IRS memo illustrates application of Sec. 263 to amounts paid to acquire or create intangibles.

• Author: Mostofizadeh, Hoornaz

In Technical Advice Memorandum (TAM) 202121009, the IRS Office of Chief Counsel advised that a taxpayer must capitalize the excess amounts paid to acquire a debt instrument under Sec. 263. The TAM provides an analysis of the capitalization of amounts paid to acquire or create intangibles, providing insight into capital expenditures under Sec. 263 and trade or business expenses under Sec. 162, clarifying capitalizing vs. expensing.

Facts

The TAM describes a consolidated manufacturer (Taxpayer) and its captive finance subsidiary (Finance Company), a consolidated group member. As part of its trade or business, Finance Company purchases contracts from an independent party (Brand Retailer) that is not a member of Taxpayer's consolidated group. The purchase of a contract by Finance Company from Brand Retailer is memorialized in an agreement.

The agreement states that the purchase price of a contract is its principal amount, which Taxpayer claims is the contract's fair market value (FMV). The agreement also defines the Finance Company's Retailer Program. Under this program, Finance Company agrees to make Retailer Program payments to Brand Retailer as compensation for purchase of the contract. These payments, made under three different formulas set out in the agreement, are paid separately from the purchase price of the contract. All of the Retailer Program payments are tracked to a specific contract.

In the taxpayer's industry, it is common for product manufacturers like Taxpayer to offer a promotional below-market interest rate to increase sales. Taxpayer offers such a program, under which it authorizes Brand Retailer to make contracts with purchasers for the sale of Brand 1 and Brand 2 products at below-market interest rates. When Finance Company purchases a contract made under the program from Brand Retailer, Finance Company purchases it for the contract principal amount, even though the principal amount of the contract is greater than the fair value of the below-market interest rate contract. Taxpayer reimburses Finance Company for this difference through an interest rate subvention payment, thereby shifting the cost of the below-market interest rate program from Finance Company to Taxpayer. Taxpayer claims that the subvention payment is a sales and marketing expense that is deductible under Sec. 162.

Legal principles

In general, a taxpayer must capitalize any expenditures to acquire (in a purchase or similar transaction) or create...