2. Transfer of debt instruments to FASIT
In general, when an asset is transferred to a FASIT by the holder of the ownership interest, the holder will be required to recognize gain but not loss equal to the difference between the value of the asset as determined under the FASIT rules and its adjusted basis to the holder prior to contribution. The value of the property transferred to a FASIT will be its fair market value. Where a debt instrument that is not traded on an established securities market is transferred to a FASIT by the holder of the ownership interest a special valuation rule exists. In such an instance, the value of the property transferred to the FASIT will equal the sum of the present values of the reasonably expected payments under such instrument (determined in a manner to be provided by Treasury Regulations) using a discount rate equal to 120 per cent of the applicable Federal rate. The legislative history of the FASIT provisions indicates that expected losses, prepayments, and reasonable cost of servicing are to be taken into account for these purposes. The legislative history further indicates that the value of property calculated under the special FASIT rule may be different than the value of such assets under a willing buyer/seller standard.
If property held by the holder of the ownership interest in a FASIT (or held by a related party) supports any regular interest in such FASIT, gain will be recognized to such holder in the same manner as if the holder had sold such property at its values at the time that such property was deemed to support such interest.
3. Taxation of holder of ownership interest (the Owner)
a. Upon transfer of assets to the FASIT
The value of property transferred to the FASIT by the Owner equals the sum of the present values of the reasonably expected payments under such instrument using a discount rate equal to 120 per cent of the applicable Federal rate.
In Scenario 1, since Corporation A will hold the ownership interest in the FASIT, when it transfers the debt instruments to the FASIT, it will be required to recognize gain, calculated by determining the value of such assets under the FASIT rules. Since the debt instruments are capital assets, Corporation A will have a capital gain as a result of the transfer of these assets to the FASIT. The FASIT valuation rule results in the generation of capital gain for the owner upon contribution even if the owner has basis in the debt instruments identical to their market value.
b. On a going forward basis
In general, the holder of the ownership interest of a FASIT is required to treat all assets, liabilities, and items of income, gain, deduction, loss, and credit of the FASIT as if it were generated directly by the holder. In calculating the net income of the FASIT, the Owner must report income with respect to each debt instrument in the FASIT according to the constant yield method, for purposes of determining all interest, acquisition discount, original issues discount (hereinafter: OID), and market discount and all premium deductions or adjustments. Interest income that is accrued by the FASIT, which is exempt from tax, shall be taken into account by the Owner as ordinary income. Income, gain, or deduction allocable to a prohibited transaction are not taken into account by the Owner; rather, the item are taxed at the FASIT entity level and paid by the Owner.