[Code of Federal Regulations]
[Title 26, Volume 11]
[Revised as of April 1, 2003]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.1275-2]
[Page 546-552]
TITLE 26--INTERNAL REVENUE
CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
(CONTINUED)
PART 1--INCOME TAXES--Table of Contents
Sec. 1.1275-2 Special rules relating to debt instruments.
(a) Payment ordering rule--(1) In general. Except as provided in
paragraph (a)(2) of this section, each payment under a debt instrument
is treated first as a payment of OID to the extent of the OID that has
accrued as of the date the payment is due and has not been allocated to
prior payments, and second as a payment of principal. Thus, no portion
of any payment is treated as prepaid interest.
(2) Exceptions. The rule in paragraph (a)(1) of this section does
not apply to--
[[Page 547]]
(i) A payment of qualified stated interest;
(ii) A payment of points deductible under section 461(g)(2), in the
case of the issuer;
(iii) A pro rata prepayment described in paragraph (f)(2) of this
section; or
(iv) A payment of additional interest or a similar charge provided
with respect to amounts that are not paid when due.
(b) Debt instruments distributed by corporations with respect to
stock--(1) Treatment of distribution. For purposes of determining the
issue price of a debt instrument distributed by a corporation with
respect to its stock, the instrument is treated as issued by the
corporation for property. See section 1275(a)(4). Thus, under section
1273(b)(3), the issue price of a distributed debt instrument that is
traded on an established market is its fair market value. The issue
price of a distributed debt instrument that is not traded on an
established market is determined under section 1274 or section
1273(b)(4).
(2) Issue date. The issue date of a debt instrument distributed by a
corporation with respect to its stock is the date of the distribution.
(c) Aggregation of debt instruments--(1) General rule. Except as
provided in paragraph (c)(2) of this section, debt instruments issued in
connection with the same transaction or related transactions (determined
based on all the facts and circumstances) are treated as a single debt
instrument for purposes of sections 1271 through 1275 and the
regulations thereunder. This rule ordinarily applies only to debt
instruments of a single issuer that are issued to a single holder. The
Commissioner may, however, aggregate debt instruments that are issued by
more than one issuer or that are issued to more than one holder if the
debt instruments are issued in an arrangement that is designed to avoid
the aggregation rule (e.g., debt instruments issued by or to related
parties or debt instruments originally issued to different holders with
the understanding that the debt instruments will be transferred to a
single holder).
(2) Exception if separate issue price established. Paragraph (c)(1)
of this section does not apply to a debt instrument if--
(i) The debt instrument is part of an issue a substantial portion of
which is traded on an established market within the meaning of
Sec. 1.1273-2(f); or
(ii) The debt instrument is part of an issue a substantial portion
of which is issued for money (or for property traded on an established
market within the meaning of Sec. 1.1273-2(f)) to parties who are not
related to the issuer or holder and who do not purchase other debt
instruments of the same issuer in connection with the same transaction
or related transactions.
(3) Special rule for debt instruments that provide for the issuance
of additional debt instruments. If, under the terms of a debt instrument
(the original debt instrument), the holder may receive one or more
additional debt instruments of the issuer, the additional debt
instrument or instruments are aggregated with the original debt
instrument. Thus, the payments made pursuant to an additional debt
instrument are treated as made on the original debt instrument, and the
distribution by the issuer of the additional debt instrument is not
considered to be a payment made on the original debt instrument. This
paragraph (c)(3) applies regardless of whether the right to receive an
additional debt instrument is fixed as of the issue date or is
contingent upon subsequent events. See Sec. 1.1272-1(c) for the
treatment of certain rights to issue additional debt instruments in lieu
of cash payments.
(4) Examples. The following examples illustrate the rules set forth
in paragraphs (c)(1) and (c)(2) of this section.
Example 1. Exception for debt instruments issued separately to other
purchasers. On January 1, 1995, Corporation M issues two series of
bonds, Series A and Series B. The two series are sold for cash and have
different terms. Although some holders purchase bonds from both series,
a substantial portion of the bonds is issued to different holders. H
purchases bonds from both series. Under the exception in paragraph
(c)(2)(ii) of this section, the Series A and Series B bonds purchased by
H are not aggregated.
