Intercompany Obligations

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-105964-98]

RIN 1545-AW30

Intercompany Obligations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains a proposed regulation that clarifies

the treatment of the transfer or extinguishment of rights under an

intercompany obligation. The existing regulation has caused uncertainty

concerning the tax treatment of such transactions. The proposed

regulation affects corporations that are members of consolidated

groups, their subsidiaries, and their shareholders.

DATES: Comments and requests for a public hearing must be received by

March 22, 1999.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-105964-98), room

5228, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. Submissions may be hand delivered Monday through

Friday between the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (REG-

105964-98), Courier's Desk, Internal Revenue Service, 1111 Constitution

Avenue, NW., Washington, DC. Alternatively, taxpayers may submit

comments electronically via the Internet by selecting the ``Tax Regs''

option on the IRS Home Page, or by submitting comments directly to the

IRS Internet site at http://www.irs.ustreas.gov/prod/tax___regs/

comments.html.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulation,

Theresa A. Abell, (202) 622-7790; concerning submissions of comments,

LaNita Van Dyke, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed amendments to Sec. 1.1502-13(g) of

the Income Tax Regulations. Section 1.1502-13(g) prescribes rules

relating to the treatment of the transfer or extinguishment of rights

under an intercompany obligation. An intercompany obligation is

generally defined as an obligation between members of a consolidated

group, but only for the period during which both parties are members of

the group. The current regulation provides that if a member of a

consolidated group realizes an amount (other than zero) of income,

gain, deduction, or loss upon the transfer or extinguishment of all or

part of its remaining rights or obligations under an intercompany

obligation, the obligation is treated as satisfied (and the

transferor's basis in the property received is adjusted to reflect the

satisfaction amount) and, if the obligation remains outstanding, it is

treated as reissued as a new obligation.

The current regulation is, however, ambiguous regarding the form of

the recast transaction, i.e., the deemed transaction that encompasses

the satisfaction, reissuance, and actual transaction. Under one

interpretation of the regulation, there is a potential that the form of

the recast jeopardizes the tax-free treatment of common corporate

restructuring transactions. While it is not clear the regulation

produces such consequences, the IRS and Treasury believe that any such

consequences would be inappropriate and unnecessary to achieve the

objectives of the regulation. Accordingly, the IRS and Treasury propose

to amend the regulation as described below.

Explanation of Provisions

The existing regulation does not apply to transactions in which the

amount of income, gain, deduction, or loss realized is zero. This rule

was intended to avoid application of the regulation to transactions in

which preservation of gain or loss location, an objective of

Sec. 1.1502-13(g), would not be at issue. However, the determination of

whether the amount of income, gain, deduction, or loss realized is zero

might depend on the fair market value of property received in an

exchange. The difficulty and manipulability of that valuation is a

reason for the enactment of certain provisions of the original issue

discount (OID) rules, particularly section 1274. To the extent that

taxpayers were able to avoid the deemed satisfaction and reissuance

rule by inaccurately maintaining that the amount of income, gain,

deduction, or loss realized is zero, taxpayers could avoid those OID

rules and could inappropriately shift gain or loss among members. The

IRS and Treasury have concluded that the better and more administrable

approach is not to condition the application of the regulation on a

realization of some amount of income, gain, deduction, or loss other

than zero. Accordingly, the regulation as proposed will apply to all

transactions in which any amount is realized due to the transfer or

extinguishment of rights in an intercompany obligation.

The IRS and Treasury believe the exception from the operation of

this provision for transactions that will not have a significant effect

on any person's Federal income tax liability for any year is unclear in

its application and scope. Further, the exception offers little, if

any, relief from the requirements of the provision. Accordingly, the

exception is eliminated from the regulation.

The proposed regulation clarifies the form and timing of the recast

applied to transactions subject to the regulation. In particular, it

clarifies that the deemed satisfaction proceeds (rather than the

obligation) are treated as transferred by the initial creditor in the

actual transaction and then advanced by the transferee to the debtor in

the deemed reissuance of the obligation. The proposed regulation

includes an example to illustrate clearly the mechanics of the proposed

regulation. It also includes certain conforming adjustments.

