SECTION 13. SHORT-TERM

OBLIGATIONS (§ 1281)

.01 Interest income on short-term obligations.

(a) Applicability. This change applies to a taxpayer that must change its method of accounting for a pool of debt instruments to comply with § 1272(a)(6) (as required by § 1004 of the Taxpayer Relief Act of 1997, Pub. L. No. 105–34, 111 Stat. 788, 911), provided the change is for the taxpayer’s first taxable year beginning after August 5, 1997.

(b) Scope limitations inapplicable. A taxpayer that must make this change is not subject to the scope limitations in section 4.02 of this revenue procedure. However, if the taxpayer is under examination, before an appeals office, or before a federal court, the taxpayer must provide a copy of the application to the examining agent(s), appeals officer, or counsel for the government, as appropriate, at the same time that it files the copy of the application with the national office. The application must contain the name(s) and telephone number(s) of the examining agent(s), appeals officer, or counsel for the government, as appropriate.

(1) Description of change and scope.

(c) Description.

(i) Under § 1272, the holder of a debt instrument with original issue discount (OID) must include in income the sum of the daily portions of the OID for each day during the taxable year on which the holder held the instrument. Section 1272(a)(6) provides special rules to determine the daily portions of OID for certain debt instruments subject to prepayments. Under these rules, the daily portions of OID are determined, in part, by taking into account an assumption regarding the prepayment of principal on the debt instruments.

(a) On a statement attached to the application, the taxpayer must provide a detailed description of the pool(s) of debt instruments and the proposed method (including the prepayment assumption used for each pool).

(b) A taxpayer that, on or before March 1, 1999, files its original federal income tax return for its first taxable year beginning after August 5, 1997, may com

(2) Additional requirements.

(a) This change applies to a taxpayer that wants to change its method of accounting to comply with § 1281 for interest income on short-term obligations.

(b) Under § 1281, a holder of certain short-term obligations, including a bank as defined in § 581, must include in gross income any accrued interest income on such obligations, regardless of the holder’s overall method of accounting. Section 1281 applies to all types of interest income, including acquisition discount, original issue discount (OID), and stated interest. See S. Rep. No. 99–313, 99th Cong., 2d Sess. 903 (1986), 1986–3 (Vol. 3) C.B. 903.

(c) Section 1283(a)(1) generally defines a short-term obligation as any bond, debenture, note, certificate, or other evidence of indebtedness that matures in one year or less from its issue date. A short-term loan, including a short-term loan made in the ordinary course of the taxpayer’s business, is a short-term obligation.

(d) Under §§ 1281(a) and 1283(c), a holder of a short-term obligation subject to § 1281 must include in gross income an amount equal to the sum of the daily portions of the acquisition discount or OID, whichever is applicable, on the obligation for each day during the taxable year that the obligation is held by the holder. See § 1283(b), as modified by § 1283(c), to determine the daily portions of acquisi

December 21, 1998 44 1998–51 I.R.B.

tion discount or OID. In addition, § 1281(a) requires the holder to include in gross income any stated interest that is payable on the short-term obligation (other than stated interest taken into account to determine the amount of the acquisition discount or OID) as it accrues.

(2) Section 481(a) adjustment pe- riod. A taxpayer must take the entire § 481(a) adjustment into account in computing taxable income for the year of change.

ordinary course of business. If this change was made on or before November 6, 1995, the Service will not seek to deny cash method banks in the Eighth Circuit the use of the cash method on the ground that there was an unauthorized change in method of accounting.

(2) Section 481(a) adjustment pe- riod. A taxpayer must take the entire § 481(a) adjustment into account in computing taxable income for the year of change.

(3) No ruling protection. If the Service is later successful in further litigation on this issue in other circuits, or there is a change in law, then cash method banks in the Eighth Circuit may be required to use an accrual method of accounting for any taxable year not barred by the statute of limitations.

.02 Stated interest on short-term loans of cash method banks in the Eighth Cir- cuit.

(1) Description of change and scope.

term loans made in the ordinary course of business to using the cash method for that interest.

(b) In Security Bank Minnesota v. Commissioner, 994 F.2d 432 (8th Cir. 1993), aff’g 98 T.C. 33 (1992), the U.S. Circuit Court of Appeals for the Eighth Circuit held that § 1281 does not require a cash method bank to include in gross income stated interest on short-term loans made in the ordinary course of business as that interest accrues. The Service disagrees with the interpretation of § 1281 in Security Bank Minnesota and intends to pursue this issue in other circuits. In light of Security Bank Minnesota, however, cash method banks in the Eighth Circuit will be granted permission to change to the cash method of accounting for stated interest on short-term loans made in the

(a) This change applies to a cash method bank in the Eighth Circuit that wants to change its method of accounting from accruing stated interest on short

1998–51 I.R.B. 45 December 21, 1998