Rev. Rul. 89-6
1989-1 C.B. 119, 1989-3 I.R.B. 4.
Internal Revenue Service
Revenue Ruling
INTEREST; TIMING OF DEDUCTION; CONTESTED TAX LIABILITY; ASSERTED
LIABILITY
Published: January 17, 1989
SECTION 461. - GENERAL RULE FOR TAXABLE YEAR OF DEDUCTION, 26 CFR 1.461-2: Timing of deductions in certain cases where asserted liabilities are contested
(Also Section 163; 1.163-1.)
Interest; timing of deduction; contested tax liability; asserted liability. Interest paid by accrual basis corporation in connection with a contested tax liability is deductible under section 163(a) and 461(f) of the Code in the tax year of payment when the taxpayer remits the total amount of the proposed tax liability and does not designate the amount remitted as a deposit in the nature of a cash bond.
The Service sent a corporation a notice of proposed deficiency (30-day letter), accompanied by a letter explaining the basis of the proposed deficiency. The corporation, an accrual basis taxpayer, disagreed with the examiner's report and filed a protest. While the protest was pending, the corporation, in accordance with Rev. Proc. 84-58, 1984-2 C.B. 501, remitted the entire proposed tax deficiency, plus interest. The corporation did not designate the remittance as a deposit in the nature of a cash bond, but it did file a claim for refund. But for the contested nature of the tax liability posed by the refund claim, the corporation had satisfied all the requirements for deducting the interest under section 163.
ISSUE. At issue is whether the corporation may deduct, in the year of the remittance, that portion of the remittance attributable to interest.
HOLDING. The Service has held that the corporation may deduct the interest portion of the remittance. The Service emphasized that the deduction was dependent upon the corporation's (1) remittance of the total amount of unassessed tax (and appropriate interest) proposed in the 30-day letter accompanied by an examiner's report, (2) failure to designate the amount remitted as a deposit in the nature of a cash bond, and (3) contesting the proposed tax and related interest, both before and after making the remittance.
ANALYSIS. The Service's conclusion turned on two provisions: sections 461(a) and 461(f). Regulation section 1.461-1(a)(2) provides the general rule that an accrual basis taxpayer will fail to meet the all events test prerequisite to a deduction if it contests the liability giving rise to the deduction. Section 461(f) provides an escape from this result where the taxpayer not only contests the liability, but (1) transfers money for the satisfaction of the liability, (2) the contest over the asserted liability exists after the time of the transfer, and (3) 'but for the fact that the asserted liability is contested, a deduction would be allowed for the taxable year of the transfer.' The key to the entire determination is whether the remittance made by the taxpayer is placed beyond the taxpayer's control for purposes of regulation section 1.461- 2(c)(1).
Noting the corporation's compliance with section 4.03 of Rev. Proc. 84-58, 1984-2 C.B. 501, in making the remittance, and the corporation's compliance with section 461(f)'s requirements, the Service concluded that a deduction should be allowed for the interest remitted by the corporation.
ISSUE
If an accrual method corporate taxpayer remits the total amount of unassessed tax proposed in a 30-day letter accompanied by an examiner's report, plus appropriate interest, does not designate the amount remitted as a deposit in the nature of a cash bond, and contests the proposed tax and related interest, both before and after making the remittance, is the portion of the remittance that is attributable to interest deductible under sections 163(a) and 461(f) of the Internal Revenue Code in the tax year of the
remittance?
FACTS
X is a corporate taxpayer and thus not subject to the disallowance of deduction for personal interest under section 163(h) of the Code. X uses the accrual method of accounting for federal income tax purposes. After auditing X's 1986 federal income tax return, a revenue agent proposed several adjustments that would result in an increase in X's tax liability for 1986. The increase in tax liability would also result in liabilities for interest. X disagreed with the proposed adjustments and subsequently received a Notice of Proposed Deficiency (30-day letter) from the District Director accompanied by an examiner's report explaining the basis of the proposed deficiency. X filed a protest with the District Director contesting the proposed deficiency. While the issues set forth in the protest were pending, X, pursuant to section 4.03(1) of Rev. Proc. 84-58, 1984-2 C.B. 501, made a remittance with respect to the proposed deficiency, and the related interest. X did not designate that the remittance was to be treated as a deposit in the nature of a cash bond. On the day X made the remittance. X filed a claim for refund of the remittance. But for the contest posed by the claim for refund, X had satisfied all of the requirements for deduction of the interest portion of the remittance under section 163.
