Rev. Rul. 72-315

Advice has been requested whether, under the circumstances described below, amounts designated as "finance charges" levied on customer charge accounts by a retail store are deductible as interest under section 163(a) of the Internal Revenue Code of 1954.

A retail store maintains what it calls "revolving charge accounts" for its customers with approved credit. These customers may charge their purchases and then either pay for them in full or in installments. If the customer pays for his purchases within 30 days from the date of the statement billing date, no charge is made to his account by the store. In the event that full payment is not made within 30 days, a charge is made to the customer's account based on his unpaid balance at the beginning of the month. The charge made to these accounts is stated as a "finance charge" and expressed as an annual percentage rate on the customer's billing statement in accordance with the Consumer Credit Protection Act, P.L. 90-321; 82 Stat. 146, et seq. (Truth in Lending Act).

Section 163(a) of the Code, and the regulations thereunder provide that all interest paid or accrued within the taxable year on indebtedness shall be allowed as a deduction in computing taxable income.

Section 163(b) of the Code provides, in part, that if personal property is purchased under a contract which provides that payment of part or all of the purchase price is to be made in installments, and the carrying charges are separately stated but the interest charge cannot be ascertained, then the payments made during the taxable year under the contract shall be treated as if they included interest equal to the lesser of six percent of the average unpaid monthly balance or the actual charges for the year.

If the interest charge is separately stated or can be ascertained, section 163(b) of the Code does not apply.

For income tax purposes, interest has been defined by the Supreme Court of the United States as the amount one has contracted to pay for the use of borrowed money, and as compensation paid for the use or forbearance of money. See Old Colony Railroad Co. v. Commissioner, 284 U.S. 552 (1932), Ct. D. 456, C.B. XI-1, 274 (1932) and Pearl E. Deputy, Administratrix, et al. v. du Pont, 308 U.S. 488 (1940), Ct. D. 1435, C.B. 1940-1, 118.

A charge which is not paid for the use or forbearance of money, but is paid to compensate the lender for the cost of specific services performed in connection with the borrower's account does not qualify as interest, but is a "service charge". See Revenue Ruling 69-189, C.B. 1969-1, 55, holding that the portion of the maximum loan charge allowed under Chapter 1321 of the Ohio Revised Code that can be established as paid by the borrower for the use or forbearance of money and that is not attributable to specific services performed in connection with the borrower's account, is deductible as interest under section 163(a) of the Code.

However, it is not necessary for the parties to a transaction to label a payment made for the use of money as interest for it to be so treated. The facts of the transaction control its character; not the terminology. See Revenue Ruling 69-188, C.B. 1969-1, 54, which holds that a "loan processing fee" paid by a mortgagor-borrower as compensation to a lender solely for the use or forbearance of money is considered to be interest.

One of the factors distinguishing a "service charge" from interest is that a "service charge" is a fixed charge having no relationship to the amount borrowed or the time given to pay whereas interest is based on the amount deferred and the time of deferral. Compare Noteman et al. v. Welch, 108 F. 2d 206 and Workingmen's Loan Assn. v. United States, 142 F. 2d 359.

In the instant case, the "finance charge" is levied by the retail store only in the event the customer does not pay his full balance within 30 days. Further, the charge is not a fixed fee but is based on the customer's unpaid balance and computed monthly.

Accordingly, it is held that the amount charged to the customer's "revolving charge account" is solely for the privilege of deferring payment and is interest. Since the interest charge is ascertainable, section 163(b) does not apply and the total charge is deductible under section 163(a) of the Code.

Revenue Ruling 67-62, C.B. 1967-1, 44, which relates to the deductibility as interest of service charges paid by customers of a department store and holds that the formula provided by section 163(b) of the Code applies with respect to service charges levied on budget charge accounts is revoked.

Revenue Ruling 71-98, C.B. 1971-1, 57, is modified to hold that, even if the fee charged by the bank to the retailer did not cover all of the bank's credit card plan expenses, the amount paid by the customer is still ascertainable as interest and deductible under section 163(a) of the Code.