experience — and this is the situation with which we are faced in this case.

The plaintiff is entitled to recover in accordance with the foregoing opinion, and the case is remanded to the trial commissioner for further proceedings pursuant to Buie 47(c).

FINDINGS OF FACT

The court, having considered the evidence, the report of Trial Commissioner W. Ney Evans, and the briefs and argument of counsel, makes findings of fact as follows:

1. (a) The North Carolina National Bank (hereinafter sometimes called plaintiff and sometimes called taxpayer) is a national banking corporation under the amended charter of the Security National Bank of Greensboro (hereinafter called the Bank) which was duly organized under the laws of the United States on August 28,1933.

(b) As of June 30, 1960, all rights and obligations of the Bank became those of the plaintiff, and the principal office and place of business was removed from that of the Bank, at 101 North Elm Street, Greensboro, North Carolina, to that of the plaintiff, at 200 South Try on Street, Charlotte, North Carolina.

(c) During the years involved in this action, the Bank had branches in various cities and towns in North Carolina, including (besides Greensboro) Burlington, High Point, Baleigh, Tarboro, and Wilmington.

(d) Since 1955, the Bank and plaintiff liave been parties to mergers with 6 other banks; 1 in 1959, 3 in 1960, and 2 in 1962.

2. (a) Plaintiff’s claims arise under the Internal Revenue laws of the United States to recover income taxes for the years 1953,1954, and 1955, which were assessed and collected by the District Director of Internal Revenue at Greensboro, North Carolina (hereinafter referred to as the District Director).

(b) No action on these claims other than as set forth herein has been taken before Congress or in any department of the Government of the United States or in any court.

(c) The plaintiff is the sole owner of these claims, and no part thereof has been assigned or transferred to a third party by the Bank or by the plaintiff.

3. Beginning with the year 1947, the Bank, with the consent of the Commissioner of Internal Revenue, has used the reserve method of treating bad debts for Federal income tax purposes; and the controversy in this action concerns amounts of allowable deductions as reasonable additions to the Bank’s reserve for bad debts (1) under section 23(k) (1), Internal Revenue Code of 1939, as amended, applicable for the year 1953, and (2) for the years 1954 and 1955, under section 166 (c), Internal Revenue Code of 1954.

4. (a) In its income tax return for the year 1953, the Bank claimed a deduction of $172,298.92 as an addition to its reserve for bad debts; and on December 15, 1954, paid in full the income taxes shown to be due on such return.

(b) Upon examination of the Bank’s 1953 return, the District Director (1) disallowed, in full, the claimed deduction set forth in the preceding paragraph and (2) computed and assessed a tax deficiency of $89,595.44, which the Bank paid together with interest thereon in the amount of $15,525.78 (computed from March 15, 1954, to February 4, 1957).

(c) On March 14, 1957, the Director a claim for refund, which the District Director disallowed, in full, by registered mail, on November 6, 1959.

5. (a) In its income tax return for the year 1954, the Bank claimed a deduction of $135,544.80 as an addition to its reserve for bad debts; and on June 15, 1955, paid in full the income taxes shown to be due on such return.

(b) Upon examination of the Bank’s 1954 return, the District Director (1) disallowed a total of $25,224.98 of the claimed deduction set forth in the preceding paragraph;

(2) reduced the allowable deduction to $110,319.82; and

(3) computed and assessed a tax deficiency of $13,116.99, which the Bank paid together with interest thereon in the amount of $1,485.99 (computed from March 15, 1955, to February 4,1957).

(c) On March 17, 1958, the Bank filed with the District Director a claim for refund computed on an addition of $115,930.38 as a reasonable addition to the Bank’s reserve for bad debts in 1954, which claim the District Director disallowed, in full, by registered mail, on November 6,1959.

6. (a) In its income tax return for the calendar year 1955, the Bank claimed a deduction of $305,138.35 as an addition to its reserve for bad debts; and on June 18, 1956, paid in full the income taxes shown to be due on such return.

(b) Upon examination of the Bank’s 1955 return, the District Director (1) disallowed a total of $137,540.68 of the claimed deduction set forth in the preceding paragraph;

(2) reduced the allowable deduction to $167,597.67; and

(3) computed and assessed a tax deficiency of $71,521.15, which the Bank paid together with interest thereon in the amount of $3,811.19 (computed from March 15,1956, to February 4,1957).

(c) On March 13, 1959, the Bank filed with the District Director a claim for refund, which the District Director disallowed, in full, by registered mail, on November 6, 1959.

7. (a) Table 1, incorporated herein, contains a recapitulation of findings 4, 5, and 6, showing: in column 1, the years involved; in column 2, the dollar amounts claimed by the Bank as reasonable additions to its reserve for bad debts, as reflected in its several claims for refund; in column 8, the amounts allowed by the District Director as additions to the Bank’s reserve for bad debts; and in column 4, the difference between the amounts claimed and the amounts allowed.

(b) Table 2, incorporated herein, contains a further recapitulation of findings 4, 5, and 6, showing: in column 1, the years involved; in column 2, the deficiencies assessed; in column 3, the date of the payment of the deficiencies; in column 4, the amount of interest paid on the deficiencies; and in column 5, the dates of such payments of interest.

