                       129 T.C. No. 15



                UNITED STATES TAX COURT



           PSB HOLDINGS, INC., Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 14724-05.               Filed November 1, 2007.



     P is the holding company of an affiliated group of
corporations that files consolidated Federal income tax
returns. The other members are P’s wholly owned bank
(B) and B’s wholly owned investment company (IC). Both
B and IC own tax-exempt obligations. Only B incurs
interest expenses. IC’s tax-exempt obligations were
either purchased by IC or received from B before the
subject years as contributions to capital. R
determined that B must include all of IC’s tax-exempt
obligations in the calculation of B’s average adjusted
bases of tax-exempt obligations under secs.
265(b)(2)(A) and 291(e)(1)(B)(ii)(I), I.R.C. On the
consolidated income tax returns for the subject years,
B included IC’s obligations in the calculation only to
the extent that B had purchased the obligations and
transferred them to IC; in other words, B omitted from
the calculation those obligations that IC purchased.
     Held: The calculation of B’s average adjusted
bases of tax-exempt obligations does not include the
tax-exempt obligations purchased by IC.
                               - 2 -

     Debra Sadow Koenig, for petitioner.

     Lawrence C. Letkewicz, Christa A. Gruber, and Sharon S.

Galm, for respondent.



                              OPINION


     LARO, Judge:   This case was submitted to the Court under

Rule 122 for decision without trial.1   Petitioner petitioned the

Court to redetermine respondent’s determination of deficiencies

of $33,622, $38,571, $41,654, and $31,868 in the 1999, 2000,

2001, and 2002 Federal income taxes, respectively, of its

affiliated group.   For those years, the group filed consolidated

Federal corporate income tax returns.   The group included

petitioner, petitioner’s wholly owned subsidiary Peoples State

Bank (Peoples), and Peoples’ wholly owned investment subsidiary

PSB Investments, Inc. (Investments).

     We decide whether Peoples must include the tax-exempt

obligations purchased and owned by Investments in the calculation

of Peoples’ average adjusted bases of tax-exempt obligations

under sections 265(b)(2)(A) and 291(e)(1)(B)(ii)(I).   We hold

that the calculation does not include those obligations.




     1
       Rule references are to the Tax Court Rules of Practice and
Procedure. Unless otherwise noted, section references are to the
applicable versions of the Internal Revenue Code.
                               - 3 -

                            Background

     All facts were stipulated or contained in the exhibits

submitted with the stipulations.    The stipulated facts and

exhibits are incorporated herein by this reference.    When the

petition was filed, petitioner’s mailing address and principal

place of business were in Wausau, Wisconsin.

     Petitioner is a holding company and the common parent of an

affiliated group of corporations that file consolidated Federal

income tax returns.   Petitioner’s common stock is held by

approximately 1,000 shareholders.    The other members of the

affiliated group are petitioner’s wholly owned subsidiary

(Peoples) and Peoples’ wholly owned subsidiary (Investments).

For financial and regulatory accounting purposes, Investments and

Peoples consolidate their assets, liabilities, income, and

expenses.

     Peoples was organized in 1962 as a State bank under

Wisconsin law.   Peoples’ main office is located in Wausau,

Wisconsin, and it has several branch offices in Wisconsin

communities near Wausau.   Peoples is petitioner’s sole

subsidiary.   Peoples’ sole subsidiary is Investments.

     On or about April 23, 1992, Peoples organized Investments in

Nevada.   Investments does business exclusively in Nevada, with

offices in Las Vegas, Nevada, and offsite record storage at a

third-party facility in Las Vegas.     Investments has no depository
                                 - 4 -

or lending powers, and, as relevant here, does not qualify as

either a “bank” or a “financial institution” for Federal income

tax purposes.    For other purposes, Investments is considered to

be a financial institution subject to Federal and State

supervision.

       Peoples organized Investments to consolidate and improve the

efficiency of managing, safekeeping, and operating the securities

investment portfolio then held by Peoples and to reduce Peoples’

State tax liability.    Nevada has neither a corporate income tax

nor a corporate franchise tax.    Wisconsin has a corporate

franchise tax of 7.9 percent of a corporation’s net income.    For

purposes of the Wisconsin tax, Wisconsin considers “income” to

include interest income from federally tax-exempt obligations.      A

wholly owned subsidiary of a Wisconsin corporation with no nexus

to the State is not subject to Wisconsin’s corporate franchise

tax.    Investments was organized without a nexus to Wisconsin so

as not to be subject to Wisconsin’s corporate franchise tax.

