Reopenings of Treasury Securities and Other Debt Instruments; Original Issue Discount

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-115932-99]

RIN 1545-AX60

Reopenings of Treasury Securities and Other Debt Instruments;

Original Issue Discount

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking by cross-reference to temporary

regulations, notice of proposed rulemaking, and notice of public

hearing.

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SUMMARY: This document proposes, by cross reference to temporary

regulations, amendments to the final regulations concerning the Federal

income tax treatment of certain reopenings of Treasury securities. The

temporary regulations, published in the Rules and Regulations section

of this issue of the Federal Register, remove the requirement that the

issuance of the Treasury securities in the reopening must be intended

to alleviate an acute, protracted shortage of the original securities.

The text of the temporary regulations also serves as the text of the

proposed regulations. This document also contains proposed regulations

that would provide guidance on the Federal income tax treatment of

reopenings of debt instruments other than Treasury securities. The

proposed regulations would provide guidance to holders and issuers of

debt instruments. This document also provides notice of a public

hearing on the proposed regulations.

DATES: Written and electronic comments must be received by February 3,

2000. Requests to appear and outlines of topics to be discussed at the

public hearing scheduled for March 22, 2000, at 10 a.m., must be

received by March 1, 2000.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-115932-99), room

5226, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. Submissions may be hand delivered between the

hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-115932-99), 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 of

the IRS Home Page or by submitting comments directly to the IRS

Internet

[[Page 60396]]

site at http://www.irs.gov/tax__regs/regslist.html. A public hearing

will be held in room 2615, Internal Revenue Building, 1111 Constitution

Avenue NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, William E.

Blanchard, (202) 622-3950; concerning submissions and the hearing,

Michael L. Slaughter, (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

Temporary regulations in the Rules and Regulations section of this

issue of the Federal Register amend the Income Tax Regulations (26 CFR

part 1) relating to section 1275 of the Internal Revenue Code (Code).

The temporary regulations provide rules for qualified reopenings of

Treasury securities. See Sec. 1.1275-2T(d).

This document also proposes new rules under sections 163(e) and

1275 of the Code for qualified reopenings of debt instruments other

than Treasury securities.

Explanation of Provisions

Reopenings of Treasury Securities

The text of the temporary regulations (Sec. 1.1275-2T(d)) also

serves as the text of the proposed regulations. The preamble to the

temporary regulations explains the temporary regulations.

Reopenings of Debt Instruments Other Than Treasury Securities

A. In General

Over the past few years, a number of issuers have developed

programs or practices where debt instruments with identical terms and

CUSIP numbers are sold subsequent to their original issue date. These

subsequent sales are often called ``reopenings.'' The original issue

discount (OID) rules generally accommodate reopenings during periods of

stable or falling market interest rates. As is explained in more detail

below, during periods of rising market interest rates, the OID rules

can effectively prohibit reopenings. The proposed regulations in this

document would modify the OID rules to accommodate certain qualified

reopenings.

Under Sec. 1.1275-1(f), two or more debt instruments are part of

the same issue if they have the same payment and credit terms and are

sold reasonably close in time either pursuant to a common plan or as

part of a single transaction or series of related transactions.

Usually, there is little doubt as to what constitutes an issue because

all of the relevant debt instruments have identical terms, have the

same CUSIP number, and are sold on the same day. When the third

condition is not met, however, there is a question as to whether the

subsequently sold debt instruments are part of the original issue or

are themselves a new issue.

This question--whether the subsequently sold debt instruments are

part of the original issue--has important tax consequences. If the

subsequently sold debt instruments are considered part of the original

issue, they have OID only to the extent the debt instruments in the

original issue have OID. Thus, if the original debt instruments were

issued without OID, the subsequently sold debt instruments also do not

have OID. In this case, any discount on the subsequently sold debt

instruments generally is market discount, not OID. Conversely, if the

subsequently sold debt instruments are a separate issue for tax

purposes, any discount that arises as part of their issuance is OID if

it equals or exceeds the OID de minimis amount for the debt

instruments. See Sec. 1.1273-1(d) to determine the de minimis amount.

