Rev. Rul. 85-65

1985-1 C.B. 366, 1985-20 I.R.B. 36.

NET OPERATING LOSS; FINANCIAL INSTITUTIONS; BAD DEBT DEDUCTIONS;

RESTRICTED INTEREST

Published: 1985

26 CFR 301.6601-1: Interest on underpayments.

(Also Sections 593. 6211: 1.593-6A. 301.6211-1.)

  Net operating loss; financial institutions; bad debt deductions; restricted interest. Interest will not accrue on an unassessed deficiency created when a financial institution that used the 'percentage of taxable income' method to compute its bad debt deduction in the carryback year carries back a net operating loss and is required to recompute its bad debt deduction under section 1.593-6A(b)(5)(vi) of the regulations.

ISSUE

  Under section 6601 of the Internal Revenue Code, is interest assessed in the situation described below?

FACTS

  X, a corporation, is a mutual savings bank to which the provisions of section 593 of the Code, relating to reserves for losses on loans, apply. X filed its income tax returns timely on a calendar year basis. For tax year 1971, X computed the limit to its deduction for an addition to its bad debt reserve using the percentage of taxable income method provided by section 593(b)(2) of the Code. Its taxable income for 1971, computed without taking into account the bad debt deduction, was $2,000,000. In tax year 1981, X sustained a net operating loss of $1,000,000. X filed a Form 1139, Corporation Application for Tentative Refund, and carried back the loss to 1971 under the provisions of section 172(b)(1)(F). Under section 1.593-6A(b)(5)(vi) of the Income Tax Regulations, X was required to recompute its bad debt deduction for 1971. The recomputation reduced X's bad debt deduction from $1,080,000 to $540,000 and thereby tentatively increased its taxable income from $920,000 to $1,460,000. Application of the net operating loss to this figure resulted in a tax for 1971 of $184,000 and a resulting overpayment for 1971 of $184,000, assuming a 40 percent tax rate.

LAW AND ANALYSIS

  Section 593(b) of the Code sets forth 3 methods that a taxpayer using the reserve method of accounting pursuant to section 166(c) may use in computing the maximum amount it may deduct as a reasonable addition to its bad debt reserve: (1) the percentage of taxable income method in section 593(b)(2), (2) the percentage of eligible loans outstanding method in section 593(b)(3), and (3) the experience method in section 593(b)(4).

  Section 1.593-6A(b)(5)(vi) of the regulations requires a taxpayer to determine its bad debt deduction for tax years beginning before January 1, 1978 based on the amount of its taxable income taking into account any deduction for a net operating loss carryback from a taxable year beginning on or after January 1, 1979. Section 1.593-6A(b)(5)(vii), which relates to carrybacks to years beginning after December 31, 1977, has the same effect.

  Section 6211(a) of the Code provides that in the case of income taxes, the term 'deficiency' means that amount by which the tax imposed exceeds the excess of the sum of the amount shown as tax by the taxpayer upon the return plus the amounts previously assessed as a deficiency, over the amount of any rebates made.

  Section 6411 of the Code provides that a taxpayer may file an application for a tentative carryback adjustment of the tax for the prior taxable year affected by a net operating loss carryback provided in section 172(b).

  Section 6601(a) of the Code provides that interest must be paid at an annual rate if any amount of income tax is not paid on or before the last day prescribed for payment. Interest is due for the period from the last date prescribed of the tax to the date the tax is paid.

  Section 6601(d)(1) of the Code, as applicable to interest accruing before October 4, 1982, provides that, if the amount of any income tax imposed is reduced by reason of a net operating loss carryback, the reduction in tax will not affect the computation of interest under section 6601 for the period ending with the last day of the tax year in which the net operating loss arises.

  Under section 6611(f)(1) of the Code, as applicable to interest accruing before October 4, 1982, for purposes of determining interest on an overpayment, if any payment of tax results from carryback of a net operating loss, the overpayment is deemed not to have been made prior to the close of the tax year in which the net operating loss arises.

