33 T.C. 720">*720 The Commissioner determined deficiencies in the petitioner's income and excess profits tax of $ 26,218.84 for 1950, $ 93,077.59 for 1951, and $ 147,416.99 for 1952. The primary issue for decision is whether certificates issued by the petitioner and outstanding during the taxable years evidenced "borrowed capital" within the meaning of section 439 of the 1939 Code for the purpose of computing its excess profits credit based upon invested capital. An alternative issue, if the decision is against the petitioner on the above issue, is whether the petitioner is entitled to compute its average base period net income 33 T.C. 720">*721 under section 444(c) of the 1939 Code in arriving at its "adjusted excess profits net income" because of a section 444(b) (3) increase in its capacity for production or operation.

FINDINGS OF1960 U.S. Tax Ct. LEXIS 221">*223 FACT.

The petitioner was organized in January 1916 and at all times material hereto was incorporated under and subject to sections 18,000 to 18,825 of the Financial Code of the State of California (entitled "Industrial Loan Companies") and its predecessor, the Industrial Loan Act of 1917, as amended. Its principal office is at 715 Market Street, San Francisco, California, but it has other offices in California.

The petitioner used an accrual method of accounting and reporting its income. It filed its returns for the taxable years with the district director of internal revenue in San Francisco.

The petitioner is subject to regulation and examination by and must make an annual report to the commissioner of corporations of California. It was not a bank at any time material hereto. It is an industrial loan company. Its income for the taxable years was derived principally from discounts on notes and purchase contracts acquired by it and from interest on small loans made by it. It was authorized by its articles of incorporation "to issue, purchase and sell certificates, notes and other written evidences of indebtedness." It acquired its working capital from the sale of its capital1960 U.S. Tax Ct. LEXIS 221">*224 stock and through loans from banks but primarily from the sale of its certificates to the public.

The petitioner issued its "Definite Term Thrift Certificates" in face amounts of $ 500 and multiples thereof during 1950 and the first 3 months of 1951 but not thereafter. The petitioner had outstanding but did not issue during the taxable years some of its "Full Paid Investment Certificates" and, up to April 1, 1951, some of its "Unit Thrift Certificates." It had outstanding and issued during the taxable years its "Installment Thrift Certificates." Each certificate issued by the petitioner was registered by it by number and in the name of the owner. The definite term thrift certificates had a maturity date but the installment thrift certificates bore no maturity date.

The laws of California required that the following be shown in large type on the face of each certificate issued by the petitioner and other industrial loan companies: "THIS IS NOT A CERTIFICATE OF DEPOSIT."

The petitioner was required under the California Industrial Loan Law to apply to the Division of Corporations of the State for permits and extensions thereof "authorizing the sale and issuance of 33 T.C. 720">*722 securities," 1960 U.S. Tax Ct. LEXIS 221">*225 i.e., its certificates. It had to make an application every time it wanted to issue new certificates, to issue an additional amount of a type outstanding certificates, or to change the interest rate on any type of outstanding certificates. The application had to include a current financial statement, the resolution of the directors pertaining to the issue, a copy of the proposed form of certificate, a statement of the interest rate to be paid, the number of certificates already issued on existing permits, the total amount of certificates outstanding, the amount being requested, and the period during which the certificates would be issued. The application and the form of the certificate had to be approved by the Division of Corporations before the certificates could be issued.

The petitioner during the taxable years received numerous permits and extensions and amendments thereof to issue certificates. Two permits were issued on December 21, 1950, authorizing total issues of $ 904,500 definite term thrift certificates paying 3 per cent per annum. An amendment to one of these permits was issued on June 26, 1951. All of the other permits, extensions, and amendments pertained to 1960 U.S. Tax Ct. LEXIS 221">*226 the issuance of installment thrift certificates. These were in amounts ranging from $ 100,000 to $ 20,000,000. Total issues of $ 600,000 at 4 per cent were permitted in 1950. A permit for $ 500,000 at 2 1/2 per cent was issued in March 1950, one for $ 5,000,000 at 2 per cent in August 1950, and all of the others were at 3 per cent. If the interest rate increased, holders of certificates at a lower rate were notified and could change their investment to the higher rate.