The holder and issuer have different tax consequences depending

upon whether the discount is characterized as OID or market discount.

For the holder, the primary difference is whether the holder has to

include the discount in income on a current basis as it accrues. If it

is OID, the holder must include the accruals in income currently; if it

is market discount, the holder generally does not have to include

discount in income until the debt instrument is disposed of or

redeemed. The issuer's tax consequences also depend on whether the

discount is OID or market discount. If the subsequently sold debt

instruments are part of a separate issue and if the discount is OID,

the issuer (or a broker or middleman) generally is required to make OID

information reports for these debt instruments. See Sec. 1.6049-5. To

comply with this reporting obligation, the issuer must be able to

distinguish the subsequently sold debt instruments (which require OID

information reports) from the originally sold debt instruments. As a

practical matter, the only way the subsequently sold debt instruments

can be distinguished is if they are assigned new CUSIP numbers. The

assignment of new CUSIP numbers prevents the debt instruments from

being fungible and, thereby, defeats the purpose of the reopening.

B. Qualified Reopenings

This document proposes new qualified reopening rules. Under these

rules, additional debt instruments sold in a qualified reopening would

be part of the same issue as the original debt instruments. As a

result, the additional debt instruments would have the same issue date,

the same issue price, and (with respect to holders) the same adjusted

issue price as the original debt instruments.

A qualified reopening would be a reopening of original debt

instruments that meets the following conditions: (1) The original debt

instruments are publicly traded; (2) The issue date of the additional

debt instruments (treated as a separate issue) is not more than 6

months after the issue date of the original debt instruments; (3) Seven

days before the date on which the price of the additional debt

instruments is established, the yield of the original debt instruments

(based on their fair market value) is not more than 107.5 percent of

the yield of the original debt instruments on their issue date (or, if

the original debt instruments were issued with no more than a de

minimis amount of OID, the coupon rate); and (4) The yield of the

additional debt instruments (based on the sales price of the additional

debt instruments) is not more than 115 percent of the yield of the

original debt instruments on their issue date (or, if the original debt

instruments were issued with no more than a de minimis amount of OID,

the coupon rate).

A qualified reopening also would include a reopening of original

debt instruments if the first two conditions described above are met

and the additional debt instruments (treated as a separate issue) were

issued with no more than a de minimis amount of OID. A qualified

reopening, however, would not include a reopening of tax-exempt

obligations or contingent payment debt instruments.

The qualified reopening rules attempt to strike a balance between

tax policy concerns about the conversion of OID into market discount

and the need to have the tax rules reflect current capital market

practices. The IRS and the Treasury Department believe the appropriate

balance is to provide reopening rules for situations where the issuer

can prove by objective, market-based information that the reopening

will convert, at most, only a small amount of OID into market discount.

To clearly and accurately measure the conversion benefit across

different interest rate environments and debt instrument terms, the

proposed regulations use a yield-based standard. The 107.5 percent

standard was designed to give some relief to the reopening of

relatively short-term issues (that is, issues with a remaining term of

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10 years or less). These issues tend to be the most impacted by the OID

de minimis rule standard.

The two yield-based rules are designed to work in tandem. The 107.5

percent of yield restriction is tested 7 days before the anticipated

pricing date. This rule is designed to give the issuer a preliminary

indication that its reopening will be a qualified reopening prior to

the issuer's announcement of the reopening. Importantly, this

preliminary indication is not controlling. Absent the 115 percent rule,

if market interest rates were to move sharply upward in the week

between the announcement date and the pricing date, the reopened debt

instruments would go out with a significant amount of market discount

(instead of OID) notwithstanding the fact that seven days before the

pricing date the instruments satisfied the 107.5 percent rule. In this

presumably rare and unusual case, the tax policy concern of converting

a significant amount of OID into market discount becomes relatively

more important. The proposed regulations, therefore, limit the total

amount of discount that can be converted into market discount with the

115 percent rule.

