Bankers Group Raises Concerns With Tax Accounting Regs

November 18, 2019

Internal Revenue Service
CC:PA:LPD:PR (REG-104870-18)
1111 Constitution Avenue, NW
Washington, DC 20224

RE: Taxable Year of Inclusion under an Accrual Method of Accounting (REG-104870-18)

Dear Sir or Madam:

On behalf of its members, the American Bankers Association (ABA)¹ is pleased to submit the following comments on proposed regulations regarding the timing of income inclusion under Section 451 of the Internal Revenue Code (IRC). We appreciate the efforts of the Internal Revenue Service (IRS) and Treasury in issuing significant guidance related to the Tax Cuts and Jobs Act (TCJA). Certain portions of the new statute and these proposed regulations have important implications for issuers of credit cards, specifically those relating to the recognition of income with respect to certain credit card fees. We believe there are certain principles that are inherent in the proposed regulations that should be carefully considered, as they may apply to large numbers of taxpayers.

Definitions of gross income, revenue and transaction price

Section 451(b)(1)(A) of the Internal Revenue Code states:

(b) INCLUSION NOT LATER THAN FOR FINANCIAL ACCOUNTING PURPOSES. —

(1) INCOME TAKEN INTO ACCOUNT IN FINANCIAL STATEMENT. —

(A) In general. — In the case of a taxpayer the taxable income of which is computed under an accrual method of accounting, the all events test with respect to any item of gross income (or portion thereof) shall not be treated as met any later than when such item (or portion thereof) is taken into account as revenue in —

(i) an applicable financial statement of the taxpayer, or . . .

To apply this section, definitions of “gross income” and “revenue” are obviously important to interpret the statute:

• Section 1.451-3(c)(4) of the proposed regulations defines revenue as all transaction price amounts includible in gross income under Section 61.

• Section 1.451-3(c)(6) of the proposed regulations defines transaction price as the gross amount of consideration to which a taxpayer expects to be entitled for applicable financial statement (AFS) purposes in exchange for transferring promised goods, services, or other property, including amounts referred to in paragraph (i) of this section, but not including:

  (iii) Reductions from amounts subject to section 461, including allowances, adjustments, rebates, chargebacks, refunds, rewards (for example, estimated redemption costs associated with loyalty programs), and amounts included in costs of goods sold.

The preamble to the proposed regulations includes the following explanation for these provisions and concurrently requests comments on the interaction among Sections 61, 461, and 451(b) and specific situations in which future contingent income and liabilities might be included in revenue for AFS purposes. The applicable section from the preamble follows:

Commenters raised concerns about the interaction between sections 61 and 461 with the AFS income inclusion rule. For AFS purposes, taxpayers may be required to include variable consideration when determining the transaction price of a contract. Under the New Standards, variable consideration includes items such as discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties, and other similar items. Variable consideration may also include promised consideration that taxpayers are not yet entitled to under the contract because it is contingent on the occurrence or nonoccurrence of a future event. For Federal income tax purposes, these items of variable consideration may be contingent future income under section 61 or liabilities subject to section 461. Section 451(b) could be read to accelerate the timing of contingent future income and liabilities to match their inclusion in revenue for AFS purposes. However, section 451(b) was intended to change only the timing of income to ensure that those items of income are not included later than when they are included for AFS purposes. See H.R. Rep. No. 115-466, at 428 fn. 874 (2017) (Conf. Rep.) and Joint Committee on Taxation, General Explanation of Public Law 115-97 (JCS-1-18) at 166 (Dec. 20, 2018).

Accordingly, proposed § 1.451-3(c)(6) provides that the transaction price that is used to determine whether an amount has been included in revenue does not include items to which a taxpayer's entitlement is contingent on the occurrence or nonoccurrence of a future event, reductions for amounts subject to section 461 (including allowances, adjustments, rebates, chargebacks, refunds, rewards, and amounts included in the cost of goods sold), and amounts collected for third parties. However, in order to reduce compliance burden and prevent abuse and undue administrative burden, proposed § 1.451-3(c)(6) presumes that an amount included in the transaction price for AFS purposes is not contingent future income unless, upon examination of all of the facts and circumstances existing at the end of the taxable year, it can be established to the satisfaction of the Commissioner that the amount is contingent on the occurrence or nonoccurrence of a future event.

