SECTION 2. BACKGROUND

.01 A debt instrument is issued with OID if the instrument’s issue price is less than its stated redemption price at maturity. Section 1273(a)(1). Under § 1.1273–1(b) of the Income Tax Regulations, the stated redemption price at maturity of a debt instrument is the sum of all payments provided by the debt instrument other than payments of qualified stated interest. In

general, qualified stated interest is stated interest that is unconditionally payable in cash, or that is constructively received under § 451, at least annually at a single fixed rate. Section 1.1273–1(c).

.02 Accruals of OID generally are taken into account over the term of a debt instrument using the constant yield method. See § 1272(a)(3) and § 1.1272–1. The Code provides special rules, however, for certain debt instruments for which the principal is subject to acceleration. See § 1272(a)(6). Under § 1272(a)(6), if the principal on a debt instrument is subject to acceleration, OID accruals are determined based on a prepayment assumption and a formula involving the present value of all remaining payments under the debt instrument as of the close of the accrual period, payments during the accrual period of amounts included in the stated redemption price at maturity of the debt instrument, and the adjusted issue price of the debt instrument at the beginning of the accrual period (“statutory method”).

.03 The Taxpayer Relief Act of 1997 extended the rules of § 1272(a)(6) to OID on any pool of debt instruments the yield on which may be affected by reason of prepayments, including a pool of credit card receivables. See Pub. L. 105–34, § 1004(a), 1997–4 C.B. 1, 125. However, unlike the debt instruments previously subject to § 1272(a)(6), the balance of a pool of credit card receivables can be increased, as well as decreased, from one accrual period to the next, which adds complexity in applying the rules of § 1272(a)(6).

.04 The Internal Revenue Service (“IRS”) has challenged the methods of accounting for OID on pools of credit card receivables adopted by some taxpayers as not clearly reflecting income. See, for example, Capital One Financial Corp. v. Commissioner, 133 T.C. 136 (2009) (holding, in relevant part, that the model used by the taxpayer for computing OID accruals under § 1272(a)(6) was a reasonable method after some modifications by the court).

.05 The proportional method as described in this revenue procedure is intended to reduce administrative burdens and controversy for taxpayers and the IRS

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riod referred to below is a calendar month (or that portion of a month that falls within a short taxable year). A taxpayer that changes its method of accounting to the proportional method must make the required computations for each month in the year of change by the due date for the taxpayer’s timely filed (including any extension) original federal income tax return implementing the change in method of accounting for the year of change.

.02 At the beginning of each computation period, the taxpayer must determine the following information for each pool of credit card receivables:

(1) The stated redemption price at maturity as of the beginning of the period (“Beginning SRPM”), which is equal to the aggregate balance owed on all credit card receivables included in the pool at the beginning of such period, other than amounts representing charges or fees that are not properly treated as OID (such as finance charges that are qualified stated interest).

(2) The unaccrued OID as of the beginning of the period (“Beginning OID”), which is equal to the OID with respect to the credit card receivables included in the pool at the beginning of such period that has not previously been taken into income.

.03 During each computation period, the taxpayer must determine for each pool of credit card receivables the sum of the payments during the period of amounts that reduce the Beginning SRPM for the period (“SRPM Payments”) (equivalently, total payments less amounts that are not included in SRPM, such as charges or fees that are not properly treated as OID).

.04 For each computation period, the taxpayer must compute the OID allocated to the period (“Monthly OID”) and include this amount in income for the period. Monthly OID is the product of (1) the Beginning OID multiplied by (2) the quotient of the SRPM Payments divided by the Beginning SRPM.

.05 The formula in section 5.04 of this revenue procedure can be restated as follows:

in computing OID accruals on a pool of credit card receivables under § 1272(a)(6). Under certain assumptions, the proportional method is a simplified method of calculation that generally produces the same results as an implementation of the statutory method.

.06 Certain credit card fees are treated as creating or increasing the amount of OID on the pool of credit card receivables to which the fees relate. See, for exam- ple, Rev. Proc. 2004–33, 2004–1 C.B. 989 (Commissioner will allow a taxpayer to treat late fees as OID). However, certain fees do not create or increase the amount of OID on the pool of credit card receivables to which the fees relate. See, for ex- ample, Rev. Rul. 2004–52, 2004–1 C.B. 973 (credit card annual fees do not result in OID).