C. Definition of Issue

The proposed regulations also change the definition of issue that

is currently in Sec. 1.1275-1(f) of the final OID regulations

(described above). Essentially, the proposed regulations limit the

``reasonably close in time'' standard of current law to 13 days. The

IRS and the Treasury Department believe that reopenings should be done

through the proposed qualified reopening rule (discussed above), not

through an expansive interpretation of the regulatory definition of

issue. The 13-day limitation was chosen to prevent an issuer that comes

to market every two weeks from stretching the definition of issue to

cover two consecutive market sales. If an issuer wants to reopen more

than 13 days after the initial offering, the sole test should be

whether the reopening qualifies under the proposed qualified reopening

rules.

D. Issuer's Treatment

This document also proposes rules that clarify the issuer's

treatment of the debt instruments comprising an issue when there is a

qualified reopening. The proposed regulations require the issuer to

take into account, as an adjustment to its interest expense, any

difference between the amounts paid by the holders to acquire the

additional debt instruments issued in the qualified reopening and the

adjusted issue price of the original debt instruments. This difference

would either increase or decrease the aggregate adjusted issue prices

of all of the debt instruments in the issue (both original and

additional) with respect to the issuer (but not the holder). The issuer

would then, as of the reopening date, recompute the yield of the debt

instruments in the issue based on this aggregate adjusted issue price

and the remaining payment schedule of the debt instruments. The issuer

would use this redetermined yield for purposes of applying the constant

yield method to determine its accruals of interest expense over the

remaining term of the debt instruments in the issue.

During the consideration of the issuer's treatment of the

additional debt instruments, a question arose as to whether the

issuer's all-in-cost-of-capital should be used to determine the

issuer's interest expense for a particular borrowing. Under current

law, the costs of anticipatory hedges and bond issuance costs (such as

underwriter fees) are not treated as interest expense even though they

affect the issuer's cost of acquiring funds (the issuer's all-in-cost-

of-capital). The IRS and the Treasury Department request comments on

whether the issuer's all-in-cost-of-capital should be used to determine

the issuer's interest expense for a particular borrowing.

E. Proposed Effective Dates

Section 1.163-7(e) of the proposed regulations would apply to

qualified reopenings where the reopening date is on or after the date

that is 60 days after the date final regulations are published in the

Federal Register. Section 1.1275-2(k) of the proposed regulations would

apply to debt instruments that are part of a reopening where the

reopening date is on or after the date that is 60 days after the date

final regulations are published in the Federal Register.

The proposed revision to the definition of the term issue would

apply to debt instruments whose issue date is on or after the date that

is 60 days after the date final regulations are published in the

Federal Register. For debt instruments issued prior to the effective

date of the regulations, no inference is intended as to how the term

issue should be interpreted under the current final regulations.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in Executive Order

12866. Therefore, a regulatory assessment is not required. It also has

been determined that section 553(b) of the Administrative Procedure Act

(5 U.S.C. chapter 5) does not apply to these regulations and, because

the regulations do not impose a collection of information on small

entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not

apply. Pursuant to section 7805(f) of the 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 Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written or electronic comments (a

signed original and eight (8) copies, if written) that are submitted

timely (in the manner described in the ADDRESSES portion of this

preamble) to the IRS. The IRS and Treasury specifically request

comments on the clarity of the proposed regulations and how the

regulations may be made easier to understand. All comments will be

available for public inspection and copying.

A public hearing has been scheduled for March 22, 2000, at 10 a.m.,

in room 2615, Internal Revenue Building, 1111 Constitution Avenue NW.,

Washington, DC. Due to building security procedures, visitors must

enter at the 10th Street entrance, located between Constitution and

Pennsylvania Avenues, NW. In addition, all visitors must present photo

identifications to enter the building. Because of access restrictions,

visitors will not be admitted beyond the immediate entrance area more

than 15 minutes before the hearing starts. For information about having

your name placed on the building access list to attend the hearing, see

the FOR FURTHER INFORMATION CONTACT section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who

wish to present oral comments at the hearing must submit written

comments by February 3, 2000, and submit an outline of the topics to be

discussed and the time to be devoted to each topic (signed original and

eight (8) copies) by March 1, 2000. A period of 10 minutes will be

allotted to each person for making comments. An agenda showing the

scheduling of the speakers will be prepared after the deadline for

receiving outlines has passed. Copies of the agenda will be available

free of charge at the hearing.

