Final consolidated return regs. on transactions involving intercompany debt.

• Author: Kegerreis, Angela

On December 24, 2008, the IRS issued final regulations for transactions involving debt obligations between members of a consolidated group (T.D. 9442). These regulations replace former Regs. Sec. 1.1502-13(g) and apply to three types of transactions: inbound, outbound, and intragroup.

An intragroup transaction involves the assignment or extinguishment of an intercompany obligation between two members of a consolidated group. An inbound transaction is a transaction that involves a member entering into an obligation with a nonmember that then becomes an intercompany obligation. Finally, an outbound transaction occurs when an intercompany obligation leaves the consolidated group.

Under the former and current regulations, the obligations involved in each type of transaction are deemed satisfied and reissued as a new obligation. This is referred to as the "deemed satisfaction-reissuance model."

Under the current regulations, the deemed satisfaction-reissuance model separates the deemed transaction from the actual transaction. A series of events is deemed to occur separate and distinct from the actual transaction. The obligation must be considered satisfied by the debtor for a cash amount equal to its fair market value (FMV) and then reissued to the creditor for the same amount. As a result, the participants engage in the actual transaction but with a new obligation.

Regs. Sec. 1.1502-13(g)(7), Example (10), illustrates the current deemed satisfaction-re-issuance model in the case of an outbound transaction, as follows:

Example 1: On January 1 of year 1, B borrows $100 from X in return for B's note providing for $10 of interest annually at the end of each year and repayment of $100 at the end of year 5. As of January 1 of year 3, B has fully performed its obligations, but the note's FMV is $70, reflecting an increase in prevailing market interest rates. On January 1 of year 3, P (the parent of the consolidated group that includes B) buys all of X's stock. B is solvent within the meaning of Sec. 108(d)(3).

Immediately after it becomes an intercompany obligation, B's note is treated as satisfied for its FMV. X's $30 capital loss and B's discharge of indebtedness income of the same amount are both taken into account in determining the consolidated taxable income for year 3. B is treated as issuing a new note to X with a $70 issue price and a $100 stated redemption price at maturity. The $30 original issue discount (OID) is taken into account as...