Intercompany Obligations

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [REG-105964-98] RIN 1545-AW30

TITLE: Intercompany Obligations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains a proposed regulation that clarifies
the treatment of the transfer or extinguishment of rights under an
intercompany obligation. The existing regulation has caused
uncertainty concerning the tax treatment of such transactions. The
proposed regulation affects corporations that are members of
consolidated groups, their subsidiaries, and their shareholders.

DATES: Comments and requests for a public hearing must be received
by March 22, 1999.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-105964-98), room
5228, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday
through Friday between the hours of 8 a.m. and 5 p.m. to
CC:DOM:CORP:R (REG-105964-98), Courier's Desk, Internal Revenue
Service, 1111 Constitution Avenue, NW., Washington, DC.
Alternatively, taxpayers may submit comments electronically via the
Internet by selecting the "Tax Regs" option on the IRS Home Page, or
by submitting comments directly to the IRS Internet site at
http://www.irs.ustreas.gov/prod/tax_regs/comments.html.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulation,
Theresa A. Abell, (202) 622-7790; concerning submissions of
comments, LaNita Van Dyke, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed amendments to �1.1502-13(g) of the
Income Tax Regulations. Section 1.1502-13(g) prescribes rules
relating to the treatment of the transfer or extinguishment of
rights under an intercompany obligation. An intercompany obligation
is generally defined as an obligation between members of a
consolidated group, but only for the period during which both
parties are members of the group. The current regulation provides
that if a member of a consolidated group realizes an amount (other
than zero) of income, gain, deduction, or loss upon the transfer or
extinguishment of all or part of its remaining rights or obligations
under an intercompany obligation, the obligation is treated as
satisfied (and the transferor's basis in the property received is
adjusted to reflect the satisfaction amount) and, if the obligation
remains outstanding, it is treated as reissued as a new obligation.

The current regulation is, however, ambiguous regarding the form of
the recast transaction, i.e., the deemed transaction that
encompasses the satisfaction, reissuance, and actual transaction.
Under one interpretation of the regulation, there is a potential
that the form of the recast jeopardizes the tax-free treatment of
common corporate restructuring transactions. While it is not clear
the regulation produces such consequences, the IRS and Treasury
believe that any such consequences would be inappropriate and
unnecessary to achieve the objectives of the regulation.

Accordingly, the IRS and Treasury propose to amend the regulation as
described below.

Explanation of Provisions

The existing regulation does not apply to transactions in which the
amount of income, gain, deduction, or loss realized is zero. This
rule was intended to avoid application of the regulation to
transactions in which preservation of gain or loss location, an
objective of �1.1502-13(g), would not be at issue. However, the
determination of whether the amount of income, gain, deduction, or
loss realized is zero might depend on the fair market value of
property received in an exchange. The difficulty and manipulability
of that valuation is a reason for the enactment of certain
provisions of the original issue discount (OID) rules, particularly
section 1274. To the extent that taxpayers were able to avoid the
deemed satisfaction and reissuance rule by inaccurately maintaining
that the amount of income, gain, deduction, or loss realized is
zero, taxpayers could avoid those OID rules and could
inappropriately shift gain or loss among members. The IRS and
Treasury have concluded that the better and more administrable
approach is not to condition the application of the regulation on a
realization of some amount of income, gain, deduction, or loss other
than zero.

Accordingly, the regulation as proposed will apply to all
transactions in which any amount is realized due to the transfer or
extinguishment of rights in an intercompany obligation.

The IRS and Treasury believe the exception from the operation of
this provision for transactions that will not have a significant
effect on any person's Federal income tax liability for any year is
unclear in its application and scope. Further, the exception offers
little, if any, relief from the requirements of the provision.
Accordingly, the exception is eliminated from the regulation.

The proposed regulation clarifies the form and timing of the recast
applied to transactions subject to the regulation. In particular, it
clarifies that the deemed satisfaction proceeds (rather than the
obligation) are treated as transferred by the initial creditor in
the actual transaction and then advanced by the transferee to the
debtor in the deemed reissuance of the obligation. The proposed
regulation includes an example to illustrate clearly the mechanics
of the proposed regulation. It also includes certain conforming
adjustments.

The proposed regulation retains the rule that the deemed
satisfaction and reissuance amounts are determined under the
principles of the OID provisions if the debt is transferred for
property. The IRS and Treasury recognize that an alternate rule
providing for a fair market value determination of the deemed
satisfaction and reissuance amounts might (in theory) more
accurately preserve location of economic gain or loss. In such an
alternate regime, however, the inherent difficulty of valuing
intercompany obligations would prove burdensome to both taxpayers
and the IRS and may provide significant potential for abuse when
member obligations are transferred.

