[Federal Register Volume 59, Number 53 (Friday, March 18, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-6087]


[[Page Unknown]]

[Federal Register: March 18, 1994]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8532]
RIN 1545-AP19

 

Final Regulations Under Section 108 of the Internal Revenue Code; 
Discharge of Indebtedness

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains final regulations under section 
108(e)(8) of the Internal Revenue Code of 1986, which provides that the 
common law stock-for-debt exception to the realization of discharge of 
indebtedness income does not apply where stock issued for indebtedness 
is nominal or token or fails to satisfy a proportionality test. The 
final regulations are necessary to provide guidance in applying section 
108(e)(8). The regulations provide rules for determining whether stock 
issued for indebtedness is nominal or token under section 108(e)(8)(A) 
and rules for applying the proportionality test of section 
108(e)(8)(B).

EFFECTIVE DATE: Effective May 17, 1994.

FOR FURTHER INFORMATION CONTACT: Annette Ahlers (202) 622-7750 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document adds final regulations Sec. 1.108-1 under sections 
108(e)(8) (A) and (B) of the Internal Revenue Code (Code). Sections 
108(e)(8) (A) and (B) were added by section 2(a) of the Bankruptcy Tax 
Act of 1980 [Pub. L. 96-589, 94 Stat. 3389] and amended by section 
11325 of the Revenue Reconciliation Act of 1990 [Pub. L. 101-508, 104 
Stat. 1368]. On November 4, 1992, [57 FR 52601] the Service published 
these regulations in proposed form in a Notice of Proposed Rulemaking. 
Subsequent to the publication of the proposed regulations, section 
13226 of the Omnibus Budget Reconciliation Act of 1993 repealed the 
stock-for-debt exception. The amendments made by section 13226 of the 
Omnibus Budget Reconciliation Act of 1993 apply to stock transferred 
after December 31, 1994, in satisfaction of any indebtedness unless 
such transfer is in a title 11 or similar case (as defined in section 
368(a)(3)(A)) that was filed on or before December 31, 1993.
    The rules of the final regulations are effective with respect to 
any issuance of stock for indebtedness on or before December 31, 1994, 
or any issuance of stock for indebtedness in a title 11 or similar case 
(as defined in section 368(a)(3)(A) of the Code) that was filed on or 
before December 31, 1993, pursuant to: (1) A plan confirmed by the 
court in a title 11 case after May 17, 1994, or (2) if there is no 
title 11 case, an insolvency workout in which all issuances of stock 
for indebtedness occur after May 17, 1994. No inference is intended 
concerning the interpretation of sections 108(e)(8) (A) and (B) of the 
Code prior to the effective date of the regulations.
    These final regulations adopt the proposed regulations with a few 
minor changes in response to comments. As indicated in the preamble to 
the proposed regulations, the Service is also publishing Rev. Proc. 94-
26, I.R.B 1994-13, containing ruling guidelines for the nominal or 
token determination under section 108(e)(8)(A).
    One commentator suggested that the final regulations contain safe 
harbors or a list of specified factors for the nominal or token 
determination required by section 108(e)(8)(A) and that a revenue 
procedure be published for determining whether preferred stock meets 
the nominal or token requirement of section 108(e)(8)(A). Prior 
proposed regulations under section 108(e)(8) included factors that 
would be considered in determining whether stock was nominal or token. 
Commentators, with respect to those regulations, asserted that the list 
of factors was incomplete. The Service and Treasury agree that the 
determination of whether a stock issuance is nominal or token must be 
based on all the facts and circumstances, and that a list of specified 
factors would not fully address the relevant considerations in many 
cases. Rev. Proc. 94-26, I.R.B. 1994-13, provides one safe harbor on 
when common stock is not nominal or token. In the future, the Service 
and Treasury will consider issuing additional ruling guidelines as 
circumstances warrant.
    The commentator suggested that the final regulations provide that 
for purposes of computing both the common stock and preferred stock 
proportionality tests the definition of adjusted issue price should be 
modified to include accrued interest that the issuer of the debt 
instrument has not paid. The Service and Treasury agree with the 
recommendation. The final regulations clarify that for purposes of the 
proportionality tests of section 108(e)(8)(B), the denominator includes 
any indebtedness that is discharged in the title 11 case or workout, 
including accrued but unpaid stated interest.
    The commentator suggested that the final regulations provide that, 
for purposes of determining whether certain stock is preferred stock 
for purposes of the regulations, preferred stock that is convertible 
into common stock should be considered participating stock if the 
conversion right represents, in substance, a meaningful right to 
participate in corporate growth. This suggestion is adopted in the 
final regulations.
    In addition, the commentator suggested that a conversion right 
permitting a holder to receive common stock should always be treated as 
affording such holder a meaningful right to participate in corporate 
growth. The Service and Treasury have rejected this suggestion, because 
a conversion right does not necessarily afford the holder a meaningful 
right to participate in corporate growth. Whether a conversion right 
affords a meaningful right to participate in corporate growth must be 
determined on a case-by-case basis.
    The preamble to the proposed regulations requested comments on the 
treatment of contingent liabilities under section 108(e)(8). No 
comments, however, were received on this issue. Although the 
regulations contain no provision for the treatment of contingent 
liabilities, contingent liabilities may not be used to increase the 
denominator inappropriately for purposes of meeting the proportionality 
tests. For example, the mere assertion by a claimant that it is owed a 
specific amount does not by itself warrant inclusion of the asserted 
liability in the denominator for purposes of determining the group 
ratios.