       From on or about April 23, 1992, through December 1, 2002,

Peoples transferred to Investments cash, tax-exempt obligations,

taxable securities, and loan participations (fractional interests

in loans originated by Peoples), including substantially all of

Peoples’ long-term investments.    The cash totaled $18,460 and was

transferred to Investments upon its organization in exchange for

all of its common stock.    The tax-exempt obligations and taxable
                               - 5 -

securities totaled $38,141,487, and the loan participations

totaled $27,710,909; these three categories of assets were

transferred to Investments as paid-in capital.   No security or

tax-exempt obligation of any kind was transferred by Peoples to

Investments during the subject years.   Of the taxable securities

and tax-exempt obligations that Peoples transferred to

Investments, 17 percent were federally tax-exempt municipal

securities, 41 percent were federally taxable securities (issued

primarily by Government agencies), and 42 percent were loan

participation interests.   At the time of the transfers, no

liabilities encumbered the transferred securities or obligations,

and Investments did not assume any liability of Peoples.

Investments did not sell any tax-exempt obligation or taxable

security before maturity, and all such obligations and securities

received from Investments matured by the end of the subject

years.   Investments’ income for the subject years was

attributable to holding federally taxable securities, federally

tax-exempt obligations, and loan participations.   Investments did

not own any other asset, and it did not provide services to

unrelated third parties.

     Investments’ total assets during the subject years

represented about 20 percent of the total assets of Investments

and Peoples combined.   During each of those years, Peoples

incurred approximately $8 million to $12 million of interest
                               - 6 -

expenses; Investments incurred no interest expense.     During 1999

and 2000, Investments owned almost $14 million in tax-exempt

obligations; Peoples owned virtually none.     During 2001 and 2002,

Investments owned over $17 million in tax-exempt obligations,

which represented more than 80 percent of the tax-exempt

obligations owned by Investments and Peoples combined.

     The Internal Revenue Code provides (as further discussed

below) that the amount of a financial institution’s interest

expense allocated to tax-exempt interest, and thus rendered

nondeductible, is computed by multiplying the otherwise allowable

interest expense by a fraction prescribed in the statutes.     The

fraction’s numerator (numerator) equals “the taxpayer’s average

adjusted [bases] * * * of [tax-exempt] obligations”.     See secs.

265(b)(2)(A), 291(e)(1)(B)(ii)(I).     The fraction’s denominator

(denominator) equals the “average adjusted [bases] for all assets

of the taxpayer”.   See secs. 265(b)(2)(B), 291(e)(1)(B)(ii)(II).

On the consolidated returns filed by petitioner’s affiliated

group for the subject years, Peoples included its adjusted basis

in its Investments’ stock in Peoples’ calculation of the

denominator.   Peoples’ basis in its Investments’ stock equaled

Investments’ basis in Investments’ assets.     For each subject

year, Peoples included all of the tax-exempt obligations that

were purchased by Peoples and that were outstanding as of the end

of the year in Peoples’ calculation of the numerator.     Some of
                              - 7 -

those obligations were owned by Investments during the year,

having been earlier transferred by Peoples to the capital of

Investments.

     The notice of deficiency states as follows:

          It has been determined that you transferred
     tax-exempt securities from your bank to investment
     subsidiaries. By this transfer, you managed to
     separate tax-exempt investments from their interest
     expense which resulted in a reduction of your exposure
     to the TEFRA interest expense disallowance rules under
     Internal Revenue Code sections 291 and 265(b).

          It has further been determined that the investment
     subsidiaries do not carry on any real business
     operations on their own. Rather, they are merely an
     incorporated “Shell” whose only real purpose is to
     avoid taxation. In actuality, their business is
     conducted by or through their parent banks.

          It has further been determined that the investment
     subsidiaries’ assets and liabilities are those of their
     parent banks, since for all other reporting purposes,
     both financial and regulatory, reporting is required to
     be done on a consolidated basis. The assets and
     liabilities are considered those of their parent banks.
     Therefore, it is determined that for purposes of
     computing your income tax liabilities, you must include
     the assets and tax-exempt securities of the
     subsidiaries in your computation of unallowable
     interest expense under the TEFRA provisions.

