IRS extends suspension of AHYDO limits

Tax Update

The IRS has extended the suspension of limits on the deduction of interest on certain applicable high-yield discount obligations called AHYDOs.

The extension, announced December 28, 2009, provides increased flexibility for corporate debt restructures in 2010, but the benefit applies to a more narrow class of debt obligations than was the case for restructures during the period from September 2008 through December 2009.

AHYDO Limits

An AHYDO is a debt instrument that (i) is issued by a corporation, (ii) has a term of more than five years, (iii) has a yield to maturity equal to or greater than the relevant applicable federal rate at the time of issue plus 500 basis points, and (iv) has “significant OID.” Generally, an instrument has significant OID if at the end of any accrual period ending after the fifth anniversary of the date of issue, the amount of interest accrued for income tax purposes but not yet paid exceeds the product of the instrument’s issue price and its yield to maturity.

The Internal Revenue Code disallows a corporation’s interest deduction for the “disqualified portion” of the original issue discount (OID) on an AHYDO, and the corporation’s deduction for the remaining portion of the OID is deferred until the OID is actually paid.

2009 Suspension of Limits

The American Recovery and Reinvestment Tax Act of 2009 suspended the limits on interest deductions for any AHYDO issued from September 1, 2008 through December 31, 2009, if the new AHYDO was issued in exchange for an obligation that was not an AHYDO and that had the same issuer or obligor as the new AHYDO. For this purpose, exchanges included modifications of debt instruments that are treated as exchanges for income tax purposes. The 2009 legislation authorized the IRS to extend the suspension if it determines that an extension “is appropriate in light of distressed conditions in the debt capital markets.”

Extension Through 2010 for Certain Obligations

In Notice 2010‑11, the IRS extended to December 31, 2010, the suspension of the limits on interest deductions for any AHYDO that is a “qualified obligation.” An AHYDO is a qualified obligation if it meets all of the following conditions:

  1. The AHYDO is issued after December 31, 2009, and on or before December 31, 2010, in exchange for an obligation that is not an AHYDO (including a deemed exchange resulting from a modification of the obligation);
  2. The issuer or obligor of the new AHYDO is the same as the issuer or obligor of the obligation exchanged for the AHYDO; 
  3. The AHYDO does not pay certain types of contingent interest (interest based on the receipts, cash flow, income, profits, property value, dividends or distributions of the debtor or a related person); 
  4. The AHYDO is not issued to a related person; 
  5. The issue price of the AHYDO is determined under Code Section 1273(b)(1), 1273(b)(2), 1273(b)(3) or 1274(b)(3) (This includes instruments that are either publicly traded, issued in exchange for property that is publicly traded, not issued for property, or issued for non-traded property and not publicly traded but issued in connection with a tax shelter or other situation that the IRS has specified as having potential for tax avoidance.); and 
  6. The AHYDO would not be an AHYDO if its issue price were increased by the amount of any discharge of indebtedness income realized upon the exchange.

Notice 2010‑11 illustrates the last item above with the following example. Prior to 2010 Corporation X issued a debt instrument that was not an AHYDO. In 2010, Corporation X exchanges the debt instrument (which has an adjusted issue price of $100 on the exchange date), for a new debt instrument that is an AHYDO having an issue price of $80 and a stated redemption price at maturity of $100. Corporation X realizes $20 of discharge of indebtedness income on the exchange.

To determine whether the new debt instrument is a qualified obligation, the issue price of the new debt instrument is increased by the $20 of debt discharge income, and this amount is treated as the issue price for purposes of determining whether the new debt instrument is an AHYDO. If the new debt instrument would be an AHYDO if its issue price were $100, then it is not a qualified obligation and is subject to the limits on interest deductions generally applicable to AHYDOs. If the new debt instrument would not be an AHYDO if its issue price were $100, then, provided the other conditions above are satisfied, the new debt instrument is a qualified obligation and is not subject to the AHYDO limits.

Please click here to read the IRS Notice about the extension.

For more information, please contact:

Bruce Wein

Nicholas Minear