LAW AND ANALYSIS
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.
Section 461(a) of the Code provides that the amount of any deduction or credit allowed by subtitle A of the Code shall be taken for the taxable year that is the proper taxable year under the method of accounting used in computing taxable income.
Section 1.461-1(a)(2) of the Income Tax Regulations provides that, under an accrual method of accounting, an expense is deductible for the taxable year in which all the events have occurred which determine the fact of the liability and the amount thereof can be determined with reasonable accuracy. In the instant situation, the all events test of section 1.461-1(a)(2) is not met because X contests the liability. Nevertheless, the taxpayer may be allowed a deduction if the requirements of section 461(f) of the Code are met.
Section 461(f) of the Code provides an exception to the all events test in certain situations in which a taxpayer transfers money or other property to provide for the satisfaction of a contested liability. The provision provides that if (1) the taxpayer contests an asserted liability, (2) the taxpayer transfers money or other property to provide for the satisfaction of the asserted liability, (3) the contest with respect to the asserted liability exists after the time of the transfer, and (4) but for the fact that the asserted liability is contested, a deduction would be allowed for the taxable year of the transfer (or for an earlier taxable year) determined after application of section 461(h), then the deduction shall be allowed for the taxable year of the transfer.
Section 1.461-2(b)(1) of the regulations provides that the term 'asserted liability' means an item with respect to which, but for the existence of any contest in respect of such item, a deduction would be allowable under an accrual method of accounting.
Section 1.461-2(b)(2) of the regulations provides that any contest that would prevent accrual of a liability under section 461(a) of the Code shall be considered to be a contest. A contest arises when there is a bona fide dispute as to the proper evaluation of the law or the facts necessary to determine the existence or correctness of the amount of an asserted liability. It is not necessary to institute suit in a court of law in order to contest an asserted liability. An affirmative act denying the validity or accuracy, or both, of an asserted liability to the person who is asserting the liability, such as including a written protest with payment of the asserted liability, is sufficient to commence a contest.
Section 1.461-2(c)(1) of the regulations provides that a taxpayer may provide for the satisfaction of an asserted liability by transferring money or other property beyond the taxpayer's control to the person who is asserting the liability. In order for money or other property to be beyond the control of the taxpayer, the taxpayer must relinquish all authority over such money or other property.
Section 1.461-2(d) of the regulations provides that, in order for a contest with respect to an asserted liability to exist after the time of transfer, such contest must be pursued subsequent to such time.
Section 1.461-2(e)(1) of the regulations provides that the existence of the contest with respect to an asserted liability must prevent (without regard to section 461(f)) and be the only factor preventing a deduction for the taxable year of transfer (or, in the case of an accrual method taxpayer, for an earlier taxable year for which such amount would be accruable) to provide for the satisfaction of the liability.
Rev. Proc. 84-58, 1984-2 C.B. 501, sets forth procedures for taxpayers to make remittances in order to stop the running of interest on federal income tax deficiencies. Section 4.03 of Rev. Proc. 84-58 provides that a remittance not specifically designated as a deposit in the nature of a cash bond will be treated as a payment of tax if it is made in response to a proposed liability, for example, as proposed in a revenue agent's or examiner's report, and remittance in full of the proposed liability is made.
In order to receive an interest deduction under sections 163(a) and 461(f) of the Code, the taxpayer must meet each of the requirements of section 461(f)(1) through (4).
