Rev. Rul. 67-62

Advice has been requested as to the applicability of section 163 of the Internal Revenue Code of 1954, relating to the deductibility, as interest, of service charges paid by customers of a department store under the circumstances described below.

Y, a department store, has a credit arrangement under which its customers may pay for their purchases either in full or in installments. Under the terms of this arrangement, which is called a "budget charge account," the customer signs an agreement under which he is to pay each month, within 20 days of the date of his statement, either the balance due or a specified portion of the balance due. When less than the balance due is paid, a service charge is added to the next month's balance. The service charge is 1 percent of the balance remaining unpaid at the end of the 20-day payment period.

Purchases made under the above-described "budget charge account" may fall into three general categories: (1) Purchases treated as cash purchases (paid for within 20 days from the date on the statement) for which no service charges are imposed; (2) purchases treated as delayed payment purchases (purchases paid for in full at one time, but subsequent to 20 days after the original billing date), with respect to which service charges must be paid in addition to the cash price; and (3) purchases actually paid for in two or more installments, on which service charges are paid in addition to the cash price of the purchases. These three general categories are illustrated by the following examples:

Example 1.--A customer purchased $70 worth of merchandise in 1 month and, within 20 days from the date on his monthly statement, paid his account in full. No service charge was imposed.

Example 2.--A customer purchased $70 worth of merchandise in 1 month and paid nothing on account in the month following, when he received his bill. When the customer received his bill in the next succeeding month he paid his account in full with a payment of $70.70 (the remaining balance plus the service charge of 1 percent of the balance remaining unpaid).

Example 3.--A customer purchased $70 worth of merchandise in 1 month and paid $10 on account when he received his bill. In the next succeeding month the customer received a bill with a balance of $60.00 (the remaining balance plus the service charge of 1 percent of the balance remaining unpaid). The customer then paid the amount of this balance in full.

Section 163(a) of the Code (formerly sec. 23(b) of the Internal Revenue Code of 1939) provides the general rule that all interest paid or accrued within the taxable year on indebtedness is deductible. It has been held, however, that where property is sold on a deferred payment basis and the contract of purchase does not provide that any part of the deferred payment is interest, no part of such payment may be deducted as interest. See I.T. 2674, C.B. XII-1, 96 and I.T. 3254, C.B. 1939-1, 98.

In order to provide a statutory basis for deductions by installment purchasers Congress adopted section 163(b) of the Code which provides as follows:

(1) GENERAL RULE.--If personal property * * * [is] purchased under a contract--

(A) which provides that payment of part or all of the purchase price is to be made in installments, and

(B) in which 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 for purposes of this section as if they included interest equal to 6 percent of the average unpaid balance under the contract during the taxable year. For purposes of the preceding sentence, the average unpaid balance is the sum of the unpaid balance outstanding on the first day of each month beginning during the taxable year, divided by 12. * * *

(2) LIMITATION.--In the case of any contract to which paragraph (1) applies, the amount treated as interest for any taxable year shall not exceed the aggregate carrying charges which are properly attributable to such taxable year.

Accordingly, if the actual interest charge cannot be ascertained and established, the formula provided by section 163(b) of the Code is applicable to service charges paid under the agreement entered into by the customers of Y, in applying for credit under the so-called budget charge account.

With respect to example 1 there are no carrying charges. With respect to example 2, the formula provided by section 163(b) of the Code applies to the 70 cents paid as carrying charges. Similarly, with respect to example 3, the formula provided by section 163(b) of the Code applies to the 60 cents paid as carrying charges.

The determination, under the above circumstances, that a taxpayer-customer is entitled to a deduction for interest payments under section 163 of the Code does not necessarily form a basis for finding that the retail merchant involved may report the income on such a transaction on the installment method under section 453(a) of the Code.