          The recalculation of non deductible interest
     expense, under Sections 291 and 265(b) of the Internal
     Revenue Code, based on the inclusion of the assets and
     tax-exempt balances of Peoples State Bank and/or PSB
     Investments, Inc. with that of the assets and
     tax-exempt balances of their respective parent banks
     increases your taxable incomes by: $98,890 for the
     year ended 12-31-1999; $113,445 for the year ended
     12-31-2000; $122,513 for the year ended 12-31-2001 and;
     $93,731 for the year ended 12-31-2002. Refer to
     Exhibit A through Exhibit D for further explanation.
                                 - 8 -

Respondent has since conceded the determination stated in the

second paragraph quoted above.    Respondent also concedes that

Investments was created to reduce State taxes and is a separate

business entity that is not a sham.

                            Discussion

     We decide the narrow issue of whether Peoples must include

the tax-exempt obligations purchased and owned by Investments in

the calculation of Peoples’ average adjusted bases of tax-exempt

obligations under sections 265(b)(2)(A) and 291(e)(1)(B)(ii)(I).2

Petitioner argues that the relevant text in those sections

provides that Peoples calculate the numerator without regard to

those obligations.3   Respondent disagrees.   As respondent sees


     2
       Petitioner invites the Court to decide that the
calculation does not include any tax-exempt obligation owned by
Investments. We decline to do so. The consolidated returns
reported that the calculation included all outstanding tax-exempt
obligations purchased by Peoples and transferred to Investments,
and respondent’s determination in the notice of deficiency
relates to that position. Moreover, petitioner states in its
opening posttrial brief that it is not requesting either an
adjustment or a refund as to its reporting position. Nor does
the petition request such an adjustment or refund. We consider
it inappropriate to decide the issue proffered by petitioner
because it does not relate to the decision that we will enter on
the amount of deficiency (if any) in the affiliated group’s
income tax for the subject years.
     3
       We set forth the applicable text of secs. 265(b) and
291(e) in the appendix. The relevant text of sec. 265(b)(2)(A),
“the taxpayer’s average adjusted bases (within the meaning of
section 1016) of tax-exempt obligations” is similar to the
relevant text of sec. 291(e)(1)(B)(ii)(I), “the taxpayer’s
average adjusted basis (within the meaning of section 1016) of
obligations described in clause (i)”; i.e., tax-exempt
                                                   (continued...)
                                - 9 -

it, the relevant text when read in the light of the statutes’

legislative intent allows respondent for purposes of the

numerator to treat Investments’ assets as owned by Peoples.   We

agree with petitioner that the relevant text does not include in

the numerator the tax-exempt obligations purchased and owned by

Investments.

     Section 265(a)(2) provides that no deduction shall be

allowed for interest on indebtedness incurred or continued to

purchase or carry obligations the interest on which is wholly

exempt from Federal income tax.   For purposes of that provision,

whether a taxpayer’s indebtedness was incurred or continued to

purchase or carry tax-exempt obligations generally depends on the

taxpayer’s purpose in incurring the indebtedness.   See Wisconsin

Cheeseman, Inc. v. United States, 388 F.2d 420, 422 (7th Cir.

1968).    In other words, a disallowance of interest expenses under

section 265(a)(2) requires a finding of a sufficiently direct

relationship between a borrowing and a tax-exempt investment.

See id.

     Congress enacted section 291(a)(3) and (e)(1)(B) in 1982.

See Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA),

Pub. L. 97-248, sec. 204(a), 96 Stat. 423.   As enacted, those



     3
      (...continued)
obligations. For purposes of our analysis, we consider the
relevant text of each of those sections to be the same and refer
to that text as the relevant text.
                              - 10 -

provisions provided a 15-percent cutback in a corporate tax

preference item affecting certain financial institutions.4    The

cutback applied to the deduction otherwise allowable for “the

amount of interest on indebtedness incurred or continued to

purchase or carry [tax-exempt] obligations acquired after

December 31, 1982”.   The amount of the cutback was calculated by

applying to the otherwise allowable interest expense a fraction

that is virtually the same as in the current version of the

statutes.   The report of the Senate Finance Committee, the

committee in which TEFRA section 204(a) originated, sets forth

the following rationale with respect to the cutback and similar

provisions:

          Numerous corporate tax preferences have been
     enacted over the years in order to stimulate business
     investment and advance other worthwhile purposes. For
     several reasons, some of these tax preferences should
     be scaled back. First, the federal budget faces large
     deficits, which will require large reductions in direct
     Federal spending. In addressing these deficits, tax
     preferences should also be subject to careful scrutiny.
     Second, in 1981 Congress enacted the Accelerated Cost
     Recovery System, which provides very generous
     incentives for investment in plant and equipment. ACRS
     makes some corporate tax preferences less necessary.
     Third, there is increasing concern about the equity of
     the tax system, and cutting back corporate tax
     preferences is a valid response to that concern.


