Bond exchange produces issuance premium and current repurchase deductions with one integrated-tranche exception

Plain-English summary

A public parent corporation issued seven new bond tranches in exchange for bonds previously issued by a consolidated subsidiary. Because the new bonds traded on an established market, their issue prices were their fair market values. The IRS ruled that any excess of issue price over stated principal was bond issuance premium that the parent must amortize against interest deductions. For six old tranches, the subsidiary could deduct any repurchase premium arising from the deemed satisfaction when the bonds became intercompany obligations. The seventh old tranche had been integrated with interest rate swaps, so its deemed satisfaction instead triggered the special legging-out rules and recognition on a deemed repurchase of the synthetic debt instrument.

Ruling snapshot

• Question: How should the consolidated group account for bond issuance premium and repurchase premium from the debt exchange?
• Outcome: mixed, issuance premium is amortized, most repurchase premium is currently deductible, and the integrated tranche follows legging-out treatment
• Key authorities: IRC § 163; Treas. Reg. §§ 1.163-7, 1.163-13, 1.1273-2, 1.1275-6, and 1.1502-13(g)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201707006 Third Party Communication: None
Release Date: 2/17/2017 Date of Communication: Not Applicable
Index Number: 163.17-00, 1502.13-02
Person To Contact:
---------------------------------------------- -----------------, ID No. -----------------
-------------------------------- Telephone Number:
----------------------------- (202) 317-4945
---------------------------------------------------- Refer Reply To:
CC:FIP:B03
PLR-116052-16
Date:
November 10, 2016

                                                LEGEND

Parent = ------------------------------------------------------------------------
Sub1 = --------------------------------------------------
Sub2 = ---------------------------------------------------------
State1 = -------------------
State2 = -------------
Old Bond 1 = --------------------------------------------------------------
Old Bond 2 = --------------------------------------------------------------
Old Bond 3 = ----------------------------------------------------------
Old Bond 4 = -------------------------------------------------------
Old Bond 5 = --------------------------------------------------------------
Old Bond 6 = -----------------------------------------------------------
Old Bond 7 = ------------------------------------------------------------
New Bond 1 = ------------------------------------------------------------
New Bond 2 = -------------------------------------------------------------
New Bond 3 = ----------------------------------------------------------
New Bond 4 = ------------------------------------------------------
New Bond 5 = ---------------------------------------------------------
New Bond 6 = -----------------------------------------------------------
New Bond 7 = -----------------------------------------------------------
Date 1 = ------------------
a% = ----------
b% = --------
c% = ----------
d% = ----------
e% = ----------
f% = ----------
g% = ----------
PLR-116052-16 2

Dear ------------------:

  This letter responds to your letter of May 12, 2016, and subsequent

correspondence requesting the following rulings:

   (1) Parent must account for any bond issuance premium arising from the

issuance of its bonds in exchange for certain tendered bonds of which Sub2 was the
obligor in accordance with section 1.163-13 of the Income Tax Regulations; and

    (2) Sub2 is entitled to a deduction, pursuant to section 1.163-7(c), for any

repurchase premium realized upon the deemed satisfaction of certain tendered bonds,
in the taxable year in which the deemed satisfaction occurred.

                                       FACTS

   Parent is a publicly traded corporation organized under the laws of State1. Sub1,

a State2 corporation, is a wholly owned subsidiary of Parent. Sub2, a State1
corporation, is a wholly owned subsidiary of Sub1. Parent, Sub1, and Sub2 are
members of an affiliated group of corporations, which files a consolidated federal
income tax return. Parent is the common parent of the affiliated group.

    Sub2 was the obligor of seven tranches of fixed-rate, senior, unsecured bonds:

Old Bond 1, Old Bond 2, Old Bond 3, Old Bond 4, Old Bond 5, Old Bond 6, and Old
Bond 7 (“Old Tranches”). The bonds in Old Bond 7 had been integrated previously with
three interest rate swaps under § 1.1275-6. Parent and Sub2 represent that Old Bond 7
and the swaps constituted a qualifying debt instrument within the meaning of section
1.1275-6(b)(1) and section 1.1275-6 hedges within the meaning of section
1.1275-6(b)(2), respectively. They further represent that the requirements of section
1.1275-6(c)(1)(i) – (vii) were satisfied in a timely manner. On Date 1, Parent issued
bonds in seven corresponding tranches: New Bond 1, New Bond 2, New Bond 3, New
Bond 4, New Bond 5, New Bond 6, and New Bond 7 (“New Tranches”), none of which
belongs to an issue for which a substantial amount of the bonds was issued for money
within the meaning of section 1.1273-2(a)(1).