8. (a) The Internal Revenue Service Examining Officer (hereinafter the Examining Officer), in his report, dated February 4, 1957, gave the following reason for the disal-lowance of the deduction claimed by the taxpayer for 1953 :

During 1953 taxpayer deducted the amount * * * [$172,298.92] as 'bad debts per its return, the amount being the addition to the reserve for bad debts as computed by taxpayer.
In computing this addition, taxpayer used 2% of time payment department receivables as of December 31, 1953, which totaled $8,294,412.06. No addition was made for commercial department receivables.
In this report, a computation has been made under provisions of Mim. 6209, and such computation discloses that no addition to reserve for bad debts is permissible inasmuch as the reserve already exceeds three times the allowable ceiling. * * *
Tn view of the above, the deduction claimed has been restored to income.

(b) In the same report the Examining Officer gave the following reason for the disallowance of part of the deduction claimed by the taxpayer for 1954:

During 1954 taxpayer deducted $135,544.80 as a reasonable addition to reserve for bad debts. In making this computation, taxpayer utilized the provisions of I.R. Mim. No. 54-55 dated April 8,1954.
However, in making the determination of the allowance, taxpayer separated the commercial receivables and time payment receivables, and applied loss ratios of four personal loan companies to the time payment loans.
It is held that the determination of an allowable addition as computed by taxpayer is erroneous and that it cannot use a substituted experience for its own.
In this report a computation of an allowable addition to reserve for bad debts has been made under provisions of Mim. 6209 as supplemented by I. R. Mim. No. 5N55, and the excessive amount disallowed. * * *

(c) The reason given by the Examining Officer for the disallowance of part of the deduction claimed by the taxpayer for 1955 was the same as the reason given for the dis-allowance of 1954.

(d) The controversy thus centers upon the application by the District Director to taxpayer’s 1953 return of Internal Revenue Mimeograph 6209, and to taxpayer’s returns for 1954 and 1955 of Mimeograph 6209 as supplemented by In-Mimeograph No. 54-55. The taxpayer contends that snch applications were, in each instance, so unreasonable as to represent an abuse of discretion. The factual foundation for this contention rests upon the expansion of the taxpayer’s banking activities in 1951 to include a Time Payment Department in addition to its commercial lending business.

9. (a) Following are pertinent portions of the text of Mimeograph 6209:

$ ‡ ‡ ‡ $
1. The Bureau has given careful and extended consideration to the situation of banks in general with respect to the use of reserves for bad debts, the proper measure of such reserves, and amounts to be allowed as deductions.
2. In determining a reasonable annual addition to a reserve for bad debts by a bank it is believed to be fair and sufficiently accurate to resort to the average annual bad-debt loss of the bank over a period of 20 years, to include the taxable year, as constituting a representative period in the bank’s history and to accept the equivalent percentage of presently outstanding loans as indicative of the probable annual accruing loss. * * * However, such reserve can not be permitted to accumulate indefinitely simply because of the possibility that at some future date large losses may be concentrated within a relatively short period of time and operate to absorb the greatest probable reserve. To permit this would sanction the deduction of a mere contingency reserve for losses, which is not an allowable deduction for income or excess profits tax purposes. This latter rule makes imperative the imposition of some reasonable ceiling on the accumulation of the reserve other than such indefinite limitation as might eventually prevail under a moving average method.
3. The Bureau has accordingly approved the use by banks of a moving average experience factor for the determination of the ratio of losses to outstanding loans for taxable years beginning after December 31, 1946. Such a moving average is to be determined on a basis of 20 years, including the taxable year, as representing a sufficiently long period of a bank’s experience to constitute a reasonable cycle of good and bad years.. The percentage so obtained, applied to loans outstanding at the close of the taxable year, determines the amount, of permissible reserve * * * and the minimum reserve which the taxpayer will be entitled to maintain in future years. * * * A bank, * * * may continue to take deductions from taxable income equal to the current moving average percentage of actual bad debts times the outstanding loans at the close of the year, or an amount sufficient to bring the reserve at the close of the year to the minimum mentioned above, whichever is greater. Such continued deductions will be allowed only in such amounts as will bring the accumulated total at the close of any taxable year to a total not exceeding three times the moving average loss rate applied to outstanding loans * * *.
* * * * ❖
4. In computing the moving average percentage of actual bad debt losses to loans, the average should be computed on loans comparable in their nature and risk involved to those outstanding at the close of the current taxable year involved. * * *
5. A newly organized bank or a bank without sufficient years’ experience for computing an average as provided for above will be permitted to set up a reserve commensurate with the average experience of other similar banks with respect to the same type of loans, preferably in the same locality, subject to adjustment after a period of years when the bank’s own experience is established.
6. Bad debt losses sustained are to be charged to the reserve, and recoveries made of specific debts which have been previously charged against the reserve by a bank on the reserve method of treating bad debts should be credited to the reserve.
# * * * *

(b) Following are pertinent portions of the text of Revenue Ruling 5N-148:

