[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: 26CFR1.1275-5]
[Page 570-577]
TITLE 26--INTERNAL REVENUE
CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
(CONTINUED)
PART 1--INCOME TAXES--Table of Contents
Sec. 1.1275-5 Variable rate debt instruments.
(a) Applicability--(1) In general. This section provides rules for
variable rate debt instruments. Except as provided in paragraph (a)(6)
of this section, a variable rate debt instrument is a debt instrument
that meets the conditions described in paragraphs (a)(2), (3), (4), and
(5) of this section. If a debt instrument that provides for a variable
rate of interest does not qualify as a variable rate debt instrument,
the debt instrument is a contingent payment debt instrument. See
Sec. 1.1275-4 for the treatment of a contingent payment debt instrument.
See Sec. 1.1275-6 for a taxpayer's treatment of a variable rate debt
instrument and a hedge.
(2) Principal payments. The issue price of the debt instrument must
not exceed the total noncontingent principal payments by more than an
amount equal to the lesser of--
(i) .015 multiplied by the product of the total noncontingent
principal payments and the number of complete years to maturity from the
issue date (or, in the case of an installment obligation, the weighted
average maturity as defined in Sec. 1.1273-1(e)(3)); or
(ii) 15 percent of the total noncontingent principal payments.
[[Page 571]]
(3) Stated interest--(i) General rule. The debt instrument must not
provide for any stated interest other than stated interest (compounded
or paid at least annually) at--
(A) One or more qualified floating rates;
(B) A single fixed rate and one or more qualified floating rates;
(C) A single objective rate; or
(D) A single fixed rate and a single objective rate that is a
qualified inverse floating rate.
(ii) Certain debt instruments bearing interest at a fixed rate for
an initial period. If interest on a debt instrument is stated at a fixed
rate for an initial period of 1 year or less followed by a variable rate
that is either a qualified floating rate or an objective rate for a
subsequent period, and the value of the variable rate on the issue date
is intended to approximate the fixed rate, the fixed rate and the
variable rate together constitute a single qualified floating rate or
objective rate. A fixed rate and a variable rate will be conclusively
presumed to meet the requirements of the preceding sentence if the value
of the variable rate on the issue date does not differ from the value of
the fixed rate by more than .25 percentage points (25 basis points).
(4) Current value. The debt instrument must provide that a qualified
floating rate or objective rate in effect at any time during the term of
the instrument is set at a current value of that rate. A current value
is the value of the rate on any day that is no earlier than 3 months
prior to the first day on which that value is in effect and no later
than 1 year following that first day.
(5) No contingent principal payments. Except as provided in
paragraph (a)(2) of this section, the debt instrument must not provide
for any principal payments that are contingent (within the meaning of
Sec. 1.1275-4(a)).
(6) Special rule for debt instruments issued for nonpublicly traded
property. A debt instrument (other than a tax-exempt obligation) that
would otherwise qualify as a variable rate debt instrument under this
section is not a variable rate debt instrument if section 1274 applies
to the instrument and any stated interest payments on the instrument are
treated as contingent payments under Sec. 1.1274-2. This paragraph
(a)(6) applies to debt instruments issued on or after August 13, 1996.
(b) Qualified floating rate--(1) In general. A variable rate is a
qualified floating rate if variations in the value of the rate can
reasonably be expected to measure contemporaneous variations in the cost
of newly borrowed funds in the currency in which the debt instrument is
denominated. The rate may measure contemporaneous variations in
borrowing costs for the issuer of the debt instrument or for issuers in
general. Except as provided in paragraph (b)(2) of this section, a
multiple of a qualified floating rate is not a qualified floating rate.
If a debt instrument provides for two or more qualified floating rates
that can reasonably be expected to have approximately the same values
throughout the term of the instrument, the qualified floating rates
together constitute a single qualified floating rate. Two or more
qualified floating rates will be conclusively presumed to meet the
requirements of the preceding sentence if the values of all rates on the
issue date are within .25 percentage points (25 basis points) of each
other.
