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Internal Revenue Bulletin - February 9, 2009 - T.D. 9442
T.D. 9442
Former Regulations Under §1.1502-13(g) (the Former Regulations)
1. Overlap of Exceptions and Deemed Exchanges under §1.1001-3
b. Scope of Exception under Section 332
c. Gain or Loss With Respect to an Intercompany Obligation
Applicability Date: For dates of applicability, see §§1.1502-13(g)(8) and 1.1502-28(d).
On September 28, 2007, the IRS and the Treasury Department published a notice of proposed rulemaking (REG-107592-00, 2007-44 I.R.B. 908) in the Federal Register (72 FR 55139) (the 2007 Proposed Regulations) which proposed to amend §1.1502-13(g) (regarding the treatment of transactions involving obligations between members of a consolidated group) and to add §1.1502-13(e)(2)(ii)(C) (regarding the treatment of certain transactions involving the provision of insurance between members of a consolidated group). The 2007 Proposed Regulations replaced an earlier proposal (REG-105964-98, 1999-1 C.B. 22 [63 FR 70354]), published in the Federal Register on December 21, 1998, which was withdrawn.
On February 25, 2008, the IRS and the Treasury Department published a notice (Announcement 2008-25, 2008-14 I.R.B. 732) in the Federal Register (73 FR 9972) withdrawing the portion of the 2007 Proposed Regulations relating to the treatment of intercompany insurance transactions. No public hearing regarding the remaining portion of the 2007 Proposed Regulations was requested or held. However, written, electronic, and oral comments were received. After consideration of all of the comments, the 2007 Proposed Regulations are adopted as revised by this Treasury decision. The principal comments and changes are discussed in this preamble.
An intercompany obligation is generally defined as an obligation between members of a consolidated group, but only for the period during which both the creditor and debtor are members of the group. The Former Regulations under §1.1502-13(g) (the 1995 regulations and the 1998 proposed regulations, as in effect before these final regulations), prescribe rules relating to the treatment of transactions involving such obligations, and apply generally to three broad categories of transactions; transactions in which an obligation between a group member and a nonmember becomes an intercompany obligation (inbound transactions), transactions in which an intercompany obligation ceases to be an intercompany obligation (outbound transactions), and transactions in which an intercompany obligation is assigned or extinguished within the consolidated group (intragroup transactions).
First, the 2007 Proposed Regulations simplify the mechanics of the deemed satisfaction-reissuance model by separating the deemed transactions from the actual transaction. In general, the new model deems the following sequence of events to occur immediately before, and independently of, the actual transaction: (i) the debtor is deemed to satisfy the obligation for a cash amount equal to the obligation’s fair market value, and (ii) the debtor is deemed to immediately reissue the obligation to the original creditor for that same cash amount. The parties are then treated as engaging in the actual transaction but with the new obligation.
Third, the 2007 Proposed Regulations narrow the scope of intragroup and outbound transactions that trigger the deemed satisfaction-reissuance model by providing a number of exceptions to its application. A deemed satisfaction and reissuance generally is not required for these excepted transactions either because it is not necessary to apply the deemed satisfaction-reissuance model to carry out the purposes of §1.1502-13(g) or because the burdens associated with valuing the obligation or applying the mechanics of the deemed satisfaction-reissuance model outweigh the benefits achieved by its application.
Finally, the 2007 Proposed Regulations include two anti-abuse rules, the “material tax benefit rule” and the “off-market issuance rule,” which are intended to prevent distortions of consolidated taxable income resulting from the shifting of built-in items from intercompany obligations, or from the issuance of obligations at a materially off-market rate of interest through the manipulation of a member’s tax attributes or stock basis. These rules are aimed at intragroup transactions otherwise excepted from the deemed satisfaction-reissuance model (to ensure that the exceptions cannot be used to distort consolidated taxable income through intragroup transactions) and similar direct lending transactions.
