INSIGHT: MoneyGram’s Bank Aspirations Are Dashed

MoneyGram International Inc.’s second attempt to convince the U.S. Tax Court that it was a bank was no more successful than its first attempt. The company sought to deduct as bad debt, rather than capital losses, its losses from a foray into asset-backed securities in the 2000s.

If MoneyGram could have shown that it was a bank, it would have been able to take the bad debt deduction against its ordinary income—something it couldn’t do with the capital losses. The Tax Court ruled the company wasn’t a bank in 2015, and the company appealed.

MoneyGram found itself back before the Tax Court after the U.S. Court of Appeals for the Fifth Circuit disagreed with the manner in which the Tax Court defined “deposits” and “loans.” The appellate court further directed the Tax Court to consider whether MoneyGram made “discounts.” The Tax Court again ruled in December that MoneyGram was not a bank and, thus, not entitled to bad debt deductions (MoneyGram Int’l Inc. v. Commissioner, 153 T.C. No. 9 (12/3/19)).

The Business

MoneyGram is incorporated in Delaware and is headquartered in Texas. It is the parent of a group of companies that operate a global payment services business. MoneyGram’s business involves the movement of money through three main channels: money transfers, money orders, and payment processing services.

A money transfer involves the transfer of funds from a consumer at one location to a consumer at a different location. In a typical money transfer, a consumer goes to the location of a MoneyGram agent, completes a form, and pays the agent the money to be transferred (plus a fee). In a matter of minutes, the funds are made available for payment to the designated recipient through MoneyGram’s vast agent network. During the tax years at issue, 2007 and 2008, MoneyGram derived the bulk of its revenues from the money transfer business. MoneyGram conceded, however, that its money transfer activity did not involve “receiving deposits” or “making loans and discounts.”

Money Orders

During the tax years at issue, MoneyGram sold money orders through agents. To obtain a money order, a customer entered the location of an MoneyGram agent and gave the agent cash equal to the money order amount (plus a fee). The customer received a blank money order in that amount. He or she completed the money order by filling in the name of the payee and signing the order. Once presented for payment, the money order was cleared through the Federal Reserve interbank system.

MoneyGram executed with each of its agents a master trust agreement under which the agent accepted appointment as “trustee” for MoneyGram. MoneyGram historically took the position that an agreement created an express trust that gave it a preferred position over its agents’ other creditors in the event of bankruptcy. The agreements typically required the agent to remit trust funds “in accordance with the remittance schedule for the service.” MoneyGram treated funds due from its money order agents as accounts receivable. Outstanding money orders were treated as liabilities.

Payment Systems

MoneyGram, through its payment systems segment, provided services to financial institutions. These services generally consisted of payment processing, including the processing of “official checks.” Before the first day on which the bank issued official checks, it supplied MoneyGram with funds equal to its anticipated average daily volume of official checks. As official checks clear, the bank’s account balance with MoneyGram was drawn down. If a bank issued more official checks than anticipated, its account balance with MoneyGram could temporarily go negative. In that event, MoneyGram would allow the bank’s official checks to clear, but it would demand payment from the bank that same business day. Outstanding official checks were treated as liabilities on MoneyGram’s financial statements.

Regulation and Reporting

During the tax years at issue, MoneyGram was registered with the Treasury Department as a “money services business.” MoneyGram was subject to regulation under Title 31 of the U.S. Code. Banks are generally regulated under Title 12. No MoneyGram affiliate was incorporated as a bank under state law. As a money transmitter, MoneyGram was subject to regulation under some provisions of Title 12, but is was never regulated as a “bank” by any federal banking regulator. MoneyGram never maintained deposit insurance with, or paid deposit insurance premiums to, the FDIC. MoneyGram never represented to the SEC or to its shareholders that it was a “bank” or that any part of its business consisted of receiving deposits or making loans.

Investments

As a money transmitter, MoneyGram was required by state regulators to maintain reserves. During 2007 and 2008, MoneyGram’s reserve assets included investments in commercial paper, (CP) and asset-backed securities. At the beginning of 2007, MoneyGram held asset-backed securities valued at approximately $4.2 billion. During 2007 and 2008, the securities lost much of their value. MoneyGram reported substantial losses with respect to its asset-backed securities portfolio. These securities fell into two categories: REMIC (real estate mortgage investment conduit) and non-REMIC.