Example 2. Tiered REMICs. Z forms a dual tier real estate mortgage
investment conduit (REMIC). In the dual tier structure, Z forms REMIC A
to acquire a pool of real estate mortgages and to issue a residual
interest
[[Page 548]]
and several classes of regular interests. Contemporaneously, Z forms
REMIC B to acquire as qualified mortgages all of the regular interests
in REMIC A. REMIC B issues several classes of regular interests and a
residual interest, and Z sells all of those interests to unrelated
parties in a public offering. Under the general rule set out in
paragraph (c)(1) of this section, all of the regular interests issued by
REMIC A and held by REMIC B are treated as a single debt instrument for
purposes of sections 1271 through 1275.
(d) Special rules for Treasury securities--(1) Issue price and issue
date. The issue price of an issue of Treasury securities is the average
price of the securities sold. The issue date of an issue of Treasury
securities is the first settlement date on which a substantial amount of
the securities in the issue is sold. For an issue of Treasury securities
sold from November 1, 1998, to March 13, 2001, the issue price of the
issue is the price of the securities sold at auction.
(2) Reopenings of Treasury securities--(i) Treatment of additional
Treasury securities. Notwithstanding Sec. 1.1275-1(f), additional
Treasury securities issued in a qualified reopening are part of the same
issue as the original Treasury securities. As a result, the additional
Treasury securities have the same issue price, issue date, and (with
respect to holders) the same adjusted issue price as the original
Treasury securities. This paragraph (d)(2) applies to qualified
reopenings that occur on or after March 25, 1992.
(ii) Definitions--(A) Additional Treasury securities. Additional
Treasury securities are Treasury securities with terms that are in all
respects identical to the terms of the original Treasury securities.
(B) Original Treasury securities. Original Treasury securities are
securities comprising any issue of outstanding Treasury securities.
(C) Qualified reopening--reopenings on or after March 13, 2001. For
a reopening of Treasury securities that occurs on or after March 13,
2001, a qualified reopening is a reopening that occurs not more than one
year after the original Treasury securities were first issued to the
public or, under paragraph (k)(3)(iii) of this section, a reopening in
which the additional Treasury securities are issued with no more than a
de minimis amount of OID.
(D) Qualified reopening--reopenings before March 13, 2001. For a
reopening of Treasury securities that occurs before March 13, 2001, a
qualified reopening is a reopening that occurs not more than one year
after the original Treasury securities were first issued to the public.
However, for a reopening of Treasury securities (other than Treasury
Inflation-Indexed Securities) that occurred prior to November 5, 1999, a
qualified reopening is a reopening of Treasury securities that satisfied
the preceding sentence and that was intended to alleviate an acute,
protracted shortage of the original Treasury securities.
(e) Disclosure of certain information to holders. Certain provisions
of the regulations under section 163(e) and sections 1271 through 1275
provide that the issuer's determination of an item controls the holder's
treatment of the item. In such a case, the issuer must provide the
relevant information to the holder in a reasonable manner. For example,
the issuer may provide the name or title and either the address or
telephone number of a representative of the issuer who will make
available to holders upon request the information required for holders
to comply with these provisions of the regulations.
(f) Treatment of pro rata prepayments--(1) Treatment as retirement
of separate debt instrument. A pro rata prepayment is treated as a
payment in retirement of a portion of a debt instrument, which may
result in a gain or loss to the holder. Generally, the gain or loss is
calculated by assuming that the original debt instrument consists of two
instruments, one that is retired and one that remains outstanding. The
adjusted issue price, holder's adjusted basis, and accrued but unpaid
OID of the original debt instrument, determined immediately before the
pro rata prepayment, are allocated between these two instruments based
on the portion of the instrument that is treated as retired by the pro
rata prepayment.
(2) Definition of pro rata prepayment. For purposes of paragraph
(f)(1) of this section, a pro rata prepayment is a
[[Page 549]]
payment on a debt instrument made prior to maturity that--
(i) Is not made pursuant to the instrument's payment schedule
(including a payment schedule determined under Sec. 1.1272-1(c)); and
(ii) Results in a substantially pro rata reduction of each payment
remaining to be paid on the instrument.
