1.385-6(a)(1)] are applied separately to each class of instruments issued. However, the IRS reserves the right to treat two or more classes of instruments as a single class instrument to determine proportionality. e.g. A and B each own one-half of the stock of Corporation Z. Z then, pursuant to a plan, issues $100,000 of Class A convertible debentures to A on January 1, 1983, and $1 00,000 of Class B convertible debentures to B on January 1, 1985. Class A and Class B debentures are then considered together which make the holdings of the debentures and the stock substantially proportionate. e.g. With the same ownership and other facts as above, the debentures are not issued pursuant to a plan. Consequently, the proportionality rules do not apply to either class, unless Corporation Z fails to pay interest on the debentures, at which time they then may be treated as stock.
obligations of comparable maturity, or (d) any rate in between the preceding three rates (the new regulations do not speak to the point of state usury limits); (2) The debt to equity ratio of the corporation does not exceed 1 to 1; and (3) All principal and interest is paid when due.
Safe Harbor Rule Related to Excessive Debt-If all the terms of the debt instrument and the corporation's financial structure would not be satisfactory to a lending institution, commercial bank, insurance company, etc., then the corporation's debt is considered excessive [Treas. Reg. § 1.385-6(f)(2»). Additionally, shareholder loans may also be treated as debt if the debt-equity ratio is considered excessive as defined in Treas. Reg. § 1.385-6(g)(1 )(2) and Treas. Reg. § 1.385-6(f)(3)(4). Caution must be used should a temporary contribution to equity or any
Constructive Ownership Rules are Applied for the Proportionality Test-The constructive stock ownership rules of IRC § 318(a) are used to determine whether a debt instrument is issued proportionally to shareholders. e.g. A and B each own one-half of the common stock of Corporation U. U has outstanding $100,000 of 7% debentures owned 60% by A's spouse and 40% by B's spouse. The holdings are considered substantially proportionate.
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(1) The instrument has a fixed maturity date and provides for annual payments of interest at (a) the rate charged for tax deficiencies and refunds under IRC § 6621, (b) the prime rate at any local commercial bank, (c) a rate determined by the Treasury from time to time based on the average yield of U.S.
To give their techniques of calculation the regulations give the example: e.g. Corporation M on December 31, 1990, has assets with an adjusted basis of $150,000 and liabilities of $100,000, which creates a stockholders' equity of $50,000 in M ($150,000 - $100,000). Should M have no trade accounts payable or other such items, the debt to equity ratio at that time is 2 to 1 ($100,000 to $50,000). This is obviously a summary of some of the provisions of the new debt/equity regUlations as issued by the Treasury Department, pursuant to IRC § 385. It behooves any practitioner, with corporate clients which are closely held, to review the new regulations and apprise the client of them before they become effective the first of next year.
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POSITION AVAILABLE Safe Harbor Rule for Debt Instruments-A straight debt instrument qualifies under the safe harbor rule [Treas. Reg. § 1.385-2(d)] if all of the following conditions are present:
other contrivance be considered. [Treas. Reg. § 1.385-6(g)(5)(vi») It should be noted that special rules prevail for banks, insurance companies, etc., as well as for affiliated groups.
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October 1981/Arkansas Lawyer/145