4. IRC Section 860J (a)
Section 860J(a) provides that the taxable income of an Owner or the holder of a high yield interest, cannot be less than the sum of such holder’s taxable income determined solely with respect to such interests (including gains and losses from sales and exchanges of such interests), and the excess inclusion (if any) under IRC S860E(a)(1) for such taxable year. The effect of this provision is to prohibit the holder of an ownership interest from using income from the FASIT to offset any deductions or net operating losses not attributable to the FASIT.
The issue has been raised as to whether gains that are recognized by an owner upon a sale or contribution of assets to a FASIT, can be offset with the owner’s capital losses. The New York State Bar Association Tax Section’s report on suggested FASIT regulations, suggests that the gains that are recognized on an asset transferred in exchanged for the receipt of such interest (or to increase the value of an existing interest), is not an amount that is recognized “with respect to” the ownership or high yield interest, and this, the loss limitation rule should not apply. They suggest that the Treasury issue regulations that clarify that gains recognized by an owner or holder of a high yield interest on a transfer of assets to a FASIT can be offset by the transferor’s capital losses.
In Scenario 1, if the debt instruments are capital assets in the hands of Corporation A, then the transfer of the debt instruments to the FASIT should generate capital gain income to the extent that the value, as determined under the FASIT rules for non-traded debt instruments, exceeds Corporation A’s basis in such assets.
Therefore, utilizing its own debt instruments, Corporation A should be able to generate capital gain to offset its expiring capital losses. Corporation A would also preserve tax benefit for the future by creating a high basis in its FASIT interests that would offset future FASIT income.
B. Scenario 2 Corporation A Acquires debt instruments from Bank, retains ownership interest, and sells regular interests
Lacking its own debt instruments, Corporation A must acquire such debt instruments from a financial institution. A will retain the ownership interest and will sell the regular interests back to Bank.
- Purchase of debt instruments
Corporation A purchases “permitted debt instruments” from Bank in order to participate in the instant transaction. Bank recognizes income on the difference between its tax basis in the financial assets and the purchase price. No further tax consequences result to the seller (Bank) on the receipt of payments on the financial assets. Corporation A owns the debt instruments and then contributes the debt instruments to a newly created FASIT.
2. Mechanics of FASIT ownership
a. Classes of interests
Interests issued by a FASIT must be either regular interests or the ownership interest. The ownership interest and regular interests are the interests designated as such and issued after the first day of the FASIT’s taxable year.