Rev. Rul. 56-136

Advice has been requested (1) whether commitment fees or standby charges paid by a taxpayer pursuant to a bond sale agreement, the proceeds of which are to be used for construction purposes, are deductible in the taxable year paid or accrued as interest or as a business expense; (2) whether such commitment fees or standby charges should be treated as bond discount or expense and amortized over the life of the bonds; or (3) whether such commitment fees or standby charges are in the nature of a carrying charge, deductible as a business expense or capitalized as part of construction cost.

The commitment fees or standby charges under discussion are amounts paid, usually at one percent or less per annum, on unissued balances of bonds under a bond sale agreement whereby the total amount of bonds to be issued is delivered to the purchaser in agreed amounts over a specified period. Delivery of the bonds to the purchaser and the "draw down" of funds are related to the cash requirement of the particular taxpayer, and the commitment fees or standby charges are paid or incurred for the purpose of having money made available when needed and preserving a firm price and interest rate for the total bond issue, without incurring the heavy interest expense which would result if the bonds were sold in advance of full need of the funds.

Section 163 of the Internal Revenue Code of 1954 provides for the deduction of all interest paid or accrued within the taxable year on indebtedness. In Estate of Willard P. Deputy v. Pierre S. DuPont, 308 U. S. 488, Ct. D. 1435, C. B. 1940-1, 118, the court defines "interest on indebtedness" as meaning "compensation for the use or forbearance of money."

Since commitment fees or standby charges are not paid upon an indebtedness of the taxpayer, they are not considered to be "compensation for the use of forbearance of money" and, accordingly, do not represent interest on indebtedness within the meaning of section 163 of the Code.

Further, since the fees or charges appear to be expenses applicable to the standby period prior to the issuance of the bonds, they are not considered as bond discount or expense amortizable over the life of the bonds.

In accordance with the foregoing, the commitment fees or standby charges described herein are held to be business expenses deductible under section 162 of the Code, when paid or accrued, depending on the taxpayer's method of accounting. Such fees or charges are considered carrying charges which may, at the election of the taxpayer, be capitalized as part of construction cost in accordance with the provisions of section 39.24(a)-6(b) of Regulations 118, made applicable to the 1954 Code by virtue of Treasury Decision 6091, C. B. 1954-2, 47. Once an election is made, however, to capitalize commitment fees or standby charges incurred with respect to a particular project, charges of the same type incurred with respect to the particular project in subsequent years must also be capitalized for the entire period to which the election so to treat items of that type is applicable.