These final regulations adopt the commentators’ suggestions that the rules should be “intent-based.” However, consistent with other consolidated return anti-abuse rules, these final regulations provide that the rules’ application will be determined based upon a “with a view” standard and eliminate the requirement that the tax benefit to be secured by the transaction (or issuance) be material. In addition, because the IRS and the Treasury Department remain concerned about distortions that could result from transfers of intercompany obligations in section 351 exchanges that are excepted from the deemed satisfaction and reissuance model, these final regulations also adopt more specific rules regarding such transfers (described in part C.3.a. of this Preamble).
Commentators were generally supportive of the 2007 Proposed Regulations’ use of fair market value as the amount for which an intercompany obligation is deemed satisfied and reissued. However, commentators also noted the difficulty in valuing intercompany obligations. Based upon these comments, the IRS and the Treasury Department are continuing to study whether it is appropriate to include certain simplifying presumptions in determining value, and comments are requested in this regard.
However, the 2007 Proposed Regulations also contain an exception to the deemed satisfaction-reissuance model for certain routine debt modifications involving a single issuer (the routine modification exception). This exception applies if all of the rights and obligations under an intercompany obligation are extinguished in an exchange (or deemed exchange under §1.1001-3) for a newly issued intercompany obligation, and the issue price of the new obligation equals both the adjusted issue price and basis of the extinguished obligation.
In addition to the routine modification exception, the 2007 Proposed Regulations except from the deemed satisfaction-reissuance model many transactions that involve the assumption of a debtor member’s obligations under an intercompany obligation (for example, an assumption of an intercompany obligation in connection with an intercompany nonrecognition transaction). A number of commentators noted that, in some cases, these assumption transactions also may be a significant modification of the instrument resulting in a deemed exchange under §1.1001-3. In such cases, commentators questioned how the deemed exchange interacted with the various exceptions to the deemed satisfaction-reissuance model.
The IRS and the Treasury Department believe that a deemed exchange under §1.1001-3 that results from an assumption transaction should be subject to the same set of rules and exceptions as apply to an actual two-party exchange of a debt instrument. Thus, even if the assumption transaction is excepted from the deemed satisfaction-reissuance model, any deemed exchange resulting from the assumption would be a triggering transaction potentially subject to the model. However, in most such cases the deemed exchange will generally qualify for the routine modification exception and thus not require a deemed satisfaction-reissuance.
Accordingly, these final regulations clarify that the routine modification exception applies to a deemed exchange of intercompany debt for intercompany debt that occurs under §1.1001-3 as a result of an assumption transaction. Specifically, these final regulations provide that, solely for purposes of this exception, a newly issued intercompany obligation will include an obligation that is issued (or deemed issued) by a member other than the original debtor if such other member assumes the original debtor’s obligations in certain excepted transactions (intercompany nonrecognition exchanges or intercompany taxable assumption transactions), and the assumption results in a significant modification and deemed exchange under §1.1001-3.
The 2007 Proposed Regulations provide an exception to the application of the deemed satisfaction-reissuance model for certain intercompany sales or dispositions of assets where intercompany obligations are assumed as part of the transaction. This exception was intended to apply only in the case of a taxable sale (or other taxable disposition) of assets. Commentators noted, however, that the 2007 Proposed Regulations may be read to apply to nonrecognition transactions as well as taxable transactions. The IRS and the Treasury Department agree with the commentators and have revised the regulation to reflect its intended scope. However, as discussed in this preamble, these final regulations also clarify that the exception for certain section 351 nonrecognition exchanges is available for transactions in which a debtor’s obligation is assumed.
Commentators questioned whether the exception for section 351 exchanges is available only for transactions in which a creditor assigns an intercompany obligation or if it also is available for transactions in which a debtor’s obligation under an intercompany obligation is assumed. The exception is intended to apply to both such transactions. Consistent with the exception for intercompany exchanges under section 332 and section 361, these final regulations revise the exception for intercompany exchanges under section 351 by providing that it will apply only if neither the creditor nor the debtor recognizes an amount.