Certain provisions of the OID rules are intended to address the
difficulty and manipulability of this valuation. Other developments
in the tax law have recognized that issue price, as determined under
the OID rules, is the surrogate for fair market value in the case of
a debt obligation. For example, �1.1001-1(g) provides that issue
price is used in determining the amount realized from the receipt of
a debt instrument.

For these reasons, and consistent with the objective of promoting
single entity treatment of the group, the IRS and Treasury continue
to believe that the use of the OID provisions is appropriate and
desirable in determining the deemed satisfaction amount and the
amount for which the obligation is deemed reissued. Accordingly, the
regulation as proposed continues to use the OID provisions to
determine both the amount repaid in the deemed satisfaction and the
issue price of the reissued obligation in cases involving the
exchange of an intercompany obligation for cash or property.

In addition, the proposed regulation clarifies that the term
"conversion" includes only conversions pursuant to the terms of the
instrument.

Proposed Effective Date

The regulation is proposed to be effective on the date that the
final regulation is published in the Federal Register. For purposes
of determining the tax treatment of transactions undertaken prior to
such effective date, taxpayers may rely on the form and timing of
the recast transaction, as clarified by these proposed regulations.
No inference is intended, however, as to the correct interpretation
of the existing regulation.

Special Analyses

It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866.
Therefore, a regulatory assessment is not required. It is hereby
certified that these regulations will not have a significant impact
on a substantial number of small entities. This certification is
based on the fact that these regulations principally affect
corporations filing consolidated Federal income tax returns.
Available data indicates that many consolidated return filers are
large companies (not small businesses). Therefore, a Regulatory
Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C.
chapter 6) is not required.

Pursuant to section 7805(f) of the Internal Revenue Code, this
notice of proposed rulemaking will be submitted to the Chief Counsel
for Advocacy of the Small Business Administration for comment on its
impact on small business.

Comments and Requests for a Public Hearing

Before this proposed regulation is adopted as a final regulation,
consideration will be given to any written comments (preferably a
signed original and eight copies) that are timely submitted to the
IRS. All comments will be available for public inspection and
copying. A public hearing may be scheduled if requested in writing
by any person that timely submits written comments. If a public
hearing is scheduled, notice of the date, time, and place of the
hearing will be published in the Federal Register.

Drafting Information

The principal author of this regulation is Theresa A. Abell of the
Office of Assistant Chief Counsel (Corporate), IRS. However, other
personnel from the IRS and Treasury Department participated in its
development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations Accordingly, 26 CFR part 1 is
proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in
part as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.1502-13 also issued under 26 U.S.C. 1502.

Par. 2. Section 1.1502-13 is amended by:

1. Revising paragraphs (g)(3)(i)(A), (g)(3)(i)(B)(3), (g)(3)(ii)(A),
and (g)(3)(iii), and removing paragraph (g)(3)(i)(B)(4).

2. Revising paragraph (g)(4)(i)(B).

3. Amending paragraph (g)(5) by:

a. Removing the language "Example 2" in each place it appears in
paragraphs (d), (e) and (f) of Example 2 and adding "Example 3" in
its place.

b. Removing the language "Example 3" in each place it appears in
paragraphs (c) and (d) of Example 3 and adding "Example 4" in its
place.

c. Removing the language "Example 5" in each place it appears in
paragraph (c) of Example 5 and adding "Example 6" in its place.

d. Redesignating Examples 2, 3, 4 and 5 as Examples 3, 4, 5 and 6
and adding a new Example 2.

The revisions and additions read as follows:

� 1.1502-13 Intercompany transactions.

* * * * *

(g) * * *

(3) Deemed satisfaction and reissuance of intercompany
obligations-(i) Application-(A) In general. If a member realizes an
amount from the assignment or extinguishment of all or part of its
remaining rights or obligations under an intercompany obligation,
the intercompany obligation is treated for all Federal income tax
purposes as satisfied under paragraph (g)(3)(ii) of this section
and, if it remains outstanding (either as an intercompany obligation
or a nonintercompany obligation), reissued under paragraph (g)(3)
(iii) of this section. Similar principles apply under this paragraph
(g)(3) if a member realizes an amount, directly or indirectly, from
a comparable transaction (for example, a marking-to-market of an
obligation or a bad debt deduction), or if an intercompany
obligation becomes an obligation that is not an intercompany
obligation.

