Debt issuance costs deductible upon subsequent borrowing
TAX ALERT |
A company issuing a debt instrument generally incurs various costs that are amortized over the debt’s term to maturity. When the debt is later modified or refinanced, a question often arises: Is the company allowed to immediately deduct the balance of its unamortized debt issuance costs? Based upon the taxpayer’s facts, the IRS answered “yes” in a Field Attorney Advice (FAA 20172901F), addressing a situation involving a refinancing and a substantial additional cash borrowing.
For borrowers who are contemplating refinance, have recently refinanced and/or have increased their borrowings, this FAA could help support a favorable tax position on existing unamortized debt issuance costs. It also serves as a reminder that the federal tax rules governing debt issuance costs and other items in debt refinancings are independent of the financial accounting rules, and accordingly may lead to book-tax differences.
Initial issuance followed by refinancing and additional borrowing
The taxpayer in the FAA had issued term loans under a credit agreement that also provided for a revolving credit facility. Subsequently, the taxpayer and its creditors agreed to amend the credit agreement and refinance the term loans. As a result of this refinancing amendment, the old term loans were treated for federal income tax purposes as exchanged for new term loans.
In addition, the taxpayer made a new cash borrowing under the same amendment. Approximately 51 percent of the new term loans resulted from this new cash borrowing. The lenders on the new cash borrowing included of some of the pre-amendment term loan creditors. Some other pre-amendment term loan creditors received cash in connection with the refinancing, and these creditors held a lesser amounts of the term loans after the amendment than they held prior to the amendment.
Later, the taxpayer filed an amended tax return claiming that it could deduct the remaining unamortized debt issuance costs for the loans in the year of amendment as a result of the amendment. IRS counsel agreed.
Deduction of debt issuance costs
For the purpose of determining the timing of debt issuance costs deductions, the tax regulations treat these costs as original issue discount (OID). This treatment generally prescribes an amortization method, and it also authorizes deduction of unamortized debt issuance costs upon certain debt-for-debt exchanges.
There is also case law predating the regulations that applies a facts and circumstances analysis to the treatment of debt issuance costs in a refinancing. The FAA did not address this case law; it was not necessary for reaching the taxpayer’s favorable result under the facts in this case.
Because the credit agreement amendment represented a debt-for-debt exchange, the unamortized debt issuance costs would only be deductible in the year of the amendment if the new term loans were traded on an established market or issued for cash. Otherwise, the deduction would be delayed and amortized over the life of the new debt.
Substantial additional borrowing results in cash issue price at refinancing
Continued amortization of debt issuance costs is not required if the debt for debt exchange includes, not just a debt swap, but also a substantial cash issuance. In this case, the taxpayer was allowed a current deduction because in addition to the debt swap, approximately 51 percent of the new term loans resulted from a new cash borrowing, which the IRS considered a substantial amount.
The FAA shows that debt issuers undergoing refinancings that involve a substantial new cash borrowing generally may deduct previously unamortized debt issuance costs. It is also a reminder that the tax rules governing debt issuance costs in debt-for-debt exchanges and refinancings purposes are independent of the financial accounting rules in this area. Debt issuers considering debt issuance costs tax deductions should consult with their tax advisors.
 The taxpayer and the IRS agreed that the amendment’s terms resulted in a change in yield for the old term loans that triggered debt-for-debt exchange treatment under Reg. § 1.1001-3(e)(2).
 Reg. § 1.446-5(b).
 Reg. §§ 1.163-7(c), 1.446-5(b).
 Reg. §§ 1.163-7(c), 1.1273-2(a)(1).