[Federal Register Volume 59, Number 53 (Friday, March 18, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-6087]
[[Page Unknown]]
[Federal Register: March 18, 1994]
=======================================================================
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8532]
RIN 1545-AP19
Final Regulations Under Section 108 of the Internal Revenue Code;
Discharge of Indebtedness
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
-----------------------------------------------------------------------
SUMMARY: This document contains final regulations under section
108(e)(8) of the Internal Revenue Code of 1986, which provides that the
common law stock-for-debt exception to the realization of discharge of
indebtedness income does not apply where stock issued for indebtedness
is nominal or token or fails to satisfy a proportionality test. The
final regulations are necessary to provide guidance in applying section
108(e)(8). The regulations provide rules for determining whether stock
issued for indebtedness is nominal or token under section 108(e)(8)(A)
and rules for applying the proportionality test of section
108(e)(8)(B).
EFFECTIVE DATE: Effective May 17, 1994.
FOR FURTHER INFORMATION CONTACT: Annette Ahlers (202) 622-7750 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document adds final regulations Sec. 1.108-1 under sections
108(e)(8) (A) and (B) of the Internal Revenue Code (Code). Sections
108(e)(8) (A) and (B) were added by section 2(a) of the Bankruptcy Tax
Act of 1980 [Pub. L. 96-589, 94 Stat. 3389] and amended by section
11325 of the Revenue Reconciliation Act of 1990 [Pub. L. 101-508, 104
Stat. 1368]. On November 4, 1992, [57 FR 52601] the Service published
these regulations in proposed form in a Notice of Proposed Rulemaking.
Subsequent to the publication of the proposed regulations, section
13226 of the Omnibus Budget Reconciliation Act of 1993 repealed the
stock-for-debt exception. The amendments made by section 13226 of the
Omnibus Budget Reconciliation Act of 1993 apply to stock transferred
after December 31, 1994, in satisfaction of any indebtedness unless
such transfer is in a title 11 or similar case (as defined in section
368(a)(3)(A)) that was filed on or before December 31, 1993.
The rules of the final regulations are effective with respect to
any issuance of stock for indebtedness on or before December 31, 1994,
or any issuance of stock for indebtedness in a title 11 or similar case
(as defined in section 368(a)(3)(A) of the Code) that was filed on or
before December 31, 1993, pursuant to: (1) A plan confirmed by the
court in a title 11 case after May 17, 1994, or (2) if there is no
title 11 case, an insolvency workout in which all issuances of stock
for indebtedness occur after May 17, 1994. No inference is intended
concerning the interpretation of sections 108(e)(8) (A) and (B) of the
Code prior to the effective date of the regulations.
These final regulations adopt the proposed regulations with a few
minor changes in response to comments. As indicated in the preamble to
the proposed regulations, the Service is also publishing Rev. Proc. 94-
26, I.R.B 1994-13, containing ruling guidelines for the nominal or
token determination under section 108(e)(8)(A).
One commentator suggested that the final regulations contain safe
harbors or a list of specified factors for the nominal or token
determination required by section 108(e)(8)(A) and that a revenue
procedure be published for determining whether preferred stock meets
the nominal or token requirement of section 108(e)(8)(A). Prior
proposed regulations under section 108(e)(8) included factors that
would be considered in determining whether stock was nominal or token.
Commentators, with respect to those regulations, asserted that the list
of factors was incomplete. The Service and Treasury agree that the
determination of whether a stock issuance is nominal or token must be
based on all the facts and circumstances, and that a list of specified
factors would not fully address the relevant considerations in many
cases. Rev. Proc. 94-26, I.R.B. 1994-13, provides one safe harbor on
when common stock is not nominal or token. In the future, the Service
and Treasury will consider issuing additional ruling guidelines as
circumstances warrant.
The commentator suggested that the final regulations provide that
for purposes of computing both the common stock and preferred stock
proportionality tests the definition of adjusted issue price should be
modified to include accrued interest that the issuer of the debt
instrument has not paid. The Service and Treasury agree with the
recommendation. The final regulations clarify that for purposes of the
proportionality tests of section 108(e)(8)(B), the denominator includes
any indebtedness that is discharged in the title 11 case or workout,
including accrued but unpaid stated interest.
The commentator suggested that the final regulations provide that,
for purposes of determining whether certain stock is preferred stock
for purposes of the regulations, preferred stock that is convertible
into common stock should be considered participating stock if the
conversion right represents, in substance, a meaningful right to
participate in corporate growth. This suggestion is adopted in the
final regulations.
In addition, the commentator suggested that a conversion right
permitting a holder to receive common stock should always be treated as
affording such holder a meaningful right to participate in corporate
growth. The Service and Treasury have rejected this suggestion, because
a conversion right does not necessarily afford the holder a meaningful
right to participate in corporate growth. Whether a conversion right
affords a meaningful right to participate in corporate growth must be
determined on a case-by-case basis.
