IRS ISSUES SPECIAL RULES FOR CHANGING METHOD OF ACCOUNTING FOR OID.

Rev. Proc. 94-30

CONTENTS

SECTION 1. PURPOSE

Rev. Proc. 94-28, page __, this Bulletin, and Rev. Proc. 94-29, page __, this Bulletin, provide procedures for taxpayers to change their methods of accounting for de minimis original issue discount, including de minimis original issue discount attributable to points. Under those procedures, however, the new methods of accounting apply only to loans acquired on or after certain "cut-off dates." This revenue procedure applies to loans acquired before the applicable cut-off dates and prescribes the only methods of accounting to which taxpayers may change for these loans. This revenue procedure also provides an exclusive automatic consent procedure for taxpayers that want to change to one of these methods.

SEC. 2. BACKGROUND

.01 On February 2, 1994, the Service published final rules for the treatment of original issue discount (OID), de minimis OID, stated interest, and unstated interest. See generally sections 1.163- 7, 1.446-2, 1.483-1 through 1.483-3, 1.1001-1(g), 1.1012-1(g), and 1.1271-0 through 1.1275-5 of the Income Tax Regulations (T.D. 8517, 1994-9 I.R.B. 4).

.02 Section 1.163-7 and sections 1.1271-0 through 1.1275-5 provide final rules for the treatment of OID, including de minimis OID. In general, the regulations apply to debt instruments issued on or after April 4, 1994. Taxpayers, however, may rely on the regulations for debt instruments issued on or after December 22, 1992, and before April 4, 1994. Sections 1.163-7(e) and 1.1271-0(a).

.03 Points treated as paid when a loan is originated generally reduce the issue price of the loan. See section 1.1273-2(g) (concerning the effect of certain cash payments on the issue price of a loan). Thus, all points charged on a loan create or increase OID on the loan. As used in this revenue procedure, the term "points" refers only to amounts charged for the use or forbearance of money.

.04 Rev. Proc. 94-28 provides procedures for taxpayers to effect timely changes in their methods of accounting to comply with the final regulations dealing with OID and other related matters. Because these changes are made on a cut-off basis, a method of accounting used prior to the adoption of the method provided in the final regulations is not changed for loans issued prior to the cut-off date that is chosen by the taxpayer under section 4 of Rev. Proc. 94-28.

.05 Rev. Proc. 94-29 permits certain taxpayers to use the principal-reduction method of accounting -- an aggregate method of accounting for discount on loans that do not have OID or, because the OID is de minimis under section 1.1273-1(d), are treated as not having OID. Rev. Proc. 94-29 also describes how eligible taxpayers may change to the principal-reduction method. Because the change to the principal-reduction method is made on a cut-off basis, a method of accounting used prior to the adoption of the principal-reduction method is not changed for loans acquired prior to the cut-off date that is chosen by the taxpayer under section 8 of Rev. Proc. 94-29.

.06 Rev. Rul. 70-540, 1970-2 C.B. 101, amplified by Rev. Rul. 74-607, 1974-2 C.B. 149, provided guidance concerning when points charged by a lending institution in connection with making real estate mortgage loans were to be included in the income of the lending institution. The holdings in these rulings concerning the treatment of points by lenders were made obsolete by Rev. Proc. 94-29.

.07 For a bank or similar taxpayer using the cash receipts and disbursements method of accounting, Rev. Rul. 64-278, 1964-2 C.B. 120, provided the "liquidation method" of accounting to determine the amount of interest taken into account from loans made at a discount. Under the liquidation method, the taxpayer took into account unrecognized discount in the same proportion that the amount of loan principal liquidated during each month bore to the total loan principal outstanding at the beginning of the month. Rev. Rul. 64-278 was made obsolete by Rev. Proc. 94-29.

