The California Franchise Tax Board recently issued a Chief Counsel Ruling addressing whether a taxpayer was a financial corporation for California income tax purposes. The taxpayer at issue acquired residential loans, then promptly securitized and sold them to unrelated third parties. Under a contract entered into with the buyer at the time of the sale, the taxpayer retained rights to service the loans. The taxpayer also purchased mortgage servicing rights contracts from other financial institutions. The taxpayer requested a ruling as to whether it was a “financial corporation” when it earned more than 50 percent of its total gross income from performing services under mortgage servicing rights contracts. The taxpayer also earned income from selling loans and interest from the brief period it held the loans. Under California’s regulations, a financial corporation is defined as a corporation that predominantly deals in money or moneyed capital in substantial competition with the business of national banks. “Predominantly” means that more than 50 percent of a corporation’s total gross income is attributable to dealings in money or moneyed capital in substantial competition with the business of national banks. The FTB, citing to earlier cases, noted that making and selling loans gives rise to income from an activity that deals in moneyed capital. Servicing loans generates income from a service activity, not from dealing in money or moneyed capital. Because the taxpayer derived more than 50 percent of its gross income from performing mortgage servicing activities that were not attributable to dealings in money or moneyed capital, the FTB concluded it was not a financial corporation.
The FTB next addressed whether the taxpayer’s income from hedging activities undertaken to manage its exposure to interest rate fluctuations constituted financial income. The taxpayer represented that when it engaged in these hedging activities it was in substantial competition with national banks as banks were allowed to engage in similar transactions. However, in the FTB’s view, regardless of whether banks are allowed to engage in hedging, the taxpayer’s hedging contracts and transactions did not constitute "dealing in money or moneyed capital" as required under the regulatory test for a financial corporation. Although there was no comprehensive definition of “moneyed capital” the FTB observed that the examples of types of moneyed capital listed in the regulation all related to actual legal tender and debt instruments. Under the rule of statutory construction called ejusdem generis (of the same kind or class) when a statute contains a list or catalogue of items, a court should determine the meaning of each by reference to the others, giving preference to an interpretation that uniformly treats items similar in nature and scope. Noting that the rule of statutory construction applies equally to construing a regulation, the FTB concluded that the interest rate hedging contracts at issue were not specifically listed in the regulation and did not share common characteristics with the listed examples of moneyed capital. Because the taxpayer's interest rate hedging contracts were not money or moneyed capital, the gains therefrom constituted general, not financial, income. Please contact John Harper at (615) 744-2170 with questions on Chief Counsel Ruling 2018-01.