Service Rules that Cross-Border Debt Cancellation Between Related Parties Did Not Result in Cancellation of Indebtedness Income
In PLR 201016048 (4/23/2010) the Service held that the issuance of a share of stock of a foreign parent corporation issued as consideration to cancel a debt obligation of the wholly owned domestic subsidiary would not trigger cancellation of indebtedness income even though the issued share as cancelled shortly thereafter.
Filing the PLR request was the common parent of an affiliated group of U.S. corporations which filed a consolidated U.S. corporate income tax return. The common parent was the wholly owned subsidiary of its foreign parent corporation. The common parent had borrowed a substantial amount of funds from the foreign parent for conducting business operations. It was stipulated that the foreign parent did not carry on a trade or business within the U.S. or maintain a fixed base or permanent establishment within the U.S. It did not file a U.S. income tax return.
As part of a prior acquisition transaction, a portion of the debt which had been used to finance the operations of a domestic subsidiary, was cancelled by the foreign parent in exchange for the taxpayer’s stock in the subsidiary. Still, the taxpayer, despite this cancellation, was still in debt to its foreign parent.
To improve the common parent’s balance sheet, the foreign parent wanted to cancel the balance of the debt. For purposes of the foreign parent corporation’s domestic tax position, the cancellation was made in exchange for stock of the U.S. subsidiary (common parent of the consolidated group) with the value of the stock estimated to be equal to the value of the cancelled debt. The cancellation would occur before year end at which time the common parent intended to enter into a rescission agreement pursuant to which (i) the debt cancellation would be voided, with interest paid accordingly, and (ii) the transferred shares of the taxpayer's stock would be cancelled. Subsequent to the rescission, the debt and the interest would revert back to their original amounts as if the transaction never occurred.
Following the rescission of the original cancellation agreement, the taxpayer intended to enter into an agreement with the foreign parent pursuant to which (i) solely for purposes of its foreign taxes, the foreign parent would purchase a single share of the taxpayer's stock in exchange for cancellation of an amount of the debt intended to be equal to the FMV of the single share, (ii) the foreign parent would cancel the aforementioned amount of the debt as a capital contribution to the taxpayer, and (iii) the single share, which was issued solely for foreign tax reasons, would be cancelled.
Based on the facts provided and a number of taxpayer representations, the IRS ruled that:
(1) The original cancellation of the debt and issuance of the shares of taxpayer stock pursuant to the transaction would be disregarded for U.S. federal income tax purposes (i.e., the rescission would be respected).
(2) The taxpayer's transitory single share would be disregarded for U.S. federal income tax purposes.
(3) The taxpayer would be treated as having satisfied the debt with an amount of money equal to the foreign parent's adjusted basis in the debt for purposes of determining income from discharge of indebtedness under Section 108(e)(6).
The Service accepted as immaterial the taxpayer’s having to issue a share and cancel it for foreign tax purposes without muddying the waters so to speak and adversely affect the favorably ruling that it was seeking to obtain. Thus, the Service may have looked at the stock issuance and cancellation as being controlled by section 108(e)(6) based on the foreign parent’s 100% stock ownership instead of section 108(e)(8). Were the latter to apply to the transaction, the debt cancellation would result in COD income since the value of a single share by the common parent would have been less than the face amount of the debt cancelled by the foreign parent.
Under section 108(e)(6) where a debtor corporation acquires its indebtedness from a shareholder as a contribution to capital, such corporation is treated as having satisfied the indebtedness with an amount of money equal to the shareholder's adjusted basis in the indebtedness. Section 108(e)(8) provides that where a debtor-corporation transfers stock to a creditor to satisfy the repayment of an indebtedness, the corporation-debtor is viewed as satisfying the debt in an amount of money equal to the value of the stock.