The petitioner, upon receiving a permit, advertised to the public in the Wall Street Journal, the financial pages of other papers, and through commercials on a music radio program, that it had certificates for sale.

All advertising of the petitioner is subject to the approval of the commissioner of corporations of the State of California who checks the truth of all statements made to see that there are no omissions or misleading statements and particularly that it does not lead the public to confuse the certificates with bank deposits.

The interest on the definite term thrift certificates was paid when the certificate was surrendered, whether at the 5-year maturity date or later and meanwhile drew interest at 3 per1960 U.S. Tax Ct. LEXIS 221">*227 cent. The interest rate on the unit thrift certificates ranged from 1 1/2 per cent to 2 1/2 per cent, depending upon the principal amount of each certificate. The interest rate on installment thrift certificates was 2 per cent or 2 1/2 per cent during 1950 and the first 3 months of 1951 and thereafter was 3 per cent except that 4 per cent was paid on those issued to employees, of which $ 190,372.71 was the largest amount outstanding in any taxable year. The interest on the unit and installment 33 T.C. 720">*723 certificates was either paid or added to the principal semiannually, as requested by the owner. The interest on the full paid investment certificates was paid semiannually.

The prevailing interest rates paid on bank savings accounts in cities where the petitioner had offices did not exceed 1 to 1 1/2 per cent in 1950 and 2 per cent in 1951 and 1952.

The owner could add to his unit thrift certificate $ 100 or multiples thereof. The owner could add to his installment thrift certificate $ 1 or multiples thereof. All forms of certificates issued by the petitioner were transferable and could be assigned as collateral. An assignment of a definite term certificate or a full paid investment1960 U.S. Tax Ct. LEXIS 221">*228 certificate would continue in the assignee all benefits of the accumulating interest. The certificates could be assigned at the office of the petitioner or by forwarding to the petitioner a properly endorsed certificate for assignment with the signature guaranteed, as in the case of the assignment of a stock certificate. The certificates were not traded in markets or exchanges. Any certificate could be redeemed in part or in full at any time since the petitioner did not invoke the restrictions on withdrawals.

The installment certificates issued by the petitioner differ from bank savings accounts represented by a passbook at least in the following respects: The certificates are transferable, they can be used as collateral, they are signed by the issuer, they are registered by the number that each bears and the name of the owner, the right of an owner to withdraw is limited with other withdrawals to the amount issued in the preceding month, and they can be redeemed by the petitioner upon notice, whereas a bank savings account has none of these features, but a bank savings account is secured by cash reserves and by insurance, whereas the certificates are not. Also, the bank receiving1960 U.S. Tax Ct. LEXIS 221">*229 the deposits is examined by the banking authorities of the State or Nation, whereas the petitioner is subject to the supervision of the Division of Corporations of the State.

The average daily balance of the total amount of certificates outstanding during each of the taxable years was: $ 16,073,897 for 1950, $ 17,866,997 for 1951, and $ 23,962,294 for 1952. The outstanding installment certificates averaged a little less than $ 13,000,000 during 1950, a little more than $ 16,000,000 during 1951, and a little more than $ 23,000,000 during 1952. The unit thrift certificates averaged a little less than $ 3,000,000 during 1950 and were insignificant after April 30, 1951. The installment investment certificates issued to employees were issued for the first time in April 1950 and thereafter averaged a little over $ 146,000 during 1950. They averaged a little over $ 150,000 during 1951 and a little over $ 176,000 during 1952. The definite term thrift certificates averaged a little over $ 266,000 33 T.C. 720">*724 during 1950, a little over $ 474,000 for 1951, and a little over $ 342,000 for 1952. The full paid investment certificates did not exceed $ 1,500 at any time material hereto.