% sfc s& % H*
SectioN 1. Purpose.
The purpose of this Revenue Ruling is to supplement Com. — Mimeograph Coll. No. 6209 dated December 8, 1947 (C.B. 1947-2, 26), which authorizes, in the case of banks, a special method for computing a reasonable addition to the reserve for bad debts under section 23 (k) (1) of the Internal Revenue Code and the regulations promulgated thereunder.
Sec. 2. Background.
The Service has carefully reexamined the provisions of Mimeograph 6209, supra, in the light of experience developed thereunder and, as a result of such reexamination, has approved an alternative method for the use of banks in computing the annual addition to the reserve for bad debts and the maximum amount permitted to be accumulated in such reserve, as set forth in section 4 hereunder.
‡ ‡ $
Seo. .4. Alternative Method.
.01 In lieu of the moving average experience factor provided in paragraph 3 of Mimeograph 6209, which is determined on a basis of 20 years- including the taxable year, a bank may use an average experience factor based on any 20 consecutive years of its own experience after the year 1927. Such average experience factor, representing the percentage of bad debt losses to loans for the period selected, applied to loans outstanding at the close of the taxable year, determines the maximum permissible addition to the reserve for the year.
.02 The amounts permitted to be added in each taxable year to the bad debt reserve under (.01) above may not exceed an amount which will bring the accumulated total in the bad debt reserve at the close of the taxable year to a ceiling equal to three times the average experience factor applied to outstanding loans: Provided,
1. That for the first taxable year beginning after December 31, 1953, the amount of the addition therein to the reserve computed under (.01) above may not exceed one-third of the difference between the ceiling so computed and the accumulated total in the reserve at the close of the year before the addition; and
2. That for the second taxable year beginning after December 31, 1953, the amount of the addition therein to the reserve computed under (.01) above may not exceed one-half of the difference between the ceiling so computed and the accumulated total in the reserve at the close of the year before the addition.
.03 Consistent with the provisions of Mimeograph 6209 which permit newly organized banks and banks without sufficient years’ experience of their own to set up a reserve commensurate with the average experience of other similar banks with respect to the same type of loans, preferably in the same locality, banks which select a 20-year period under (.01) above which extends back into years for which they have no experience of their own will be permitted to fill in such years with similar comparable data.
* ¡i * #
Sno. 5. Effect on Other Documents.
This Revenue Ruling merely supplements Mimeograph 6209 by providing an additional or alternative method for computing the annual addition to a reserve for bad debts and the maximum amount permitted to be accumulated in such reserve. Banks which are now using the moving average method provided in Mimeograph 6209 may continue to use that method if they so desire, and such method is still available to any other banks using or changing to the reserve method of accounting for bad debts.
iji ^
Seo. 7. Eeeective Date.
The provisions of this Revenue Ruling are applicable only for taxable years beginning after December 31, 1953.
% íj: ijí ^4

10. (a) From August 28,1933, the date of the Bank’s organization, to June 15, 1951, when its Time Payment Department was created, all loans made by the Bank were made in the course of what it considered to be a commercial lending business. The type of loans so granted is reflected in its Reports of Condition to the Comptroller of the Currency. Table 3, incorporated herein, contains “Schedule A— Loans and Discounts” of the Report so submitted for the close of business on December 30,1950.

(b) Loans listed in item 7 of table 3, as “Other loans to individuals,” total $5,445,097.33, and represent 21.28 percent of all loans outstanding.

Entries in item 7 identifiable as installment loans total $1,697,234.54, representing 31.17 percent of all “Other loans to individuals” (all of item 7) and 6.63 percent of all loans outstanding.

All loans listed in item 7 were made to “customers” of the Bank, meaning individuals who maintained with the Bank

either accounts (deposits) or lines of credit, or both, and who were personally known to one or more of the Bank’s officers.

11. (a) Prior to the establishment by the Bank of its Time Payment Department, the Bank’s directors made (or caused to be made) an investigation of the operations of national finance companies, and engaged in extended discussions as to whether or not the Bank should go into what the directors denominated the consumer credit business.

(b) Historically, the commercial lending business and the consumer lending business had different origins. The history of the commercial lending business encompasses the history of traditional banking. The consumer lending business is a byproduct of the development of mass production and mass distribution.

Pioneering in the field of consumer credit was done by the automobile manufacturers, in the sale, first, of automobiles, and then in the sale of byproduct appliances, such as electric refrigerators.

As early as the 1920’s the National City Bank of New York entered the consumer lending business. In the 1930’s the Morris Plan banks began the first area-wide extension of consumer lending through banking institutions. Not until the 1950’s did the traditionally commercial banks begin to be a competitive factor in the field of consumer credit. Many of the commercial banks entering the . consumer lending business have maintained institutional separation of commercial lending from consumer lending.

12. (a) Such institutional separation was initiated and has been maintained by the Bank in the creation and development of its Time Payment Department. One of the Bank’s first steps was the employment of a manager whose previous experience had been altogether with automobile finance companies. He selected the staff of the Time Payment Department, insofar as duties included discretionary functions, from persons having prior experience in the consumer lending field. No transfers were made of personnel from the commercial lending business to-the consumer lending business.

The newly created Time Payment Department opened for business in its own quarters, physically removed from the quarters of the commercial lending business. A separate bookkeeping and accounting system, suitable to its needs, was installed and has since been maintained. Interest was and is paid by the Time Payment Department to the Bank for the funds it has out on loan, and the Department prepares profit and loss statements and balance sheets for its operations separate from those of the commercial operations of the Bank.

(b)' From its inception the Time Payment Department has made wholesale loans and retail loans.

The wholesale loans are generally known as floor-planning loans. They are granted to automobile and appliance dealers to finance their inventories, and as an inducement to the dealers to sell their retail installment paper to the Department.

Retail loans are made to individuals and involve a large number of relatively small loans, payable in installments, usually over periods of 24 to 86 months.

(c) Approximately 50 percent of the Time Payment Department’s loan portfolio has been in retail automobile installment paper, of which 90 percent was purchased from dealers under lender-dealer agreements.

There were two types of these agreements. Under one type, the Department had the right to return a repossessed car to the dealer for resale by the dealer. Under the other type, the Department sold repossessed cars itself. Under both, types of agreement, a dealer-loss reserve of 3 percent of outstanding loans (to the dealer) was retained in a fund against which the Department could resort for satisfaction of unpaid installment contracts purchased from the dealer in the event of the dealer’s default through insolvency or bankruptcy. As a matter of usual practice the dealer, upon repossession of a car, bought back the installment contract from the Department without resort to the dealer-loss reserve.

