Could a mortgage company exclude a reserve for possible repurchase of defaulted loans sold with recourse from Louisiana franchise-tax surplus and undivided profits?

Plain-English summary

A reserve for possible repurchase of defaulted mortgage loans sold with recourse was included in surplus and undivided profits for franchise tax.

The reserve was contingent on future borrower defaults and fit none of the exclusions in La. R.S. 47:605(A).

Why the exclusions did not apply

• It was not a definitely fixed liability because no unconditional payment obligation existed unless a borrower defaulted.
• It was not depreciation because it did not reflect use, wear, or obsolescence of a tangible asset.
• It was not a bad-debt reserve because the company had sold and removed the receivables and received cash for them.
• It was not an established valuation reserve because no remaining asset on the company's books was being revalued.

Common questions

Q: Did the possibility of a future repurchase make the reserve a fixed liability?

A: No.

Q: Could the company characterize the reserve as bad debt after selling the receivables?

A: No. The receivables were no longer on its books.

Q: What was the franchise-tax result?

A: The reserve entered surplus and undivided profits.

Citations and references

• La. R.S. 47:605(A) — reserve exclusions from surplus and undivided profits
• Black's Law Dictionary definitions of depreciation and bad debt discussed in the ruling
• LAC 61:III.101.C — Revenue Ruling authority and reliance statement

Source

• Landing page: Louisiana Department of Revenue Policies
• Original PDF: LA Revenue Ruling 02-002

Original ruling text

evenue RevenueRRRRevenue Information Bulletin No 01-xxxx

Revenue Ruling
No. 02- 002
August 30, 2002
Corporation Franchise Tax
Mortgage Recourse Reserves Included in Franchise Tax Base
Purpose: The purpose of this Revenue Ruling is to determine whether recourse reserves should
be included in the computation of surplus and undivided profits for franchise tax purposes.
Analysis/Discussion: Consumer mortgage loan companies make mortgage loans to consumers.
These companies then bundle groups of these loans and sell the bundled receivables created by
these loans to agencies such as Fannie Mae. Some sales agreements with Fannie Mae are “with
recourse.” That is, if the original borrower defaults on a loan, the consumer mortgage loan
company must buy the loan back from Fannie Mae.
When the receivables are sold with recourse, they are removed from the books of the consumer
mortgage loan company because it no longer owns the receivables. At the same time, based
upon historical data, the consumer mortgage loan company creates a reserve in anticipation of
any loans it might have to repurchase due to consumer defaults.
It is the recourse reserve created at the time of sale to Fannie Mae that is the subject of this
revenue ruling. The question is if the recourse reserve can be excluded from the franchise tax
base.
La. Rev. Stat. Ann. § 47:605(A)(West 2001), provides that “… in computing surplus and
undivided profits there shall be included all reserves other than those for definitely fixed
liabilities, reasonable depreciation, bad debts and established valuation reserves….”
A definitely fixed liability implies an existing, unconditional, and legally enforceable obligation
to pay in all events. Since the mortgage recourse reserve is contingent upon the default of the
borrower, it cannot be thought of as a definitely fixed liability.
“Depreciation” is defined in Black’s Law Dictionary 452 (7th ed. 1999) as “a decline in an asset’s
value because of use, wear, or obsolescence.” Since the mortgage recourse reserve doesn’t
impact the use, wear and tear, or obsolescence of a tangible asset, it cannot be thought of as
being capable of reasonable depreciation.
“Bad Debt” is defined in Black’s Law Dictionary 410 (7th ed. 1999) as “a debt that is
uncollectible ….” Since when receivables are sold with recourse, they are removed from the
books of the consumer mortgage loan company and the company receives the cash associated
with the receivables, the mortgage recourse reserve cannot be thought of as a bad debt because
there are no accounts receivable to value.
“Established valuation reserve” is a reserve created to reflect a decrease in the value of an asset.
Since the receivable is no longer on the taxpayer’s books, the mortgage recourse reserve cannot
be thought of as an established valuation reserve because there is no asset to value.
A Revenue Ruling is issued under the authority of LAC 61III.101 (C ). A Revenue Ruling is written to provide
guidance to the public and to Department of Revenue employees. It is a written statement issued to apply principles
of law to a specific set of facts. A Revenue Ruling does not have the force and effect of law and is not binding on
the public. It is a statement of the department's position and is binding on the department until superseded or
modified by a subsequent change in statute, regulation, declaratory ruling, or court decision.

Revenue Ruling No. 02-002
Page 2 of 2

Conclusion: Since mortgage recourse reserves cannot be considered definitely fixed liabilities,
reasonable depreciation, bad debts, or established valuation reserves, such reserves should be
included in the computation of surplus and undivided profits for franchise tax purposes.
Cynthia Bridges
Secretary
By:

William (Mac) E. Little
Attorney
Policy Services Division