    Parent offered to exchange a newly issued bond from New Bond 1 and a consent

fee for each bond tendered from Old Bond 1. Parent made similar offers with respect to
New Bond 2 and Old Bond 2, with respect to New Bond 3 and Old Bond 3, with respect
to New Bond 4 and Old Bond 4, with respect to New Bond 5 and Old Bond 5, with
respect to New Bond 6 and Old Bond 6, and with respect to New Bond 7 and Old
Bond 7. These seven offers will be referred to collectively as the “Tender Offer”.
PLR-116052-16 3

   Pursuant to the Tender Offer, holders tendered a% of the bonds in Old Bond 1,

b% of the bonds in Old Bond 2, c% of the bonds in Old Bond 3, d% of the bonds in Old
Bond 4, e% of the bonds in Old Bond 5, f% of the bonds in Old Bond 6, and g% of the
bonds in Old Bond 7. On Date 1, Parent exchanged newly issued bonds from the New
Tranches and consent fees for the tendered bonds (collectively, the “Exchange”).

   Parent and Sub2 represent that the tendered bonds were not intercompany

obligations, within the meaning of section 1.1502-13(g)(2)(ii), before the Exchange.

    The aggregate stated principal amount of each of the seven New Tranches of

bonds issued by Parent (i.e., New Bond 1, New Bond 2, New Bond 3, New Bond 4, New
Bond 5, New Bond 6, and New Bond 7) was equal to the aggregate stated principal
amount of the bonds tendered from the seven corresponding Old Tranches of bonds
(i.e., Old Bond 1, Old Bond 2, Old Bond 3, Old Bond 4, Old Bond 5, Old Bond 6, and
Old Bond 7).

    Parent represents that the newly issued bonds in each of the New Tranches

were traded on an established market within the meaning of section 1.1273-2(f). Parent
further represents that the newly issued bonds in each of the New Tranches provided
for stated interest, which met the definition of qualified stated interest (“QSI”) in section
1.1273-1(c).

   Sub2 retired each of the tendered bonds from the Old Tranches in exchange for

an intercompany payable to Parent. Parent and Sub2 recorded the intercompany
receivable and intercompany payable in their respective books and records for an
amount equal to the aggregate stated principal amount of the tendered bonds. Sub2
did not issue notes to Parent or otherwise document the intercompany payable. The
recorded amount did not bear interest and was being paid over time by Sub2 to Parent
in cash. Sub2 remained the obligor on the bonds from the Old Tranches that were not
tendered.

                                Ruling request (1)

   Section 163(a) provides that there shall be allowed as a deduction all interest

paid or accrued within the taxable year on indebtedness.

   Subject to certain exceptions not relevant here, section 1.163-13 limits the

amount of the issuer’s interest deduction otherwise allowable under section 163(a) for
debt instruments issued with bond issuance premium. See section 1.163-13(a).
In general, an issuer determines its interest deductions by offsetting the interest
allocable to an accrual period with the bond issuance premium allocable to that period.
See section 1.163-13(a). Bond issuance premium is the excess, if any, of the issue
price of a debt instrument over its stated redemption price at maturity. See section
1.163-13(c)
PLR-116052-16 4

    Under section 1.163-13(d)(1), an issuer amortizes bond issuance premium by

offsetting the QSI allocable to an accrual period with the bond issuance premium
allocable to the accrual period. This offset occurs when the issuer takes the QSI into
account under its regular method of accounting. Section 1.163-13(d)(3) provides rules
to determine the amount of bond issuance premium allocable to an accrual period.
Section 1.163-13(d)(4) provides rules for the case that the bond issuance premium
allocable to an accrual period exceeds the QSI allocable to the accrual period.

   Section 1.1273-2(a)(1) provides that if a substantial amount of the debt

instruments in an issue is issued for money, the issue price of each debt instrument in
the issue is the first price at which a substantial amount of the debt instruments is sold
for money. Thus, if an issue consists of a single debt instrument that is issued for
money, the issue price of the debt instrument is the amount paid for the instrument.

    Section 1.1273-2(b)(1) provides that if a substantial amount of the debt

instruments in an issue is traded on an established market and the issue is not
described in section 1.1273-2(a)(1), the issue price of each debt instrument in the issue
is the fair market value of the debt instrument, determined as of the issue date.

   Section 1.1273-2(f) provides rules for determining whether property (including a

debt instrument described in section 1.1273-2(b)(1)) is traded on an established market.

  The stated redemption price at maturity of a debt instrument is the sum of all

payments provided by the debt instrument other than QSI payments. See section
1.1273-1(b).