(2) Certain rates based on a qualified floating rate. For a debt
instrument issued on or after August 13, 1996, a variable rate is a
qualified floating rate if it is equal to either--
(i) The product of a qualified floating rate described in paragraph
(b)(1) of this section and a fixed multiple that is greater than .65 but
not more than 1.35; or
(ii) The product of a qualified floating rate described in paragraph
(b)(1) of this section and a fixed multiple that is greater than .65 but
not more than 1.35, increased or decreased by a fixed rate.
(3) Restrictions on the stated rate of interest. A variable rate is
not a qualified floating rate if it is subject to a restriction or
restrictions on the maximum stated interest rate (cap), a restriction or
restrictions on the minimum stated interest rate (floor), a restriction
or restrictions on the amount of increase or decrease in the stated
interest rate (governor), or other similar
[[Page 572]]
restrictions. Notwithstanding the preceding sentence, the following
restrictions will not cause a variable rate to fail to be a qualified
floating rate--
(i) A cap, floor, or governor that is fixed throughout the term of
the debt instrument;
(ii) A cap or similar restriction that is not reasonably expected as
of the issue date to cause the yield on the debt instrument to be
significantly less than the expected yield determined without the cap;
(iii) A floor or similar restriction that is not reasonably expected
as of the issue date to cause the yield on the debt instrument to be
significantly more than the expected yield determined without the floor;
or
(iv) A governor or similar restriction that is not reasonably
expected as of the issue date to cause the yield on the debt instrument
to be significantly more or significantly less than the expected yield
determined without the governor.
(c) Objective rate--(1) Definition--(i) In general. For debt
instruments issued on or after August 13, 1996, an objective rate is a
rate (other than a qualified floating rate) that is determined using a
single fixed formula and that is based on objective financial or
economic information. For example, an objective rate generally includes
a rate that is based on one or more qualified floating rates or on the
yield of actively traded personal property (within the meaning of
section 1092(d)(1)).
(ii) Exception. For purposes of paragraph (c)(1)(i) of this section,
an objective rate does not include a rate based on information that is
within the control of the issuer (or a related party within the meaning
of section 267(b) or 707(b)(1)) or that is unique to the circumstances
of the issuer (or a related party within the meaning of section 267(b)
or 707(b)(1)), such as dividends, profits, or the value of the issuer's
stock. However, a rate does not fail to be an objective rate merely
because it is based on the credit quality of the issuer.
(2) Other objective rates to be specified by Commissioner. The
Commissioner may designate in the Internal Revenue Bulletin variable
rates other than those described in paragraph (c)(1) of this section
that will be treated as objective rates (see Sec. 601.601(d)(2)(ii) of
this chapter).
(3) Qualified inverse floating rate. An objective rate described in
paragraph (c)(1) of this section is a qualified inverse floating rate
if--
(i) The rate is equal to a fixed rate minus a qualified floating
rate; and
(ii) The variations in the rate can reasonably be expected to
inversely reflect contemporaneous variations in the qualified floating
rate (disregarding any restrictions on the rate that are described in
paragraphs (b)(3)(i), (b)(3)(ii), (b)(3)(iii), and (b)(3)(iv) of this
section).
(4) Significant front-loading or back-loading of interest.
Notwithstanding paragraph (c)(1) of this section, a variable rate of
interest on a debt instrument is not an objective rate if it is
reasonably expected that the average value of the rate during the first
half of the instrument's term will be either significantly less than or
significantly greater than the average value of the rate during the
final half of the instrument's term.
(5) Tax-exempt obligations. Notwithstanding paragraph (c)(1) of this
section, in the case of a tax-exempt obligation (within the meaning of
section 1275(a)(3)), a variable rate is an objective rate only if it is
a qualified inverse floating rate or a qualified inflation rate. A rate
is a qualified inflation rate if the rate measures contemporaneous
changes in inflation based on a general inflation index.