.08 Rev. Rul. 216, 1953-2 C.B. 38, permitted mutual savings banks, building and loan associations, and cooperative banks to amortize mortgage acquisition costs on a composite basis. Rev. Rul. 54-367, 1954-2 C.B. 109, permitted mutual savings banks that were carrying large numbers of interest-bearing mortgages purchased at a discount to elect to report those purchase discounts on a composite basis. Rev. Rul. 216 and Rev. Rul. 54-367 were made obsolete by Rev. Proc. 94-29.

.09 Section 446(e) and section 1.446-1(e) state that, except as otherwise provided, a taxpayer must obtain the consent of the Commissioner to change a method of accounting for federal income tax purposes.

.10 Section 1.446-1(e)(3)(i) requires that, in order to obtain the Commissioner's consent to change a method of accounting, a Form 3115, Application for Change in Accounting Method, generally must be filed within 180 days after the beginning of the taxable year in which the proposed change is to be made.

.11 Section 1.446-1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the limitations, terms, and conditions deemed necessary to permit a taxpayer to obtain consent to change its method of accounting in accordance with section 446(e).

.12 When taxable income for a taxable year is computed under a method of accounting that is different from the method used to compute taxable income for the preceding taxable year, section 481(a) requires the taxpayer to take into account those adjustments necessary to prevent amounts from being duplicated or omitted.

.13 Section 481(c) and section 1.481-5 provide that the adjustments required by section 481(a) may be taken into account in determining taxable income in the manner and subject to the conditions agreed to by the Commissioner and the taxpayer.

.14 The Commissioner may determine that certain changes in methods of accounting are to be effected on a cut-off basis. If a change is made on a cut-off basis, only the items arising on or after the beginning of the year of change (or other operative date) are accounted for under the new method of accounting. Any items arising prior to that date continue to be accounted for under the former method of accounting. When a change is made on a cut-off basis, no items of income or deduction are duplicated or omitted, and therefore no adjustment is necessary under section 481(a). Section 2.05(3) of Rev. Proc. 92-20, 1992-1 C.B. 685, 689.

.15 Section 6001 and the regulations thereunder require taxpayers to keep permanent books of account or records to establish the amount of gross income for a taxable year.

SEC. 3. SCOPE

.01 Except as provided in sections 3.02 and 3.03, a taxpayer is eligible to use this revenue procedure to change its method of accounting if the taxpayer --

(1) Is changing its method of accounting for de minimis OID under Rev. Proc. 94-29 and the year of change under that revenue procedure is not later than the first taxable year beginning after April 4, 1994; or

(2) Is changing its method of accounting for de minimis OID under Rev. Proc. 94-28 (under which the year of change may be no later than the first taxable year beginning after April 4, 1994).

.02 This revenue procedure does not apply to a taxpayer that, at the time of the filing of the Form 3115 required by section 8.01 below, is the subject of a criminal investigation or proceeding concerning (1) directly or indirectly, any issue relating to the taxpayer's federal tax liability for any taxable year, or (2) the possibility of false or fraudulent statements made by the taxpayer with respect to any issue relating to its federal tax liability for any taxable year.

.03 In the case of loans that are being accounted for under a deferred recognition method, as defined in section 4.03 below, this revenue procedure may not be used to change the method of accounting for those loans if, at the time of the filing of the Form 3115 required by section 8.01 below, the taxpayer is described in one of the following paragraphs --

(1) The taxpayer is under examination for any taxable year. However, if the taxpayer is not under examination on April 4, 1994, or on that date the taxpayer was eligible to file a Form 3115 to change from that deferred recognition method under section 6 of Rev. Proc. 92-20, this section 3.03(1) does not prevent this revenue procedure from applying to the taxpayer if the taxpayer complies with section 8.01(3) below.

(2) The taxpayer is before an appeals office of the Internal Revenue Service with respect to an examination of its federal income tax return(s) for any taxable year, unless the taxpayer obtains a statement from the appeals officer that there is no objection to the proposed change in method of accounting and attaches this statement to the Form 3115. See section 4.02 of Rev. Proc. 92-20.