Drafting Information

The principal author of these regulations is William E. Blanchard,

Office of Assistant Chief Counsel

[[Page 60398]]

(Financial Institutions and Products). However, other personnel from

the IRS and the Treasury Department participated in their 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 * * *

Par. 2. Section 1.163-7 is amended by:

1. Redesignating paragraph (e) as paragraph (f).

2. Adding a new paragraph (e).

3. Revising newly designated paragraph (f).

The revision and addition read as follows:

Sec. 1.163-7 Deduction for OID on certain debt instruments.

* * * * *

(e) Qualified reopening--(1) In general. In a qualified reopening

of an issue of debt instruments, if a holder pays more or less than the

adjusted issue price of the original debt instruments to acquire an

additional debt instrument, the issuer treats this difference as an

adjustment to the issuer's interest expense for the original and

additional debt instruments. As provided by paragraphs (e)(2) through

(e)(5) of this section, the adjustment is taken into account over the

term of the instrument using constant yield principles.

(2) Positive adjustment. If the difference is positive (that is,

the holder pays more than the adjusted issue price of the original debt

instrument), then, with respect to the issuer but not the holder, the

difference increases the aggregate adjusted issue prices of all of the

debt instruments in the issue, both original and additional.

(3) Negative adjustment. If the difference is negative (that is,

the holder pays less than the adjusted issue price of the original debt

instrument), then, with respect to the issuer but not the holder, the

difference reduces the aggregate adjusted issue prices of all of the

debt instruments in the issue, both original and additional.

(4) Determination of issuer's interest accruals. As of the

reopening date, the issuer must redetermine the yield of the debt

instruments in the issue for purposes of applying the constant yield

method described in Sec. 1.1272-1(b) to determine the issuer's accruals

of interest expense over the remaining term of the debt instruments in

the issue. This redetermined yield is based on the aggregate adjusted

issue prices of the debt instruments in the issue (as determined under

this paragraph (e)) and the remaining payment schedule of the debt

instruments in the issue. If the aggregate adjusted issue prices of the

debt instruments in the issue (as determined under this paragraph (e))

are less than the aggregate stated redemption price at maturity of the

instruments (determined as of the reopening date) by a de minimis

amount (within the meaning of Sec. 1.1273-1(d)), the issuer may use the

rules in paragraph (b) of this section to determine the issuer's

accruals of interest expense.

(5) Effect of adjustments on issuer's adjusted issue price. The

adjustments made under this paragraph (e) are taken into account for

purposes of determining the issuer's adjusted issue price under

Sec. 1.1275-1(b).

(6) Definitions. The terms additional debt instrument, original

debt instrument, qualified reopening, and reopening date have the same

meanings as in Sec. 1.1275-2(k).

(f) Effective dates. This section (other than paragraph (e) of this

section) applies to debt instruments issued on or after April 4, 1994.

Taxpayers, however, may rely on this section (other than paragraph (e)

of this section) for debt instruments issued after December 21, 1992,

and before April 4, 1994. Paragraph (e) of this section applies to

qualified reopenings where the reopening date is on or after the date

that is 60 days after the date final regulations are published in the

Federal Register.

Par. 3. In Sec. 1.1275-1, paragraph (f) is revised to read as

follows:

Sec. 1.1275-1 Definitions.

* * * * *

(f) Issue--(1) Definition. Two or more debt instruments are part of

the same issue if the debt instruments--

(i) Have the same credit and payment terms;

(ii) Are issued either pursuant to a common plan or as part of a

single transaction or a series of related transactions; and

(iii) Are issued within a period of 13 days beginning with the date

on which the first debt instrument that would be part of the issue is

issued to a person other than a bond house, broker, or similar person

or organization acting in the capacity of an underwriter, placement

agent, or wholesaler.