The 2007 Proposed Regulations retain the exceptions in the Former Regulations for transactions involving an obligation that becomes (in the context of an inbound transaction) or became (in the context of an intragroup or outbound transaction), an intercompany obligation by reason of an event described in §1.108-2(e). In general, these events are: (1) acquisitions of indebtedness with a stated maturity date within one year of the acquisition date if the indebtedness is retired on or before that date (the “short-term debt exception”); and (2) acquisitions of indebtedness by a dealer that acquires and disposes of the indebtedness in the ordinary course of its business of dealing in securities (the “dealer exception”).
The short-term debt exception is premised upon the view that imposition of the deemed satisfaction-reissuance model is unwarranted because the indebtedness would be retired within the short term by its own terms (and the retirement would produce the same results as that of the deemed satisfaction and reissuance). With respect to the dealer exception, because the indebtedness’ status as an intercompany obligation is likely transitory, the burden associated with the deemed satisfaction-reissuance model does not warrant its application.
One commentator questioned whether the short-term debt exception is appropriate because the intragroup retirement of the instrument may produce items that differ in character from those that would be obtained if the instrument were subject to the deemed satisfaction-reissuance model upon entering the group. For example, if a depreciated obligation is deemed satisfied and reissued immediately after it enters the group, the attributes of the creditor’s loss and the debtor’s discharge of indebtedness income are determined on a separate entity basis. However, if the instrument is excepted from the deemed satisfaction-reissuance model when it enters the group, the subsequent retirement of the note may result, arguably, in a character match of the creditor’s and debtor’s items. In cases where the adjusted issue price and basis of the note differ in amount, the potential for differing results is amplified. Therefore, the IRS and the Treasury Department agree that the short term debt exceptions for both inbound and intragroup transactions should be eliminated in these final regulations. The dealer exception has been retained in these final regulations.
Consistent with the Former Regulations’ treatment of inbound transactions, the 2007 Proposed Regulations treat the attributes of the debtor and creditor member’s items from the deemed satisfaction on a separate entity basis. The IRS and the Treasury Department continue to believe that separate entity treatment is appropriate for such inbound transactions.
Sections 1.1502-13 and 1.1502-28 also issued under 26 U.S.C. 1502. * * *
1. Revising the heading and the entries for §1.1502-13(g)(5) in paragraph (a)(6)(ii).
4. Removing paragraph (j)(9) Example (5)(c).
(1) Assignment and extinguishment transactions. Any intercompany transaction in which a member realizes an amount, directly or indirectly, from the assignment or extinguishment of all or part of its remaining rights or obligations under an intercompany obligation or any comparable transaction in which a member realizes any such amount, directly or indirectly, from an intercompany obligation (for example, a mark to fair market value of an obligation or a bad debt deduction). However, a reduction of the basis of an intercompany obligation pursuant to §1.1502-36(d) (attribute reduction to prevent duplication of loss), or pursuant to sections 108 and 1017 and §1.1502-28 (basis reductions upon the exclusion from gross income of discharge of indebtedness) or any other provision that adjusts the basis of an intercompany obligation as a substitute for income, gain, deduction, or loss, is not a comparable transaction.
(i) The transferor or transferee member has a loss subject to a limitation (for example, a loss from a separate return limitation year that is subject to limitation under §1.1502-21(c), or a dual consolidated loss that is subject to limitation under §1.1503(d)-4), but only if the other member is not subject to a comparable limitation;
(ii) The transferor or transferee member has a special status within the meaning of §1.1502-13(c)(5) (for example, a bank defined in section 581, or a life insurance company subject to tax under section 801) that the other member does not also possess;
(iii) A member of the group realizes discharge of indebtedness income that is excluded from gross income under section 108(a) within the same taxable year as that of the exchange, and the tax attributes attributable to either the transferor or the transferee member are reduced under sections 108, 1017, and §1.1502-28 (except if the attribute reduction results solely from the application of §1.1502-28(a)(4) (reduction of certain tax attributes attributable to other members));
(2) Intercompany assumption transaction. All of the debtor’s obligations under an intercompany obligation are assumed in connection with the debtor’s sale or other disposition of property (other than solely money) in an intercompany transaction in which gain or loss is recognized under section 1001.
(3) Exception to the application of section 108(e)(4). The obligation became an intercompany obligation by reason of an event described in §1.108-2(e)(2) (exception to the application of section 108(e)(4) in the case of acquisitions by securities dealers).
