Editor: Michael Dell, CPA
In Chief Counsel Notice CC-2010-018, the IRS announced that it will no longer challenge whether interchange fee income earned by credit card issuers creates or increases original issue discount (OID) on a pool of credit card loans. The IRS did not address the calculation of the portion of interchange fees includible under the OID rules in each period.
In Capital One Financial Corp., 133 T.C. 136 (2009), the Tax Court determined that interchange fees charged on credit card transactions were a form of OID. Accordingly, the taxpayer was not required to include the fees in full in income in the year of the transaction but could spread the fees over the life of the credit card loans to which they related.
The court also addressed the methodology of recognizing the interchange fees (and other fees treated as OID) in income under the provisions of Sec. 1272(a)(6) and generally accepted the taxpayer’s methodology, with certain exceptions. Further, the court ruled that the taxpayer’s credit card rewards were not issued to customers for sales within the meaning of Regs. Sec. 1.451-4, and therefore costs associated with the rewards could not be deducted earlier than when the rewards were actually redeemed.
The good news is that taxpayers should no longer have IRS auditors challenging their treatment of credit card interchange fees as OID. The bad news is that there is still plenty of room for the IRS to challenge taxpayers on how they calculate the accretion of the OID into income. In addition, the notice is specifically limited to interchange fees. It does not cover merchant discount fees, which were not at issue in the Capital One case.
Taxpayers that have filed a request for change in method of accounting (Form 3115, Application for Change in Accounting Method) on this issue might expect to receive permission to change their method, but it is unlikely that they will receive it soon. Although the IRS has conceded that the interchange fees are OID, it is not endorsing any particular inclusion methodology at this time.
As to the Tier II directive on interchange fees, IRS auditors will no longer be raising the issue of whether it is OID, but they may still examine the method a taxpayer is using as well as the merchant discount issue. Since these are all contained in the same Tier II directive, it seems unlikely that the IRS will withdraw the directive.
Michael Dell is a partner at Ernst & Young LLP in Washington, DC.
For additional information about these items, contact Mr. Dell at 202-327-8788 or firstname.lastname@example.org.