     4
       The 15-percent cutback was increased to 20 percent in the
Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 68(a),
98 Stat. 588. The referenced corporate tax preference was that
under prior law, banks had been effectively excused from sec.
265(a)(2) on the ground that their obligations to their
depositors did not constitute “indebtedness” within the meaning
of that section.
                               - 11 -

          For these reasons, the committee bill contains a
     15-percent across-the-board cutback in a series of
     corporate tax preferences. [S. Rept. 97-494 (Vol. 1),
     at 118-119 (1982).]

     Four years later, in 1986, Congress enacted section 265(b).

See Tax Reform Act of 1986, Pub. L. 99-514, sec. 902(a), 100

Stat. 2380.   According to the report of the House Ways and Means

Committee, Congress enacted section 265(b) for two reasons.

First, the report states, financial institutions had been allowed

to deduct interest payments regardless of their tax-exempt

holdings, a result, the committee concluded, that discriminated

in favor of financial institutions at the expense of other

taxpayers.    See H. Rept. 99-426, at 588-589 (1985), 1986-3 C.B.

(Vol. 2) 1, 588-589.   Second, the report states, financial

institutions had been allowed to reduce their tax liability

drastically by investing in tax-exempt obligations.    Id.    The

report explains that

           To correct these problems, the committee bill
     denies financial institutions an interest deduction in
     direct proportion to their tax-exempt holdings. The
     committee believes that this proportional disallowance
     rule is appropriate because of the difficulty of
     tracing funds within a financial institution, and the
     near impossibility of assessing a financial
     institution’s “purpose” in accepting particular
     deposits. The committee believes that the proportional
     disallowance rule will place financial institutions on
     approximately an equal footing with other taxpayers.
     [Id.]

The report explains that the amount of interest allocable to

tax-exempt obligations for purposes of section 265(b) is
                                 - 12 -

determined under rules similar to those that apply under section

291(a)(3) and (e)(1)(B).   Id.

     As enacted, sections 265(b) and 291(a)(3) and (e)(1)(B)

reduce the interest expense deductions of financial institutions

without requiring evidence of a direct relationship between

borrowing and tax-exempt investment.      Specifically, those

sections disallow a deduction with respect to the portion of a

financial institution’s interest expense that is allocable, on a

pro rata basis, to its holdings in tax-exempt obligations.      While

section 265(b) disallows a deduction for the entire amount of

that portion of a financial institution’s interest expense

allocable to tax-exempt obligations, section 291(a)(3) and

(e)(1)(B) disallows only 20 percent of the interest expense

allocable to those obligations.

     The 20-percent rule of section 291(a)(3) and (e)(1)(B)

applies with respect to tax-exempt obligations acquired from

January 1, 1983, through August 7, 1986.      The 100-percent rule of

section 265(b) generally applies to those tax-exempt obligations

acquired after August 7, 1986.     In the latter case, however,

section 265(b)(3) provides a special rule for a “qualified

tax-exempt obligation”, defined in section 265(b)(3)(B) as a

certain tax-exempt obligation issued by small issuers.      Under

section 265(b)(3)(A), a “qualified tax-exempt obligation”

acquired after August 7, 1986, is treated for purposes of
                                - 13 -

sections 265(b)(2) and 291(e)(1)(B) as if it were acquired on

August 7, 1986; thus, qualified tax-exempt obligations reduce

interest expense deductions under section 291(a)(3) and

(e)(1)(B), rather than under section 265(b).    The parties agree

that the tax-exempt obligations owned by Investments are

“qualified tax-exempt obligations”.

     In calculating the amount of the denominator for Peoples,

the parties agree that the denominator includes Peoples’ adjusted

basis in its Investments stock.    The parties lock horns on

whether the tax-exempt obligations purchased and owned by

Investments must be included in the numerator.    On the

consolidated returns, Peoples omitted those obligations from the

numerator.   Respondent determined that those obligations are

included in the numerator.   As respondent sees it, because the

basis of Peoples’ Investments stock is included in the

denominator, the portion of that basis attributable to the bases

of Investments’ tax-exempt obligations is included in the

numerator.

