Rev. Rul. 84-94

ISSUE

Is the portion of an international loan that is subject to an allocated transfer risk reserve under federal banking regulations conclusively presumed to be worthless under section 1.166-2(d)(1) of the Income Tax Regulations?

FACTS

Section 905(a) of the International Lending Supervision Act of 1983, Pub.L. 98-181, 97 Stat. 1153, directs the federal banking agencies (Comptroller of the Currency, Board of Governors of the Federal Reserve System, and Federal Reserve System, and Federal Deposit Insurance Corporation) to promulgate regulations requiring banks to establish special transfer risk reserves against certain international loans when the agencies determine that the quality of those assets has been impaired by a protracted inability of borrowers in the foreign country concerned to make payments on their external indebtedness. The regulations promulgated by the federal banking agencies require a bank to establish an allocated transfer risk reserve (ATRR) for an international loan found by the agencies to be affected by transfer risk problems as described above. 49 Fed.Reg. 5587 (1984) (to be codified at 12 C.F.R. 20.8, 211.42, 351.1).

Under the regulations, "transfer risk" means the possibility that a loan cannot be serviced in the currency of payment because of a lack of, or restraints on the availability of, needed foreign exchange in the country of the obligor. Factors considered by the agencies in determining whether an ATRR is required for particular international loans include whether 1) the obligors have failed to make full interest payments on external indebtedness, 2) the obligors have failed to comply with the terms of any restructured indebtedness, or 3) a foreign country has failed to comply with any International Monetary Fund or other suitable adjustment program, or whether no definite prospects exist for the orderly restoration of debt service. In determining what portion of the loan is subject to the ATRR, the agencies shall consider 1) the length of time the quality of the loan has been impaired, 2) recent actions taken to restore debt service capability, 3) prospects for restored loan quality, and 4) such other factors as the agencies may consider relevant to the quality of the loan.

The regulations promulgated by the federal banking agencies further provide that, for financial accounting purposes, a bank shall account for an ATRR separately from the allowance for possible loan losses. The ATRR must be established for each loan subject to the ATRR in the percentage amount specified. However, the regulations provide that a bank need not establish an ATRR if it charges off, in the period in which the ATRR is required, the requisite amount against the allowance for possible loan losses.

LAW AND ANALYSIS

Section 166(a) of the Internal Revenue Code provides that there shall be allowed as a deduction any debt that becomes worthless within the tax year.

Section 166(c) of the Code provides that in lieu of any deduction under section 166(a) there shall be allowed in the discretion of the Secretary a deduction for a reasonable addition to a reserve for bad debts.

Section 1.166-2(d)(1) of the regulations provides that if a corporation subject to supervision by federal authorities charges off a debt in whole or in part in obedience to the specific orders of the authorities then the debt shall, to the extent charged off within the tax year, be conclusively presumed to have become worthless in that year.

Section 585 of the Code and the regulations thereunder provide rules for the determination of a reasonable addition to a reserve for bad debts in the case of losses on the loans of banks.

In accordance with the regulations promulgated by the federal banking agencies, a bank with certain international loans affected by transfer risk will be directed by the agencies to establish on its books a separate ATRR, unless the bank charges off the requisite portion of each loan against the allowance for possible loan losses. The Internal Revenue Service will view either accounting treatment as the charge off of a debt in whole or in part pursuant to the specific orders of the federal authorities within the meaning of section 1.166-2(d)(1) of the regulations. For federal income tax purposes, a bank using the reserve method provided by section 166(c) of the Code will charge either the ATRR or the amount charged against the allowance for possible loan losses against its reserve for bad debts.

HOLDING

The portion of an international loan that is subject to an ATRR is conclusively presumed to be worthless under section 1.166-2(d)(1) of the regulations. The portion of the loan that is either charged to the ATRR or against the allowance for possible loan losses is excluded from the bank's loans or eligible loans outstanding for purposes of determining the reasonable addition to the reserve for bad debts under section 585 of the Code.