Memo supports taxpayer’s position on debt-related fees
The IRS recently released a Field Attorney Advice memorandum, FAA 20182502F, addressing commitment fees paid by a taxpayer in connection with a revolving credit facility. This FAA affirms the deductibility of certain debt-related fees under section 162. The fees were period commitment fees for a revolving line of credit, similar to the fees addressed in an earlier IRS Technical Advice Memorandum, TAM 200514020.
The FAA further affirms that the tax treatment of a commitment fee, or similar fee, is not determined by the fee’s name or label, but instead is dependent upon the facts and circumstances that give rise to the fee. Though tax case law and revenue rulings addressing debt-related fees and options provide some guidance, they are not necessarily consistent with one another. Accordingly, taxpayers should access each of their debt-related fees to determine how each fee should be treated for U.S. federal income tax purposes.
Similar to the fact pattern of TAM 200514020, the taxpayer in FAA 20182502 secured a revolving credit facility (Revolver) for a specific amount which could be used for general business purposes, including an amount for the issuance of letters of credit. One of the fees the taxpayer paid in connection with the Revolver was a commitment fee. The commitment fee was payable in arrears on the last day of each calendar quarter and on the Revolver’s termination date. The fee was computed based on the amount of the unused facility for the calendar year quarter preceding the payment. Failure to pay the fee would constitute an event of default and a failure to remedy the event of default could cause the acceleration of all of the taxpayer’s obligations under the terms of the Revolver and lead to the termination of the credit facility.
At issue was whether the taxpayer should treat the fees as capital expenditures under section 263 of the tax code or as business expenses deductible under section 162. The IRS determined that the fees were not capital expenditures as defined under section 263, the associated regulations, and relevant case law but were a business expense deductible under section 162.
The IRS concluded that the fees in question were not incurred in connection with the acquisition of any asset, with respect to which the regulations under section 263A require capitalization, except perhaps an option (i.e., an option to borrower money, which would be viewed as an option to sell a debt instrument for cash.)
The IRS expressed the view that the fee was not for acquisition of an option, but instead related to maintenance of the taxpayer’s rights under the Revolver for the calendar quarter preceding the payment date. Further, the IRS noted that even if the payment was considered made in exchange for an option, that option only related to the three-month period ending on the payment date and the taxpayer’s method of accounting for the payments–deducting the payments when made–was permissible, because it clearly reflected the taxpayer’s income. The IRS noted that the fees were commonly and frequently incurred in the taxpayer’s type of business and that they were appropriate and helpful to the development of that business, rendering them currently deductible since capitalization was not required.
It’s worth noting that banks and other lenders charge various types of fees, and FAA 20182502F and TAM 200514020 address only certain fees paid periodically under revolving credit agreements. Tax regulations, case law and revenue rulings generally govern the treatment of fees and may require different results for different types of fees. Accordingly, taxpayers and their tax advisors should analyze each debt-related fee based on these applicable authorities to determine their federal income tax treatment.