The preamble to the proposed regulations requested comments on the
treatment of contingent liabilities under section 108(e)(8). No
comments, however, were received on this issue. Although the
regulations contain no provision for the treatment of contingent
liabilities, contingent liabilities may not be used to increase the
denominator inappropriately for purposes of meeting the proportionality
tests. For example, the mere assertion by a claimant that it is owed a
specific amount does not by itself warrant inclusion of the asserted
liability in the denominator for purposes of determining the group
ratios.
Special Analyses
It has been determined that this treasury decision is not a
significant regulatory action as defined in Executive Order 12866. It
has also been determined that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act
(5 U.S.C. chapter 6) do not apply and, therefore, a Regulatory
Flexibility Analysis is not required. Pursuant to section 7805(f) of
the Internal Revenue Code, the notice of proposed rulemaking was
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.
Drafting Information
The principal author of these final regulations is Annette M.
Ahlers, Office of Assistant Chief Counsel (Corporate), Office of Chief
Counsel, Internal Revenue Service. 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.
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 is amended by adding
an entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * * Section 1.108-1 also issued
under 26 U.S.C. 108(e)(8) and 108(e)(10)(B). * * *
Par. 2. Section 1.108-1 is added to read as follows:
Sec. 1.108-1 Stock-for-debt exception not to apply in de minimis
cases.
(a) Overview. Section 108(e)(8) provides that the common law stock-
for-debt exception does not apply if stock issued for indebtedness is
nominal or token or if a proportionality test is not met. Paragraph (b)
of this section provides rules for the nominal or token determination
under section 108(e)(8)(A). Paragraph (c) of this section provides
rules for the proportionality test under section 108(e)(8)(B).
Paragraph (d) of this section provides certain general rules and
definitions. Paragraph (e) of this section provides an effective date.
(b) Issuance of nominal or token stock. Under section 108(e)(8)(A),
the common law stock-for-debt exception does not apply to indebtedness
discharged for stock that is nominal or token. All relevant facts and
circumstances must be considered in making this determination. If
common and preferred stock are issued for indebtedness, the
determination is made separately with respect to the common stock and
the preferred stock. The determination of whether common stock issued
for unsecured indebtedness is nominal or token is made on an aggregate
basis with respect to all common stock issued for unsecured
indebtedness in the title 11 case or insolvency workout. Preferred
stock issued for unsecured indebtedness is also tested on an aggregate
basis with respect to all preferred stock issued for unsecured
indebtedness in the title 11 case or insolvency workout.
(c) Issuance of a disproportionately small amount of stock for
unsecured indebtedness--(1) Common stock issued for unsecured
indebtedness--(i) In general. The common law stock-for-debt exception
does not apply to an unsecured indebtedness discharged for common stock
in a title 11 case or insolvency workout if the individual common stock
ratio does not equal at least one-half of the group common stock ratio.
(ii) Individual common stock ratio defined. The individual common
stock ratio is the ratio of the value of the common stock issued for an
unsecured indebtedness to the amount of the unsecured indebtedness
allocated to that common stock. The amount of unsecured indebtedness
allocated to the common stock is the amount of the indebtedness for
which the common stock is issued (as defined in paragraph (d)(5) of
this section), reduced by the amount of other consideration, if any,
transferred in exchange for the indebtedness, including--
(A) The amount of any money;
(B) The issue price (determined under section 1273 or 1274) of any
new indebtedness;
(C) With respect to any preferred stock, the amount of indebtedness
allocated to the preferred stock under paragraph (c)(2)(ii) of this
section; and
(D) The value of any other property, including any disqualified
stock.
(iii) Group common stock ratio defined. The group common stock
ratio is the ratio of the aggregate value of all common stock issued
for unsecured indebtedness in the title 11 case or insolvency workout
to the aggregate amount of unsecured indebtedness allocated to that
common stock. The amount of unsecured indebtedness allocated to the
common stock is the aggregate amount of all unsecured indebtedness
exchanged for stock or cancelled in the title 11 case or insolvency
workout, reduced by the amount of other consideration, if any, issued
for that indebtedness, including--
(A) The amount of any money;
(B) The issue price (determined under section 1273 or 1274) of any
new indebtedness;
(C) With respect to any preferred stock, the amount of indebtedness
allocated to the preferred stock under paragraph (c)(2)(iii) of this
section; and
(D) The value of any other property, including any disqualified
stock.
(iv) Example. The following example illustrates these provisions.
Example. (A) X Corporation has three outstanding debts, Debt 1,
Debt 2, and Debt 3. Debts 1 and 2 are unsecured and each has an
adjusted issue price of $100,000. Debt 3 is also unsecured, and it
has an adjusted issue price of $90,000 and accrued but unpaid
interest of $10,000. In a title 11 case, Debt 1 is exchanged for
$50,000 cash and $20,000 of common stock, Debt 2 is exchanged for
$10,000 cash, and Debt 3 is exchanged for $5,000 common stock. The
individual common stock ratio for Debt 1 is 40 percent, which is
determined by comparing the value of the common stock issued for the
indebtedness ($20,000) to the amount of unsecured indebtedness
allocated to that stock ($100,000 adjusted issue price less $50,000
cash received). The individual common stock ratio for Debt 2 is 0
percent because no stock is received in exchange for the
indebtedness. The individual common stock ratio for Debt 3 is 5
percent, which is determined by comparing the value of the common
stock issued for the indebtedness ($5,000) to the amount of
unsecured indebtedness allocated to that stock ($100,000=$90,000
adjusted issue price and $10,000 of accrued but unpaid interest).
