Tax Treatment of Debt Issuance Costs

1. Introduction

The purpose of this article is to provide clarification of the tax treatment of costs associated with the issue of debt instruments. The type of costs concerned are legal and professional fees, brokerage fees, commissions, rating agency fees, swap costs and payments, arrangement fees, debt advisory fees, negotiation fees and other similar payments associated with fund-raising by financial institutions and by section 110 and other companies.

1.1 Conditions for Deduction in Computing Trade Income

To obtain a tax deduction for costs under section 81 of the Taxes Consolidation Act 1997, a company must be able to show that,

• the expenditure has been incurred wholly and exclusively for the purposes of the trade and
• it is not capital in nature or otherwise statutorily prohibited.

2. Purposes of the Trade

The nature of the debt and the associated expenditure will determine whether or not the cost is deductible. In this regard, a cost must first be incurred for the purposes of the trade. Expenditure on the borrowing company’s production wages or salaries or the purchase of trading stock is clearly incurred for the purposes of the trade and would be deductible in computing the income of that trade. Costs associated with any sums borrowed to fund such expenditure, incurred for the purposes of the trade, would also be deductible.

2.1 Deductible Costs - Swaps

Statement of Practice CT1/91 outlines the tax treatment applicable to equalisation payments made under interest rate or currency swap agreements entered into to hedge Case I or Case V expenditure. Essentially, it provides that:

• where the swap agreement is directly related to interest payments which are an allowable expense in computing the profits of the trade, equalisation payments made or received under the agreement are treated as trading expenses or income, and
• where the swap agreement is directly related to interest payments which are an allowable expense in arriving at the profits or gains assessable under Case V of Schedule D, equalisation payments made or received under the agreement, may be treated as income or expenses proper to the computation of Case V profits or losses.

2.2 Non-deductible costs - section 247 borrowings

Costs incurred in connection with S.247 borrowings to fund investments or loans to another company would not be incurred for the purposes of a trade. Section 243 of the Taxes Consolidation Act 1997 provides that interest arising on a loan to invest in, or lend to, another company may be deducted as a charge on the company’s income provided the loan meets the requirements set out in section 247 of that Act. Interest claimed as a charge is not incurred for the purposes of the claimant’s trade and is not deductible in computing the income of that trade. Consistent with this, costs associated with a loan, where the interest on that loan is claimed as a charge on income and is not deductible in computing the income of that trade, are also not deductible in computing the income of the trade.

2.3 Swaps entered into to hedge section 247 borrowings

Where an interest rate or currency swap agreement is entered into in relation to a loan the interest on which qualifies for relief as a charge on income under the provisions of Section 247 of the Taxes Consolidation Act, 1997, equalisation payments made or received under the agreement are linked directly to the interest on the loan. To the extent that the payments relate to interest on the loan, companies may treat such equalisation payments as an increase or reduction in the interest charge, as the case may be, provided such treatment is applied on a consistent basis.

The treatments outlined in relation to swaps will apply provided the swap has been entered into for bona fide commercial purposes and the approach outlined is consistently applied.

3. Capital/Revenue

Expenditure, which has been incurred wholly and exclusively for the purposes of a trade may still be disallowed if it is capital expenditure. In this connection, Revenue will look to the nature of the borrowings to determine whether or not the costs will be deductible. Where the borrowing is applied for capital purposes (e.g. to purchase a building or other fixed asset), costs associated with that borrowing will not be deductible.

3.1 Financial Institutions

For the purpose of this article the term "financial institution" includes a leasing company as well as a company which advances money in the ordinary course of a trade carried on in the State which includes the lending of money and for which any interest payable in respect of money so advanced is taken into account in computing the income of that trade of the company.

In relation to the issuance of debt (other than Tier 1 debt, which is always capital in nature, see 3.2 below) by a financial institution, Revenue considers that the borrowings may be regarded as revenue in nature where the life of the debt is expected to be 12 years or less. In this regard, Revenue will treat the expected life of the debt, as set out in the prospectus or other document governing the debt issue, as determining the life of the debt. Accordingly, a financial institution may deduct the costs associated with the issue in computing the income of its trade. Where the debt is not redeemed within this 12 year period, the deduction granted will not be withdrawn, unless at the time the debt was issued, the financial institution was in possession, or aware, of information, including information about any arrangement or understanding, which could reasonably be taken to indicate that the debt would not be redeemed within the 12 year period. Any costs connected with the extended term will not be deductible.

The business of a section 110 company is essentially the issue of debt and Revenue are prepared to accept that costs associated with issuing debt by a section 110 company can be deducted for tax purposes irrespective of the term of the debt.

3.2 Tier 1 Debt in banks or other financial institutions

Debt issued to meet the Tier 1 solvency requirements for banks is always regarded as capital in nature. Accordingly, interest associated with the issue of this debt is not deductible for tax purposes. For the avoidance of doubt it must also be noted that costs associated with Tier 1 debt are also not deductible.