Rev. Rul. 72-562

The Internal Revenue Service has been asked to clarify certain provisions of Revenue Ruling 72-100, C.B. 1972-1, 122, relating to the reporting of interest by the lender and the interest deduction by the borrower on installment loans made at a discount with a requirement that, in the event of prepayment, interest is to be computed on the Rule of 78's method.

Question 1. Does the term "installment loans made at a discount" include loans made with add-on interest (i.e. a loan in which the interest is added to the principal amount of the loan made to the borrower)?

Answer. Yes.

Question 2. Will Revenue Procedure 70-27, C.B. 1970-2, 509, be applicable for taxable years ending after March 6, 1972 (date of publication of Revenue Ruling 72-100), if, under that Revenue Procedure, the taxpayer requests permission to change his method of accounting?

Answer. A taxpayer wishing to take advantage of Revenue Procedure 70-27 should generally file Form 3115 (Application for Change in Accounting Method) within 180 days from the beginning of the taxable year for which the change is requested. See section 4.01 of Revenue Procedure 70-27. If a taxpayer's return is being examined by the Service and there is an issue involving a change in accounting practice or method the taxpayer may request the application of Revenue Procedure 70-27, provided the taxpayer qualifies for its application. In such a case, the Revenue Procedure will generally be applicable to the most recent taxable year for which a Federal income tax return has been filed. See section 4.03 and section 6 of Revenue Procedure 70-27.

Question 3. Several questions have also been raised regarding the "consistency" and "conformity" requirements contained in the third from the last paragraph of Revenue Ruling 72-100. That paragraph provides:

Under the authority of section 7805(b) of the Code, the conclusions of this Revenue Ruling regarding the reporting of income on discounted installment obligations will not be applied to require a change in a taxpayer's method of accounting where (1) the taxpayer has consistently used a method other than the Rule of 78's method in determining taxable income and under that method at the end of any fraction of the term of the loan at least as much interest would be included in gross income as under the straight-line method, and (2) in his taxable years ending after the publication of this Revenue Ruling the amount of interest included in gross income on any loan in any taxable year is not less than the amount of interest reported with respect to that loan in all reports (including consolidated financial statements) to shareholders, partners, other proprietors, beneficiaries and for credit purposes in such taxable year. The answers to the specific questions raised with respect to this paragraph are as follows:

(a) The requirement that a method of accounting has been "consistently used" is satisfied if the taxpayer properly uses the straight-line or equivalent method of determining taxable income (other than the Rule of 78's) on its return for the last taxable year ending before March 6, 1972 (date of publication of Revenue Ruling 72-100) and does not change from that method thereafter.

(b) In the case of a transaction to which the provisions of section 381 of the Internal Revenue Code of 1954 applies, the transferee's principal method of accounting (as defined in section 1.381(c)(4)-1(c)(2) of the Income Tax Regulations) for interest income will be used to determine if the taxpayer has "consistently used" the straight-line method of determining interest income.

(c) In applying the conformity requirement, if the taxpayer is including a greater amount of interest in income in financial reports than for tax purposes solely because he is using an accrual method of accounting for financial reporting and the cash receipts and disbursements method of accounting for Federal income tax purposes, the conformity requirement shall be deemed met.

(d) A taxpayer who, in good faith, because of the short interval of time between publication of Revenue Ruling 72-100 and issuance of the report, was unable to meet the conformity requirement with respect to any report to shareholders, creditors, etc., issued after March 6, 1972 (date of publication of Revenue Ruling 72-100), may request relief from the conformity requirement for such report by writing to the Commissioner of Internal Revenue, Attention: T:I:C, 1111 Constitution Avenue, N.W., 20224.

The following examples illustrate the principles of Revenue Ruling 72-100, as clarified by this Revenue Ruling.

Example 1. X is engaged in the general commercial banking business and uses a calendar year accounting period. For 1971 and prior years, X has consistently used the straight-line method of reporting interest income on installment loans for Federal income tax purposes, has used the Rule of 78's method for rebating interest on prepaid loans, and, in its financial reports to shareholders, has reported the interest income on such loans on the Rule of 78's method. Under such circumstances, in order to preserve its right to continue using the straight-line method for Federal income tax purposes, X must change its financial reports to shareholders, creditors, etc., issued after March 6, 1972, to the straight-line method of reporting such interest income. Otherwise, the Commissioner may require X to change to the Rule of 78's upon examination of X's returns. See question 2 as to the application of Revenue Procedure 70-27.

Example 2. Y is engaged in the general commercial banking business and uses a calendar year accounting period. For 1971 and prior taxable years, Y has used the Rule of 78's method for rebating interest on prepaid installment loans but has consistently used the straight-line method of reporting interest on installment loans for both financial reports to shareholders and for Federal income tax purposes. Since Y has used conforming methods of reporting interest income for both financial reports and Federal income tax purposes, Y is not required to change its method of tax accounting for such interest.

Example 3. Z was organized on January 1, 1972, is engaged in the general commercial banking business, and uses a calendar year accounting period. If, for any reason, Z uses the Rule of 78's method for rebating interest on prepaid loans, Z is required to use the Rule of 78's method for reporting the interest on the installment loans for Federal income tax purposes.

This Revenue Ruling and Revenue Ruling 72-100 have equal application to other taxpayers who make installment loans at a discount and make rebates in the manner set forth.

Revenue Ruling 72-100, C.B. 1972-1, 122, is hereby clarified.