  Section 301.6601-1(e)(3) of the Regulations on Procedure and Administration, as applicable to interest accruing before October 4, 1982, provides that when there has been an allowance of an overpayment attributable to a net operating loss carryback and all or part of such allowance is later determined to be excessive, interest is to be computed on the excessive amount from the last day of the year in which the net operating loss arose until the date on which the repayment of the excessive amount is received.

  Under section 1.593-6A(b)(5)(vi) of the regulations, the taxpayer must recompute the deduction for the addition to the bad debt reserve taking into account the effect of the net operating loss carryback on 'taxable income'. This recomputation, therefore, will result in an increase in taxable income for the year. This increase arises, however, at the time the net operating loss is applied to the taxable income in the prior year. Under section 301.6601- 1(e)(1), as applicable to interest accruing before October 4, 1982, the carryback of a net operating loss will not affect the computation of interest on any income tax for the period beginning with the last day prescribed for the payment of the tax and ending with the last day of the taxable year in which the loss arises.

  Payment of interest is mandatory on underpayments and overpayments of any internal revenue tax unless specifically prohibited by law or by mutual agreement. In the case of an underpayment, interest is collected for the time the taxpayer has the use of the government's money. Rev. Proc. 60-17, 1960-2 C.B. 942, as modified by Rev. Proc. 62-77, 1962-2 C.B. 495, Rev. Proc. 65-20, 1965-2 C.B. 1003, and Rev. Proc. 83-58, 1983-2 C.B. 575.

  Situations in which an adjustment is not directly attributable to the carryback itself are distinguishable from the case at hand, since in such situations section 6601(d)(1) of the Code does not operate to provide an exception to the general rule of a section 6601(a). Such distinguishable situations may involve underpayments that could have been determined at the time payment of tax for the carryback year was due (i.e. pre-existing deficiency). See, e.g., Manning v. Seeley Tube and Box Co., U.S. 561 (1950), 1950-1 C.B. 113; Rodgers v. United States, 108 F. Supp. 727 (Ct. Cl. 1952). They may also involve situations in which the fact of amount of the underpayment could not be determined until some time subsequent to the date payment for the carryback year was due (i.e., a deficiency that 'relates-back', such as the failure to reinvest in a principal residence under section 1034). See, e.g., Rev. Rul. 122, 1953-2 C.B. 226; Rev. Rul. 57-179, 1957-1 C.B. 112; Rev. Rul. 76-383, 1976-2 C.B. 429.

  The result in General Dynamics Corp. v. United States, 562 F.2d 1201  (Ct. Cl. 1977), is consistent with the rationale expressed in this ruling. In General Dynamics the taxpayer was able to carry back a net operating loss to two earlier years. The taxes against which it had taken a foreign tax credit in the carryback years were eliminated as a direct result of the carryback. Since it was unable to use the eliminated credits in other years because of limitations imposed by section 904(d) of the Code, the taxpayer elected to deduct the foreign taxes in the carryback years. The Court of Claims held that the taxpayer owed interest on tax for the carryback years calculated as if the foreign tax credits had never been invoked. The taxpayer's decision in that case to change its prior election in order to take advantage of the changed situation after taking the carryback into account was not directly attributable to the carryback. It was, therefore, proper to take into account the effect of the taxpayer's change of election in computing interest for the carryback years.

  If the adjustment is not attributable to the carryback, and if the year is barred by the statute of limitations, interest will accrue and can be collected by offset against a refund due the taxpayer, under Lewis v. Reynolds, 284 U.S. 281 (1932) XI-1 C.B. 130. See Rev. Rul. 85-64, page 35, this Bulletin.

HOLDING

  No interest under section 6601 of the Code can be assessed for the period ending with the last day of the loss year.

  The result would be no different had the taxpayer chosen to carry back its net operating loss by filing a Form 1120X, Amended Corporation Income Tax Return.

Rev. Rul. 85-65, 1985-1 C.B. 366, 1985-20 I.R.B. 36.