IRS discusses deductibility of underwriting fees.

Taxpayer T and Agent X entered into a credit arrangement for T's benefit that provided for both fixed and revolving amounts of borrowings. X entered into the arrangement both on its own behalf as a member of lender groups A and B, and as the agent for A and B. X was the principal lender under both groups.

X's participation interest was a percentage of the revolving-loan portion and of the fixed-loan portion. Each of the other participants in the revolving-loan arrangement held an interest in the fixed financing portion.

The proceeds from loans made to T had to be used for (1) T's purchase of a specifically identified business; (2) refinancing T's existing debt (including any associated fees and expenses); and (3) T's general working capital needs and other corporate purposes. The agreement included a number of terms and conditions governing the subsequent syndication of both fixed and revolving loans, and a termination date that applied to both the fixed and revolving portions.

X later entered into a second agreement, under which the first agreement was amended and restated in its entirety. X entered into this financing arrangement with T, both on its own behalf as a member of lender groups C and D and as their agent.

The proceeds of any revolving credit loans made pursuant to the second agreement had to be used for (1) refinancing T's existing debt (including any associated fees and expenses) and (2) T's general working capital needs and other corporate purposes. In addition, the agreement had a number of terms and conditions not contained in the first agreement, which did not appear to be inconsistent with the syndication of loan-participation interests in the secondary market through restricted offerings.

Under both agreements, the percentage interests held by the various lenders established their allocable commitments to make funds available to T in accordance with the terms and conditions of the respective agreements. They expressly provided for T's payment of commitment fees and certain other costs, including amounts X earned in its capacity as an agent.

In addition to the amounts specified, T paid underwriting fees to X. T apparently deducted the underwriting fee for the first agreement when it entered into the second agreement, but capitalized the underwriting fee for the second agreement.

Analysis

Amounts paid by a borrower for services rendered in connection with obtaining a loan have to be capitalized. Accordingly, because T paid the underwriting fee to X solely to compensate X for its general services in securing financing for T, the fee had to be capitalized.

Generally, capitalized costs incurred by a borrower are amortized ratably over the term of the loan to which the costs relate. If a loan is repaid prior to maturity, any remaining unamortized capitalized costs of obtaining a loan might be deductible on satisfaction of that loan with proceeds from another loan, even if such proceeds were obtained from the same lender. Thus, T's position on deducting the fee for X's services in connection with the first agreement when it entered into the second agreement was not without a basis in the law.

However, in some situations, a second loan from the same lender does not result in the satisfaction of the first loan, but instead constitutes the refinancing or an extension of the original loan. In such circumstances, the proper period for amortizing the capitalized costs of obtaining the first loan includes the term of the second loan. Whether a subsequent financing arrangement with the same lender is more properly viewed as a satisfaction of the first loan with proceeds from a separate second loan (or simply as an extension or refinancing of the first loan) is a factual question.

The two agreements may be viewed as separate lending transactions. However, it appears that the parties always intended the first agreement to be an interim financing arrangement that would be changed (in a relatively short time) into more permanent financing. The second agreement had a longer-term source of funds, replacing the funds T originally obtained under the first agreement.

Further, T and A and B might have contemplated that any loans made pursuant to the first agreement could be further syndicated by the participating lenders. This appears to have been a necessary precursor step to T's obtaining more permanent financing. In such circumstances, capitalized fees paid for the first agreement have to be amortized over the combined terms of the two agreements.

IRS LETTER RULING (FSA) 200207011 (11/9/01)