Special Analyses

    It has been determined that this treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. It 
has also been determined that section 553(b) of the Administrative 
Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act 
(5 U.S.C. chapter 6) do not apply and, therefore, a Regulatory 
Flexibility Analysis is not required. Pursuant to section 7805(f) of 
the Internal Revenue Code, the notice of proposed rulemaking was 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Drafting Information

    The principal author of these final regulations is Annette M. 
Ahlers, Office of Assistant Chief Counsel (Corporate), Office of Chief 
Counsel, Internal Revenue Service. However, other personnel from the 
IRS and the Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * * Section 1.108-1 also issued 
under 26 U.S.C. 108(e)(8) and 108(e)(10)(B). * * *


    Par. 2. Section 1.108-1 is added to read as follows:


Sec. 1.108-1  Stock-for-debt exception not to apply in de minimis 
cases.

    (a) Overview. Section 108(e)(8) provides that the common law stock-
for-debt exception does not apply if stock issued for indebtedness is 
nominal or token or if a proportionality test is not met. Paragraph (b) 
of this section provides rules for the nominal or token determination 
under section 108(e)(8)(A). Paragraph (c) of this section provides 
rules for the proportionality test under section 108(e)(8)(B). 
Paragraph (d) of this section provides certain general rules and 
definitions. Paragraph (e) of this section provides an effective date.
    (b) Issuance of nominal or token stock. Under section 108(e)(8)(A), 
the common law stock-for-debt exception does not apply to indebtedness 
discharged for stock that is nominal or token. All relevant facts and 
circumstances must be considered in making this determination. If 
common and preferred stock are issued for indebtedness, the 
determination is made separately with respect to the common stock and 
the preferred stock. The determination of whether common stock issued 
for unsecured indebtedness is nominal or token is made on an aggregate 
basis with respect to all common stock issued for unsecured 
indebtedness in the title 11 case or insolvency workout. Preferred 
stock issued for unsecured indebtedness is also tested on an aggregate 
basis with respect to all preferred stock issued for unsecured 
indebtedness in the title 11 case or insolvency workout.
    (c) Issuance of a disproportionately small amount of stock for 
unsecured indebtedness--(1) Common stock issued for unsecured 
indebtedness--(i) In general. The common law stock-for-debt exception 
does not apply to an unsecured indebtedness discharged for common stock 
in a title 11 case or insolvency workout if the individual common stock 
ratio does not equal at least one-half of the group common stock ratio.
    (ii) Individual common stock ratio defined. The individual common 
stock ratio is the ratio of the value of the common stock issued for an 
unsecured indebtedness to the amount of the unsecured indebtedness 
allocated to that common stock. The amount of unsecured indebtedness 
allocated to the common stock is the amount of the indebtedness for 
which the common stock is issued (as defined in paragraph (d)(5) of 