(d) Examples. The following examples illustrate the rules of
paragraphs (b) and (c) of this section. For purposes of these examples,
assume that the debt instrument is not a tax-exempt obligation. In
addition, unless otherwise provided, assume that the rate is not
reasonably expected to result in a significant front-loading or back-
loading of interest and that the rate is not based on objective
financial or economic information that is within the control of the
issuer (or a related party) or that is unique to the circumstances of
the issuer (or a related party).
Example 1. Rate based on LIBOR. X issues a debt instrument that
provides for annual payments of interest at a rate equal to the value of
the 1-year London Interbank Offered
[[Page 573]]
Rate (LIBOR) at the end of each year. Variations in the value of 1-year
LIBOR over the term of the debt instrument can reasonably be expected to
measure contemporaneous variations in the cost of newly borrowed funds
over that term. Accordingly, the rate is a qualified floating rate.
Example 2. Rate increased by a fixed amount. X issues a debt
instrument that provides for annual payments of interest at a rate equal
to 200 basis points (2 percent) plus the current value, at the end of
each year, of the average yield on 1-year Treasury securities as
published in Federal Reserve bulletins. Variations in the value of this
interest rate can reasonably be expected to measure contemporaneous
variations in the cost of newly borrowed funds. Accordingly, the rate is
a qualified floating rate.
Example 3. Rate based on commercial paper rate. X issues a debt
instrument that provides for a rate of interest that is periodically
adjusted to equal the current interest rate of Bank's commercial paper.
Variations in the value of this interest rate can reasonably be expected
to measure contemporaneous variations in the cost of newly borrowed
funds. Accordingly, the rate is a qualified floating rate.
Example 4. Rate based on changes in the value of a commodity index.
On January 1, 1997, X issues a debt instrument that provides for annual
interest payments at the end of each year at a rate equal to the
percentage increase, if any, in the value of an index for the year
immediately preceding the payment. The index is based on the prices of
several actively traded commodities. Variations in the value of this
interest rate cannot reasonably be expected to measure contemporaneous
variations in the cost of newly borrowed funds. Accordingly, the rate is
not a qualified floating rate. However, because the rate is based on
objective financial information using a single fixed formula, the rate
is an objective rate.
Example 5. Rate based on a percentage of S&P 500 Index. On January
1, 1997, X issues a debt instrument that provides for annual interest
payments at the end of each year based on a fixed percentage of the
value of the S&P 500 Index. Variations in the value of this interest
rate cannot reasonably be expected to measure contemporaneous variations
in the cost of newly borrowed funds and, therefore, the rate is not a
qualified floating rate. Although the rate is described in paragraph
(c)(1)(i) of this section, the rate is not an objective rate because,
based on historical data, it is reasonably expected that the average
value of the rate during the first half of the instrument's term will be
significantly less than the average value of the rate during the final
half of the instrument's term.
Example 6. Rate based on issuer's profits. On January 1, 1997, Z
issues a debt instrument that provides for annual interest payments
equal to 1 percent of Z's gross profits earned during the year
immediately preceding the payment. Variations in the value of this
interest rate cannot reasonably be expected to measure contemporaneous
variations in the cost of newly borrowed funds. Accordingly, the rate is
not a qualified floating rate. In addition, because the rate is based on
information that is unique to the issuer's circumstances, the rate is
not an objective rate.
Example 7. Rate based on a multiple of an interest index. On January
1, 1997, Z issues a debt instrument with annual interest payments at a
rate equal to two times the value of 1-year LIBOR as of the payment
date. Because the rate is a multiple greater than 1.35 times a qualified
floating rate, the rate is not a qualified floating rate. However,
because the rate is based on objective financial information using a
single fixed formula, the rate is an objective rate.