Similar1960 U.S. Tax Ct. LEXIS 221">*230 averages for the borrowings from banks by the petitioner were $ 345,890.41 for 1950, $ 633,562 for 1951, and $ 461,252.51 for 1952.

The issuance by the petitioner of its certificates was always in good faith for the purposes of its business.

The purchaser of an installment thrift certificate is issued a book showing the certificate number and having columns for the entry of withdrawals, payments, interest, balance, and "TRANS." The last page and inside cover of this book contain the following:

Installment Thrift Certificate

of

THE MORRIS PLAN COMPANY

OF CALIFORNIA

THE MORRIS PLAN COMPANY OF CALIFORNIA hereby certifies as follows:

1.     is the registered owner of this INSTALLMENT THRIFT CERTIFICATE of THE MORRIS PLAN COMPANY OF CALIFORNIA, subject to the terms hereof.

2. The company is indebted to the registered owner hereof in the principal sum shown by the last balance entry herein when entered by an authorized officer or agent of the company, together with interest to be determined and computed as hereinafter provided.

3. The amount of this certificate may be increased in sums of One Dollar or multiples thereof, at any time by the registered owner hereof, subject to the following1960 U.S. Tax Ct. LEXIS 221">*231 regulations.

4. Interest hereon at the rate of 3% per annum will be credited the registered owner hereof semi-annually on the first day of January and July of each year. Funds received between the first and third of each month will earn interest from the first day of that month; funds received after the third day of the month will receive interest from the first day of the following month, with the exception of January, April, July and October. Funds received before the tenth day of those months will receive interest from the first day of those months. Funds withdrawn will be deducted from the earliest credits. On withdrawals, no interest will be allowed thereon for the quarter in which withdrawn. A charge of 50c will be made for each withdrawal exceeding 2 in any one month.

5. The company will redeem this certificate in full, or any part of the same in sums of One Dollar or multiples thereof, at any time on request of the registered owner hereof, subject to the right of the company to require thirty (30) days' notice in writing, to limit the aggregate amount of the redemption of its Thrift Certificate in any one calendar month to an amount not exceeding its net receipts of the1960 U.S. Tax Ct. LEXIS 221">*232 previous calendar month provided, however, that in the event the amount payable hereunder is not paid within six months from the date of demand, the entire amount due hereunder, together with accruals from date of demand shall become immediately due and payable.

33 T.C. 720">*725 6. Payment will be made to any person producing this certificate, who, on comparison of his or her signature with the signature of the registered owner on file with the company appears to be such owner or the duly authorized representative of such owner, and shall be a valid payment and discharge of the company from all liability for the amount so paid.

7. No money will be received or paid by the company hereon unless this certificate is presented, so that the proper entries of the same may be made hereon.

8. This certificate is registered in books kept at the office of the company and is transferable only upon its presentation at said company with a written assignment duly executed by the person appearing to be the registered owner hereof.

This certificate may be registered as payable to two or more persons, or their representatives, in which case payment to the person producing this certificate and appearing to1960 U.S. Tax Ct. LEXIS 221">*233 be one or the other of such registered owners, or the legal representative of either of such owners, shall have the same force and effect as if there were only one registered owner hereof.

9. In the event of the loss of this certificate and upon proof of such loss satisfactory to the company, a new certificate identical in form and conditions with this certificate will be issued to the person producing such proof, and who appears to be the registered owner hereof, and thereupon the company will be discharged from all further liability under this certificate.

10. The corporation reserves the right to redeem this Certificate at its face value with accrued interest, on any interest payment date, provided it shall give not less than thirty days' notice in writing addressed to the last recorded address of the registered owner or owners hereof, of its intention to redeem, and interest hereon shall cease on and after the date of redemption so indicated.

In Witness Whereof, The Morris Plan Company of California has caused this Certificate to be executed by its duly authorized officers this     day of    , 19   

Authorized Signature

THIS IS NOT A

CERTIFICATE OF DEPOSIT

The petitioner, 1960 U.S. Tax Ct. LEXIS 221">*234 in preparing its Federal income and excess profits tax returns for the years 1950, 1951, and 1952, considered and treated its indebtedness attributable to its certificates issued and outstanding in each of the tax years as "borrowed capital" within the meaning of section 439(b)(1).