     We begin our analysis with the relevant text.   We interpret

the text with reference to the legislative history primarily to

learn the purpose of the statutes and to resolve any ambiguity in

the text.    See United States v. Am. Trucking Associations, Inc.,

310 U.S. 534, 543-544 (1940).    We apply the text as written

unless we find that a word’s meaning is “‘inescapably ambiguous’”
                               - 14 -

or that such an application “‘would thwart the purpose of the

overall statutory scheme or lead to an absurd or futile result.’”

Booth v. Commissioner, 108 T.C. 524, 568, 569 (1997) (quoting

Garcia v. United States, 469 U.S. 70, 76 n.3 (1984), and

Albertson’s, Inc. v. Commissioner, 42 F.3d 537, 545 (9th Cir.

1994), affg. 95 T.C. 415 (1990)); see United States v. Am.

Trucking Associations, Inc., supra at 543; see also United States

v. Shriver, 989 F.2d 898, 901 (7th Cir. 1992); Allen v.

Commissioner, 118 T.C. 1 (2002).

       The applicable text refers to “the taxpayer’s average

adjusted [bases] * * * of [tax-exempt] obligations” and the

“average adjusted bases for all assets of the taxpayer”.    We read

that text to refer to the tax-exempt obligations and assets owned

by Peoples alone or, in other words, by the “taxpayer” for whom

the subject calculation is performed.    We do not read that text

to provide that a taxpayer such as Peoples must include in its

tax-exempt obligations any tax-exempt obligation purchased and

owned by another taxpayer, whether the taxpayers be related or

not.    Cf. First Chicago NBD Corp. v. Commissioner, 135 F.3d 457

(7th Cir. 1998) (holding that section 902 did not allow

aggregation where the statute referred literally to “a”

corporation rather than to a group of affiliated corporations),

affg. 96 T.C. 421 (1991).    We understand Congress to have enacted

the text as a means for raising revenue and bolstering equity in
                              - 15 -

our tax system.   We understand Congress to have intended for the

statutes to deny some or all of a financial institution’s

otherwise allowable interest expense deduction to the extent that

the interest is allocable to the tax-exempt obligations it owns.

We do not understand Congress to have specifically spoken through

the statutes to the situation here, where tax-exempt obligations

are purchased and owned by a subsidiary of a financial

institution.

     Respondent asserts that the adjusted bases of Peoples’

assets in the denominator include the adjusted basis of Peoples’

stock in Investments which, in turn, reflects the assets owned by

Investments.   Respondent concludes that Investments’ assets are

therefore considered assets of Peoples for purposes of

calculating the numerator.   We disagree.   The numerator consists

of the “taxpayer’s average adjusted bases   * * * of tax-exempt

obligations”, but Peoples has no adjusted bases in any of the

tax-exempt obligations purchased and owned by Investments.

Moreover, the statutes use the term “taxpayer” in the singular,

and well-established law treats Peoples and Investments as

separate taxpayers notwithstanding the fact that they join in the

filing of a consolidated return.   See, e.g., Wegman’s Props.,

Inc. v. Commissioner, 78 T.C. 786, 789 (1982) (citing, inter

alia, Natl. Carbide Corp. v. Commissioner, 336 U.S. 422 (1949),

Interstate Transit Lines v. Commissioner, 319 U.S. 590 (1943),
                              - 16 -

and Woolford Realty Co. v. Rose, 286 U.S. 319 (1932)); cf.

Gottesman & Co. v. Commissioner, 77 T.C. 1149, 1156 (1981) (“to

the extent the consolidated return regulations do not mandate

different treatment, corporations filing consolidated returns are

to be treated as separate entities when applying other provisions

of the Code”).   Nor do the consolidated return regulations, as

applicable here, change this result.   Those regulations require

that Peoples calculate its net income separately from

Investments’ net income.   See sec. 1.1502-11(a)(1), Income Tax

Regs. (stating that taxable income is calculated for an

affiliated group by taking into account the separate taxable

income of each member of the group).   Respondent has not

identified, nor are we aware of, any provision in the

consolidated return regulations that would require the tax-exempt

obligations purchased and owned by Investments to be taken into

account in the calculation of Peoples’ interest expense

deduction.   Nothing that we read in the statutes or in the

consolidated return regulations directs us to ignore the separate

existence of Investments and Peoples or otherwise to treat

Investments’ self-purchased tax-exempt obligations as owned by

Peoples for purposes of calculating the numerator as to Peoples.