this section), reduced by the amount of other consideration, if any, 
transferred in exchange for the indebtedness, including--
    (A) The amount of any money;
    (B) The issue price (determined under section 1273 or 1274) of any 
new indebtedness;
    (C) With respect to any preferred stock, the amount of indebtedness 
allocated to the preferred stock under paragraph (c)(2)(ii) of this 
section; and
    (D) The value of any other property, including any disqualified 
stock.
    (iii) Group common stock ratio defined. The group common stock 
ratio is the ratio of the aggregate value of all common stock issued 
for unsecured indebtedness in the title 11 case or insolvency workout 
to the aggregate amount of unsecured indebtedness allocated to that 
common stock. The amount of unsecured indebtedness allocated to the 
common stock is the aggregate amount of all unsecured indebtedness 
exchanged for stock or cancelled in the title 11 case or insolvency 
workout, reduced by the amount of other consideration, if any, issued 
for that indebtedness, including--
    (A) The amount of any money;
    (B) The issue price (determined under section 1273 or 1274) of any 
new indebtedness;
    (C) With respect to any preferred stock, the amount of indebtedness 
allocated to the preferred stock under paragraph (c)(2)(iii) of this 
section; and
    (D) The value of any other property, including any disqualified 
stock.
    (iv) Example. The following example illustrates these provisions.

    Example. (A) X Corporation has three outstanding debts, Debt 1, 
Debt 2, and Debt 3. Debts 1 and 2 are unsecured and each has an 
adjusted issue price of $100,000. Debt 3 is also unsecured, and it 
has an adjusted issue price of $90,000 and accrued but unpaid 
interest of $10,000. In a title 11 case, Debt 1 is exchanged for 
$50,000 cash and $20,000 of common stock, Debt 2 is exchanged for 
$10,000 cash, and Debt 3 is exchanged for $5,000 common stock. The 
individual common stock ratio for Debt 1 is 40 percent, which is 
determined by comparing the value of the common stock issued for the 
indebtedness ($20,000) to the amount of unsecured indebtedness 
allocated to that stock ($100,000 adjusted issue price less $50,000 
cash received). The individual common stock ratio for Debt 2 is 0 
percent because no stock is received in exchange for the 
indebtedness. The individual common stock ratio for Debt 3 is 5 
percent, which is determined by comparing the value of the common 
stock issued for the indebtedness ($5,000) to the amount of 
unsecured indebtedness allocated to that stock ($100,000=$90,000 
adjusted issue price and $10,000 of accrued but unpaid interest).
    (B) The group common stock ratio is 10.4 percent, which is 
determined by comparing the value of all of the common stock issued 
for unsecured indebtedness in the title 11 case ($25,000) to the 
amount of unsecured indebtedness allocated to the stock ($290,000 
aggregate adjusted issue price of all indebtedness exchanged for 
stock or cancelled in the title 11 case plus $10,000 accrued but 
unpaid interest less $60,000 cash received). Accordingly, section 
108(e)(8)(B) is satisfied only with respect to the common stock 
issued for Debt 1. The stock-for-debt exception does not apply to 
Debt 2 or Debt 3.