The Commissioner in determining the deficiencies gave the following explanation:

In your returns filed for the taxable years 1950, 1951, 1952 and 1953, you elected to compute your excess profits credit under the historical invested capital method provided by Section 458 of the Internal Revenue Code of 1939. In determining the average invested capital upon which you computed your excess profits credit, you included as borrowed capital 75 per cent of your obligations which were evidenced by Full Paid Investment Certificates, Certificates Receipt Book Form, and Installment Investment Certificates. It is held that your obligations evidenced by those certificates do not constitute borrowed capital within the meaning of Section 439 of the Internal Revenue Code of 1939.

33 T.C. 720">*726 Since your excess profits credit computed on your invested capital, exclusive of borrowed capital, is less than your excess profits1960 U.S. Tax Ct. LEXIS 221">*235 credit as provided in Section 435 of the Internal Revenue Code of 1939, your excess profits credit is computed under Section 435.

Your alternative contention for allowance of average base period net income and excess profits credit under Sections 444 and 447 of the Internal Revenue Code of 1939 as raised in your protest and accompanying application for the benefits of Section 444 is disallowed since you have failed to establish eligibility under Subsection 444(b) of the Internal Revenue Code of 1939, and Regulations 130, Sections 40.444-1 and 40.444-2, and the amount of average base period net income allowable under Section 444 (c).

All stipulated facts are incorporated herein by this reference.

OPINION.

The term thrift certificates involved in the present case are not different in any material respect from those involved in the recent case of Valley Morris Plan, 33 T.C. 572">33 T.C. 572, and for the reasons given there we hold that the petitioner is entitled to include the indebtedness evidenced by its term thrift certificates in the computation of the invested capital credit.

The petitioner in the present case is claiming the right to include all of the indebtedness1960 U.S. Tax Ct. LEXIS 221">*236 evidenced by its outstanding certificates in the computation of its invested capital credit. These included not only the term thrift certificates referred to above, but also an insignificant amount of full paid investment certificates which for present purposes can be regarded as similar to the term thrift certificates, unit thrift certificates which for present purposes are substantially similar to the installment thrift certificates, certificates issued to employees which also may be regarded for present purposes as similar to the installment thrift certificates, and the installment thrift certificates issued to the public which represent by far the largest amount in controversy.

Section 439 (b) (1) provides, inter alia, that there shall be included in daily borrowed capital --

The amount of the outstanding indebtedness (not including interest) of the taxpayer, incurred in good faith for the purposes of the business, which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, deed of trust, bank loan agreement, or conditional sales contract. * * *

It is stipulated that the petitioner's indebtedness on all of its certificates was1960 U.S. Tax Ct. LEXIS 221">*237 incurred in good faith for the purpose of its business.

The question for decision is whether the petitioner is entitled, in computing its excess profits credit under section 439(b)(1), to include the amount evidenced by its installment thrift certificates in the computation of its borrowed capital. This point was not involved in the Valley Morris Plan case. The answer depends, under 33 T.C. 720">*727 the arguments of the parties, on whether an installment thrift certificate as issued by the petitioner might fairly be regarded as a "certificate of indebtedness" within the meaning of this section. The Commissioner has provided in Regulations 130, section 40.439-1(e) and (f), that --

The name borne by the certificate is of little importance. More important attributes to be considered are whether or not there is a maturity date, the source of payment of any "interest" or "dividend" specified in the certificate (whether only out of earnings or out of capital and earnings), rights to enforce payment, and other rights as compared with those of general creditors.

The term "certificate of indebtedness" includes only instruments having the general character of investment securities issued1960 U.S. Tax Ct. LEXIS 221">*238 by a corporation as distinguishable from instruments evidencing debts arising in ordinary transactions between individuals. * * * Borrowed capital does not include indebtedness incurred by a bank arising out of the receipt of a deposit and evidenced, for example, by a certificate of deposit, a passbook, a cashier's check, or a certified check, and the term "bank loan agreement" does not include the indebtedness of a bank to a depositor.