(g) Anti-abuse rule--(1) In general. If a principal purpose in
structuring a debt instrument or engaging in a transaction is to achieve
a result that is unreasonable in light of the purposes of section
163(e), sections 1271 through 1275, or any related section of the Code,
the Commissioner can apply or depart from the regulations under the
applicable sections as necessary or appropriate to achieve a reasonable
result. For example, if this paragraph (g) applies to a debt instrument
that provides for a contingent payment, the Commissioner can treat the
contingency as if it were a separate position.
(2) Unreasonable result. Whether a result is unreasonable is
determined based on all the facts and circumstances. In making this
determination, a significant fact is whether the treatment of the debt
instrument is expected to have a substantial effect on the issuer's or a
holder's U.S. tax liability. In the case of a contingent payment debt
instrument, another significant fact is whether the result is obtainable
without the application of Sec. 1.1275-4 and any related provisions
(e.g., if the debt instrument and the contingency were entered into
separately). A result will not be considered unreasonable, however, in
the absence of an expected substantial effect on the present value of a
taxpayer's tax liability.
(3) Examples. The following examples illustrate the provisions of
this paragraph (g):
Example 1. A issues a current-pay, increasing-rate note that
provides for an early call option. Although the option is deemed
exercised on the call date under Sec. 1.1272-1(c)(5), the option is not
expected to be exercised by A. In addition, a principal purpose of
including the option in the terms of the note is to limit the amount of
interest income includible by the holder in the period prior to the call
date by virtue of the option rules in Sec. 1.1272-1(c)(5). Moreover, the
application of the option rules is expected to substantially reduce the
present value of the holder's tax liability. Based on these facts, the
application of Sec. 1.1272-1(c)(5) produces an unreasonable result.
Therefore, under this paragraph (g), the Commissioner can apply the
regulations (in whole or in part) to the note without regard to
Sec. 1.1272-1(c)(5).
Example 2. C, a foreign corporation not subject to U.S. taxation,
issues to a U.S. holder a debt instrument that provides for a contingent
payment. The debt instrument is issued for cash and is subject to the
noncontingent bond method in Sec. 1.1275-4(b). Six months after
issuance, C and the holder modify the debt instrument so that there is a
deemed reissuance of the instrument under section 1001. The new debt
instrument is subject to the rules of Sec. 1.1275-4(c) rather than
Sec. 1.1275-4(b). The application of Sec. 1.1275-4(c) is expected to
substantially reduce the present value of the holder's tax liability as
compared to the application of Sec. 1.1275-4(b). In addition, a
principal purpose of the modification is to substantially reduce the
present value of the holder's tax liability through the application of
Sec. 1.1275-4(c). Based on these facts, the application of Sec. 1.1275-
4(c) produces an unreasonable result. Therefore, under this paragraph
(g), the Commissioner can apply the noncontingent bond method to the
modified debt instrument.
Example 3. D issues a convertible debt instrument rather than an
economically equivalent investment unit consisting of a debt instrument
and a warrant. The convertible debt instrument is issued at par and
provides for annual payments of interest. D issues the convertible debt
instrument rather than the investment unit so that the debt instrument
would not have OID. See Sec. 1.1273-2(j). In general, this is a
reasonable result in light of the purposes of the applicable statutes.
Therefore, the Commissioner generally will not use the authority under
this paragraph (g) to depart from the application of Sec. 1.1273-2(j) in
this case.
(4) Effective date. This paragraph (g) applies to debt instruments
issued on or after August 13, 1996.
(h) Remote and incidental contingencies--(1) In general. This
paragraph (h) applies to a debt instrument if one or more payments on
the instrument are subject to either a remote or incidental contingency.
Whether a contingency is remote or incidental is determined as of the
issue date of the debt instrument, including any date there is a deemed
reissuance of the debt instrument under paragraph (h)(6) (ii) or (j) of
this section or Sec. 1.1272-1(c)(6). Except as otherwise provided, the
treatment of the contingency under this paragraph (h) applies for all
[[Page 550]]
purposes of sections 163(e) (other than sections 163(e)(5)) and 1271
through 1275 and the regulations thereunder. For purposes of this
paragraph (h), the possibility of impairment of a payment by insolvency,
default, or similar circumstances is not a contingency.