(5) Intercompany extinguishment transaction. All or part of the rights and obligations under the intercompany obligation are extinguished in an intercompany transaction (other than an exchange or deemed exchange of an intercompany obligation for a newly issued intercompany obligation), the adjusted issue price of the obligation is equal to the creditor’s basis in the obligation, and the debtor’s corresponding item and the creditor’s intercompany item (after taking into account the special rules of paragraph (g)(4)(i)(C) of this section) with respect to the obligation offset in amount.
(6) Routine modification of intercompany obligation. All of the rights and obligations under the intercompany obligation are extinguished in an intercompany transaction that is an exchange (or deemed exchange) for a newly issued intercompany obligation, and the issue price of the newly issued obligation equals both the adjusted issue price of the extinguished obligation and the creditor’s basis in the extinguished obligation. Solely for purposes of the preceding sentence, a newly issued intercompany obligation includes an obligation that is issued (or deemed issued) by a member other than the original debtor if such other member assumes the original debtor’s obligations under the original obligation in a transaction that is described in either paragraph (g)(3)(i)(B)(1) or (g)(3)(i)(B)(2) of this section and the assumption results in a significant modification of the original obligation under §1.1001-3(e)(4) and a deemed exchange under §1.1001-3(b).
(B) Treatment as separate transaction. The deemed satisfaction and deemed reissuance are treated as transactions separate and apart from the triggering transaction. The deemed satisfaction and reissuance of a member’s debt will not cause the debt to be recharacterized as other than debt for Federal income tax purposes.
(A) Paragraph (c)(6)(i) of this section (treatment of intercompany items if corresponding items are excluded or nondeductible) will not apply to exclude any amount of income or gain attributable to a reduction of the basis of the intercompany obligation pursuant to §1.1502-36(d), or pursuant to sections 108 and 1017 and §1.1502-28 or any other provision that adjusts the basis of an intercompany obligation as a substitute for income or gain;
(1) Exception to the application of section 108(e)(4). The obligation becomes an intercompany obligation by reason of an event described in §1.108-2(e)(2) (exception to the application of section 108(e)(4) in the case of acquisitions by securities dealers); or
(B) Treatment as separate transaction. The deemed satisfaction and deemed reissuance are treated as transactions separate and apart from the transaction in which the debt becomes an intercompany obligation, and the tax consequences of the transaction in which the debt becomes an intercompany obligation must be determined before the deemed satisfaction and reissuance occurs. (For example, if the debt becomes an intercompany obligation in a transaction to which section 351 applies, any limitation imposed by section 362(e) on the basis of the intercompany obligation in the hands of the transferee member is determined before the deemed satisfaction and reissuance.) The deemed satisfaction and reissuance of a member’s debt will not cause the debt to be recharacterized as other than debt for Federal income tax purposes.
(vi) Section 338 election. The facts are the same as paragraph (i) of this Example 2, except that P sells S’s stock to X and a section 338 election is made with respect to the stock sale. Under section 338, S is treated as selling all of its assets to new S, including the B note, at the close of the acquisition date. The aggregate deemed sales price (within the meaning of §1.338-4) allocated to the B note is $70. Because the B note becomes an obligation that is not an intercompany obligation, the transaction is a triggering transaction under paragraph (g)(3)(i)(A)(2) of this section. Under paragraph (g)(3)(ii) of this section, B’s note is treated as satisfied and reissued immediately before S’s deemed sale to new S for $70, the amount realized with respect to the note (the aggregate deemed sales price allocated to the note under §1.338-6). The results to S and B are the same as in paragraph (ii) of this Example 2.