The petitioner was not a bank and was prohibited by law from receiving deposits. Its certificates were not certificates of deposit. The portion of the above regulation relating to banks has no application here. The interest specified in the certificates was to be paid in any event and was not limited to payment out of earnings. The certificates were not "instruments evidencing debts arising in ordinary transactions between individuals" but were distinguishable from such instruments in much the same way as are "instruments having the general character of investment securities issued by a corporation." These certificates were issued by a corporation under express authority from the department of corporations. The application for the permit and 1960 U.S. Tax Ct. LEXIS 221">*239 the permit to issue these certificates described them as "investments." They were also regarded as investments by the Securities and Exchange Commission. The petitioner obtained by far the largest part of its working capital from the sale of these certificates. It seems fair to conclude from the entire record that they represented investments by the holders of the certificates. They were similar in many respects to the types of evidences of indebtedness listed in section 439(b)(1). It is difficult to exclude these certificates from borrowed capital under that section even under the Commissioner's regulations, despite their lack of a maturity date.

Commissioner v. Ames Trust & Savings Bank, 185 F.2d 47, reversing 12 T.C. 770">12 T.C. 770, National Bank of Commerce, 16 T.C. 769">16 T.C. 769, and Capital National Bank of Sacramento, 16 T.C. 1202">16 T.C. 1202, appeal dismissed on stipulation, all involved regular banking institutions claiming borrowed capital on certificates of deposit and are not in point here where the petitioner is not a bank and is not making any claim based upon certificates 1960 U.S. Tax Ct. LEXIS 221">*240 of deposit which by law it is not even permitted to issue. A closely parallel case is Jackson Finance & Thrift 33 T.C. 720">*728 ., 29 T.C. 272">29 T.C. 272. There are some differences in the facts between that case and this, but they do not serve to distinguish the two cases. That case was reversed, Jackson Finance & Thrift Co. v. Commissioner, 260 F.2d 578.

The Court of Appeals for the Tenth Circuit in the Jackson Finance & Thrift Co. case pointed out that the State of Utah had adopted many statutory safeguards so that the issuance of thrift certificates by industrial loan companies could not be confused with banking functions. The same is true in the State of California. The court said in part:

Depositors place their money in banks primarily for safekeeping, secure in the knowledge that many governmental restrictions, both state and federal, are placed upon banks to assure and sometimes, as in the case of Federal Deposit Insurance banks, to insure the safety of the deposit. "Bank" and "bank deposit" are terms as well known in common parlance as they are in technical commercial use. And the terms do not include industrial1960 U.S. Tax Ct. LEXIS 221">*241 loan companies nor monies received by sale of thrift certificates either in actual or technical understanding. Money paid for thrift certificates (or other evidences of indebtedness whatever called) are intended as investments, influenced largely by the promise of payment of a high rate of interest, here 4%, but with a concomitant risk. Bank deposits are made at a lower rate of interest, here 2 1/2%, for safekeeping.

The court held that the certificates issued by the industrial loan companies in that case "are, and are intended to be, evidences of indebtedness to a purchaser who has invested, and has intended to invest, in a corporate security rather than make a deposit for safekeeping." Cf. Economy Savings & Loan Co., 5 T.C. 543">5 T.C. 543, modified as to other issues 158 F.2d 472, in which a similar conclusion was reached.

This Court, after restudying the whole question, has come to the conclusion that all of the indebtedness evidenced by the certificates issued by the present petitioner should be included in the computation of the invested capital credit under section 439(b)(1). The parties have stipulated for each year the amount1960 U.S. Tax Ct. LEXIS 221">*242 of equity capital as defined in section 437 under the above holding. The alternative issue raised by the petitioner need not be considered or decided in view of this holding.

Decision will be entered under Rule 50.