Example 8. Variable rate based on the cost of borrowed funds in a
foreign currency. On January 1, 1997, Y issues a 5-year dollar
denominated debt instrument that provides for annual interest payments
at a rate equal to the value of 1-year French franc LIBOR as of the
payment date. Variations in the value of French franc LIBOR do not
measure contemporaneous changes in the cost of newly borrowed funds in
dollars. As a result, the rate is not a qualified floating rate for an
instrument denominated in dollars. However, because the rate is based on
objective financial information using a single fixed formula, the rate
is an objective rate.
Example 9. Qualified inverse floating rate. On January 1, 1997, X
issues a debt instrument that provides for annual interest payments at
the end of each year at a rate equal to 12 percent minus the value of 1-
year LIBOR as of the payment date. On the issue date, the value of 1-
year LIBOR is 6 percent. Because the rate can reasonably be expected to
inversely reflect contemporaneous variations in 1-year LIBOR, it is a
qualified inverse floating rate. However, if the value of 1-year LIBOR
on the issue date were 11 percent rather than 6 percent, the rate would
not be a qualified inverse floating rate because the rate could not
reasonably be expected to inversely reflect contemporaneous variations
in 1-year LIBOR.
Example 10. Rate based on an inflation index. On January 1, 1997, X
issues a debt instrument that provides for annual interest payments at
the end of each year at a rate equal to 400 basis points (4 percent)
plus the annual percentage change in a general inflation index (e.g.,
the Consumer Price Index, U.S. City Average, All Items, for all Urban
Consumers, seasonally unadjusted). The rate, however, may not be less
than zero. Variations in the value of this interest rate cannot
reasonably be expected to measure contemporaneous variations in the cost
of newly borrowed funds. Accordingly, the rate is not
[[Page 574]]
a qualified floating rate. However, because the rate is based on
objective economic information using a single fixed formula, the rate is
an objective rate.
(e) Qualified stated interest and OID with respect to a variable
rate debt instrument--(1) In general. This paragraph (e) provides rules
to determine the amount and accrual of OID and qualified stated interest
on a variable rate debt instrument. In general, the rules convert the
debt instrument into a fixed rate debt instrument and then apply the
general OID rules to the debt instrument. The issue price of a variable
rate debt instrument, however, is not determined under this paragraph
(e). See Secs. 1.1273-2 and 1.1274-2 to determine the issue price of a
variable rate debt instrument.
(2) Variable rate debt instrument that provides for annual payments
of interest at a single variable rate. If a variable rate debt
instrument provides for stated interest at a single qualified floating
rate or objective rate and the interest is unconditionally payable in
cash or in property (other than debt instruments of the issuer), or will
be constructively received under section 451, at least annually, the
following rules apply to the instrument:
(i) All stated interest with respect to the debt instrument is
qualified stated interest.
(ii) The amount of qualified stated interest and the amount of OID,
if any, that accrues during an accrual period is determined under the
rules applicable to fixed rate debt instruments by assuming that the
variable rate is a fixed rate equal to--
(A) In the case of a qualified floating rate or qualified inverse
floating rate, the value, as of the issue date, of the qualified
floating rate or qualified inverse floating rate; or
(B) In the case of an objective rate (other than a qualified inverse
floating rate), a fixed rate that reflects the yield that is reasonably
expected for the debt instrument.
(iii) The qualified stated interest allocable to an accrual period
is increased (or decreased) if the interest actually paid during an
accrual period exceeds (or is less than) the interest assumed to be paid
during the accrual period under paragraph (e)(2)(ii) of this section.
(3) All other variable rate debt instruments except for those that
provide for a fixed rate. If a variable rate debt instrument is not
described in paragraph (e)(2) of this section and does not provide for
interest payable at a fixed rate (other than an initial fixed rate
described in paragraph (a)(3)(ii) of this section), the amount of
interest and OID accruals for the instrument are determined under this
paragraph (e)(3).
(i) Step one: Determine the fixed rate substitute for each variable
rate provided under the debt instrument--(A) Qualified floating rate.
