In conclusion, the rules governing the issue price of a debt instrument not issued for money often turn on whether the instrument, or the property for which it is issued, is traded on an established market. If such trading
exists, the issue price is the FMV of the instrument. This term is not defined but is assumed to equal the values found on the established market on which the debt, or the property, is traded. This leads to anomalous results,
and so Treasury and the IRS might consider providing guidance on the meaning of FMV, to ensure that a taxpayer has access to the necessary information, within a reasonable time frame around the issuance of its debt.
b. Underwriting rule. The issue price of a debt instrument issued for money is generally the first price at which a substantial amount of the instrument is sold. However, sales to bond houses, brokers, or similar persons or organizations acting in the capacity of underwriters, placement agents, or wholesales are ignored. When these intermediaries are involved in the distribution of the debt instrument, the issue price depends on the first price at which they resold the instrument (the underwriting rule).
In this context, underwriters generally act either as principals in ‘‘firm-commitment’’ under-writings, or as agents in ‘‘best efforts’’ under-writings.
When an underwriter acts as principal, it buys securities from an issuer and resells them in the open market, earning a profit (or risking a loss) equal to the difference between the prices at which it bought the securities from the issuer and resold them to investors (‘‘firm commitment’’ underwriting). In contrast, when an underwriter acts as agent for the issuer, it earns a fee for securities that it sells, but is not obligated to pay for any securities that are not sold (‘‘best efforts’’ underwriting).
Regulations in other contexts reflect this understanding of the underwriting function. For example, reg. section 1.351-1(a)(3) defines a ‘‘qualified underwriting transaction’’ for purposes of section 351 as ‘‘a transaction
in which a corporation issues stock for cash in an underwriting in which either the underwriter is an agent of the corporation or the underwriter’s ownership of the stock is transitory.’’ This definition reflects both types of underwriting functions. Reg. section 1.721-1(c) provides a rule similar to reg. section 1.351-1(a)(3) in the context of partnership interests. The preamble to the notice of proposed rulemaking that introduced the partnership rules states that the treatment of underwriters for those purposes is intended to be similar to their treatment under the underwriting rule of reg. section 1.1273-2(e). It therefore appears that Treasury understands the underwriting rule to encompass both principal and agent types of underwriting
The underwriting rule appears to have been written so that the issue price of a debt instrument is calculated irrespective of the commissions charged by an underwriter for its services in placing the instrument; the tax
law is trying to find the ‘‘retail’’ rather than the ‘‘wholesale’’ price for an instrument. The government may also have been concerned that, without the underwriting rule, an issuer could collude with its underwriters to manipulate the issue price of an instrument.
In the case of a borrowing under a financing commitment, it is unclear how, and whether, the underwriting rule would apply. Such a transaction resembles a bank loan, in which the lender advances money to the borrower, and the borrower agrees to repay the lender. However, parties often enter into transactions under financing commitments expecting the lender to quickly resell the newly issued debt securities rather than keep
the instruments on its own books, or they may structure the terms to include a ‘‘discount’’ or other fee intended to serve as the lender’s compensation (rather than expecting the interest payable on the debt to serve as the lender’s main compensation). Some commentators have argued that these facts are consistent with viewing the lender’s role in such a transaction as that of an underwriter, placement agent, or wholesaler. The analysis can be further complicated if the lender enters into the transaction with the intention to immediately resell the debt, but has difficulty doing so. Neither the underwriting rule itself nor the policies that appear to justify it provide guidance in this case.
Even when the underwriting rule applies in theory, it can be difficult or impossible to apply it in practice. This is particularly true when, in a firm-commitment underwriting, the underwriter refuses to tell the issuer what
price the debt instruments ultimately sold for. Without access to this information, an issuer simply cannot know what the issue price for its instrument is.
If the underwriting rule does not (or, for practical reasons, cannot) apply, the parties are left with the daunting task of characterizing the various fees and charges that constitute what may otherwise have been the lender’s underwriting discount. For a debt instrument that is issued for money and that is not publicly offered, a cash payment from the borrower to the lender will generally reduce the issue price. However, payments for property or for services provided by the lender such as commitment fees or loan processing costs, do not reduce the issue price, but are generally deductible as debt issuance cost.