(viii) Deferral of loss or deduction with respect to nonmember indebtedness acquired in debt exchange. The facts are the same as in paragraph (i) of this Example 2, except that S sells B’s note to X for a non-publicly traded X note with an issue price and face amount of $100 and a fair market value of $70, and that, subsequently, S sells the X note for $70. Because the B note becomes an obligation that is not an intercompany obligation, the transaction is a triggering transaction under paragraph (g)(3)(i)(A)(2) of this section. Under paragraph (g)(3)(ii) of this section, B’s note is treated as satisfied and reissued immediately before S’s sale to X for $100, the amount realized with respect to the note (determined under section 1274). As a result of the deemed satisfaction, neither S nor B take into account any items of income, gain, deduction, or loss. S is then treated as selling the new B note to X for the X note received by S in the actual transaction. Because S has a basis of $100 in the new note, S recognizes no gain or loss from the sale to X. After the sale, the new B note held by X is not an intercompany obligation, it has a $100 issue price, a $100 stated redemption price at maturity, and a $100 basis. S also holds an X note with a basis of $100 but a fair market value of $70. When S disposes of the X note, S’s loss on the disposition is deferred under paragraph (g)(4)(iv) of this section, until B retires its note (the former intercompany obligation in the hands of X).
Example 4. Intercompany nonrecognition transactions. (i) Facts. On January 1 of year 1, B borrows $100 from S in return for B’s note providing for $10 of interest annually at the end of each year, and repayment of $100 at the end of year 5. As of January 1 of year 3, B has fully performed its obligations, but the note’s fair market value is $130, reflecting a decline in prevailing market interest rates. On January 1 of year 3, S transfers the note and other assets to a newly formed corporation, Newco, for all of Newco’s common stock in an exchange to which section 351 applies.
(iii) Receipt of other property. The facts are the same as in paragraph (i) of this Example 4, except that the other assets transferred to Newco have a basis of $100 and a fair market value of $260, and S receives, in addition to Newco common stock, $15 of cash. Because S would recognize $15 of gain under section 351(b), the assignment of the B note is a triggering transaction under paragraph (g)(3)(i)(A)(1) of this section. Under paragraph (g)(3)(ii) of this section, B’s note is treated as satisfied and reissued for its fair market value of $130 immediately before the transfer to Newco. As a result of the deemed satisfaction of the note for more than its adjusted issue price, B takes into account $30 of repurchase premium under §1.163-7(c). On a separate entity basis, S’s $30 gain would be a capital gain under section 1271(a)(1). Under the matching rule, however, the attributes of S’s intercompany item and B’s corresponding item must be redetermined to produce the same effect as if the transaction had occurred between divisions of a single corporation. Under paragraph (c)(4)(i) of this section, the attributes of B’s premium deduction control the attributes of S’s gain. Accordingly, S’s gain is treated as ordinary income. B is also treated as reissuing, immediately after the satisfaction, a new note to S with a $130 issue price, $100 stated redemption price at maturity, and $130 basis in the hands of S. S is then treated as transferring the new note to Newco for the Newco stock and cash received by S in the actual transaction. Because S has a basis of $130 in the new B note, S recognizes no gain or loss with respect to the transfer of the note in the section 351 exchange, and S recognizes $10 of gain with respect to the transfer of the other assets under section 351(b). After the transfer, the note has a $130 issue price and a $100 stated redemption price at maturity. The treatment of B’s $30 of bond issuance premium under the new note is determined under §1.163-13.
(iv) The facts are the same as in paragraph (i) of this Example 4, except that T is a member with a loss from a separate return limitation year that is subject to limitation under §1.1502-21(c) (a SRLY loss), and on January 1 of year 3, S transfers the assets and the B note to T in an exchange to which section 351 applies. Because the transferee, T, has a loss that is subject to a limitation, the assignment of the B note is a triggering transaction under paragraph (g)(3)(i)(A)(1) of this section (the exception in paragraph (g)(3)(i)(B)(1) of this section does not apply). Under paragraph (g)(3)(ii) of this section, B’s note is treated as satisfied and reissued for its fair market value, immediately before S’s transfer to T. As a result of the deemed satisfaction of the note for more than its adjusted issue price, B takes into account $30 of repurchase premium under §1.163-7(c). On a separate entity basis, S’s $30 gain would be a capital gain under section 1271(a)(1). Under the matching rule, however, the attributes of S’s intercompany item and B’s corresponding item must be redetermined to produce the same effect as if the transaction had occurred between divisions of a single corporation. Under paragraph (c)(4)(i) of this section, the attributes of B’s premium deduction control the attributes of S’s gain. Accordingly, S’s gain is treated as ordinary income. B is also treated as reissuing, immediately after the satisfaction, a new note to S with a $130 issue price, $100 stated redemption price at maturity, and $130 basis in the hands of S. The treatment of B’s $30 of bond issuance premium under the new note is determined under §1.163-13. S is then treated as transferring the new note to T as part of the section 351 exchange. Because T will have a fair market value basis in the reissued B note immediately after the exchange, T’s intercompany item from the subsequent retirement of the B note will not reflect any of S’s built-in gain (and the amount of T’s SRLY loss that may be absorbed by such item will be limited to any appreciation in the B note accruing after the exchange).