Section 461(f)(1) provides that the taxpayer must contest an asserted liability. X has contested the proposed liability for tax and interest by filing a protest to deny its validity. As required under section 1.461-2(b)(2) of the regulations, there is a bona fide dispute as to the proper evaluation of the law or facts necessary to determine the existence and correctness of the amount of X's liability. Further, the 30-day letter and examiner's report resulted in the existence of an asserted liability within the meaning of section 461(f)(1).
Section 461(f)(2) of the Code provides that the taxpayer must transfer money or other property to provide for the satisfaction of the asserted liability. Here, X has made a payment of money to the Service for satisfaction of the asserted liability. Because X has made a payment and not a deposit in the nature of a cash bond, the funds are placed beyond X's control within the meaning of section 1.461-2(c)(1) of the regulations.
Section 461(f)(3) of the Code provides that the contest with respect to the asserted liability must exist after the time of the transfer. Thus, the contest must have been neither settled nor abandoned at the time of the transfer. See section 1.461-2(d) of the regulations. In the instant situation, X has filed a claim for the refund of the amounts paid and continues to contest the validity of the asserted liability even after it is paid.
Section 461(f)(4) of the Code requires that, but for the fact that the asserted liability is contested, a deduction would be allowed for the taxable year of the transfer (or for an earlier taxable year) determined after application of section 461(h). This requirement is also met because X has made a payment to the Service for satisfaction of the asserted tax liability and associated interest.
In Charles Leich and Co. v. United States, 329 F.2d 649, reh'g denied, 333 F.2d 871 (Ct. Cl. 1964), the taxpayer made remittances in response to deficiencies proposed in a revenue agent's report. The taxpayer never signed a waiver agreeing to the assessment of all or any portion of the proposed deficiencies, no statutory notice of deficiency was ever issued to the taxpayer formally proposing any of the deficiencies, and none of the proposed deficiencies were ever assessed. The Court of Claims held that the remittances were not overpayments upon which interest could not be deducted as interest expenses in the years of the remittances.
In denying the taxpayer's motion for a rehearing, the Court of Claims considered the language currently contained in section 461(f) of the Code. The court noted that the legislative history of that language seems to indicate that before section 461(f) 'becomes operative taxpayer must be put in a position where inaction on his part will cause him to have a legal obligation to pay the tax.' 333 F.2d at 872. The court stated that Congress intended an asserted liability to be 'something akin to a 'tax assessment." Id. The Court concluded that there was no asserted liability in the Leich case, since there had not been an assessment with respect to the tax.
Unlike the administrative procedures of the Service when Leich was decided, currently, as provided in section 4.03 of Rev. Proc. 84-58, assessment of the amount remitted by a taxpayer in response to a liability proposed in a revenue agent's or examiner's report is not required for such a remittance to qualify as a payment of tax. Thus, a remittance not specifically designated as a deposit in the nature of a cash bond is considered a payment of tax if it is made in response to a revenue agent's or examiner's report, and remittance in full of the proposed liability is made, even if there has not been an assessment of the tax. Because of this change in administrative procedures, the Service will no longer follow the court's conclusion in Leich that, in the absence of a tax assessment, an amount proposed in a revenue agent's or examiner's report is not an asserted liability within the meaning of section 461(f) of the Code.
HOLDING
If an accrual method corporate taxpayer remits the total amount of unassessed tax proposed in a 30-day letter accompanied by an examiner's report, plus appropriate interest, does not designate the amount remitted as a deposit in the nature of a cash bond, and contests the proposed tax and related interest, both before and after making the remittance, then the portion of the remittance that is attributable to interest is deductible under sections 163(a) and 461(f) of the Code in the tax year of the remittance.
APPLICATION
This revenue ruling is not restricted to instances in which a taxpayer makes a remittance of the full amount of proposed liability. Rather, it applies also to partial remittances that constitute payments of tax and interest under section 4.03 of Rev. Proc. 84-58.
DRAFTING INFORMATION
The principal author of this revenue ruling is Steve Toomey of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Mr. Toomey on (202) 566-6320 (not a toll free call).
Rev. Rul. 89-6, 1989-1 C.B. 119, 1989-3 I.R.B. 4.