Third Circuit Applies Narrow Interpretation of INDOPCO

In PNC Bancorp, 5/19/00, the Third Circuit reversed the Tax Court and upheld the deductibility of loan origination costs as ordinary and necessary business expenses, because PNC incurred them in the normal course of its production of day-to-day income. Two banks incurred the costs before they merged with PNC, in connection with their issuance of customer loans; the court described these costs as routine and integral to the banking business.

The court cited INDOPCO, Inc., 503 US 79 (1992), for the test that capitalized expenditures "relate to the corporation's operations and betterment into the indefinite future," while deductible expenses are instead geared toward "income production or other current needs." The court determined that loan operations were the primary source of income for the banks and the loan origination expenses were normal and routine "in the particular business" of banking. Thus, the court stated, "[w]e cannot conclude that in performing credit checks, appraisals, and other tasks intended to assess the profitability of a loan, the banks 'stepped out of [their] normal method of doing business' so as to render the expenditures at issue capital in nature."

The court also rejected the Tax Court's application of Lincoln Savings & Loan Ass'n, 403 US 345 (1971), in which the Supreme Court held that payments a bank made to a reserve fund of the Federal Savings and Loan Insurance Corporation created a separate and distinct asset that required capitalization. The Third Circuit concluded that PNC's loan origination costs did not create a separate and distinct asset and contrasted the facts in Lincoln Savings, stating that the reserve fund existed apart from Lincoln Savings' "main daily business of taking deposits and making loans" and also that the fund itself was an asset earmarked as Lincoln Savings' property.

This case is highly significant, even outside of the banking industry, as it questions the IRS's broad interpretation of INDOPCO. It is not clear at this point what effect PNC will have on future guidance.

From Patricia C. Anderson, J.D., LL.M., CPA, and Jane I. Trachtenberg, J.D., LL.M., Washington, DC