(3) The taxpayer is before any federal court with respect to an income tax issue arising in any taxable year, unless the taxpayer obtains a statement from counsel for the government that there is no objection to the proposed change in method of accounting and attaches this statement to the Form 3115. See section 4.03 of Rev. Proc. 92-20.

SEC. 4. DEFINITIONS

.01 Cut-off date. If a taxpayer is changing its method of accounting for de minimis OID under Rev. Proc. 94-29 and the year of change is not later than the first taxable year beginning after April 4, 1994, the cut-off date for purposes of this revenue procedure is the cut-off date chosen by the taxpayer under that revenue procedure. Otherwise, the cutoff date for purposes of this revenue procedure is the cut-off date chosen by the taxpayer under Rev. Proc. 94-28 (under which the year of change may be no later than the first taxable year beginning after April 4, 1994).

.02 Current inclusion method. The current inclusion method is a method that was used by certain lenders to account for points treated as paid at the origination of a loan. Under this method, the lender included the points in income in the taxable year they were treated as paid.

.03 Deferred recognition method. The deferred recognition method is any method other than the current inclusion method used by a lender to account for points (for example, the loan liquidation method or the composite method).

.04 Terms defined in the general method change revenue procedure. Except to the extent explicitly provided in this revenue procedure, the following terms have the meaning given to them by Rev. Proc. 92-20 (or its then-current successor):

o Taxpayer (See section 3.01 of Rev. Proc. 92-20),

o Under examination (See section 3.02 of Rev. Proc. 92-20),

o Year of change (See section 3.03 of Rev. Proc. 92-20), and

o Filed (See section 3.04 of Rev. Proc. 92-20).

SEC. 5. METHOD TO BE USED

.01 Points accounted for on the current inclusion method. If a taxpayer described in section 3.01 was using the current inclusion method to account for points on some or all of its loans, the only method for those loans to which the taxpayer may change is either:

(1) a method under which the discount (including discount attributable to points) on each loan is accounted for as stated principal payments on that loan are made, or

(2) the revised loan liquidation method (described in section 5.03 below).

.02 Points accounted for on a deferred recognition method.

If a taxpayer described in section 3.01 was using a deferred recognition method (including the loan liquidation or the composite method) to account for points on some or all of its loans, the only method for those loans to which the taxpayer may change is the revised loan liquidation method (described in section 5.03 below).

.03 Revised loan liquidation method. Under the revised loan liquidation method --

(1) The amount of discount income taken into account in any taxable year is the product of the unrecognized discount (including deferred points) remaining at the end of the prior taxable year and the fraction described in the following sentence. The numerator of the fraction is the excess of the outstanding stated principal at the end of the prior year over the outstanding stated principal at the end of the current year, and the denominator of the fraction is the outstanding stated principal at the end of the prior year. Accordingly, all unrecognized discount is taken into account no later than the taxable year in which the taxpayer no longer holds any of the loans that it held at the close of the day before the cut-off-date and that were being accounted for under the taxpayer's current inclusion or deferred recognition method.

(2) Outstanding stated principal at the end of a year includes only outstanding stated principal on loans that were held by the taxpayer at the close of the day before the cut-off date, that continue to be held at the end of the year, and that, immediately before the cut-off date, were being accounted for under the taxpayer's current inclusion or deferred recognition method. Outstanding stated principal at the end of the year does not include principal on loans that have been subject to any of the following during the year: refinancings, exchanges, foreclosures not subject to section 595, charge-offs (to the extent charged off), or dispositions for tax purposes (whether or not they are treated as dispositions for regulatory or financial accounting purposes), including dispositions of foreclosed security if the foreclosure was not previously treated as a liquidation of the underlying loan. In the case of a refinancing or exchange on or after the cut-off date, the new loan is accounted for as a loan acquired on the date of the refinancing or exchange and is not included in outstanding stated principal at the end of the year. Thus, the balance of outstanding stated principal declines as loans are liquidated and is not increased for any reason.

