Rev. Rul. 71-98

Advice has been requested whether, under the circumstances described below, amounts levied on customer accounts by a bank under a credit card plan and designated as "finance charges" in accordance with the Consumer Credit Protection Act, Public Law 90-321; 82 Stat. 146 et seq. (Truth in Lending Act), are deductible as interest under section 163(a) of the Internal Revenue Code of 1954.

A bank operates a credit card plan under which retail customers in a particular geographic area may purchase goods and services from participating merchants by using the bank's credit card. Sales made by use of the credit card are credited to an account in the merchant's name at the bank. Under a previously executed participation agreement between the bank and the merchant, the merchant is charged a fee based on a stated percentage of his credit card sales to cover all the expenses incurred by the bank in connection with the operation of the credit card plan, except charges for the use of its money.

If a credit card holder pays for his purchase within 25 days from the statement billing date no charge is made to his account by the bank. In the event the full payment is not made within 25 days, the bank charges an amount to the cardholder's account at the rate of 11/2 percent per month on the unpaid balance with the minimum monthly charge of 50 cents. The bank treats these charges as interest and no part of the charge against the credit card holder is a carrying charge (including a finance charge, service charge, and the like), loan fees, credit investigation fees, or similar charges.

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. 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 the 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); Pearl E. Deputy, Administratrix, et al. v. Pierre S. duPont, 308 U.S. 488 (1940), Ct. D. 1435, C.B. 1940-1, 118.

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 taxable year.

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

The Truth in Lending Act requires that all charges made for the use of consumer credit be disclosed and that all charges including interest, service charges, carrying charges, loan fees, credit investigation fees, and other similar charges made for the use of credit be stated as a "finance charge" and as an annual percentage rate. The purpose of the Act as set forth in Regulation Z of the Board of Governors of the Federal Reserve System, 12 CFR 226.1(a)(2), is "* * * to assure that every customer who has need for consumer credit is given meaningful information with respect to the cost of that credit which, in most cases, must be expressed in the dollar amount of finance charge, and as an annual percentage rate computed on the unpaid balance of the amount financed. Other relevant credit information must also be disclosed so that the customer may readily compare the various credit terms available to him from different sources and avoid the uninformed use of credit * * * Neither the Act nor this Part is intended to control charges for consumer credit * * *"

The fact that the Truth in Lending Act and Regulation Z require all charges made for the use of credit to be stated as a "finance charge" and as an annual percentage rate does not convert noninterest charges into interest nor does it make charges that are actually interest non-deductible for Federal income tax purposes. However, when it can be shown that no part of the "finance charge" is for service charges, loan fees, credit investigation fees, etc., the entire "finance charge" is for the use or forbearance of money. Accordingly it is interest.

Revenue Ruling 69-189, C.B. 1969-1, 55, concerns the extent to which a maximum annual charge allowed to a licensed small loan lender by chapter 1321 of the Ohio Revised Code and paid by the borrower is deductible as interest. By definition this total maximum loan charge includes interest and all manner of compensation for any examination, service, brokerage, commission, or bonus, and reimbursements of any expenses incurred that may be paid by the borrower. Revenue Ruling 69-189 holds that if the borrower and the lender agreed at arm's length in the loan contract as to what was the proper portion of the maximum loan charge that was interest, such an agreement would ordinarily be accepted for Federal income tax purposes. In this connection, a statement by the lender that the entire charge was interest would not be sufficient if the facts indicated that a portion of the charge was attributable to specific services performed in connection with the borrower's account.

Accordingly, in the instant case the entire amount charged by the bank at the rate of 11/2 percent per month on the unpaid balance of the credit card holder's account in the bank is ascertainable as interest and is therefore for the use or forbearance of money and deductible under the provisions of section 163(a) of the Code.

¹ Also released as Technical Information Release 1066, dated February 3, 1971.