Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 70-88

1970-1 C.B. 32

IRS Headnote

A public utility corporation that capitalizes certain interest payments on its books as required by a state regulatory body is not precluded from deducting the interest for Federal income tax purposes; G.C.M. 3234 superseded.

Full Text

Rev. Rul. 70-88 /1/

The purpose of this Revenue Ruling is to update and restate under the current statute and regulations, the position set forth in G.C.M. 3234, C.B. VII-1, 124 (1928).

The question presented is whether a taxpayer that capitalized certain interest payments on its books, as required by a state regulatory body, is by virtue of this action precluded from deducting the interest in determining its taxable income for Federal income tax purposes.

The taxpayer is classified as a public utility corporation under the laws of a state. The state regulatory body requires public utilities to use a system of accounts that provides that interest paid on indebtedness incurred for acquisition or construction of plant and equipment shall be charged to the capital account. The taxpayer capitalized on its books the amount of the interest on its debt that was used for construction purposes but claimed such interest as a deduction in computing its Federal income tax liability for the taxable year.

Section 266 of the Internal Revenue Code of 1954 provides that no deduction shall be allowed for amounts paid or accrued for such taxes and carrying charges that under the Income Tax Regulations are chargeable to the capital account with respect to property if the taxpayer elects in accordance with the regulations to treat such taxes or charges as so chargeable.

Section 1.266-1 of the regulations provides that in certain circumstances interest that would otherwise be deductible expense may be capitalized.

Section 1.1016-2(c) of the regulations provides that adjustments to the basis of property shall be made for carrying charges such as taxes and interest that the taxpayer elects to treat as chargeable to capital account under section 266 of the Code, rather than as allowable deductions.

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

The statute and the regulations contemplate in general an election on the part of the taxpayer either to deduct interest on bona fide indebtedness in computing taxable income or to capitalize interest for the determination of gain or loss.

In the instant case the taxpayer did not elect to capitalize interest for Federal income tax purposes although it did capitalize the interest on its books to comply with the orders of the state regulatory body. The mere fact that it was required to do so for state regulatory purposes does not preclude the interest deduction under section 163 of the Code.

Accordingly, the corporation may deduct the interest under section 163 of the Code.

G.C.M. 3234 is hereby superseded since the position stated therein is restated under current law in this Revenue Ruling.

/1/ Prepared pursuant to Rev. Proc. 67-6, C.B. 1967-1, 576.