The proposed regulation retains the rule that the deemed

satisfaction and reissuance amounts are determined under the principles

of the OID provisions if the debt is transferred for property. The IRS

and Treasury recognize that an alternate rule providing for a fair

market value determination of the deemed satisfaction and reissuance

amounts might (in theory) more accurately preserve location of economic

gain or loss. In such an alternate regime, however, the inherent

difficulty of valuing intercompany obligations would prove burdensome

to both taxpayers and the IRS and may provide significant potential for

abuse when member obligations are transferred. Certain provisions of

the OID rules are intended to address the difficulty and manipulability

of this valuation. Other developments in the tax law have recognized

that issue price, as determined under the OID rules, is the surrogate

for fair market value in the case of a debt obligation. For example,

Sec. 1.1001-1(g) provides that issue price is used in determining the

amount realized from the receipt of a debt instrument.

For these reasons, and consistent with the objective of promoting

single entity treatment of the group, the IRS and Treasury continue to

believe that the use of the OID provisions is appropriate and desirable

in determining the deemed satisfaction amount and the amount for which

the obligation is deemed reissued. Accordingly, the regulation as

proposed continues to use the OID provisions to determine both the

amount repaid in the deemed satisfaction and the issue price of the

[[Page 70355]]

reissued obligation in cases involving the exchange of an intercompany

obligation for cash or property.

In addition, the proposed regulation clarifies that the term

``conversion'' includes only conversions pursuant to the terms of the

instrument.

Proposed Effective Date

The regulation is proposed to be effective on the date that the

final regulation is published in the Federal Register. For purposes of

determining the tax treatment of transactions undertaken prior to such

effective date, taxpayers may rely on the form and timing of the recast

transaction, as clarified by these proposed regulations. No inference

is intended, however, as to the correct interpretation of the existing

regulation.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory assessment is not required. It is hereby certified that

these regulations will not have a significant impact on a substantial

number of small entities. This certification is based on the fact that

these regulations principally affect corporations filing consolidated

Federal income tax returns. Available data indicates that many

consolidated return filers are large companies (not small businesses).

Therefore, a Regulatory Flexibility Analysis under the Regulatory

Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to

section 7805(f) of the Internal Revenue Code, this notice of proposed

rulemaking will be submitted to the Chief Counsel for Advocacy of the

Small Business Administration for comment on its impact on small

business.

Comments and Requests for a Public Hearing

Before this proposed regulation is adopted as a final regulation,

consideration will be given to any written comments (preferably a

signed original and eight copies) that are timely submitted to the IRS.

All comments will be available for public inspection and copying. A

public hearing may be scheduled if requested in writing by any person

that timely submits written comments. If a public hearing is scheduled,

notice of the date, time, and place of the hearing will be published in

the Federal Register.

Drafting information. The principal author of this regulation is

Theresa A. Abell of the Office of Assistant Chief Counsel (Corporate),

IRS. However, other personnel from the IRS and Treasury Department

participated in its development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in

part as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.1502-13 also issued under 26 U.S.C. 1502.

Par. 2. Section 1.1502-13 is amended by:

1. Revising paragraphs (g)(3)(i)(A), (g)(3)(i)(B)(3),

(g)(3)(ii)(A), and (g)(3)(iii), and removing paragraph (g)(3)(i)(B)(4).

2. Revising paragraph (g)(4)(i)(B).

3. Amending paragraph (g)(5) by:

a. Removing the language ``Example 2'' in each place it appears in

paragraphs (d), (e) and (f) of Example 2 and adding ``Example 3'' in

its place.

b. Removing the language ``Example 3'' in each place it appears in

paragraphs (c) and (d) of Example 3 and adding ``Example 4'' in its

place.

c. Removing the language ``Example 5'' in each place it appears in

paragraph (c) of Example 5 and adding ``Example 6'' in its place.

d. Redesignating Examples 2, 3, 4 and 5 as Examples 3, 4, 5 and 6

and adding a new Example 2.

The revisions and additions read as follows:

Sec. 1.1502-13 Intercompany transactions.

* * * * *

(g) * * *

(3) Deemed satisfaction and reissuance of intercompany obligations

(i) Application--(A) In general. If a member realizes an amount from

the assignment or extinguishment of all or part of its remaining rights

or obligations under an intercompany obligation, the intercompany

obligation is treated for all Federal income tax purposes as satisfied

under paragraph (g)(3)(ii) of this section and, if it remains

outstanding (either as an intercompany obligation or a nonintercompany

obligation), reissued under paragraph (g)(3)(iii) of this section.

Similar principles apply under this paragraph (g)(3) if a member

realizes an amount, directly or indirectly, from a comparable

transaction (for example, a marking-to-market of an obligation or a bad

debt deduction), or if an intercompany obligation becomes an obligation

that is not an intercompany obligation.

