[Federal Register Volume 63, Number 19 (Thursday, January 29, 1998)]
[Rules and Regulations]
[Pages 4394-4396]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-2093]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8763]
RIN 1545-AU06
Modifications of Bad Debts and Dealer Assignments of Notional
Principal Contracts
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final and temporary regulations.
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SUMMARY: This document contains regulations that deem a charge-off and
[[Page 4395]]
allow a deduction for a partially worthless debt when the terms of a
debt instrument have been modified.
The regulations provide guidance to certain taxpayers that have
claimed a deduction for a partially worthless debt and then modified
the terms of the debt instrument. This document also contains
regulations relating to certain assignments of notional principal
contracts by dealers in those contracts. The regulations provide
guidance to taxpayers relating to the consequences of these
assignments.
DATES: Effective date: These regulations are effective February 29,
1998.
Applicability date: These regulations apply to significant
modifications of debt instruments and assignments of interest rate
swaps, commodity swaps, and other notional principal contracts
occurring on or after September 23, 1996.
FOR FURTHER INFORMATION CONTACT: Concerning the modifications of bad
debts, Craig Wojay, (202) 622-3920, and concerning dealer assignments
of notional principal contracts, Thomas M. Preston, (202) 622-3940 (not
toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
On June 25, 1996, temporary regulations (TD 8676) relating to
modifications of bad debts and dealer assignments of notional principal
contracts under sections 166 and 1001 of the Internal Revenue Code
(Code) were published in the Federal Register (61 FR 32653). A notice
of proposed rulemaking (REG-209743-94, formerly FI-59-94) cross-
referencing the temporary regulations was published in the Federal
Register for the same day (61 FR 32728). No public hearing was
requested or held.
Written comments responding to the notice were received. After
consideration of the comments, the regulations proposed by REG-209743-
94 are adopted by this Treasury decision, and the corresponding
temporary regulations are removed.
Explanation of Provisions
The preamble to the temporary regulations sets forth limited
circumstances under which a taxpayer will be permitted to deduct an
amount on account of a partially worthless debt even though an amount
has not been charged off within the taxable year.
Section 166(a)(2) and Sec. 1.166-3(a) provide that a deduction for
a partially worthless debt is allowed only to the extent the debt is
charged off in the taxable year. The charge-off requirement is
satisfied when a portion of the debt is removed from the taxpayer's
books and records. This generally is accomplished by reducing the
debt's book basis. Thus, when an amount has been deducted for partial
worthlessness, there is generally a reduction of both the book basis
and the tax basis of a debt.
When a taxpayer is required to recognize gain under Sec. 1.1001-1
because of a modification of a debt instrument, the taxpayer's tax
basis in the debt is increased by the amount of gain recognized.
However, regulatory and general accounting principles generally would
not permit a corresponding increase in the book basis of the debt.
Because the prior charge-off is not restored (that is, the book basis
of the debt is not increased), there is no opportunity for the taxpayer
to take a new charge-off for pre-existing worthlessness.
The purpose of the temporary regulations is to preserve a portion
of a taxpayer's bad debt deduction with respect to a partially
worthless debt. The portion preserved corresponds to the amount the
taxpayer would have been entitled to deduct for partial worthlessness
with respect to the modified debt if the book basis of the modified
debt were increased to the same extent as the tax basis of that debt.
Thus, if all the conditions of the temporary regulations are satisfied,
then a modified debt is deemed to have been charged off in the year in
which gain is recognized. The amount of the deemed charge-off, however,
is limited to the difference between the tax basis of the debt and the
greater of the book basis or the fair market value of the debt. The
temporary regulations also address debt that constitutes transferred
basis property under section 7701(a)(43).
In addition, the temporary regulations provide a limited rule
dealing with a dealer's assignment of its position in an interest rate
swap, commodity swap, or other notional principal contract to another
dealer. If the assignment is permitted by the terms of the contract,
the assignment is not treated as a deemed exchange by the nonassigning
party of the original contract for a new contract that differs
materially either in kind or in extent. Thus, an assignment to which
the rule applies does not trigger gain or loss to the dealer's
counterparty.
Three comments were received on the Sec. 1.166-3T regulations. The
first comment requests a deemed charge-off for a taxpayer that
purchased at a discount debt for which a previous deduction for partial
worthlessness was claimed, and then significantly modified the debt
under Sec. 1.1001-3 and recognized gain on the modification. Whenever
debt is purchased for less than the stated redemption price, recognized
gain from a significant modification is attributable to market discount
as defined in section 1278(a)(2)(A) and not to a previously claimed
deduction for partial worthlessness. In addition, the temporary
regulations refer to Sec. 1.166-3(a) (1) and (2) for guidance relating
to prior charge-offs and deductions for partial worthlessness.