(2) Cross-references for reopening and aggregation rules. See

Sec. 1.1275-2(d) and (k) for rules that treat debt instruments issued

in certain reopenings as part of an issue of original (outstanding)

debt instruments. See Sec. 1.1275-2(c) for rules that treat two or more

debt instruments as a single debt instrument.

(3) Effective date. This paragraph (f) applies to debt instruments

whose issue date is on or after the date that is 60 days after the date

final regulations are published in the Federal Register.

* * * * *

Par. 4. In Sec. 1.1275-2, paragraph (d) is revised and paragraph

(k) is added to read as follows:

Sec. 1.1275-2 Special rules relating to debt instruments.

* * * * *

(d) [The text of this proposed paragraph (d) is the same as the

text of Sec. 1.1275-2T(d) published elsewhere in this issue of the

Federal Register.]

* * * * *

(k) Reopenings--(1) In general. Notwithstanding Sec. 1.1275-1(f),

additional debt instruments issued in a qualified reopening are part of

the same issue as the original debt instruments. As a result, the

additional debt instruments have the same issue date, the same issue

price, and (with respect to holders) the same adjusted issue price as

the original debt instruments.

(2) Definitions--(i) Original debt instruments. Original debt

instruments are debt instruments comprising any single issue of

outstanding debt instruments. For purposes of determining whether a

particular reopening is a qualified reopening, debt instruments issued

in prior qualified reopenings are treated as original debt instruments

and debt instruments issued in the particular reopening are not so

treated.

(ii) Additional debt instruments. Additional debt instruments are

debt instruments that, without the application of this paragraph (k)--

(A) Are part of a single issue of debt instruments;

(B) Are not part of the same issue as the original debt

instruments; and

(C) Have terms that are in all respects identical to the terms of

the original debt instruments as of the reopening date.

(iii) Reopening date. The reopening date is the issue date of the

additional debt instruments (determined without the application of this

paragraph (k)).

(iv) Qualified reopening. A qualified reopening is a reopening of

original debt instruments (other than tax-exempt

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obligations, as defined in section 1275(a)(3), and contingent payment

debt instruments, within the meaning of Sec. 1.1275-4) that meets all

of the following conditions:

(A) The original debt instruments are publicly traded (within the

meaning of Sec. 1.1273-2(f)).

(B) The reopening date of the additional debt instruments is not

more than 6 months after the issue date of the original debt

instruments.

(C) The debt instruments satisfy either the test described in

paragraph (k)(3) of this section or the test described in paragraph

(k)(4) of this section.

(3) Yield test. For purposes of paragraph (k)(2)(iv)(C) of this

section--

(i) Seven days before the date on which the price of the additional

debt instruments is established, the yield of the original debt

instruments (based on their fair market value) is not more than 107.5

percent of the yield of the original debt instruments on their issue

date (or, if the original debt instruments were issued with no more

than a de minimis amount of OID, the coupon rate); and

(ii) The yield of the additional debt instruments (based on the

sales price of the additional debt instruments) is not more than 115

percent of the yield of the original debt instruments on their issue

date (or, if the original debt instruments were issued with no more

than a de minimis amount of OID, the coupon rate).

(4) De minimis OID test. For purposes of paragraph (k)(2)(iv)(C) of

this section, the additional debt instruments are issued with no more

than a de minimis amount of OID (determined without the application of

this paragraph (k)).

(5) Special rule for Treasury reopenings. See paragraph (d) of this

section for special rules for reopenings of Treasury securities.

(6) Issuer's treatment of a qualified reopening. See Sec. 1.163-

7(e) for the issuer's treatment of the debt instruments that are part

of a qualified reopening.

(7) Effective date. This paragraph (k) applies to debt instruments

that are part of a reopening where the reopening date is on or after

the date that is 60 days after the date final regulations are published

in the Federal Register.

David A. Mader,

Acting Deputy Commissioner of Internal Revenue.

[FR Doc. 99-28742 Filed 11-3-99; 8:45 am]

BILLING CODE 4830-01-U