(d) Approximately 5 percent of the Time Payment Department’s loan portfolio has been in floor-planning loans; 20 to 25 percent in direct loans to individuals; and 10 percent each in home-improvement installment loans and in retail appliance installment paper.

(e) Practically all of the installment paper on appliances (industrial retail) was purchased from dealers, and was subject to lender-dealer agreements granting the Department full recourse against the dealer in the event of nonpayment by the individual consumer.

(f) On all installment paper purchased from dealers (in automobiles or appliances), the Department had the further security of a lien on the automobile or appliance and the right to collect from a-n individual borrower from whatever assets he might have.

(g) In all lender-dealer agreements (covering either automobiles or appliances) the Department reserved the right to reject a proffered installment loan to an individual after a credit investigation of the individual borrower.

(h) Direct installment loans granted by the Time Payment Department could be for a variety of purposes. They were sometimes made on the signature of the borrower and sometimes secured by a lien on property, such as an automobile or appliance. All such direct loans tended to be smaller in amount than loans of other types.

(i) Two types of home-improvement loans were made by the Time Payment Department. One type was insured by the FHA; the other was not insured. In amount, each type accounted for approximately half of the total of home-improvement loans.

(j) The details set forth in paragraphs (b) through (i) of this finding reflect (1) the method of the Time Payment Department of developing, through lender-dealer agreements, a substantial volume of business with individual borrowers who were not known to the Bank as was usually the case with “customers” of the traditional, commercial lending business; and (2) the insistence of the Time Payment Department upon the insertion of various cushions against losses resulting from the failure of these individual borrowers to discharge their obligations.

(k) The Time Payment Department’s method of generating new business was subject to the pressure of competition by other banks and lending institutions for the same business. Subject to this pressure and the success of the Time Payment Department in generating new business in adequate volume without extending credit to weak or undercapitalized dealers, the cushions against losses afforded protection against wide fluctuations in annual loss ratios subject only to the vicissitudes of community-wide economic misfortunes such as widepread unemployment, sufficient to topple dealer structures.

13. Figures are in evidence showing a comparison of the ratios of net losses to loans, for the Commercial Department and the Time Payment Department separately, for the years 1951-1959. They are shown in table 4, incorporated herein. In assembling the data, the Bank inserted the floor-planning loans of the Time Payment Department in the loan column of the Commercial Department and excluded them from the loan column of the Time Payment Department. The result lends emphasis to the loss ratio of the Time Payment Department as being the loss ratio of individual consumer loans. The averages of the ratios, for the 9-year period, are: for the Commercial Department, 0.0106 percent; and for the Time Payment Department, 0.0766 percent.

14. (a) The deduction claimed by the Bank in its 1953 return as an addition to its reserve for bad debts, in the amount of $172,298.92, was computed by it in the following manner:

Gommeroial Department
Reserve Balance, December 31, 1952_$237,414. 71
Net Losses_ 929.13
Reserve Balance, December 31, 1953_ 236,485. 58
Time Payment Department
Reserve Balance, December 31, 1952- -
Net Losses_ 6,410. 31
Additions, 1953_ 172,298.92
Reserve Balance, December 31, 1953- 165, 888. 61
Total Reserves (both. Departments)- 402, 374.19

The reserve balance, as of December 31,1953, for the Time Payment Department, in the amount of $165,888.61, represented 2 percent of Time Payment Department Eeceivables as of tlie same date. To this figure the Bank added the net losses of the Time Payment Department for the year 1953, to provide for a total, or gross addition to the reserve of $172,298.92. The formula of 2 percent of receivables was derived from a resolution adopted by the Executive Committee of the Bank on December 30,1953.

(b) As heretofore noted in finding 8(a), the Internal Revenue Service Examining Officer applied the provisions of Mimeograph 6209 and concluded that “no addition to reserve for bad debts is permissible inasmuch as the reserve already exceeds three times the allowable ceiling.” His

computation follows:

Loans and discounts, 12-31-53_$40,926,697. 00
Moving average ratio_ 0.000125
Allowable addition 1953_ 5,115.84
Times 3 allowable addition_ 3
Reserve ceiling for 1953_ 15,347.52
Reserve at 12-31-53_ 222,075.27
Allowable deduction (addition)_ None
Excessive deduction- 172,298.92

The Examining Officer’s total of loans and discounts ($40,924,298.78) reflects the total of loans outstanding in both departments.

The moving average ratio (0.0125 percent) used by the Examining Officer was derived from a computation of loan loss ratios reflecting the 20-year average of the Bank (1934r-1953), as shown in table 5, incorporated herein, where again the totals of loans outstanding were derived from a combination of loans by the two departments.

(c) Taxpayer challenges the validity of the Examining Officer’s computation because of what it considers to be his

failure to give proper consideration to the terms of paragraphs 4 and 5 of Mimeograph 6209.

15. (a) The deduction claimed by the Bank in its 1954 return as an addition to its reserve for bad debts, in the amount of $135,544.80, was computed by it as shown in table 6, incorporated herein.

