The IRS concluded in a recent field attorney advice memorandum, FAA 20172901F, that a taxpayer could deduct the unamortized debt - issuance costs related to its existing debt upon its exchange for new debt. Though the FAA redacts some facts, the circumstances may be familiar to companies that have refinanced debt obligations.
The taxpayer in the FAA had incurred costs when it entered into a credit agreement to borrow term loans from a group of lenders. Subsequently, the taxpayer sought to refinance the term loans by amending the terms of the credit agreement. Existing lenders were permitted to replace their old term loans with refinanced term loans in the same principal amount. Some of the lenders agreed to amend their loans; the taxpayer paid other loans in full or in part. In addition, the amendment allowed the taxpayer to issue new loans for cash to both existing lenders and new lenders. Approximately 49% of the new term loans were issued in exchange for old term loans, while the remaining 51% of new term loans were issued for cash.
Regs. Sec. 1. 446 - 5 (a) provides that "debt issuance costs" capitalized pursuant to Regs. Sec. 1.263(a)- 5 are deductible by the issuer over the term of the debt as determined in Regs. Sec. 1. 446 - 5 (b). Regs. Sec. 1. 446 - 5 (b) provides that the issuer must treat the costs as if they create original issue discount (OID) and take such OID into account under the rules of Regs. Sec. 1. 163 - 7 . Before the issuance of the Sec. 446 regulations, taxpayers generally amortized or deducted debt - issuance costs over the term of the debt instrument based on a straight - line method. Under case law (e.g., Buddy Schoellkopf Products, Inc., 65 T.C. 640 (1975)), taxpayers who refinanced their loans with the same lenders could deduct unamortized debt - issuance costs if the facts and circumstances indicated that the new loans were sufficiently different from the old loans. Because Regs. Sec. 1. 446 - 5 required debt - issuance costs to be treated like OID, many taxpayers took the position that on a refinancing, unamortized debt - issuance costs were deductible when unamortized OID was deductible. The IRS appears to sanction this position in the FAA.
In the FAA, to the extent that the taxpayer exchanged new term loans for existing loans, the interest rate under the new term loans resulted in a change in yield that constituted a significant modification under Regs. Sec. 1. 1001 - 3 . The IRS concluded that all of the unamortized loan costs were deductible. Specifically, the loan costs allocable to loans repurchased for money were deductible when the loans were repurchased, and the loan costs allocable to loans exchanged for new term loans were deductible upon the exchange.
The IRS based its conclusion on Regs. Sec. 1. 163 - 7 (c), which provides for the deduction of a repurchase premium. Specifically, because a "substantial amount" of new term loans was issued for money and the issue price of all the new loans was determined under Sec. 1273(b)(2), Regs. Sec. 1. 163 - 7 (c) did not require the repurchase premium from a debt - for - debt exchange to be amortized over the term of the new term loans. Thus, the IRS concluded that the unamortized loan costs were deductible, including the loan costs allocable to the existing loans that the taxpayer exchanged for the new term loans in a debt - for - debt exchange.
Editor Notes
Greg Fairbanks is a tax managing director with Grant Thornton LLP in Washington.
For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or greg.fairbanks@us.gt.com.
Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.