Extending the temporary regulations to cover a discount purchase would
significantly expand the regulations beyond their intended scope and
create a situation that would be extremely difficult to administer. The
regulations do not adopt the request to extend the regulations to cover
such a purchase.
The second comment requests a deemed charge-off for a member of a
consolidated group that purchased debt, for which a previous deduction
for partial worthlessness was claimed, from another member of the
group, then significantly modified the debt under Sec. 1.1001-3 and
recognized gain on the modification. Whenever debt is purchased for
less than the stated redemption price, subsequently recognized gain
from a significant modification is attributable to market discount as
defined in section 1278(a)(2)(A) and not to a previously claimed
deduction for partial worthlessness. Extending the temporary
regulations to cover a purchase from another member of the consolidated
group would significantly expand the regulations beyond their intended
scope. The regulations do not adopt the request to extend the
regulations to cover an intercompany transaction.
The third comment requests expanding the temporary regulations to
include other situations in which a taxpayer has tax basis in a debt
but no corresponding book basis. The first situation involves the
accrual of interest income on loans that have been placed on non-
accrual status for book purposes. The second situation involves the
requirement to accrue interest on original issue discount obligations
even if the loan has become uncollectible. This comment deals with
situations other than the modification of a debt instrument and is
beyond the scope of this regulation project.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of
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the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to
these regulations, and because the regulation does 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 Internal Revenue Code, the notice of proposed rulemaking preceding
these regulations was submitted to the Small Business Administration
for comment on its impact on small business.
Drafting Information: The principal author of the regulations
concerning the modifications of bad debts is Craig Wojay, Office of the
Assistant Chief Counsel (Financial Institutions and Products), IRS. The
principal author of the regulations concerning the dealer assignments
of notional principal contracts is Thomas M. Preston, Office of the
Assistant Chief Counsel (Financial Institutions and Products), IRS.
However, other personnel from the IRS and Treasury Department
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is 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. In Sec. 1.166-3, paragraph (a)(3) is added to read as
follows:
Sec. 1.166-3 Partial or total worthlessness.
(a) * * *
(3) Significantly modified debt--(i) Deemed charge-off. If a
significant modification of a debt instrument (within the meaning of
Sec. 1.1001-3) during a taxable year results in the recognition of gain
by a taxpayer under Sec. 1.1001-1(a), and if the requirements of
paragraph (a)(3)(ii) of this section are met, there is a deemed charge-
off of the debt during that taxable year in the amount specified in
paragraph (a)(3)(iii) of this section.
(ii) Requirements for deemed charge-off. A debt is deemed to have
been charged off only if--
(A) The taxpayer (or, in the case of a debt that constitutes
transferred basis property within the meaning of section 7701(a)(43), a
transferor taxpayer) has claimed a deduction for partial worthlessness
of the debt in any prior taxable year; and
(B) Each prior charge-off and deduction for partial worthlessness
satisfied the requirements of paragraphs (a) (1) and (2) of this
section.
(iii) Amount of deemed charge-off. The amount of the deemed charge-
off, if any, is the amount by which the tax basis of the debt exceeds
the greater of the fair market value of the debt or the amount of the
debt recorded on the taxpayer's books and records reduced as
appropriate for a specific allowance for loan losses. The amount of the
deemed charge-off, however, may not exceed the amount of recognized
gain described in paragraph (a)(3)(i) of this section.
(iv) Effective date. This paragraph (a)(3) applies to significant
modifications of debt instruments occurring on or after September 23,
1996.
* * * * *
Sec. 1.166-3T [Removed]
Par. 3. Section 1.166-3T is removed.
Par. 4. Section 1.1001-4 is added to read as follows:
Sec. 1.1001-4 Modifications of certain notional principal contracts.
(a) Dealer assignments. For purposes of Sec. 1.1001-1(a), the
substitution of a new party on an interest rate or commodity swap, or
other notional principal contract (as defined in Sec. 1.446-3(c)(1)),
is not treated as a deemed exchange by the nonassigning party of the
original contract for a modified contract that differs materially
either in kind or in extent if--
(1) The party assigning its rights and obligations under the
contract and the party to which the rights and obligations are assigned
are both dealers in notional principal contracts, as defined in
Sec. 1.446-3(c)(4)(iii); and
(2) The terms of the contract permit the substitution.
(b) Effective date. This section applies to assignments of interest
rate swaps, commodity swaps, and other notional principal contracts
occurring on or after September 23, 1996.
Sec. 1.1001-4T [Removed]
Par. 5. Section 1.1001-4T is removed.
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
Approved: January 14, 1998.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 98-2093 Filed 1-28-98; 8:45 am]
BILLING CODE 4830-01-U