(b) The Examining Officer (as heretofore noted in finding 8(b)) applied the provisions of “Mim. 6209 as supplemented by IE Mim. No. 54-55” and concluded that $110,319.82 represented the permissible deduction, whereupon he disallowed the difference in the amount of $25,224.98. His computation follows:

A. Loans and discounts, 12-31-54:
Commercial Department_$36,440,358. 31
Time Payment Department_ 7,636,975.16
Total _ 44,077,333.47
B.Average experience factor for 1928-1947 (see table 6)_ ' .004125
C.Maximum permissible addition to reserve (A times B)_ 181,819. 00
D.Ceiling applicable to 12-31-54 reserve (C times 3) 545,457.00
B. Reserve at 12-31-54 before addition_ 214,497. 52
E.Excess of ceiling over reserve (D minus E)_ 330,959.48
Gr. Permissible addition to reserve (% of E)_ 110,319.82
Deducted per return_ 135,544. 80
Excess (disallowed)_ 25,224.98

(c) The Bank’s claim for refund, filed March. 14,1958, contained the following:

* * * The disallowance [of $25,224.98] was based on the fact that taxpayer had not shown it was entitled to a larger reserve for Time Payment loans than was permitted by use of its twenty year average ratio of experience on Commercial loans.
Upon further review of its reserve and the reasonable addition thereto required in 1954, taxpayer has determined that a reasonable addition would be $115,930.08, or $5,610.26 more than was previously allowed. This is based on taxpayer’s own experience to the extent available and the experience of similar banks similarly situated with respect to Time Payment loans; the addition of $115,930.08 to the reserves is computed in accordance with the provisions of Mimeograph 6209. A schedule setting forth the data used in computing the addition can be furnished.

(d) The taxpayer in the trial of this case made no attempt to sustain the additions to the reserve for bad debts in the amounts and in the manner claimed in its return. The four personal loan companies referred to were not identified at trial nor was any effort made to establish the comparability of such companies to taxpayer or the bad debt experience of such companies.

(e) Taxpayer challenges the validity of the Examining Officer’s computation (and of the failure of the District Director to allow the amount claimed in the claim for refund) because of what it considers failure to give proper consideration to the terms of paragraphs 4 and 5 of Mimeograph 6209 and of section 4 of Revenue Ruling 54-148.

16. (a) The deduction claimed by the Bank in its 1955 return as an addition to its reserve for bad debts, in the amount of $305,138.35, was computed as shown in table 7, incorporated herein.

Table 7. — Additions to Reserves for "bad debts, 1955, Security "National Bank of Greensboro

in. ANALYSIS OR RESERVES FOR LOSSES ON LOANS, 1955

Commercial Department loans:

Reserve balance at December 31, 1954___- $280,098.19

Deduct:

Losses charged to reserve_ $1,331.00

Less — Recoveries._ 470.00 861.00

Balance before 1955 addition_ 279,237.19

1955 addition by charge to expense_ 32,715.24

Balance, December 31,1955_-_ 311,952.43

Special reserve not claimed for tax purposes. 8,000.00

Total balance, December 31, 1955_____ 319,952.43

Time Payment Department loans:

Reserve balance at December 31, 1954_ 242,243.05

Deduct:

Losses charged to reserve_ $6,409.66

Less — Recoveries_ 784.34 5,625.32

Balance before 1955 addition___ 236,617.73

1955 addition by charge to expense. 272,423.11

Balance, December 31, 1955. 509,040.84

Combined balance, December 31, 1955_ 828,993.27

(b) The Examining Officer (as heretofore noted in finding 8 (c)) applied the provisions of Mimeographs 6209 and 54-55 (Bev. Bul. 54 — 148) and concluded that $167,597.67 represented the permissible deduction, whereupon he disallowed the difference in the amount of $137,540.68. His computation follows:

A. Loans and discounts 12-31-55:
Commercial Department_$38,426,555. 56
Time Payment Department_ 14,383, 654. 32
Total _ 52,810,209.88
B. Average experience factor_ . 004125
C. Maximum permissible addition (A times B)_ 217,842.12
D. Ceiling applicable (3 times C)_ 653,526.36
E. Reserve before addition_ 318, 331.02
E. Excess of ceiling over reserve (D minus E)_ 335,195.34
G. Permissible addition (% ofE)_ 167,597.67
Deducted per return_ 305,138.35
Excessive amount (disallowed)_ 137, 540.68

(c) The Bank’s claim for refund, filed March 13, 1959, contained the following:

* * * The disallowance [of $137,540.68] was based on the fact that taxpayer had not shown that it was entitled to a larger reserve for Time Payment loans than was permitted by use of its 20-year average ratio of experience on Commercial loans.
Upon further review of its reserve, taxpayer has determined that a reasonable addition would be at least $305,138.35, the amount deducted on its return. This is based on the experience, for the 20-year period 1928 through 1947, of all the banks which are members of the Federal Reserve System in the Fifth Federal Reserve District, in which taxpayer is located. * * *

(d) Table 8, incorporated herein, shows the ratio of net losses (or recoveries) to loans, covering the period 1927 through 1953, of all member banks in the Fifth Federal Reserve District.

17. Table 9 is incorporated herein. It shows ratios, for the Bank in the years involved, of (1) actual bad debts to loans outstanding and (2) reserves allowed by the Commissioner of Internal Revenue to loans outstanding.

18. By way of recapitulation:

(a) As to taxpayer, findings 14-16 reflect its insistence upon its right, with respect to each of the years involved, to separate computations for the two departments, using borrowed experience as the basis of the Time Payment Department computation.
(b) As to defendant, finding 14 reflects the District Director’s insistence, for the year 1953, upon no separation of the two departments, no use of borrowed experience, and reliance on the previous 20-year life of the Bank.
(c) As to defendant, findings 15 and 16 reflect the District Director’s insistence, for the years 1954 and 1955, upon no separation of the two departments and the application to the combined loan total of a ratio based upon a 20-year average (1928-1947: table 6) using Fifth Federal Reserve District loss ratios for 1928-1933, and the loss ratios of the Bank for 1934-1947.
(d) Since the ratio used by the District Director for the years 1954 and 1955 is the same ratio that was used by the Bank for the same years as applied to its Commercial Department, the essence of the difference between the parties is the Bank’s insistence upon (1) separate computations for the two departments and (2) borrowed experience as the basis of a loss ratio computation for the Time Payment Department.