SEC. 6. MANNER OF EFFECTING THE CHANGE

.01 Year of change. The year of change is the taxable year that includes the cut-off date, as defined in section 4.01 of this revenue procedure.

.02 Points accounted for on the current inclusion method. In the case of points accounted for on the current inclusion method, a taxpayer effects the change under the following principles:

(1) Section 481(a) adjustment. The section 481(a) adjustment is equal to:

(a) The amount of discount that would have been taken into account up to the cut-off date if the new method of accounting (provided by section 5 above) had been applied to discount on all loans that are included in the balance of outstanding stated principal at the end of the day before the cut-off date, minus

(b) The amount of discount taken into account by the taxpayer up to the cut-off date under its current inclusion method with respect to all loans that are included in the balance of outstanding stated principal at the end of the day before the cut-off date.

(2) Section 481(a) adjustment period. A taxpayer changing its method of accounting for discount under this revenue procedure is treated as a taxpayer changing from a category B method. Accordingly, the section 481(a) adjustment must be taken into account ratably over a period not to exceed six taxable years, beginning with the year of change. The adjustment period is subject to being shortened under principles similar to those in section 8 of Rev. Proc. 92-20.

.03 Points accounted for on a deferred recognition method. In the case of points accounted for on a deferred recognition method, for purposes of the year-of-change computations under the revised loan liquidation method (described in section 5.03), the remaining unrecognized discount under the deferred recognition method as of the end of the day prior to the cut-off date must be used as the "unrecognized discount remaining at the end of the prior taxable year." If the cut-off date is other than the beginning of the year of change, the discount income for the year of change includes any discount accruing before the cut-off date under the taxpayer's deferred recognition method. Because the revised loan liquidation method is applied only to the remaining balance of unrecognized discount, there is no section 481(a) adjustment.

.04 Audit protection. If a taxpayer changes its method of accounting pursuant to this revenue procedure, an examining agent may not propose that the taxpayer change the same method of accounting for any period prior to the cut-off date. The section 481(a) adjustment allowed under section 6.02 above, however, is subject to verification by the District Director.

SEC. 7. CONSENT

.01 Waiver. In accordance with section 1.446-1(e)(3)(ii), the Commissioner hereby waives the provision in section 1.446-1(e)(3)(i) that otherwise would have required the taxpayer to file an application within 180 days after the beginning of the taxable year for which the change is to be made.

.02 Consent. Under section 1.446-1(e)(2)(i), the Commissioner grants consent for a taxpayer to change to a method described in section 5 of this revenue procedure for loans that were held by the taxpayer on the cut-off date and that were being accounted for under the taxpayer's current inclusion or deferred recognition method. This consent is granted for the taxable year (year of change) for which the taxpayer makes a request in the manner described in section 8 of this revenue procedure. The taxpayer also must comply with the provisions of this revenue procedure in all other respects.

.03 Exclusive procedure. This revenue procedure is the exclusive way for taxpayers described in section 3 of this revenue procedure to obtain the Commissioner's consent to change the method of accounting for points on loans acquired before the cut-off date.

.04 Compliance with conditions. If a taxpayer to which this revenue procedure applies changes to a method described in section 5 of this revenue procedure without authorization or without complying with all of the provisions of this revenue procedure, the taxpayer has initiated a change in method of accounting without obtaining the consent of the Commissioner required by section 446(e).

.05 Books and records. The taxpayer must maintain books and records sufficient to satisfy the District Director that loans subject to this revenue procedure have been adequately segregated from all other loans.

SEC. 8. PROCEDURES FOR REQUESTING CONSENT

.01 Filing of the Form 3115. A taxpayer that desires to change its method of accounting pursuant to this revenue procedure must satisfy the following requirements:

(1) The taxpayer must file a current Form 3115 for the taxable year (year of change) that includes the cut-off date.