(2) Remote contingencies. A contingency is remote if there is a
remote likelihood either that the contingency will occur or that the
contingency will not occur. If there is a remote likelihood that the
contingency will occur, it is assumed that the contingency will not
occur. If there is a remote likelihood that the contingency will not
occur, it is assumed that the contingency will occur.
(3) Incidental contingencies--(i) Contingency relating to amount. A
contingency relating to the amount of a payment is incidental if, under
all reasonably expected market conditions, the potential amount of the
payment is insignificant relative to the total expected amount of the
remaining payments on the debt instrument. If a payment on a debt
instrument is subject to an incidental contingency described in this
paragraph (h)(3)(i), the payment is ignored until the payment is made.
However, see paragraph (h)(6)(i)(B) of this section for the treatment of
the debt instrument if a change in circumstances occurs prior to the
date the payment is made.
(ii) Contingency relating to time. A contingency relating to the
timing of a payment is incidental if, under all reasonably expected
market conditions, the potential difference in the timing of the payment
(from the earliest date to the latest date) is insignificant. If a
payment on a debt instrument is subject to an incidental contingency
described in this paragraph (h)(3)(ii), the payment is treated as made
on the earliest date that the payment could be made pursuant to the
contingency. If the payment is not made on this date, a taxpayer makes
appropriate adjustments to take into account the delay in payment.
However, see paragraph (h)(6)(i)(C) of this section for the treatment of
the debt instrument if the delay is not insignificant.
(4) Aggregation rule. For purposes of paragraph (h)(2) of this
section, if a debt instrument provides for multiple contingencies each
of which has a remote likelihood of occurring but, when all of the
contingencies are considered together, there is a greater than remote
likelihood that at least one of the contingencies will occur, none of
the contingencies is treated as a remote contingency. For purposes of
paragraph (h)(3)(i) of this section, if a debt instrument provides for
multiple contingencies each of which is incidental but the potential
total amount of all of the payments subject to the contingencies is not,
under reasonably expected market conditions, insignificant relative to
the total expected amount of the remaining payments on the debt
instrument, none of the contingencies is treated as incidental.
(5) Consistency rule. For purposes of paragraphs (h) (2) and (3) of
this section, the issuer's determination that a contingency is either
remote or incidental is binding on all holders. However, the issuer's
determination is not binding on a holder that explicitly discloses that
its determination is different from the issuer's determination. Unless
otherwise prescribed by the Commissioner, the disclosure must be made on
a statement attached to the holder's timely filed Federal income tax
return for the taxable year that includes the acquisition date of the
debt instrument. See Sec. 1.1275-2(e) for rules relating to the issuer's
obligation to disclose certain information to holders.
(6) Subsequent adjustments--(i) Applicability. This paragraph (h)(6)
applies to a debt instrument when there is a change in circumstances.
For purposes of the preceding sentence, there is a change in
circumstances if--
(A) A remote contingency actually occurs or does not occur, contrary
to the assumption made in paragraph (h)(2) of this section;
(B) A payment subject to an incidental contingency described in
paragraph (h)(3)(i) of this section becomes fixed in an amount that is
not insignificant relative to the total expected amount of the remaining
payments on the debt instrument; or
(C) A payment subject to an incidental contingency described in
paragraph (h)(3)(ii) of this section becomes fixed such that the
difference between the assumed payment date and the due
[[Page 551]]
date of the payment is not insignificant.
(ii) In general. If a change in circumstances occurs, solely for
purposes of sections 1272 and 1273, the debt instrument is treated as
retired and then reissued on the date of the change in circumstances for
an amount equal to the instrument's adjusted issue price on that date.
(iii) Contingent payment debt instruments. Notwithstanding paragraph
(h)(6)(ii) of this section, in the case of a contingent payment debt
instrument subject to Sec. 1.1275-4, if a change in circumstances
occurs, no retirement or reissuance is treated as occurring, but any
payment that is fixed as a result of the change in circumstances is
governed by the rules in Sec. 1.1275-4 that apply when the amount of a
contingent payment becomes fixed.