Table 8. — Ratios of net losses (or recoveries) to loams, 1927 — 1958, of all member bcmks of the Fifth Federal Reserve District

Note. — Losses and recoveries for 1948, and later years, are not of transfers to and from valuation reserves on loans. Prior to 1948, transfers to and from valuation reserves in the aggregate were not important.

Table 9. — Reserves allowed J)y the Commissioner of Internal Revenue; actual had debts of the bank; and ratios of bad debts to loans outstanding and of reserves allowed to loans outstandi/ng for the years involved.

19. On the basis of the facts recited in findings 11 and 12 it is found (1) that the business of consumer lending, as conducted by the Bank’s Time Payment Department, was and is essentially a different business from that of commercial lending, as conducted by the Bank’s Commercial Department; (2) that the losses of the Time Payment Department business have been substantially greater than those of the Commercial Department business; and (8) that the two departments cannot be said to make the same type of loans.

20. If it be deemed, as a matter of law, that the refusal to permit the Bank to add to its reserves for bad debts on the basis of a separate computation for the Time Payment Department, using borrowed experience, was an abuse of discretion, findings 21 through 23 (following) present such guides as there are in evidence for the determination of reasonable allowances under the applicable law.

21. (a) The Bank made an extensive effort to assemble information disclosing the loss experience of other banks in the consumer lending business for a 20-year period prior to 1951. Such information was forthcoming from 4 banks only: one in Michigan; one in New York; the Bank of Georgia; and the Bank of Delaware.

(b)Table 10, incorporated herein, shows the annual ratios of bad debt losses to loans outstanding for the Bank of Georgia and the Bank of Delaware for the years 1930-1951.

Table 10. — Annual ratios of "bad debt losses to outstanding loans for the Bank of Georgia and the Bank of Delaware for the years 1980-1951

(c) The Bank also had available to it the loss experience of all member banks of the Fifth Federal Reserve District, as set forth herein in table 8 (finding 16).

(d) From the three experience tables available to it plaintiff has made four computations based upon the loss experiences of (1) the member banks of the Fifth Federal Reserve District; (2) the Bank of Georgia; (3) the Bank of Delaware; and (4) the combined experience of the Bank of Georgia and the Bank of Delaware.

22. (a) There is no specific evidence with which to relate the loss experience of the member banks of the Fifth Federal Reserve District to the loss experience of the Bank’s Time Payment Department. The broad base of the schedule, reflecting experience throughout the Fifth District area with all types of loans, represents its qualification as a comparative guide. Within this context, it affords a reasonable basis of comparison, but not a close parallel.

(b) The Bank of Georgia is an outgrowth of the Atlanta Loan and Savings Company, incorporated in 1911. The parent company became the Morris-Plan Company about 1920, and the Morris Plan Bank in 1933. The Bank of Georgia took over in 1946. The places of business have uniformly been in Atlanta.

Since the infusion of the Morris Plan into the bank’s business, circa 1920, the bank has been engaged in consumer lending; and the Bank of Georgia has conducted its business. with a moderate loan policy, developing a diversified loan portfolio in a diversified consumer market. Within this context, the experience of the Bank of Georgia affords a reasonable basis of comparison with plaintiff’s Time Payment Department.

(c) The Bank of Delaware (located in Wilmington) is the product of several mergers. One of the banks absorbed in the merger process was the Wilmington Morris Plan Bank, which had its origin in 1915. The predecessor of the Bank of Delaware which absorbed the Wilmington Morris Plan Bank in 1944 carried on the Morris Plan business as a separate department.

The Bank of Delaware thus affords a history of consumer lending and the development of a diversified loan portfolio in a diversified consumer market. As far as is known, this business has been conducted with a moderate loan policy. Within this contest, the experience of the Bank of Delaware affords a reasonable basis of comparison with plaintiff’s Time Payment Department.

(d) Both the Bank of Georgia and the Bank of Delaware were engaged in the business of consumer lending in years prior to the establishment of plaintiff’s Time Payment Department. Minute comparison between the types of loans made by these banks (or either of them) with the types of loans made by plaintiff’s Time Payment Department cannot be made because of the lack of evidence of specifics as to loans made by the Bank of Georgia and the Bank of Delaware. In the absence of such specificity, the Bank of Georgia must be deemed to afford a closer parallel to plaintiff’s Time Payment Department than the Bank of Delaware (or than the combined experience of the Bank of Georgia and the Bank of Delaware), because of the more obvious similarity of the economy of Atlanta to the economy of the North Carolina areas served by plaintiff.

23. (a) Table 11, incorporated herein, shows four alternative computations of (1) amounts of reserves for bad debts and (2) allowable additions to such reserves.

In each of the computations plaintiff has used the average experience factor allowed by the Commissioner of Internal Revenue on loans outstanding in its Commercial Department and the experience of others on loans outstanding in its Time Payment Department (other than floor-planning loans).

In the first alternative shown in table 11, plaintiff used on its Time Payment Department loans (other than floor-planning loans) the experience of all member banks of the Fifth Federal Reserve District. The factor used for 1953 was 0.3 percent, shown on table 8 (finding 16(d)) as the average for 1934 — 1953. The factor used for 1954 and 1955 was 0.7 percent, shown on table 8 as the average for 1928-1947.