     Congress knew how to require a taxpayer to take into account

the assets of another taxpayer had Congress intended to include

respondent’s “look-through” approach in the applicable statutes.
                                - 17 -

See, e.g., sec. 265(b)(3)(E).    Congress, however, did not in

those statutes provide any aggregation or indirect ownership rule

that would apply to the numerator.       Instead, Congress referred

simply to the obligations of the “taxpayer” for purposes of

making that calculation.   “‘[W]here Congress includes particular

language in one section of a statute but omits it in another

section of the same Act, it is generally presumed that Congress

acts intentionally and purposely in the disparate inclusion or

exclusion.’”   Russello v. United States, 464 U.S. 16, 23 (1983)

(quoting United States v. Wong Kim Bo, 472 F.2d 720, 722 (5th

Cir. 1972)).

     Respondent argues that not reading the relevant text as

providing for Peoples’ indirect ownership of the subject

tax-exempt obligations leads to an “absurd” result.       We disagree.

As discussed above, Congress apparently did not specifically

intend through the applicable statutes to address the gap left

open in the setting at hand.    We apply the law as written by

Congress and leave it to Congress or to the Department of the

Treasury, the latter through and to the extent of its regulatory

authority or by other permissible means, to address any gaps in

the statutes as written.   See Lamie v. United States, 540 U.S.

526, 538 (2004).   To be sure, agencies such as the Internal

Revenue Service have a great amount of authority to issue

regulations to fill gaps in a statute.       See, e.g., Chevron
                               - 18 -

U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837,

842-844 (1984).   In addition, as applicable to taxpayers who file

consolidated returns, such as here, the Commissioner has vast

authority to prescribe regulations to curtail or otherwise

address any perceived abuse.   See United Dominion Indus., Inc. v.

United States, 532 U.S. 822, 836-837 (2001).

     Respondent also argues for a contrary reading, noting that

Peoples and Investments consolidated their assets, liabilities,

income, and expenses for financial and regulatory accounting

purposes.5   We are unpersuaded by this argument.   Neither

financial nor regulatory accounting controls the manner in which

a taxpayer must report its operations for Federal income tax

purposes.    See Thor Power Tool Co. v. Commissioner, 439 U.S. 522,

542-543 (1979); Signet Banking Corp. v. Commissioner, 106 T.C.

117, 130-131 (1996), affd. 118 F.3d 239 (4th Cir. 1997).      In

fact, we note another major difference from the manner in which

Investments is treated for Federal income tax purposes; to wit,

that Investments is considered to be a financial institution for

Federal and State oversight purposes but is not considered to be

a bank or financial institution for Federal income tax purposes.

We also note that respondent has not argued, nor do we find, that


     5
       While the inconsistency between financial and regulatory
accounting, on the one hand, and tax accounting, on the other
hand, appears from the notice of deficiency to be a primary
determination by respondent, respondent in brief has relegated
this inconsistency to simply a factor to consider.
                               - 19 -

he exercised any discretion afforded to him by section 446(b) or

482.    Instead, as discussed above, the linchpin of respondent’s

arguments is that the statutes on their face require that the

basis of Peoples’ Investments stock be included in the

denominator and that the portion of that basis attributable to

the bases of Investments’ tax-exempt obligations is therefore

also included in the numerator.

       Lastly, respondent observes, the Commissioner has issued

Rev. Rul. 90-44, 1990-1 C.B. 54, interpreting the applicable

statutes to provide that the tax-exempt obligations of a

subsidiary may be taken into account in calculating the numerator

for a parent bank.    Respondent asserts that the Commissioner

issued this ruling under the same formal procedures that he would

have been required to follow had he prescribed regulations on the

subject.    Respondent argues that the revenue ruling is entitled

to “judicial respect” as “persuasive precedent that should be

followed unless unreasonable”.

       While we believe that the Commissioner’s interpretation as

set forth in Rev. Rul. 90-44, supra, is entitled to consideration

by this Court, we decline respondent’s invitation to equate the

authority of the ruling with that of a regulation or otherwise to

give the ruling the degree of deference that is typically

afforded to regulations under Chevron U.S.A. Inc. v. Natural Res.

Def. Council, Inc., supra, and its progeny.    As explained below,
                              - 20 -

we evaluate the revenue ruling under the less deferential

standard enunciated in Skidmore v. Swift & Co., 323 U.S. 134

(1944), according the ruling respect proportional to its “power

to persuade”.   See United States v. Mead Corp., 533 U.S. 218,

234-235, 237 (2001).

     Rev. Rul. 90-44, 1990-1 C.B. at 57, states in relevant part:

          If one or more financial institutions are members
     of an affiliated group of corporations (as defined in
     section 1504 of the Code), then, even if the group
     files a consolidated return, each such institution must
     make a separate determination of interest expense
     allocable to tax-exempt interest, rather than a
     combined determination with the other members of the
     group.