The sole question concerned MoneyGram’s disposition of its non-REMIC asset-backed securities. MoneyGram claimed under tax code Section 166(a) bad debt deductions. The Internal Revenue Service determined that these securities were “debts evidenced by a security” under Section 165(g)(2)(C) and hence that MoneyGram could claim bad debt deductions, as opposed to capital losses, only if it were a “bank” within the meaning of Section 581. The IRS determined that MoneyGram was not a bank and hence disallowed the bad debt deductions.

MoneyGram conceded that non-REMIC asset-backed securities were debts evidenced by a security. Thus, losses realized on the worthlessness of MoneyGram’s non-REMIC asset-backed securities would normally be treated as losses “from the sale or exchange of a capital asset.” Section 582(a) provides that notwithstanding Sections 165(g)(1) Section 166(e), “subsections (a) and (b) of Section 166…shall apply in the case of a bank to a debt which is evidenced by a security.”

Is MoneyGram a Bank?

Section 581 provides: For purposes of Section 582 and Section 584, the term, bank, means a bank or trust company…a substantial part of the business of which consists of receiving deposits and making loans and discounts and which is subject by law to supervision and examination by State or Federal authority having supervision over banking institutions.

The first statutory requirement is that the taxpayer be a “bank or trust company.” We must, the court said, decide whether MoneyGram is a bank within the common understanding of that term. In Staunton Indus. Loan Corp. v. Commissioner, the court concluded that an entity must manifest three basic features to bring itself within the commonly understood definition of a bank: (1) the receipt of deposits from the general public, (2) the use of deposit funds for secured loans, and (3) the relationship of debtor and creditor between the bank and the depositor.

Deposits

The term, deposits, is not defined in the statute, the regulations, or the legislative history. An essential element of a bank deposit is “the placement of funds…for safekeeping.” The second essential element of a bank deposit is that the funds “must be subject to the control of the depositor such that they are repayable on demand or at a fixed time.” A third characteristic of bank deposits is that they are received “from the general public.”

MoneyGram provided official check services to more than 1,900 financial institutions. MoneyGram contends that the funds advanced to it by its official check customers constituted bank deposits. The court disagreed. The financial institutions that purchased official check services from MoneyGram did not advance funds to MoneyGram “for the purpose of safekeeping.” MoneyGram accepteded these funds not to satisfy its customers’ need to protect their cash from risk of loss, but to protect itself from risk of loss in the event its customer should default or delay payment. The advance of funds that MoneyGram received from an official check customer resembled a retainer that a law firm receives from a client, or a security deposit that a landlord receives from a tenant. The advances that MoneyGram sought to characterize as bank deposits were in effect security deposits that it demanded for its own protection. These advances constituted not bank deposits but prepayments for a service.

MoneyGram contended that its retail money order business involved the receipt of deposits. In money order transactions, the court observed, the depositor would seem to be the agent that transfered to MoneyGram the funds out of which MoneyGram would pay money orders when presented for payment. If MoneyGram’s agent was the purported depositor, it is clear that the transferred funds were not deposits. The agent held the funds as trustee for MoneyGram, which was the equitable owner while the funds were in the agent’s possession. Once the agent remitted trust funds to MoneyGram, the agent could never get them back. The agent could not be viewed as transferring funds to MoneyGram “for the purpose of safekeeping,” because the funds were not the agent’s funds. And the funds were not repayable to the depositor on demand or at a fixed time.

Recognizing these infirmities, MoneyGram characterized the depositor as the retail customer who purchased the money order. The consumer, the court observed, who buys a money order “is purchasing a product, not making a deposit.” Because he or she intended to alienate the funds by directing payment to a third party, he or she could not be regarded as putting those funds in a safe location for his or her future use. He or she could not be viewed as giving money to the agent for the purpose of safekeeping. Consumers viewed MoneyGram as offering, not a safe place to keep their money, but a secure way to deliver their money to someone else. Neither the financial institutions that purchased MoneyGram’s official check services nor the consumers who purchased its money orders transfered funds to MoneyGram for the purpose of safekeeping. Because MoneyGram did not receive deposits, it was not a bank within the ordinary understanding of that term.