Example 5. Assumption of intercompany obligation. (i) Facts. On January 1 of year 1, B borrows $100 from S in return for B’s note providing for $10 of interest annually at the end of each year, and repayment of $100 at the end of year 5. The note is fully recourse and is incurred for use in Business Z. As of January 1 of year 3, B has fully performed its obligations, but the note’s fair market value is $110 reflecting a decline in prevailing market interest rates. Business Z has a fair market value of $95. On January 1 of year 3, B transfers all of the assets of Business Z and $15 of cash (substantially all of B’s assets) to member T in exchange for the assumption by T of all of B’s obligations under the note in a transaction in which gain or loss is recognized under section 1001. The terms and conditions of the note are not modified in connection with the sales transaction, the transaction does not result in a change in payment expectations, and no amount of income, gain, loss, or deduction is recognized by S, B, or T with respect to the note.
(ii) No deemed satisfaction and reissuance. Because all of B’s obligations under the B note are assumed by T in connection with the sale of the Business Z assets, the assignment of B’s obligations under the note is not a triggering transaction under paragraph (g)(3)(i)(B)(2) of this section, and the note is not treated as satisfied and reissued under paragraph (g)(3)(ii) of this section.
Example 6. Extinguishment of intercompany obligation. (i) Facts. On January 1 of year 1, B borrows $100 from S in return for B’s note providing for $10 of interest annually at the end of each year, and repayment of $100 at the end of year 20. The note is a security within the meaning of section 351(d)(2). As of January 1 of year 3, B has fully performed its obligations, but the fair market value of the B note is $130, reflecting a decline in prevailing market interest rates, and S transfers the note to B in exchange for $130 of B stock in a transaction to which both section 351 and section 354 applies.
(ii) No deemed satisfaction and reissuance. As a result of the satisfaction of the note for more than its adjusted issue price, B takes into account $30 of repurchase premium under §1.163-7(c). Although the transfer of the B note is a transaction to which both section 351 and section 354 applies, under paragraph (g)(4)(i)(C) of this section, any gain or loss from the intercompany obligation is not subject to either section 351(a) or section 354, and therefore, S has a $30 gain under section 1001. Because the note is extinguished in a transaction in which the adjusted issue price of the note is equal to the creditor’s basis in the note, and the debtor’s and creditor’s items offset in amount, the transaction is not a triggering transaction under paragraph (g)(3)(i)(B)(5) of this section, and the note is not treated as satisfied and reissued under paragraph (g)(3)(ii) of this section. On a separate entity basis, S’s $30 gain would be a capital gain under section 1271(a)(1). Under the matching rule, however, the attributes of S’s intercompany item and B’s corresponding item must be redetermined to produce the same effect as if the transaction had occurred between divisions of a single corporation. Under paragraph (c)(4)(i) of this section, the attributes of B’s premium deduction control the attributes of S’s gain. Accordingly, S’s gain is treated as ordinary income. Under paragraph (g)(4)(i)(D) of this section, section 108(e)(7) does not apply upon the extinguishment of the B note, and therefore, the B stock received by S in the exchange will not be treated as section 1245 property.