  QSI generally is stated interest that is unconditionally payable in cash at least

annually at a single fixed rate. See section 1.1273-1(c)(1).

   Based on the representations and facts submitted, the newly issued bonds in

each of the New Tranches were separate issues. The bonds were traded on an
established market and were not issued for money. Accordingly, the issue price of each
newly issued bond was determined under section 1.1273-2(b)(1) and was equal to the
bond’s fair market value on Date 1. See section 1.1273-2(b)(1); section 1.1273-2(f).
Moreover, because the stated interest for each newly issued bond constituted QSI, the
stated redemption at maturity of each bond was its stated principal amount.

   For each newly issued bond in each of the New Tranches, the excess, if any, of

the bond’s issue price (its fair market value) over the bond’s stated redemption price at
maturity (its stated principal amount) constituted bond issuance premium, for which
Parent must account in accordance with section 1.163-13(d). Thus, the interest
deduction with respect to each newly issued bond must be determined by offsetting the
PLR-116052-16 5

QSI allocable to an accrual period with the bond issuance premium allocable to that
period.

                               Ruling request (2)

   Section 163(a) provides that there shall be allowed as a deduction all interest

paid or accrued within the taxable year on indebtedness.

   Section 1.163-7(c) provides, in part, that, except to the extent disallowed by any

other section of the Code (e.g., section 249) or section 1.163-7(c), if a debt instrument is
repurchased by the issuer for a price in excess of its adjusted issue price, the excess
(repurchase premium) is deductible as interest for the taxable year in which the
repurchase occurs. If the issuer repurchases a debt instrument in a debt-for-debt
exchange, the repurchase price is the issue price of the newly issued debt instrument
(reduced by any unstated interest within the meaning of section 483). However, if the
issue price of the newly issued debt instrument is determined under either section
1273(b)(4) or section 1274, any repurchase premium is not deductible in the year of the
repurchase, but is amortized over the term of the newly issued debt instrument in the
same manner as if it were original issue discount (“OID”).

   Section 1.1275-1(b)(1) provides that the adjusted issue price of a debt instrument

at the beginning of the first accrual period is the issue price. Thereafter, the adjusted
issue price of the debt instrument is the issue price of the debt instrument, increased by
the amount of OID previously includible in the gross income of any holder, and
decreased by the amount of any payment previously made on the debt instrument other
than a payment of QSI.

  Section 1.1502-13(g) provides rules for taking into account items of income, gain,

deduction, and loss of members of a consolidated group from intercompany obligations.

   Section 1.1502-13(g)(2)(i) defines a “debt of a member” as any obligation of the

member constituting indebtedness under general principles of Federal income tax law
(for example, under non-statutory authorities, or under section 108, section 163, or
section 1.1275-1(d)), but not an executory obligation to purchase or provide goods or
services.

  Section 1.1502-13(g)(2)(ii) defines an “intercompany obligation” as an obligation

between members, but only for the period during which both parties are members.

   Section 1.1502-13(g)(5) provides rules that apply if an obligation that is not an

intercompany obligation becomes an intercompany obligation.
PLR-116052-16 6

     Section 1.1502-13(g)(5)(ii)(A) provides that, if the intercompany obligation is debt

of a member, then the debt is treated for all Federal income tax purposes, immediately
after it becomes an intercompany obligation, as having been satisfied by the debtor for
cash in an amount determined under the principles of section 1.108-2(f), and then as
having been reissued as a new obligation (with a new holding period but otherwise
identical terms) for the same amount of cash. If the intercompany obligation is a
security of a member, similar principles apply (with appropriate adjustments) to treat the
security, immediately after it becomes an intercompany obligation, as satisfied and
reissued by the debtor for cash in an amount equal to its fair market value.

    Generally, under section 1.108-2(f)(i), except as otherwise provided in section

1.108-2(f), the amount of discharge of indebtedness income realized under section
1.108-2(a) is measured by reference to the adjusted basis of the related holder (or of
the holder that becomes related to the debtor) in the indebtedness on the acquisition
date if the holder acquired the indebtedness by purchase on or less than six months
before the acquisition date.

   Under section 1.1502-13(g)(5)(ii)(B), the deemed satisfaction and deemed

reissuance are treated as transactions separate and apart from the transaction in which
the debt becomes an intercompany obligation, and the tax consequences of the
transaction in which the debt becomes an intercompany obligation must be determined
before the deemed satisfaction and reissuance occurs.