Making Loans

MoneyGram contended that the master trust agreements executed by its money order agents give rise to loans. In ascertaining whether an advance of funds constituted a loan, the central question was whether the parties intended that the recipient of the funds was obligated to repay them. The dispute here concerned not the existence of an obligation to repay—both parties agreed that this obligation existed—but the nature of the relationship between MoneyGram and its agents.

In deciding whether the master trust agreements gave rise to loans, the central question was whether the agents’ obligation to pay MoneyGram arose from a debtor-creditor relationship or from some other type of relationship. While the agreement created an obligation to repay, it indicated that this obligation arose from a trustee-beneficiary relationship, rather than from an ordinary debtor-creditor relationship. The fact that MoneyGram did not charge interest supported a finding that these advances were not loans. The agreements invariably set forth a fixed “remittance schedule.” Because fixed schedules for payment or repayment exist in many relationships other than lender-borrower relationships, “we find this factor neutral in determining whether” the master trust agreements gave rise to loans. The conduct of the parties, the court noted, pointed strongly to the conclusion that the agreements did not give rise to loans.

In a typical consumer loan, the borrower is free to use the borrowed funds for any purpose he or she wishes. The master trust agreements prohibited MoneyGram’s agents from doing this. Because the agent was prohibited from deploying trust funds in the operation of his or her business, the conduct of the parties indicated that neither MoneyGram nor its agents regarded amounts remitted pursuant to the regular remittance schedule as loans. The record established that MoneyGram recorded unpaid remittances not as loans but as receivables. MoneyGram agents have, on occasion, filed for bankruptcy. On each such occasion, MoneyGram characterized the agreement “as creating an express trust” that rendered its claim against the agent as non-dischargeable, thus affording MoneyGram favored treatment over the agent’s other creditors. In short, the agents’ payment obligations did not arise from loans. MoneyGram did not make loans to its money order agents.

Substantial Part of the Business

We will address, the court said, the second element of the Section 581 definition: the requirement that a substantial part of the entity’s business consisted of receiving deposits and making loans and discounts. If, the court said, we were to assume that the master trust agreements gave rise to loans, we would conclude that making loans did not constitute a “substantial part” of MoneyGram’s business. MoneyGram did not charge interest on remittances . Banks commonly derive a large percentage of their revenue from making loans. As far as the record revealed, MoneyGram “derived zero income from doing so.”

Making Discounts

State regulators required that MoneyGram invest its reserve assets in cash or highly-rated debt securities. MoneyGram contended that its investments in these securities involved “making discounts.” MoneyGram, the court concluded, did not make discounts when it invested in asset-backed securities. Making discounts, the court noted, “must be interpreted as referring to the type of activity in which banks engaged when they discounted promissory notes for their customers. MoneyGram did not ‘make discounts’ when it purchased asset-backed securities as an investor.” Nor did MoneyGram make discounts when it purchased CP from broker-dealers.

In making these investments, MoneyGram did not lend money to a customer by discounting a note. Any lending was done by the underwriters who initially purchased CP from the issuer. By acquiring CP in the after-market, MoneyGram was not lending to the corporation that issued the CP but was simply acquiring an asset from another investor. Assuming that MoneyGram’s purchases of CP directly from issuers involved making discounts, we find, the court said, that MoneyGram did not show that investing in CP was a substantial part of its business, either in a quantitative or in a qualitative sense.

MoneyGram was not a bank for purposes of Section 581 because it was not a bank within the ordinary meaning of the term, and because a substantial part of its business did not consist of receiving deposits and making loans and discounts. Because MoneyGram was not entitled to deduct bad debt losses against its ordinary income on the write-down of its asset-backed securities, the court ruled for the IRS and against MoneyGram.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Robert Willens is president of the tax and consulting firm Robert Willens LLC in New York and an adjunct professor of finance at Columbia University Graduate School of Business.