Example 8. Tax benefit rule. (i) Facts. On January 1 of year 1, B borrows $100 from S in return for B’s note providing for $10 of interest annually at the end of each year, and repayment of $100 at the end of year 5. As of January 1 of year 3, B has fully performed its obligations, but the note’s fair market value has depreciated, reflecting an increase in prevailing market interest rates. On that date, S transfers the B note to member T as part of an exchange for T common stock which is intended to qualify for nonrecognition treatment under section 351 but with a view to sell the T stock at a reduced gain. On February 1 of year 4, all of the stock of T is sold at a reduced gain.
(ii) Deemed satisfaction and reissuance. Because the assignment of the B note does not occur within 12 months of the sale of T stock, paragraph (g)(3)(i)(B)(1)(vi) of this section does not apply to treat the assignment as a triggering transaction. However, because the assignment of the B note was engaged in with a view to shift built-in loss from the obligation in order to secure a tax benefit that the group or its members would not otherwise enjoy, under paragraph (g)(3)(i)(C) of this section, the assignment of the B note is a triggering transaction to which paragraph (g)(3)(ii) of this section applies. Under paragraph (g)(3)(ii) of this section, B’s note is treated as satisfied and reissued for its fair market value, immediately before S’s transfer to T. As a result of the deemed satisfaction of the note for less than its adjusted issue price, B takes into account discharge of indebtedness income and S has a corresponding loss which is treated as ordinary loss. B is also treated as reissuing, immediately after the deemed satisfaction, a new note to S with an issue price and basis equal to its fair market value. S is then treated as transferring the new note to T as part of the section 351 exchange. Because S’s basis in the T stock received with respect to the transferred B note is equal to its fair market value, S’s gain with respect to the T stock will not reflect any of the built-in loss attributable to the B note. (This example does not address common law doctrines or other authorities that might apply to recharacterize the transaction or to otherwise affect the tax treatment of the transaction.)
Example 9. Issuance at off-market rate of interest. (i) Facts. T is a member with a SRLY loss. T’s sole shareholder, P, borrows an amount of cash from T in return for a P note that provides for a materially above market rate of interest. The P note is issued with a view to generate additional interest income to T over the term of the note to facilitate the absorption of T’s SRLY loss.
(iii) Amortization of repurchase premium. The facts are the same as in paragraph (i) of this Example 10, except that on January 1 of year 3, the B note has a fair market value of $130 and rather than P purchasing the X stock, P purchases the B note from X by issuing its own note. The P note has an issue price, stated redemption price at maturity, stated principal amount, and fair market value of $130. Under paragraph (g)(5)(ii) of this section, B’s note is treated as satisfied for $130 (determined under the principles of §1.108-2(f)(1)) immediately after it becomes an intercompany obligation. As a result of the deemed satisfaction of the note, P has no gain or loss and B has $30 of repurchase premium. Under paragraph (g)(6)(iii) of this section, B’s $30 of repurchase premium from the deemed satisfaction is amortized by B over the term of the newly issued P note in the same manner as if it were original issue discount and the newly issued P note had been issued directly by B. B is also treated as reissuing a new note to P. The new note is an intercompany obligation, it has a $130 issue price and $100 stated redemption price at maturity, and the treatment of B’s $30 of bond issuance premium under the new B note is determined under §1.163-13.
Par. 3. Section 1.1502-28 is amended by:
(5) Reduction of basis of intercompany obligations and former intercompany obligations—(i) Intercompany obligations that cease to be intercompany obligations. If excluded COD income is realized in a consolidated return year in which an intercompany obligation becomes an obligation that is not an intercompany obligation because the debtor or creditor becomes a nonmember, or because the assets of the debtor or the creditor are acquired by a nonmember in a transaction to which section 381 applies, then the basis of such intercompany obligation (or new obligation if the intercompany obligation is deemed reissued under §1.1502-13(g)(3)) is available for reduction in respect of such excluded COD income pursuant to sections 108 and 1017 and this section.
(ii) * * * See §1.1502-13(g)(3)(i)(A)(1) and (g)(4)(i)(A).
Approved December 18, 2008.
(Filed by the Office of the Federal Register on December 24, 2008, 8:45 a.m., and published in the issue of the Federal Register for December 29, 2008, 73 F.R. 79324)