    (2) Preferred stock issued for unsecured indebtedness--(i) In 
general. The common law stock-for-debt exception does not apply to an 
unsecured indebtedness discharged for preferred stock in a title 11 
case or insolvency workout if the individual preferred stock ratio does 
not equal at least one-half of the group preferred stock ratio.
    (ii) Individual preferred stock ratio defined. The individual 
preferred stock ratio is the ratio of the value of the preferred stock 
issued for an unsecured indebtedness to the amount of the unsecured 
indebtedness allocated to the preferred stock. The amount of the 
unsecured indebtedness allocated to preferred stock is equal to the 
lesser of the lowest redemption price (if any) or lowest liquidation 
preference (if any) of the preferred stock (determined at issuance). 
However, the allocable indebtedness may not be less than the fair 
market value of the preferred stock or greater than the amount of the 
unsecured indebtedness.
    (iii) Group preferred stock ratio defined. The group preferred 
stock ratio is the ratio of the aggregate value of all preferred stock 
issued for unsecured indebtedness in the title 11 case or insolvency 
workout to the aggregate amount of unsecured indebtedness allocated to 
the preferred stock under paragraph (c)(2)(ii) of this section.
    (d) Definitions and special rules. For purposes of this section:
    (1) Common stock. Common stock is all stock other than disqualified 
stock and preferred stock.
    (2) Disqualified stock. Disqualified stock is disqualified stock as 
defined in section 108(e)(10)(B)(ii).
    (3) Liquidation preference. A liquidation preference exists if the 
stock's right to share in liquidation proceeds is limited and 
preferred.
    (4) Preferred stock. Preferred stock is any stock (other than 
disqualified stock) that has a limited or fixed redemption price or 
liquidation preference and does not upon issuance have a right to 
participate in corporate growth to a meaningful extent. Preferred stock 
that is convertible into common stock is not treated as preferred stock 
if the conversion right represents, in substance, a meaningful right to 
participate in corporate growth. Solely for purposes of this paragraph 
(d)(4), a right to participate in corporate growth is not established 
by the fact that the redemption price or liquidation preference exceeds 
the fair market value of the preferred stock.
    (5) Amount of indebtedness. Generally, the amount of indebtedness 
is the adjusted issue price of the indebtedness. Appropriate 
adjustments are made for accrued but unpaid stated interest. (See the 
example in paragraph (c)(1)(iv) of this section.)
    (6) Undersecured indebtedness--(i) General rule. If an indebtedness 
is secured by property with a value less than its adjusted issue price, 
the indebtedness is considered to be two separate debts: a secured 
indebtedness with an adjusted issue price equal to the value of the 
property, and an unsecured indebtedness with an adjusted issue price 
equal to the remainder. Absent strong evidence to the contrary, the 
value of the property securing the indebtedness is presumed to be equal 
to the issue price of any new secured indebtedness received for the 
indebtedness plus the value of any other consideration (except stock or 
new unsecured indebtedness) received for the indebtedness. A valuation 
of that property by a court in a title 11 case is a factor in 
determining value, but is not controlling.
    (ii) Example. The following example illustrates these provisions:

    Example. Corporation X owes an indebtedness with an adjusted 
issue price of $100,000. The indebtedness is secured by certain 
property owned by Corporation X. Corporation X exchanges the 
indebtedness for $10,000 of stock and new secured indebtedness with 
an issue price of $70,000. Under paragraph (d)(6)(i) of this 
section, the indebtedness is bifurcated into a secured indebtedness 
of $70,000 (the issue price of the new secured indebtedness received 
in exchange therefor) and an unsecured indebtedness of $30,000 (the 
remainder of the adjusted issue price of the indebtedness).

    (e) Effective date. This section is effective with respect to any 
issuance of stock for indebtedness on or before December 31, 1994, or 
any issuance of stock for indebtedness in a title 11 or similar case 
(as defined in section 368(a)(3)(A) of the Internal Revenue Code) that 
was filed on or before December 31, 1993--
    (1) Pursuant to a plan confirmed by the court in a title 11 case 
after May 17, 1994; or
    (2) If there is no title 11 case, pursuant to an insolvency workout 
in which all issuances of stock for indebtedness occur after May 17, 
1994.
Margaret Milner Richardson,
Commissioner of Internal Revenue.

    Approved: February 10, 1994.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 94-6087 Filed 3-18-94; 8:45 am]
BILLING CODE 4830-01-U