In addition, section 451(b) was intended to accelerate income inclusion when (i) the taxpayer's customer controls the asset that is created or enhanced, or (ii) the taxpayer has a right to partial payment, even when a contract requires delivery, acceptance, and title transfer before a taxpayer can bill its customer. See Examples 2 and 4 of the Joint Committee on Taxation, General Explanation of Public Law 115-97 (JCS-1-18) at 162-163 (Dec. 20, 2018). Accordingly, proposed § 1.451-3(c)(6)(ii) provides that an amount included in the transaction price for AFS purposes may not be treated as contingent on the occurrence or nonoccurrence of a future event if the taxpayer has been paid or has an equitable, contractual, or other right to partial payment for performance completed to date. Additionally, proposed § 1.451-3(c)(6)(iii) provides that transaction price may not be reduced for amounts subject to section 461, including, in the case of credit card transactions, reward amounts.

After reviewing this discussion and the references provided, we respectfully suggest that IRS and Treasury have provided an overly broad interpretation of the statutory language in Section 451(b)(1)(A) of gross income being taken into account as revenue in an applicable financial statement. We respectfully ask that the following be taken into consideration:

Certain items that are included in AFS revenue on a net basis may or may not be material and of a nature to require distinct evaluation pursuant to Section 461. An item especially applicable to our industry that is included both in the preamble and in Section 1.451-3(c)(6)(iii) are amounts related to rewards or loyalty programs. This is an example of a material offset item that is often included in the revenue line of the AFS that is currently evaluated for deductibility pursuant to Section 461. If the final regulations do not apply a straightforward application of AFS revenue and the particular types of offsets need to be evaluated separately, we suggest a corresponding addition to the standards under Section 461. To allow for reasonable matching, we suggest that to the extent an expense item is included in net revenue in the AFS, then the all events test and economic performance should be deemed to occur under Section 461 for the offset in the revenue category for purposes of the application of Section 451(b). We believe this will result in a more accurate matching of gross income and expense and reduce the level of potential distortion. Establishing this matching principle is within the authority granted to the Secretary by Section 461(h)(2) to prescribe the timing of economic performance for specific items. This treatment is also consistent with the clear reflection of income doctrine of Section 446, which requires a taxpayer to generally report income and expense on its tax return in a manner that clearly reflects its income. Under the regulations to Section 446, if a method of accounting follows Generally Accepted Accounting Principles (GAAP) as reported on an AFS, that method will ordinarily be regarded as clearly reflecting income.²

Ordering rule and confirmation of the definition of specified fees

Proposed regulation section 1.451-3(i)(1) provides guidance with respect to the impact on treatment of income items currently reported pursuant to Sections 1271-1275 (OID rules):

• Special ordering rule for certain items of income with respect to debt instruments —

  (1) In general. If an item of income, or portion thereof, with respect to a debt instrument is described in paragraph (i)(2) of this section, the rules of this section apply before the rules in sections 1271 through 1275 and §§ 1.1271–1 through 1.1275–7 (OID rules). Therefore, an item of income, or portion thereof, described in paragraph (i)(2) of this section may not be taken into income later than when that item, or portion thereof, is taken into account as revenue in the taxpayer's AFS, regardless of whether the timing of income inclusion for that item is normally determined using a special method of accounting. See also § 1.1275–2(l) for the treatment of the items described in paragraph (i)(2) of this section under the OID rules.

