Did a bank report mortgage loans and debt securities at gross sales price or net gain, including when inventory securities matured or were called?

Plain-English summary

Held-for-sale loans and debt securities used gross proceeds, held-for-investment items used net gain, and the later follow-up applied gross proceeds to inventory securities that matured or were called.

The December response began with GAAP for taxable capital and federal income-tax reporting for earned surplus. Those revenue-recognition standards determined whether a mortgage loan or debt security was inventory or an investment.

• Held for sale: inventory; report gross sales price.
• Held for investment: investment or capital asset; report net gain.

The bank asked how to treat a held-for-sale security that matured or was called before an actual sale. The appended December response initially said realized gain because there was no sales price. The January 5 follow-up clarified the facts and concluded that gross proceeds received for those inventory securities were treated as gross sales price. This later clarification is the operative holding for maturity or call.

Receipts followed the location of payor: the purchaser for mortgage-loan or security sales and the issuer for maturity or call.

Currency note: This is a pre-2008 bank receipts ruling. Texas replaced the former franchise tax with the margin tax effective January 1, 2008.

What this means for you

Banks classifying loans and securities

Held-for-sale versus held-for-investment classification controlled gross-versus-net reporting under both former tax components.

Tax professionals

Read the later follow-up first. It changes the maturity/call result after factual clarification and should not be blended with the earlier sentence.

Common questions

Q: How were held-for-sale items reported?
A: At gross sales price or gross proceeds.

Q: How were held-for-investment items reported?
A: At net gain.

Q: Who was the payor on maturity or call?
A: The entity issuing the security.

Citations and references

• Texas Tax Code Secs. 171.112(a), 171.1121(a), 171.105(b), and 171.1051(b)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9901261L

Original ruling text

January 5, 1999

Dear Mr. **:

This is in response to your inquiry of December 21, 1998 which is a followup to
our letter ruling concerning the sales of mortgage loans, debt securities, and
maturities or calls of the debt securities. Thank you for the clarification of
the situation involving a maturity or call of a debt security.

In those situations, the gross proceeds received for those securities held as
inventory (as categorized in the letter ruling) would be considered the gross
sales price in the calculation of the bank's gross receipts for apportionment
purposes.

This response is based on the facts presented. If there are different or
additional facts, the response may change.

If you have any questions, please call toll-free 1-800-531-5441, extension
3-4496 or (512)463-4496.

Sincerely,

Jerry Bobbitt
Tax Policy Division

December 16, 1998

Dear Mr. **:

Thank you for the information contained in your letter of November 23, 1998
concerning the activities of a Texas banking corporation. This response
represents the franchise tax implications of the situation described in the
ruling request.

You have indicated that a portion of the bank's gross receipts are from the
sales of mortgage loans, sales of debt securities, and maturities or calls of
debt securities. The ruling request asks if the receipts from these
transactions should be reported at their gross sales price or at their net
gain. It also asks how the respective receipts should be apportioned.

As you noted, the statutory definitions of gross receipts for taxable capital
and earned surplus look to the Generally Accepted Accounting Principles (GAAP)
and federal income tax reporting (FIT) concepts of recognizing revenue,
respectively. Sections 171.112(a) and 171.1121(a), Texas Tax Code.

With respect to the "gross vs. net" issue, we have to distinguish sales of
inventory items from investments and capital assets in the application of
Sections 171.105(b) and 171.1051(b). Because of the GAAP and FIT standards
used in the definitions of gross receipts, these authorities are the starting
point for determining if an item is inventory or an investment/capital asset.

It is our understanding that in accordance with GAAP and industry practice,
banks designate mortgage loans and debt securities as either items "held for
sale" or "held for investment". Consistent with the definitions of "inventory"
contained in the ruling request, mortgage loans and debt securities designated
as "held for sale" have been considered to be inventory items for franchise tax
purposes (with the gross sales price included in the receipts factor).

Those loans and securities that have been designated as "held for investment"
would be considered investments for purposes of applying Sec. 171.105(b). Such
designation reflects the corporation's intent and ability to hold the loans as
investments. The net gain from the sale of an investment would be included in
the bank's gross receipts.

For earned surplus reporting, the same basic approach would be applied - the
loans and securities held for sale would be treated as inventory, with the
receipts reported at the gross sales price. The other loans and securities
would presumably be held for investment and be reported as such under Sec.
171.1051(b). Accordingly, the net gain from the sale of an investment would be
included in the bank's gross receipts.

You indicated that a security held for sale sometimes matures or is called
before it is actually sold. In the absence of a "gross sales price" in these
instances, the revenue recognized by the bank would be the realized gain
attributed to the security. This amount would be reported as gross receipts
for apportionment purposes.

The receipts from the transactions described above would be apportioned to the
location of payor. The purchaser of the mortgage loans or securities would be
considered the payor. For those securities that mature or are called, the
payor would be the entity issuing the security.

This response is based on the facts presented. If there are different or
additional facts, the response may change.

If you have any questions, please call toll-free 1-800-531-5441, extension
3-4496 or (512)463-4496.

Sincerely,

Jerry Bobbitt
Tax Policy Division