          However, in situations involving taxpayers which
     are under common control and one or more of which is a
     financial institution, in order to fulfill the
     congressional purpose underlying section 265(b) of the
     Code, the District Director may require another
     determination of interest expense allocable to
     tax-exempt interest to clearly reflect the income of
     the financial institution or to prevent the evasion or
     avoidance of taxes.

The first quoted paragraph parallels the text of the statutes,

stating that the subject calculation “must” be made separately

for each member of the affiliated group.    The second quoted

paragraph departs from that text, creating an exception that

“may” apply to taxpayers under common control when one or more of

the taxpayers is a financial institution.    The ruling sets forth

no reasoning or authority for the exception, other than stating

that the exception was prescribed “in order to fulfill the

congressional purpose underlying section 265(b)” and may be
                              - 21 -

invoked “to clearly reflect the income of the financial

institution and to prevent the evasion or avoidance of taxes”.

     At the outset, we note that the notice of deficiency makes

no mention of Rev. Rul. 90-44, supra.   Thus, while the ruling

states that the District Director may require a determination of

interest expense under a rule that is different from that stated

in the statutes, we find no basis in the record from which to

find (or to conclude) that the District Director has in fact

exercised the authority purportedly given to him by the statutes.

To the contrary, we read the notice of deficiency to indicate

that respondent observed that Peoples had transferred tax-exempt

obligations to Investments so that Peoples afterwards had

interest expenses but little to no tax-exempt interest income and

determined that the transfer was ineffective for Federal income

tax purposes because:   (1) Investments was not a legitimate

business entity with independent business operations but was a

sham created solely to avoid taxes, and (2) Investments’ assets

and liabilities are viewed as those of Peoples because Peoples

and Investments reported their operations for financial and

regulatory reporting purposes on a consolidated basis.

     All the same, we are not bound by an interpretation in a

revenue ruling.   See Rauenhorst v. Commissioner, 119 T.C. 157,

173 (2002); see also Johnson v. Commissioner, 115 T.C. 210, 224

(2000).   The Court of Appeals for the Seventh Circuit has held
                              - 22 -

similarly, stating that revenue rulings are entitled to limited

deference.   See Bankers Life & Cas. Co. v. United States,

142 F.3d 973, 978 (7th Cir. 1998); First Chicago NBD Corp. v.

Commissioner, 135 F.3d 457 (7th Cir. 1998); see also U.S.

Freightways Corp. v. Commissioner, 270 F.3d 1137, 1141 (7th Cir.

2001) (discussing the level of deference owed to agency

interpretations after United States v. Mead Corp., supra), revg.

113 T.C. 329 (1999).   The Commissioner also recognizes the

limited strength of a revenue ruling, explaining in his

procedural rules that “The conclusions expressed in Revenue

Rulings will be directly responsive to and limited in scope by

the pivotal facts stated in the revenue ruling”, sec.

601.601(d)(2)(v)(a), Statement of Procedural Rules, and “Revenue

Rulings published in the Bulletin do not have the force and

effect of Treasury Department Regulations”, sec.

601.601(d)(2)(v)(d), Statement of Procedural Rules.

     In United States v. Mead Corp., supra, the Supreme Court

considered the degree of judicial deference afforded to a ruling

by the U.S. Customs Service as to a tariff classification.    The

Court stated:   “We agree that a tariff classification has no

claim to judicial deference under Chevron, there being no

indication that Congress intended such a ruling to carry the

force of law, but we hold that under Skidmore v. Swift & Co.,

323 U.S. 134 (1944), the ruling is eligible to claim respect
                              - 23 -

according to its persuasiveness.”   Id. at 221.   In Skidmore v.

Swift & Co., supra at 140, the Court stated:

          We consider that the rulings, interpretations and
     opinions * * * while not controlling upon the courts by
     reason of their authority, do constitute a body of
     experience and informed judgment to which courts and
     litigants may properly resort for guidance. The weight
     of such a judgment in a particular case will depend
     upon the thoroughness evident in its consideration, the
     validity of its reasoning, its consistency with earlier
     and later pronouncements, and all those factors which
     give it power to persuade, if lacking power to control.

See also Christensen v. Harris County, 529 U.S. 576, 587 (2000)

(an agency’s interpretation reached without formal notice and

comment rulemaking is entitled to respect only when it has the

“power to persuade”); cf. Kort v. Diversified Collection Servs.,

Inc., 394 F.3d 530, 539 (7th Cir. 2005).