(B) The group common stock ratio is 10.4 percent, which is
determined by comparing the value of all of the common stock issued
for unsecured indebtedness in the title 11 case ($25,000) to the
amount of unsecured indebtedness allocated to the stock ($290,000
aggregate adjusted issue price of all indebtedness exchanged for
stock or cancelled in the title 11 case plus $10,000 accrued but
unpaid interest less $60,000 cash received). Accordingly, section
108(e)(8)(B) is satisfied only with respect to the common stock
issued for Debt 1. The stock-for-debt exception does not apply to
Debt 2 or Debt 3.
(2) Preferred stock issued for unsecured indebtedness--(i) In
general. The common law stock-for-debt exception does not apply to an
unsecured indebtedness discharged for preferred stock in a title 11
case or insolvency workout if the individual preferred stock ratio does
not equal at least one-half of the group preferred stock ratio.
(ii) Individual preferred stock ratio defined. The individual
preferred stock ratio is the ratio of the value of the preferred stock
issued for an unsecured indebtedness to the amount of the unsecured
indebtedness allocated to the preferred stock. The amount of the
unsecured indebtedness allocated to preferred stock is equal to the
lesser of the lowest redemption price (if any) or lowest liquidation
preference (if any) of the preferred stock (determined at issuance).
However, the allocable indebtedness may not be less than the fair
market value of the preferred stock or greater than the amount of the
unsecured indebtedness.
(iii) Group preferred stock ratio defined. The group preferred
stock ratio is the ratio of the aggregate value of all preferred stock
issued for unsecured indebtedness in the title 11 case or insolvency
workout to the aggregate amount of unsecured indebtedness allocated to
the preferred stock under paragraph (c)(2)(ii) of this section.
(d) Definitions and special rules. For purposes of this section:
(1) Common stock. Common stock is all stock other than disqualified
stock and preferred stock.
(2) Disqualified stock. Disqualified stock is disqualified stock as
defined in section 108(e)(10)(B)(ii).
(3) Liquidation preference. A liquidation preference exists if the
stock's right to share in liquidation proceeds is limited and
preferred.
(4) Preferred stock. Preferred stock is any stock (other than
disqualified stock) that has a limited or fixed redemption price or
liquidation preference and does not upon issuance have a right to
participate in corporate growth to a meaningful extent. Preferred stock
that is convertible into common stock is not treated as preferred stock
if the conversion right represents, in substance, a meaningful right to
participate in corporate growth. Solely for purposes of this paragraph
(d)(4), a right to participate in corporate growth is not established
by the fact that the redemption price or liquidation preference exceeds
the fair market value of the preferred stock.
(5) Amount of indebtedness. Generally, the amount of indebtedness
is the adjusted issue price of the indebtedness. Appropriate
adjustments are made for accrued but unpaid stated interest. (See the
example in paragraph (c)(1)(iv) of this section.)
(6) Undersecured indebtedness--(i) General rule. If an indebtedness
is secured by property with a value less than its adjusted issue price,
the indebtedness is considered to be two separate debts: a secured
indebtedness with an adjusted issue price equal to the value of the
property, and an unsecured indebtedness with an adjusted issue price
equal to the remainder. Absent strong evidence to the contrary, the
value of the property securing the indebtedness is presumed to be equal
to the issue price of any new secured indebtedness received for the
indebtedness plus the value of any other consideration (except stock or
new unsecured indebtedness) received for the indebtedness. A valuation
of that property by a court in a title 11 case is a factor in
determining value, but is not controlling.
(ii) Example. The following example illustrates these provisions:
Example. Corporation X owes an indebtedness with an adjusted
issue price of $100,000. The indebtedness is secured by certain
property owned by Corporation X. Corporation X exchanges the
indebtedness for $10,000 of stock and new secured indebtedness with
an issue price of $70,000. Under paragraph (d)(6)(i) of this
section, the indebtedness is bifurcated into a secured indebtedness
of $70,000 (the issue price of the new secured indebtedness received
in exchange therefor) and an unsecured indebtedness of $30,000 (the
remainder of the adjusted issue price of the indebtedness).
(e) Effective date. This section is effective with respect to any
issuance of stock for indebtedness on or before December 31, 1994, or
any issuance of stock for indebtedness in a title 11 or similar case
(as defined in section 368(a)(3)(A) of the Internal Revenue Code) that
was filed on or before December 31, 1993--
(1) Pursuant to a plan confirmed by the court in a title 11 case
after May 17, 1994; or
(2) If there is no title 11 case, pursuant to an insolvency workout
in which all issuances of stock for indebtedness occur after May 17,
1994.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: February 10, 1994.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 94-6087 Filed 3-18-94; 8:45 am]
BILLING CODE 4830-01-U