    Section 1.1502-13(g)(6)(iii) provides that if an obligation to which section

1.1502-13(g)(5) applies is acquired in exchange for the issuance of an obligation to a
nonmember and the issue price of this newly issued obligation is not determined by
reference to its fair market value (for example, the issue price is determined under
section 1273(b)(4) or 1274(a) or any other provision of applicable law), then, under the
principles of section 1.163-7(c), any repurchase premium from the deemed satisfaction
of the intercompany obligation under section 1.1502-13(g)(5)(ii) will be amortized by the
debtor over the term of the obligation issued to the nonmember in the same manner as
if it were OID and the obligation to the nonmember had been issued directly by the
debtor.

    Section 1.1275-6(d)(2) sets forth rules for legging out of an integrated

transaction. Subject to certain exceptions not relevant here, section 1.1275-6(d)(2)(i)(A)
provides, in pertinent part, that if a taxpayer has integrated a qualifying debt instrument
and a section 1.1275-6 hedge under section 1.1275-6(c)(1), “legging out” means that
prior to maturity of the synthetic debt instrument, the taxpayer disposes of or otherwise
terminates all or a part of the qualifying debt instrument or the section 1.1275-6 hedge.

  If the issuer of a qualifying debt instrument that has been integrated with a

§ 1.1275-6 hedge legs out of the integrated transaction, for example, by repurchasing
the qualifying debt instrument, immediately before the issuer legs out, the issuer is
PLR-116052-16 7

treated as repurchasing or otherwise terminating the synthetic debt instrument for its fair
market value and, except as provided in section 1.1275-6(d)(2)(ii)(D), any income,
deduction, gain, or loss is realized and recognized at that time. See section
1.1275-6(d)(2)(ii)(B).

   The acquisition by Parent of the tendered bonds from the Old Tranches on

Date 1 caused the tendered bonds to become intercompany obligations. See section
1.1502-13(g)(2). Immediately after the tendered bonds became intercompany
obligations, the tendered bonds were deemed to be satisfied in cash for an amount
equal to Parent’s adjusted basis therein under the principles of section 1.108-2(f). See
section 1.1502-13(g)(5)(ii).

  The issue price of each newly issued bond from the New Tranches was

determined under section 1273(b)(3) and was equal to its respective fair market value.
See discussion under Ruling request (1), infra; section 1.1273-2(b)(1); section
1.1273-2(f).

   As a result of the deemed satisfaction of the tendered bonds from the Old

Tranches other than Old Bond 7, Sub2 realized repurchase premium to the extent of
any excess of Parent’s adjusted basis in each tendered bond over the respective bond’s
adjusted issue price.

   Because the issue price of each newly issued bond was not determined under

section 1273(b)(4) or section 1274, the special rule in section 1.1502-13(g)(6)(iii),
requiring repurchase premium to be amortized over the term of the bond as if it were
OID, does not apply. But cf. section 1.1502-13(g)(7), ex. 10 (iii). Accordingly, the
realized repurchase premium, if any, is deductible by Sub2, as interest under section
1.163-7(c) in determining the consolidated taxable income in the taxable year in which
the deemed satisfaction occurred.

   For the tendered bonds from Old Bond 7, the deemed satisfaction under section

1.1502-13(g)(5)(ii)(A) is a legging out under section 1.1275-6(d)(2), which causes a
deemed repurchase under section 1.1275-6(d)(2)(ii)(B). Any income or deduction
realized on the deemed repurchase is recognized in lieu of recognition of any income or
deduction on the deemed satisfaction.

                                      Caveats

    No opinion is expressed about the tax treatment of the transaction under other

provisions of the Code and regulations or about the tax treatment of conditions existing
at the time of, or effects resulting from, the transactions that are not specifically covered
by the above rulings. Specifically, no opinion is expressed as to whether the
intercompany payables constituted bone fide indebtedness. Further, no opinion is
expressed as to whether the retirement of each tendered bond in exchange for an
PLR-116052-16 8

intercompany payable constituted a triggering transaction within the meaning of section
1.1502-13(g)(3)(i)(A) or qualified for the exception, pertaining to the routine modification
of an intercompany obligation, within the meaning of section 1.1502-13(g)(3)(i)(B), (6).
Finally, no opinion is expressed as to whether each bond issued by Parent qualified as
publicly traded within meaning of sections 1.1273-2(b)(1) and 1.1273-2(f).

    This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)

of the Code provides that it may not be used or cited as precedent. Parent should
attach a copy of this ruling to each tax return to which it applies. In accordance with the
provisions of a power of attorney currently on file, we are sending copies of this ruling
letter to your authorized representatives.

                               Sincerely,



                               _______________________
                               Charles W. Culmer
                               Senior Technician Reviewer, Branch 3
                               Office of the Associate Chief Counsel
                               (Financial Institutions & Products)

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