Rev. Rul. 74-187

Advice has been requested whether a late-payment charge assessed by a public utility is deductible as interest under section 163 of the Internal Revenue Code of 1954.

A public utility charges for its service at rates set by a State agency. In addition to the standard rates based on the amount of service used, the utility charges an additional five percent if a bill is paid more than 20 days after the due date.

Section 163(a) of the Code provides that there shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness.

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), XI-1 C.B. 274 (1932), and Deputy v. Dupont, 308 U.S. 488 (1940), 1940-1 C.B. 118. The United States Board of Tax Appeals has stated that interest is the compensation allowed by law or fixed by the parties for the use, forbearance, or detention of money. Fall River Electric Light Co., 23 B.T.A. 168 (1931).

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. Rev. Rul. 72-315, 1972-1 C.B. 49.

The fact that the late-payment charge is a one-time charge does not preclude a finding that it is interest. See Rev. Rul. 69-188, 1969-1 C.B. 54, which holds that a "loan processing fee" (points) paid by a mortgagor-borrower as compensation to a lender solely for the use or forbearance of money is considered to be interest. Nor does the effective rate of the late-payment charge preclude a finding that it is interest. See Rev. Rul. 72-2, 1972-1 C.B. 19, and Kena, Inc., 44 B.T.A. 217 (1941).

Rev. Rul. 72-315, which concerns the deductibility of finance charges paid on a revolving charge account, states that a charge that 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. That Revenue Ruling holds, however, that the amount charged to a customer's revolving charge account in that case is solely for the privilege of deferring payment and is deductible as interest.

Accordingly, it is held that, in the absence of evidence that the late-payment charge assessed by the public utility is for a specific service performed in connection with a customer's account, such late-payment charge is deductible as interest under section 163 of the Code.