The preamble to the proposed regulations provide background on this section:

Congress clearly expressed its intention to overturn the tax treatment of credit card late fees, cash advance fees, and interchange fees (specified credit card fees) and to subject these fees to the all events test as modified by section 451(b). Id. at 429. The legislative history quoted in the preceding paragraph further suggests that Congress intended that other fees associated with a lending transaction that might otherwise be accounted for in calculating OID are to be subjected to the AFS income inclusion rule before the application of the OID rules. Based on the legislative history, however, taxpayers have stated that section 451(b) was not intended to affect the application of the general OID timing rules to OID other than with respect to items not treated as discount for financial reporting purposes, such as the specified credit card fees. Id. at 427– 429. Moreover, taxpayers have stated that the application of section 451(b) to OID other than items not treated as discount for financial reporting purposes would result in significant administrative burden and very little additional tax revenue. The Treasury Department and the IRS agree with commenters on this issue. Therefore, in the absence of a clear indication in the legislative history that Congress intended for section 451(b) to override the general timing rules for OID, and in order to reduce administrative burden, the proposed section 451(b) regulations would not apply to determine the time at which OID generally is includible in income. See § 1.451–3(c)(5)(ix) of the proposed regulations. The proposed regulations contain two provisions that implement Congressional intent regarding the treatment of fees, including the specified credit card fees. First, under proposed § 1.451–3(i), if a fee is not treated by a taxpayer as discount or as an adjustment to the yield of a debt instrument over the life of the instrument (such as points) in its AFS and the fee otherwise would be treated as creating or increasing OID for Federal income tax purposes (specified fee), then the rules in the proposed regulations under section 451(b) apply before the rules in sections 1271 through 1275 and the regulations thereunder. For example, proposed § 1.451–3(i) applies to the specified credit card fees. Second, proposed § 1.1275–2(l) includes a proposed amendment to the final regulations under section 1275 to clarify that an item of income that is subject to the timing rules in the proposed regulations under section 451(b) (such as the specified credit card fees) is not taken into account in determining the amount of OID (if any) on the debt instrument. Removing specified fees and specified credit card fees from the calculation of OID will permit taxpayers to apply only the rules of section 451(b) to these fees, without also having to apply the rules relevant to OID. In addition, the Treasury Department and the IRS propose to obsolete Revenue Procedure 2004–33, Revenue Procedure 2005–47, Revenue Procedure 2013–26, and Chief Counsel Notice CC–2010–018. The Treasury Department and the IRS request comments on the proposed obsolescence of these documents.

We believe that this guidance confirms that the current treatment will continue for items that are not specified fees pursuant to proposed regulation section 1.451-3(i)(2). The proposed regulations clarify that Section 451(b) is an overlay on general rules regarding the treatment of OID, rather than a replacement. There are other items in the nature of OID that adjust the yield of a debt instrument that are amortized over the life of the instrument or other similar period for the AFS. An example that is applicable in our industry might be a promotional discount. In this type of arrangement, a merchant will compensate a credit card issuer for accepting a no or low interest rate on a credit card balance created by a particular promotional activity. For the issuer, this is economically an adjustment to the yield on the credit card. For AFS purposes, this income is generally amortized over the length of the promotion or similar period, and despite potential alternative labeling for AFS purposes, in substance, as noted above, it represents an adjustment to the yield of the instrument. Accordingly, we believe Section 451(b) in these situations should not apply and the tax treatment should be calculated in accordance with existing rules.

As noted above, Treasury and IRS have also requested comments regarding the proposed obsolescence of a series of revenue procedures and other guidance related to the treatment of OID and various credit card fees. We respectfully suggest that it would NOT be appropriate to make this series of guidance obsolete. We understand the above guidance directs that Section 451(b) should be applied to selected items for determination of the timing of recognition into taxable income. There continue to be items (such as market discount, promotional discounts, etc.) outside the specified fees set forth in proposed regulation section 1.451-3(i)(2) where this existing guidance is still applicable. Revenue Procedure 2013-26, for example, has broader applicability and continues to provide important guidance for taxpayers calculating taxable income. It may be appropriate to modify the guidance to recognize that Section 451(b) may impact the timing of the recognition of certain types of income, but not all types of income outlined in the guidance.

Thank you for your consideration. Please do not hesitate to contact us with questions or comments.

Sincerely,

John P. Kinsella
American Bankers Association
Washington, DC