In the second alternative shown in table 11, plaintiff used its own experience for 1952 and 1953 and borrowed experience from the Bank of Georgia for years back of 1952 (to 1934) to arrive at a factor of 0.2355 percent, which it applied to the computation for 1953. For 1954 and 1955, the factor of 0.598 percent was derived from experience borrowed from the Bank of Georgia for the years 1930-1949.

In the third alternative shown in table 11, the factor of 0.7065 percent, applied to 1953, was derived from the Bank’s own experience for 1952 and 1953, plus experience borrowed from the Bank of Delaware for the years 1934 — 1951. The factor used for the years 1954 and 1955 was 1.1185 percent. It was derived from Bank of Delaware experience for the years 1930-1949.

The fourth alternative shown in table 11 is based on the combined experience of the Bank of Georgia and the Bank of Delaware. The factor for 1953 was 0.411 percent, while the factor for 1954 and 1955 was 0.797 percent. Both factors were derived in the same manner as set forth in the two preceding paragraphs.

(b) Table 12, incorporated herein, shows the amounts by which the reserves claimed by plaintiff in its alternative computations exceed the reserves allowed to plaintiff by the Commissioner of Internal Eevenue.

Table 12. — Excess of reserves claimed by plaintiff over amounts allowed by Commissioner in terms of alternative computations

(c) Table 13, incorporated herein, shows the ratios of reserves to outstanding loans (1) as allowed by the Commissioner (from table 9) and (2) as claimed by plaintiff on the basis of experience borrowed from the sources indicated for application to its Time Payment Department, together with the excesses of ratios based on borrowed experience over the ratio of the reserves allowed by the Commissioner.

Table 13. — Ratios of reserves to outstanding loans: (1) As allowed by the Commissioner; and (2) as claimed by plaintiff on the basis of experience borroioed from the sources indicated

CONCLUSION OF LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that plaintiff is entitled to recover in accordance with this opinion, and judgment is entered to that effect. The amount of recovery will be determined pursuant to Buie 47 (c). 
      
       Section 23 (k) (1) of the Internal Revenue Code of 1939, as amended by section 113(a) of the Revenue Act of 1943, 58 Stat. 21, contains substantially the same provisions as set out above.
     
      
       1953, 1954, and 1955.
     
      
       The court has jurisdiction of this action under section 1491 of title 28, united States Code. The action was commenced less than 2 years after the date of the mailing of the registered letters by the District Director rejecting in full the Bank’s claims for refund.
     
      
       The Bank has been on an accrual basis at all relevant times.
     
      
       The parties have stipulated that the deficiency assessment and interest were paid on February 4, 1957, and April SO, 1957, respectively.
     
      
       Tie parties Rave stipulated that the deficiency assessment and interest were paid on February 4, 1957, and May 1, 1957, respectively.
     
      
       The parties have stipulated that the deficiency assessment and interest were paid on February 4, 1957, and May 1, 1957, respectively.
     
      
       The amounts shown in table 2 as deficiency and interest paid for 1954 differ from the amounts shown in finding 5(b). The explanation lies in a revision by the Bank of its claimed deduction for 1954, whereby the amount claimed was reduced from $135,544.80 to $115,930.08, leaving a difference between the amount claimed and the amount allowed of $5,610.26, instead of a difference of $25,224.98 as shown in finding 6(b). (See finding 15(c). The deficiency assessment now in dispute was computed on the difference as finally developed.
     
      
       Quaere, as to whether plaintiff has abandoned its claim for the year 1953, inasmuch as the borrowed experience upon which it relies for validation of allowable additions does not support an addition for 1953. Cf. finding 23, and tables 11 and 12 incorporated therein.
     
      
       For citation, see footnote 11.
     
      
       Hereinafter referred to as Revenue Ruling 54 — 158. For citation, see footnote 12.
     
      
       For full text, see Internal Revenue Cumulative Bulletin, Vol. 26, Part 2, page 26. ¡The Mimeograph was approved December 8, 1947.
     
      
       Originally issued as IR Mimeograph No. 54-55, dated April 8, 1954. See I.R. Cum. Bull., Vol. 33, Part 1, page 60.
     
      
       Throughout the trial of this case defendant challenged the validity of plaintiff’s sharp distinction between commercial credit or lending, on the one hand, and consumer credit, on the other. At page Sí of the transcript, the attorney for defendant read into the record the following statement which he ascribed to a publication by the Federal Reserve System (Consumer-Installment Credit, Volume I, Chapter 8, page 147) : “Short- and intermediate-term installment debt is only one of several types of debt which consumers owe. Consumers also incur obligations in the form of noninstallment short- and intermediate-term debt (single payment loans, charge accounts, and service credit), mortgage debt, security loans, and loans secured by the cash value of insurance policies (policy loans).” Plaintiff’s position, as reflected in its Requested Finding 39, is that: “Although some loans made by the Commercial Department of the Bank, both before and after June 1951, might fall within the fringes of some definitions of ‘consumer credit,’ such loans have always been to customers relatively well known to the Bank and such loans have not been of significance in amount.”
     
      
       Some economists refer to commercial loans as loans for production, to distinguish them from loans to consumers (for consumption, as distinguished from production).
     
      
       Very few direct loans of this type were made by the Time Payment Department.
     
      
       On the basis of experience oyer a period of 7 years (1953-1959), the average ratios are: for the Commercial Department, 0.0087 percent; and for the Time Payment Department, 0.0804 percent.
     
      
       There Is a minor, unexplained mathematical error in this computation. It is not of material consequence.
     
      
       The component figures are in table 4: $33,538,039.35 plus $7,386,259.43.
     