(B) * * *

(3) The amount realized is from the conversion of an obligation

(under the terms of the instrument) into stock of the obligor.

(ii) Satisfaction--(A) General rule. If a creditor member sells an

intercompany debt for cash, the debt is treated as satisfied by the

debtor immediately before the sale for an amount equal to the amount of

the cash. If the debt is transferred for property, the debt is treated

as satisfied immediately before the transaction for an amount equal to

the issue price (determined under section 1273 or section 1274) of a

new debt issued on the date of the transaction, with identical terms,

for such property. If this paragraph (g)(3) applies because the debtor

or creditor becomes a nonmember, the debt is treated as satisfied for

cash in an amount equal to its fair market value immediately before the

debtor or creditor becomes a nonmember. If the debt is transferred for

cash or property, the proceeds of the deemed satisfaction are treated

as transferred by the creditor to the transferee of the debt in

exchange for the cash or property. Similar principles apply to other

transactions and to transactions involving intercompany obligations

other than debt. For example, if a corporation assumes the debtor's

liability in exchange for property of the debtor, the debt is treated

as satisfied for an amount equal to the issue price (determined under

section 1273 or section 1274) of a new debt issued on the date of the

transaction, with identical terms, for such property. If, in a

transaction to which this paragraph (g)(3) applies, the obligation is

extinguished, including in a transaction in which the creditor and

debtor become the same entity, the obligation is treated as satisfied

for an amount equal to the issue price (determined under section 1273

or section 1274) of a new debt issued on the date of the transaction,

with identical terms, to a third party, for property that is not

publicly traded.

* * * * *

(iii) Reissuance. If an intercompany debt is transferred for cash

or property, it is treated as a new debt (with a new holding period but

otherwise identical terms) issued to the transferee in exchange for the

proceeds of the deemed satisfaction as determined under paragraph

(g)(3)(ii) of this section. If this paragraph (g)(3) applies because

the debtor or creditor becomes a nonmember, the debt is treated as a

new debt (with a new holding period but

[[Page 70356]]

otherwise identical terms) issued to the creditor for the deemed

satisfaction proceeds. Similar principles apply to other transactions

and to transactions involving intercompany obligations other than debt.

* * * * *

(4) * * *

(i) * * *

(B) Exception. This paragraph (g)(4) does not apply to an

obligation if the obligation becomes an intercompany obligation by

reason of an event described in Sec. 1.108-2(e) (exceptions to the

application of section 108(e)(4)).

* * * * *

(5) Examples.

* * * * *

Example 2. Nonrecognition transactions. (a) 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. B fully performs its obligations with

the same tax consequences as described in paragraph (a) of Example

1. At the end of Year 3, S transfers the note to a newly formed

subsidiary, Newco, in exchange for Newco stock. Section 351 applies

to the exchange. The interest is adequate stated interest within the

meaning of section 1274(c)(2) (determined on the date of the

transfer). Neither B's note nor Newco's stock is publicly traded.

(b) Deemed satisfaction and reissuance of note. Under paragraph

(g)(3)(ii) of this section, B's note is treated as satisfied for

$100 (the issue price of the reissued note, determined under section

1273(b)(4)) immediately before S's transfer of the note to Newco.

Zero gain or loss is recognized by S and B on the deemed

satisfaction of B's note. S is then treated as transferring the

deemed proceeds of the satisfaction of the note ($100) to Newco in

exchange for the Newco stock. S's basis in the Newco stock is $100.

Under paragraph (g)(3)(iii) of this section, B is treated as

reissuing the note to Newco for $100. Newco's basis in B's note is

$100.

(c) Intercompany obligation transferred in section 332

transaction. The facts are the same as in paragraph (a) of this

Example 2, except that S transfers the note to P in a complete

liquidation under section 332. Under paragraph (g)(3)(ii) of this

section, B's note is treated as satisfied for $100 (the issue price

of the reissued note, determined under section 1273(b)(4))

immediately before S's transfer of the note to P. Zero gain or loss

is recognized by S and B on the deemed satisfaction of the note. S

is then treated as transferring the deemed proceeds of the

satisfaction of the note, with its other assets, to P in complete

liquidation. Under paragraph (g)(3)(iii) of this section, B is

treated as reissuing the note to P for $100. P's basis in the note

is $100.

* * * * *

Robert E. Wenzel,

Deputy Commissioner of Internal Revenue.

[FR Doc. 98-32930 Filed 12-18-98; 8:45 am]

BILLING CODE 4830-01-U