[Federal Register Volume 63, Number 244 (Monday, December 21, 1998)]
[Proposed Rules]
[Pages 70354-70356]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-32930]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-105964-98]
RIN 1545-AW30


Intercompany Obligations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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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 Sec. 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 
Sec. 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, 
Sec. 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

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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:


Sec. 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

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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 Sec. 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.
* * * * *
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 98-32930 Filed 12-18-98; 8:45 am]
BILLING CODE 4830-01-U