(7) Effective date. This paragraph (h) applies to debt instruments
issued on or after August 13, 1996.
(i) [Reserved]
(j) Treatment of certain modifications. If the terms of a debt
instrument are modified to defer one or more payments, and the
modification does not cause an exchange under section 1001, then, solely
for purposes of sections 1272 and 1273, the debt instrument is treated
as retired and then reissued on the date of the modification for an
amount equal to the instrument's adjusted issue price on that date. This
paragraph (j) applies to debt instruments issued on or after August 13,
1996.
(k) Reopenings--(1) In general. Notwithstanding Sec. 1.1275-1(f),
additional debt instruments issued in a qualified reopening are part of
the same issue as the original debt instruments. As a result, the
additional debt instruments have the same issue date, the same issue
price, and (with respect to holders) the same adjusted issue price as
the original debt instruments.
(2) Definitions--(i) Original debt instruments. Original debt
instruments are debt instruments comprising any single issue of
outstanding debt instruments. For purposes of determining whether a
particular reopening is a qualified reopening, debt instruments issued
in prior qualified reopenings are treated as original debt instruments
and debt instruments issued in the particular reopening are not so
treated.
(ii) Additional debt instruments. Additional debt instruments are
debt instruments that, without the application of this paragraph (k)--
(A) Are part of a single issue of debt instruments;
(B) Are not part of the same issue as the original debt instruments;
and
(C) Have terms that are in all respects identical to the terms of
the original debt instruments as of the reopening date.
(iii) Reopening date. The reopening date is the issue date of the
additional debt instruments (determined without the application of this
paragraph (k)).
(iv) Announcement date. The announcement date is the later of seven
days before the date on which the price of the additional debt
instruments is established or the date on which the issuer's intent to
reopen a security is publicly announced through one or more media,
including an announcement reported on the standard electronic news
services used by security broker-dealers (for example, Reuters,
Telerate, or Bloomberg).
(3) Qualified reopening--(i) Definition. A qualified reopening is a
reopening of original debt instruments that is described in paragraph
(k)(3)(ii) or (iii) of this section. In addition, see paragraph (d)(2)
of this section to determine if a reopening of Treasury securities is a
qualified reopening.
(ii) Reopening within six months. A reopening is described in this
paragraph (k)(3)(ii) if--
(A) The original debt instruments are publicly traded (within the
meaning of Sec. 1.1273-2(f));
(B) The reopening date of the additional debt instruments is not
more than six months after the issue date of the original debt
instruments; and
(C) On the date on which the price of the additional debt
instruments is established (or, if earlier, the announcement date), the
yield of the original debt instruments (based on their fair market
value) is not more than 110 percent of the yield of the original debt
instruments on their issue date (or, if the original debt instruments
were issued with no more than a de minimis amount of OID, the coupon
rate).
[[Page 552]]
(iii) Reopening with de minimis OID. A reopening (including a
reopening of Treasury securities) is described in this paragraph
(k)(3)(iii) if--
(A) The original debt instruments are publicly traded (within the
meaning of Sec. 1.1273-2(f)); and
(B) The additional debt instruments are issued with no more than a
de minimis amount of OID (determined without the application of this
paragraph (k)).
(iv) Exceptions. This paragraph (k)(3) does not apply to a reopening
of tax-exempt obligations (as defined in section 1275(a)(3)) or
contingent payment debt instruments (within the meaning of Sec. 1.1275-
4).
(4) Issuer's treatment of a qualified reopening. See Sec. 1.163-7(e)
for the issuer's treatment of the debt instruments that are part of a
qualified reopening.
(5) Effective date. This paragraph (k) applies to debt instruments
that are part of a reopening where the reopening date is on or after
March 13, 2001.
[T.D. 8517, 59 FR 4826, Feb. 2, 1994, as amended by T.D. 8674, 61 FR
30142, June 14, 1996; T.D. 8840, 64 FR 60343, Nov. 5, 1999; T.D. 8934,
66 FR 2816, Jan 12, 2001]