     We conclude that we must evaluate the revenue ruling at hand

under the “power to persuade” standard set forth in Skidmore.

While respondent invites the Court to afford the ruling greater

judicial deference by asserting that the ruling was issued in the

same manner as regulations on the subject would have been, we

decline that invitation.   Cf. Ind. Fam. & Soc. Servs. Admin. v.

Thompson, 286 F.3d 476, 480 (7th Cir. 2002).   In addition to the

fact that the Commissioner’s procedural rules state specifically

that revenue rulings “do not have the force and effect of

Treasury Department Regulations”, sec. 601.601(d)(2)(v)(d),

Statement of Procedural Rules, we consider most significant the

fact that the revenue ruling, unlike most Treasury Department
                              - 24 -

regulations, did not undergo any public review or comment before

its issuance.

     In accordance with the analysis under United States v. Mead

Corp., 533 U.S. 218 (2001), we decline to adopt the exception set

forth in Rev. Rul. 90-44, supra.   First, as we have discussed,

the exception does not properly interpret the text of the

statutes as written.   See Commissioner v. Schleier, 515 U.S. 323,

336 n.8 (1995).   Second, we find in the ruling neither adequate

“thoroughness evident in its consideration” nor adequate

“reasoning” as to the presence of the exception in the statutes.

See Skidmore v. Swift & Co., supra at 140.      The ruling simply

states that the exception was included in the revenue ruling “in

order to fulfill the congressional purpose underlying section

265(b)” and may be invoked “to clearly reflect the income of the

financial institution and to prevent the evasion or avoidance of

taxes”.   Rev. Rul. 90-44, 1990-1 C.B. at 57.    Third, the revenue

ruling was issued many years after the enactment of the relevant

statutes, approximately 8 years after the enactment of section

291(a)(3) and (e)(1)(B) and 4 years after the enactment of

section 265(b).

     We hold that the numerator does not include the tax-exempt

obligations purchased and owned by Investments and sustain

petitioner’s reporting position.   We have considered all of the
                             - 25 -

parties’ arguments and have rejected those arguments not

discussed herein as irrelevant or without merit.


                                        Decision will be entered

                                   under Rule 155.
                          - 26 -

                         APPENDIX

     SEC. 265(b). Pro rata Allocation of Interest
Expense of Financial Institutions to Tax-Exempt
Interest.--

          (1) In general.--In the case of a
     financial institution, no deduction shall be
     allowed for that portion of the taxpayer’s
     interest expense which is allocable to
     tax-exempt interest.

          (2) Allocation.--For purposes of
     paragraph (1), the portion of the taxpayer’s
     interest expense which is allocable to
     tax-exempt interest is an amount which bears
     the same ratio to such interest expense as--

               (A) the taxpayer’s average
          adjusted bases (within the meaning
          of section 1016) of tax-exempt
          obligations acquired after August
          7, 1986, bears to

               (B) such average adjusted
          bases for all assets of the
          taxpayer.

     SEC. 291(e).   Definitions.--For purposes of this
section--

          (1) Financial institution preference
     item.--The term “financial institution
     preference item” includes the following:

          *    *     *    *    *    *      *

               (B) Interest on debt to carry
          tax-exempt obligations acquired
          after December 31, 1982, and before
          August 8, 1986.--

                    (i) In general.--In
               the case of a financial
               institution which is a
               bank (as defined in
               section 585(a)(2)), the
               amount of interest on
              - 27 -

     indebtedness incurred or
     continued to purchase or
     carry obligations
     acquired after December
     31, 1982, and before
     August 8, 1986, the
     interest on which is
     exempt from taxes for the
     taxable year, to the
     extent that a deduction
     would (but for this
     paragraph or section
     265(b)) be allowable with
     respect to such interest
     for such taxable year.

     (ii) Determination of interest
allocable to indebtedness on
tax-exempt obligations.--Unless the
taxpayer (under regulations
prescribed by the Secretary)
establishes otherwise, the amount
determined under clause (i) shall
be an amount which bears the same
ratio to the aggregate amount
allowable (determined without
regard to this section and section
265(b)) to the taxpayer as a
deduction for interest for the
taxable year as--

          (I) the taxpayer’s
     average adjusted basis
     (within the meaning of
     section 1016) of
     obligations described in
     clause (i), bears to

          (II) such average
     adjusted basis for all
     assets of the taxpayer.