The fixed rate substitute for each qualified floating rate provided for
in the debt instrument is the value of each rate as of the issue date.
If, however, a variable rate debt instrument provides for two or more
qualified floating rates with different intervals between interest
adjustment dates, the fixed rate substitutes for the rates must be based
on intervals that are equal in length. For example, if a 4-year debt
instrument provides for 24 monthly interest payments based on the value
of the 30-day commercial paper rate on each payment date followed by 8
quarterly interest payments based on the value of quarterly LIBOR on
each payment date, the fixed rate substitutes may be based on the
values, as of the issue date, of the 90-day commercial paper rate and
quarterly LIBOR. Alternatively, the fixed rate substitutes may be based
on the values, as of the issue date, of the 30-day commercial paper rate
and monthly LIBOR.
(B) Qualified inverse floating rate. The fixed rate substitute for a
qualified inverse floating rate is the value of the qualified inverse
floating rate as of the issue date.
(C) Objective rate. The fixed rate substitute for an objective rate
(other than a qualified inverse floating rate) is a fixed rate that
reflects the yield that is reasonably expected for the debt instrument.
(ii) Step two: Construct the equivalent fixed rate debt instrument.
The equivalent fixed rate debt instrument has terms that are identical
to those provided under the variable rate debt instrument, except that
the equivalent
[[Page 575]]
fixed rate debt instrument provides for the fixed rate substitutes
(determined in paragraph (e)(3)(i) of this section) in lieu of the
qualified floating rates or objective rate provided under the variable
rate debt instrument.
(iii) Step three: Determine the amount of qualified stated interest
and OID with respect to the equivalent fixed rate debt instrument. The
amount of qualified stated interest and OID, if any, are determined for
the equivalent fixed rate debt instrument under the rules applicable to
fixed rate debt instruments and are taken into account as if the holder
held the equivalent fixed rate debt instrument.
(iv) Step four: Make appropriate adjustments for actual variable
rates. Qualified stated interest or OID allocable to an accrual period
must be increased (or decreased) if the interest actually accrued or
paid during an accrual period exceeds (or is less than) the interest
assumed to be accrued or paid during the accrual period under the
equivalent fixed rate debt instrument. This increase or decrease is an
adjustment to qualified stated interest for the accrual period if the
equivalent fixed rate debt instrument (as determined under paragraph
(e)(3)(ii) of this section) provides for qualified stated interest and
the increase or decrease is reflected in the amount actually paid during
the accrual period. Otherwise, this increase or decrease is an
adjustment to OID for the accrual period.
(v) Examples. The following examples illustrate the rules in
paragraphs (e) (2) and (3) of this section:
Example 1. Equivalent fixed rate debt instrument--(i) Facts. X
purchases at original issue a 6-year variable rate debt instrument that
provides for semiannual payments of interest. For the first 3 years, the
rate of interest is the value of 6-month LIBOR on the payment date. For
the final 3 years, the rate is the value of the 6-month T-bill rate on
the payment date. On the issue date, the value of 6-month LIBOR is 3
percent, compounded semiannually, and the 6-month T-bill rate is 2
percent, compounded semiannually.
(ii) Determination of equivalent fixed rate debt instrument. Under
paragraph (e)(3)(i) of this section, the fixed rate substitute for 6-
month LIBOR is 3 percent, compounded semiannually, and the fixed rate
substitute for the 6-month T-bill rate is 2 percent, compounded
semiannually. Under paragraph (e)(3)(ii) of this section, the equivalent
fixed rate debt instrument is a 6-year debt instrument that provides for
semiannual payments of interest at 3 percent, compounded semiannually,
for the first 3 years followed by 2 percent, compounded semiannually,
for the final 3 years.
