Loan fees: deductible even if proceeds of loan are used for a redemption.

A recent bankruptcy court case, apparently of first impression, has concluded that loan fees incurred to finance a stock redemption are not denied a deduction by Sec. 162(k).

Sec. 162(k) provides that no deduction is allowed to a corporation for any amount paid or incurred in connection with a redemption of its stock. This provision (originally Sec. 162(l)) was enacted as part of the Tax Reform Act of 1986 in response to the perceived abuse in "greenmail" cases of taking a tax deduction for the amount paid to the greenmailer.

The provision, however, is not intended to be limited to greenmail transactions. Rather, it is to be construed broadly to reflect congressional intent that a corporate redemption is a capital transaction. The General Explanation of the Tax Reform Act of 1986 (the "Blue Book") illustrates the intended broad reach of Sec. 162(k) by listing numerous items that are to be nondeductible. The list includes amounts paid to repurchase stock, premiums paid for stock, legal, accounting, brokerage, transfer agent, appraisal and similar fees incurred in connection with the repurchase of stock, and any other amount necessary or incident to the stock repurchase. Moreover, the Blue Book indicated that whether an expense was incurred "in connection with" a repurchase was also to be construed broadly.

Although Sec. 162(k) has been in effect for almost six years, no regulations have yet been published. Thus, language such as the Blue Book explanation must provide guidelines in determining deductibility under Sec. 162(k).

Conspicuously absent from the list of nondeductible items are loan fees. In fact, certain loan fees (i.e., points) are apparently expressly deductible under Sec. 162(k)(2)(a)(i). (See, generally, Rev. Rul. 86-67.) Generally, loan fees are capitalized and amortized over the life of the loan (for instance, commitment fees). (See Rev. Rul. 81-60.) Because of the broad scope with which Sec. 162(k) is to be interpreted, however, it has been argued that, if a corporation borrowed funds to effect a redemption, those loan fees should become nondeductible under Sec. 162(k) as an expense incurred "in connection with" the redemption.

In what appears to be the first case dealing with this issue, the U.S. Bankruptcy Court has declined to apply Sec. 162(k) to deny deductions for loan fees (U.S. v. Kroy (Europe) Limited, Bankr. DC Ariz., 2/14/92). The court reasoned, in part, that the deductibility of the fees is dependent on the origin of the expense, and the origin of the loan fees was the loan transaction, not the redemption. Thus, the court held that the use of the loan proceeds was immaterial in determining deductibility.

This holding appears to be correct. There exists a legion of precedent (both cases and published rulings) that holds that loan fees are amortized over the life of the loan. It would seem that if the use of the loan proceeds is material in determining their deductibility, such fees would be amortized over the life of the asset purchased with the proceeds. Nothing in Sec. 162(k) or its legislative history changes the basic fact that the origin of the loan fee is the loan, not the redemption. Sec. 162(k) should therefore have no applicability.