(2) Except as provided in section 8.01(3) of this revenue procedure, the taxpayer must file the Form 3115 with its timely filed (including extensions) federal income tax return for the year of change. If the taxpayer, however, has filed a federal income tax return for the year of change prior to June 17, 1994, the Form 3115 may be attached to an amended return for the year of change, provided the amended return is filed not later than December 31, 1994, and provided the new method is appropriately reflected on returns (or amended returns filed by December 31, 1994) for taxable years after the year of change.

(3) If a taxpayer is under examination on April 4, 1994, or becomes a taxpayer under examination after April 4, 1994, and before the Form 3115 is filed but the taxpayer is nevertheless eligible to file the Form 3115 under this revenue procedure, the taxpayer must deliver the original Form 3115 to the District Director for the district with jurisdiction over the most recent taxable year before an examining agent. The Form 3115 must be delivered by the later of July 17, 1994, or 90 days after the taxpayer becomes a taxpayer under examination. A taxpayer that has so delivered the Form 3115 must, at the time the original Form 3115 is delivered, (a) deliver a copy of the Form 3115 to the principal examining agent or team coordinator examining the return for the most recent taxable year before any examining agent; and (b) deliver a copy of the Form 3115 to the District Director for any other district that is examining one of the taxpayer's taxable years. In addition, the taxpayer must comply with section 8.01(2) of this revenue procedure, substituting a copy of the Form 3115 for the original that section 8.01(2) would otherwise have required, and the return (or returns) described in that section must reflect the change. If the year of change begins after the original Form 3115 is filed under this section 8.01(3), the application must be completed in all respects except for the amount of the section 481(a) adjustment, if any, the gross receipts and taxable income amounts for the year immediately preceding the year of change, and the statement required by section 8.02 below. However, this information must be included with the copy of the Form 3115 that is filed to comply with section 8.01(2).

.02 Additional information, representations, and conditions.

(1) Labeling the Form 3115. In order to assist in the processing of the change in method of accounting and to ensure proper handling, reference to this revenue procedure must be made a part of the Form 3115 by either typing or legibly printing the following statement at the top of page 1 of Form 3115: "AUTOMATIC CHANGE FILED UNDER REV. PROC. 94-30."

(2) Written statement. On a signed written statement attached to the Form 3115, the taxpayer must (a) identify the cut-off date, (b) identify the outstanding stated principal and unrecognized discount as of the cut-off date with respect to all loans that the taxpayer will account for pursuant to this revenue procedure, and (c) state that it agrees to all the conditions of this revenue procedure.

(3) Signature for the Form 3115. The Form 3115 must be signed by or on behalf of the taxpayer requesting the change by an individual with the authority to bind the taxpayer in such matters. For example, an officer must sign on behalf of a corporation. See the signature requirements in the General Instructions for Form 3115. If the taxpayer is a member of a consolidated group, a Form 3115 submitted on behalf of the taxpayer must be signed by a duly authorized officer of the common parent. See section 1.1502-77.

(4) Authorized taxpayer representative. If an agent is authorized to represent the taxpayer before the Service, to receive the original or a copy of correspondence concerning the request, or to perform any other act(s) regarding the Form 3115 on behalf of the taxpayer, a power of attorney reflecting that authorization should be attached to the Form 3115. A taxpayer's representative without a power of attorney to represent the taxpayer will not be given any information regarding the Form 3115.

.03 No user fee. No user fee is required for an application made under this revenue procedure.

SEC. 9. EFFECTIVE DATE

This revenue procedure is effective on April 4, 1994.

DRAFTING INFORMATION

The principal author of this revenue procedure is Albert J. Kiss of the Office of the Assistant Chief Counsel (Financial Institutions and Products). For further information, contact Mr. Kiss on (202) 622-3940 (not a toll-free number).