D. Illustrative Example
A corporation (Borrower) enters into a binding financing commitment (Commitment) with an unrelated financial institution (Lender) in 2007. Under the terms of the Commitment, Lender agrees to provide $1 billion to
Borrower in early 2008, and in exchange, Borrower agrees to issue debt instruments at an interest rate and terms agreed to in the Commitment. Lender intends to resell the debt instruments to investors either before or soon after they are issued. The parties close the transaction on January 15, 2008. Lender provides $1 billion net cash to Borrower, and Borrower issues debt instruments to Lender with the following features: Maturity Date: January 15, 2015;
Principal Amount: $1.05 billion, reflecting the cash
proceeds of $1 billion and fees to Lender of $50 million. Of the $50 million in fees, $23 million reflects commitment fees, $1 million is for loan processing costs reimbursed to Lender, and there are $26 million of other fees; Interest Rate: 6 percent per year, payable semiannually. Lender placed Borrower’s debt instruments with investors unrelated to Borrower (Investors) soon after issuance for $1.02 billion.
On December 15, 2008, Borrower and the subsequent holders amend the terms of the debt instrument. Investors agree to relax certain covenants in exchange for: (1) an increase in the stated interest rate to 7 percent per
year; (2) Borrower’s prepayment of $100 million in principal; and (3) an additional cash payment from Borrower of $10 million. On the date of the amendment, the debt instruments appear on a computerized quotation medium available to subscribing brokers at an average quote of 80 percent of outstanding principal.
II. Operation of AHYDO Rules
A. Original Issue Discount
The AHYDO rules deny an issuer deductions for some or all of the OID on applicable debt obligations. OID is the difference between a debt instrument’s stated redemption price at maturity (SRPM) and issue price.29 The SRPM is the sum of all payments that are not payments of qualified stated interest (QSI).30 The issue price is determined in different ways, depending on various circumstances under which the loan was made, such as: (1) whether the obligation was issued for money or property, (2) whether the property it was issued for was publicly traded, or (3) whether the obligation itself was publicly traded.31 While the issuer can control the payment schedule and SRPM of a debt instrument, the issue price may never be under the issuer’s control, or can slip beyond the issuer’s control after issuance, as will be discussed below
Issue price. Of the many possible routes a taxpayer
may have to travel to determine the issue price of its debt,
three are of particular interest for us here:
- The issue price of debt instruments that are part
of an issuance issued for money is the first price at
which a substantial amount of the instruments in
the same issue is sold for money, disregarding
sales to certain persons acting as underwriters,
placement agents, or wholesalers. - The issue price of debt instruments that are part
of an issuance not issued for money but issued for
property in which a substantial amount of the issuance
is traded on an established market is the fair market
value of the instruments on the issue date. - If a debt instrument issuance does not fall within
(1) or (2), and a substantial amount of the issuance is
for property that is traded on an established market, then
the issue price of the instruments equals the FMV of
that property on the issue date
If the issue price of a debt instrument cannot be found
under the above rules, other rules govern, which are not
directly relevant here.
a. Established market and fair market value. Property (including a debt instrument) is considered traded on an established market (as the term is used in (2) and (3) above) in several circumstances, but most importantly if at any time during the 60-day period ending 30 days after the issue date, the property:
• appears on a ‘‘quotation medium’’; or
• is a debt instrument for which price quotes are readily available from dealers, brokers, or traders (subject to certain safe harbor exceptions)
Property appears on a ‘‘quotation medium’’ if it appears on a system of general circulation (including a computer listing disseminated to subscribing brokers, dealers, or traders) that provides a reasonable basis to determine FMV by disseminating either (a) recent price quotations of one or more identified brokers, dealers, or traders; or (b) actual prices of recent sales transactions.