Example 2. Equivalent fixed rate debt instrument with de minimis
OID--(i) Facts. Y purchases at original issue, for $100,000, a 4-year
variable rate debt instrument that has a stated principal amount of
$100,000, payable at maturity. The debt instrument provides for monthly
payments of interest at the end of each month. For the first year, the
interest rate is the monthly commercial paper rate and for the last 3
years, the interest rate is the monthly commercial paper rate plus 100
basis points. On the issue date, the monthly commercial paper rate is 3
percent, compounded monthly.
(ii) Equivalent fixed rate debt instrument. Under paragraph
(e)(3)(ii) of this section, the equivalent fixed rate debt instrument
for the variable rate debt instrument is a 4-year debt instrument that
has an issue price and stated principal amount of $100,000. The
equivalent fixed rate debt instrument provides for monthly payments of
interest at 3 percent, compounded monthly, for the first year ($250 per
month) and monthly payments of interest at 4 percent, compounded
monthly, for the last 3 years ($333.33 per month).
(iii) De minimis OID. Under Sec. 1.1273-1(a), because a portion (100
basis points) of each interest payment in the final 3 years is not a
qualified stated interest payment, the equivalent fixed rate debt
instrument has OID of $2,999.88 ($102,999.88 -$100,000). However, under
Sec. 1.1273-1(d)(4) (the de minimis rule relating to teaser rates and
interest holidays), the stated redemption price at maturity of the
equivalent fixed rate debt instrument is $100,999.96 ($100,000 (issue
price) plus $999.96 (the greater of the amount of foregone interest
($999.96) and the amount equal to the excess of the instrument's stated
principal amount over its issue price ($0)). Thus, the equivalent fixed
rate debt instrument is treated as having OID of $999.96 ($100,999.96 -
$100,000). Because this amount is less than the de minimis amount of
$1,010 (0.0025 multiplied by $100,999.96 multiplied by 4 complete years
to maturity), the equivalent fixed rate debt instrument has de minimis
OID. Therefore, the variable rate debt instrument has zero OID and all
stated interest payments are qualified stated interest payments.
Example 3. Adjustment to qualified stated interest for actual
payment of interest--(i) Facts. On January 1, 1995, Z purchases at
original issue, for $90,000, a variable rate debt instrument that
matures on January 1, 1997, and has a stated principal amount of
$100,000, payable at maturity. The debt instrument provides for annual
payments of interest on
[[Page 576]]
January 1 of each year, beginning on January 1, 1996. The amount of
interest payable is the value of annual LIBOR on the payment date. The
value of annual LIBOR on January 1, 1995, and January 1, 1996, is 5
percent, compounded annually. The value of annual LIBOR on January 1,
1997, is 7 percent, compounded annually.
(ii) Accrual of OID and qualified stated interest. Under paragraph
(e)(2) of this section, the variable rate debt instrument is treated as
a 2-year debt instrument that has an issue price of $90,000, a stated
principal amount of $100,000, and interest payments of $5,000 at the end
of each year. The debt instrument has $10,000 of OID and the annual
interest payments of $5,000 are qualified stated interest payments.
Under Sec. 1.1272-1, the debt instrument has a yield of 10.82 percent,
compounded annually. The amount of OID allocable to the first annual
accrual period (assuming Z uses annual accrual periods) is $4,743.25
(($90,000x.1082)- $5,000), and the amount of OID allocable to the second
annual accrual period is $5,256.75 ($100,000-$94,743.25). Under
paragraph (e)(2)(iii) of this section, the $2,000 difference between the
$7,000 interest payment actually made at maturity and the $5,000
interest payment assumed to be made at maturity under the equivalent
fixed rate debt instrument is treated as additional qualified stated
interest for the period.