      
       See finding 9(a). Paragraph 4 requires the average to “be computed on loans comparable in their nature and risk involved to those outstanding at the close of the current taxable year involved.”
      Paragraph 5 provides that “a bank without sufficient years’ experience for computing an average * * * will be permitted to * * * [use] * * * the average experience of other similar banks with respect to the same type of loans * *
     
      
       No such schedule Is in evidence.
     
      
       Finding 9(a).
     
      
      
         Finding 9(b).
     
      
       There is thus posed an issue of ultimate fact, vim: whether or not the business of the Time Payment Department was essentially different from the business of the Commercial Department. If there was no essential difference between the two, plaintiff's case fails. If there was an essential difference, the question remains, as an issue of law, as to whether the District Director abused his discretion in his application of Mimeograph 6209 and Revenue Ruling 54-148.
     
      
       See table 4 (finding 13).
     
      
       Loans made by the Time Payment Department involve greater risks than loans made by the Commercial Department; and the risks involved in the two types of loans differ in nature.
     
      
       Information received from the banks in Michigan and New York was not used. iThe largest bank in North Carolina, the Wachovia Bank and Trust Company, refused to disclose its data to a competitor. The evidence is silent as to the response by the next largest bank in North Carolina, the First Citizens Bank and Trust Company.
     
      
       For the results of these computations, see tables II, 12, and 13 (finding 23).
     
      
       The Fifth Federal Reserve District includes the States of Maryland, West Virginia, Virginia, North Carolina and South Carolina, and the District of Columbia.
     
      
       Defendant, in its requested findings of fact, stresses the absence of evidence pertaining to the underlying figures used in the loss experience of the Fifth Federal Reserve District member banks. While defendant does not question the accuracy of the data, it does point out that there has been no showing (1) as to what extent the loans involved in the schedule were of the type made by the Bank’s Time Payment Department; (2) that the percentage of consumer loans to total loans in the schedule was greater or lesser than the consumer loans made by the Bank’s Commercial Department throughout its history; or (3) that the Bank, in the event of another Depression comparable to that of the 1930’s would be likely to sustain losses in either of its departments as great as those reflected in the schedule.
     
      
       Defendant challenges the use of Bank of Georgia experience for comparison with plaintiff’s Time Payment Department because the evidence as to its methods of operation is limited in time to the period since 1942. There is no specific evidence for the years prior to 1942 as to the type of security on loans, the percentage of direct loans as compared to loans purchased from dealers, or the percentage of loans on automobiles and appliances as compared to other types of loans.
      Defendant further points out that the portfolio of the Bank of Georgia has varied from practically no installment automobile contracts in 1942 [when virtually no automobiles were in the hands of dealers!] to about 25 percent currently; that the percentage of its automobile and appliance installment paper obtained from dealers has always been relatively insignificant; that most of its loans have been made directly to the individual borrower; and that the bank relied on the individual borrower, having as security only the lien on the item purchased.
      Defendant further observes that it has not been established that the Depression of the 1930’s had the same or similar impact on banks in Atlanta as it had on banks in the areas of the Bank’s operations in North Carolina.
     
      
       The Bank of Delaware also has several branches in smaller cities and towns.
     
      
       Defendant challenges the use of Bank of Delaware experience for comparison with plaintiff’s Time Payment Department because of the lack of evidence as to the operation of the Wilmington Morris Plan Bank, specifically as to its loan policy, the type of security on loans, and the percentage of direct loans as compared to loans purchased from dealers.
      Defendant further points out that for years after 1944 there is no evidence as to the percentages of loans purchased from dealers, of loans with recourse of any kind against dealers, or of loans for automobile or appliance financing. Neither is the average length of maturity of loans shown.
      Defendant further observes that it has not been established that the Depression of the 1930’s had the same or similar impact on banks in Wilmington, Delaware, as it had on banks in the area of plaintiff’s operations in North Carolina.
     
      
       Tables 12 and IS, considered together, show that the issue in this case is not so much the amount involved as it is the method by which the proper amount is to be determined. Referring, for example, to the year 1954 and the experiences borrowed from the Bank of Georgia, there is a difference of 4 percent only between the reserve allowed by the Commissioner and the amount claimed by plaintiff. By what standard could it be said that this difference reflects an abuse of discretion on the part of the Commissioner? The amount claimed by plaintiff may be reasonable, but there is no criterion by which to declare it a minimum (thereby classifying the amount allowed by the Commissioner as unreasonable) except in terms of the method whereby plaintiff derived the amount claimed.
     
      
       Fifth Federal Reserve District Losses.
     
      
       Experience in Commercial Department based on (1) Fifth Federal Reserve District Losses, 1928-1933; and (2) Security National Bank Losses, 1934-1947.
     
      
       Experience in Time Payment Department based on losses of 4 personal loan companies.
     
      
       Excludes EHA-insured loans.
     
      
       Experience in Commercial Department based on (1) Fifth Federal Reserve District Losses, 1928-1933; and (2) Security National Bank Losses, 1934-1947.
     
      
       Experience in Time Payment Department based on losses of 4 personal loan companies.
     
      
       Excludes FHA-insured loans.
     
      
       Less than 0.05.
     
      
       Loans outstanding were: for 1953, $40,926,697; for 1954, $44,077,333; and for 1955, $53,567,241.
     
      
       $7,339 divided by $40,926,697.
     
      
       $222,075 divided by $40,926,697.
     
      
       $7,577 divided by $44,077,333.
     
      
       $324,817 divided by $44,077,333.
     
      
       $6,486 divided by $53,667,241.
     
      
       $485,928 divided by $53,567,241.
     