(B) * * *

(3) The amount realized is from the conversion of an obligation
(under the terms of the instrument) into stock of the obligor.

(ii) Satisfaction-(A) General rule. If a creditor member sells an
intercompany debt for cash, the debt is treated as satisfied by the
debtor immediately before the sale for an amount equal to the amount
of the cash. If the debt is transferred for property, the debt is
treated as satisfied immediately before the transaction for an
amount equal to the issue price (determined under section 1273 or
section 1274) of a new debt issued on the date of the transaction,
with identical terms, for such property. If this paragraph (g)(3)
applies because the debtor or creditor becomes a nonmember, the debt
is treated as satisfied for cash in an amount equal to its fair
market value immediately before the debtor or creditor becomes a
nonmember. If the debt is transferred for cash or property, the
proceeds of the deemed satisfaction are treated as transferred by
the creditor to the transferee of the debt in exchange for the cash
or property. Similar principles apply to other transactions and to
transactions involving intercompany obligations other than debt. For
example, if a corporation assumes the debtor's liability in exchange
for property of the debtor, the debt is treated as satisfied for an
amount equal to the issue price (determined under section 1273 or
section 1274) of a new debt issued on the date of the transaction,
with identical terms, for such property. If, in a transaction to
which this paragraph (g)(3) applies, the obligation is extinguished,
including in a transaction in which the creditor and debtor become
the same entity, the obligation is treated as satisfied for an
amount equal to the issue price (determined under section 1273 or
section 1274) of a new debt issued on the date of the transaction,
with identical terms, to a third party, for property that is not
publicly traded.

* * * * *

(iii) Reissuance. If an intercompany debt is transferred for cash or
property, it is treated as a new debt (with a new holding period but
otherwise identical terms) issued to the transferee in exchange for
the proceeds of the deemed satisfaction as determined under
paragraph (g)(3)(ii) of this section. If this paragraph (g)(3)
applies because the debtor or creditor becomes a nonmember, the debt
is treated as a new debt (with a new holding period but otherwise
identical terms) issued to the creditor for the deemed satisfaction
proceeds. Similar principles apply to other transactions and to
transactions involving intercompany obligations other than debt.

* * * * *

(4) * * *

(i) * * *

(B) Exception. This paragraph (g)(4) does not apply to an obligation
if the obligation becomes an intercompany obligation by reason of an
event described in �1.108-2(e) (exceptions to the application of
section 108(e)(4)).

* * * * *

(5) Examples.

* * * * *

Example 2. Nonrecognition transactions. (a) Facts. On January 1 of
Year 1, B borrows $100 from S in return for B's note providing for
$10 of interest annually at the end of each year, and repayment of
$100 at the end of Year 5. B fully performs its obligations with the
same tax consequences as described in paragraph (a) of Example 1. At
the end of Year 3, S transfers the note to a newly formed
subsidiary, Newco, in exchange for Newco stock. Section 351 applies
to the exchange. The interest is adequate stated interest within the
meaning of section 1274(c)(2) (determined on the date of the
transfer). Neither B's note nor Newco's stock is publicly traded.

(b) Deemed satisfaction and reissuance of note. Under paragraph (g)
(3)(ii) of this section, B's note is treated as satisfied for $100
(the issue price of the reissued note, determined under section
1273(b)(4)) immediately before S's transfer of the note to Newco.
Zero gain or loss is recognized by S and B on the deemed
satisfaction of B's note. S is then treated as transferring the
deemed proceeds of the satisfaction of the note ($100) to Newco in
exchange for the Newco stock. S's basis in the Newco stock is $100.
Under paragraph (g)(3)(iii) of this section, B is treated as
reissuing the note to Newco for $100. Newco's basis in B's note is
$100.

(c) Intercompany obligation transferred in section 332 transaction.
The facts are the same as in paragraph (a) of this Example 2, except
that S transfers the note to P in a complete liquidation under
section 332. Under paragraph (g)(3)(ii) of this section, B's note is
treated as satisfied for $100 (the issue price of the reissued note,
determined under section 1273(b)(4)) immediately before S's transfer
of the note to P. Zero gain or loss is recognized by S and B on the
deemed satisfaction of the note. S is then treated.as transferring
the deemed proceeds of the satisfaction of the note, with its other
assets, to P in complete liquidation. Under paragraph (g)(3)(iii) of
this section, B is treated as reissuing the note to P for $100. P's
basis in the note is $100.

* * * * *

Deputy Commissioner of Internal Revenue
Robert E. Wenzel

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