(4) Variable rate debt instrument that provides for a single fixed
rate--(i) General rule. If a variable rate debt instrument provides for
stated interest either at one or more qualified floating rates or at a
qualified inverse floating rate and in addition provides for stated
interest at a single fixed rate (other than an initial fixed rate
described in paragraph (a)(3)(ii) of this section), the amount of
interest and OID are determined using the method of paragraph (e)(3) of
this section, as modified by this paragraph (e)(4). For purposes of
paragraphs (e)(3)(i) through (e)(3)(iii) of this section, the variable
rate debt instrument is treated as if it provided for a qualified
floating rate (or a qualified inverse floating rate, if the debt
instrument provides for a qualified inverse floating rate), rather than
the fixed rate. The qualified floating rate (or qualified inverse
floating rate) replacing the fixed rate must be such that the fair
market value of the variable rate debt instrument as of the issue date
would be approximately the same as the fair market value of an otherwise
identical debt instrument that provides for the qualified floating rate
(or qualified inverse floating rate) rather than the fixed rate.
(ii) Example. The following example illustrates the rule in
paragraph (e)(4)(i) of this section.
Example: Variable rate debt instrument that provides for a single
fixed rate--(i) Facts. On January 1, 1995, X purchases at original
issue, for $100,000, a variable rate debt instrument that matures on
January 1, 2001, and that has a stated principal amount of $100,000. The
debt instrument provides for payments of interest on January 1 of each
year, beginning on January 1, 1996. For the first 4 years, the interest
rate is 4 percent, compounded annually, and for the last 2 years the
interest rate is the value of 1-year LIBOR, as of the payment date, plus
200 basis points. On January 1, 1995, the value of 1-year LIBOR is 2
percent, compounded annually. In addition, assume that on January 1,
1995, the variable rate debt instrument has approximately the same fair
market value as an otherwise identical debt instrument that provides for
an interest rate equal to the value of 1-year LIBOR, as of the payment
date, for the first 4 years.
(ii) Equivalent fixed rate debt instrument. Under paragraph
(e)(4)(i) of this section, for purposes of paragraphs (e)(3)(i) through
(e)(3)(iii) of this section, the variable rate debt instrument is
treated as if it provided for an interest rate equal to the value of 1-
year LIBOR, as of the payment date, for the first 4 years. Under
paragraph (e)(3)(ii) of this section, the equivalent fixed rate debt
instrument for the variable rate debt instrument is a 6-year debt
instrument that has an issue price and stated principal amount of
$100,000. The equivalent fixed rate debt instrument provides for
interest payments of $2,000 for the first 4 years and $4,000 for the
last 2 years.
(iii) Accrual of OID and qualified stated interest. Under
Sec. 1.1273-1, the equivalent fixed rate debt instrument has OID of
$4,000 because a portion (200 basis points) of each interest payment in
the last 2 years is not a qualified stated interest payment. The $4,000
of OID is allocable over the 6-year term of the debt instrument under
Sec. 1.1272-1. Under paragraph (e)(3)(iv) of this section, the
difference between the $4,000 payment made in the first 4 years and the
$2,000 payment assumed to be made on the equivalent fixed rate debt
instrument in those years is an adjustment to qualified stated interest.
In addition, any difference between the amount actually paid in each of
the last 2 years and the $4,000 payment assumed to be made on the
equivalent fixed rate debt instrument is an adjustment to qualified
stated interest.
(f) Special rule for certain reset bonds. Notwithstanding paragraph
(e) of this
[[Page 577]]
section, this paragraph (f) provides a special rule for a variable rate
debt instrument that provides for stated interest at a fixed rate for an
initial interval, and provides that on the date immediately following
the end of the initial interval (the effective date) the stated interest
rate will be a rate determined under a procedure (such as an auction
procedure) so that the fair market value of the instrument on the
effective date will be a fixed amount (the reset value). Solely for
purposes of calculating the accrual of OID, the variable rate debt
instrument is treated as--
(1) Maturing on the date immediately preceding the effective date
for an amount equal to the reset value; and
(2) Reissued on the effective date for an amount equal to the reset
value.
[T.D. 8517, 59 FR 4827, Feb. 2, 1994, as amended by T.D. 8674, 61 FR
30153, June 14, 1996]