Rev. Rul. 70-645

Advice has been requested as to the interest equalization tax consequences of "tier borrowing" in overseas financing arrangements under the circumstances described below.

X, a domestic corporation, had foreign operating subsidiaries in need of additional capital. In order to obtain such capital X formed Y, also a domestic corporation, as a wholly-owned subsidiary. X contributed 3,000x dollars to the capital of Y and Y in turn sold 15,000x dollars of 20-year debt obligations to foreign persons through a public offering in foreign countries and invested or loaned 7,000x dollars of the funds thus derived to the foreign affiliates of X. The debt obligations thus issued are deemed to be debt obligations of a foreign obligor since the domestic subsidiary was a corporation "formed or availed of" for purposes described in section 4912(b)(3) of the Internal Revenue Code of 1954. Payments of the principal and interest on the debt obligations were guaranteed by X, so that in the event Y failed to make punctually any such payments, X would cause such payment to be made.

It was determined that the debt obligations sold were those of Y, the domestic subsidiary and that interest paid by Y on such debt obligation would be interest paid on a bona fide indebtedness of Y so long as such debenture was held by a person other than X or its affiliates.

Y, subsequent to the transaction described above, formed Z, a wholly-owned subsidiary incorporated under the laws of Switzerland solely for the purpose of borrowing on a short-term basis in foreign countries. Y contributed 5,000x dollars to the capital of Z and Z borrowed 25,000x dollars abroad on a short-term basis which Z, in turn, used solely to supply short-term financing to the foreign operating subsidiaries of X. There was no guarantee of Z's obligation as to the repayment of principal and interest from either X or Y or any related affiliates. All financing of third party obligations was with full recourse against Z. The foreign lenders would loan to Z an amount up to approximately twice its capital. Therefore, amounts borrowed in excess of 10,000x dollars required collateral which was satisfied by notes of the foreign operating subsidiaries, with varying maturities, received by Z in return for funds loaned to them by Z. These notes were, in turn, directly discounted with the foreign lenders, with recourse on Z. The collateral provided did not exceed the amount of the loans to Z. As the notes of the operating companies mature and are paid to Z, the latter will, in turn, pay the foreign lenders and reduce its loan. The notes will be cancelled and returned to the operating companies.

Solely for purposes of the interest equalization tax and certain income tax purposes, debt obligations issued by wholly-owned financing subsidiaries of domestic parent corporations will be deemed to be indebtedness of such subsidiaries if the amount borrowed by the financing subsidiary does not exceed five times it equity capital. See Rev. Rul. 69-377, C.B. 1969-2, 231.

The issue herein is whether the amount borrowed by Y, the domestic financing subsidiary (15,000x dollars) and Z (25,000x dollars) the Swiss financing subsidiary wholly-owned by Y, must be lumped together in computing the relevant debt-to-equity ratio of Y.

Under the circumstances of this case, if there are no guarantees (including but not limited to, any direct or indirect guarantee agreements, pledges, or hypothecation) given by X, the domestic parent corporation, Y, the domestic financing subsidiary of X, or any of their domestic or foreign affiliates or subsidiaries with respect to loans by foreign lenders made to Z, the foreign financing subsidiary, and the collateral which may be provided by the foreign subsidiaries of X does not exceed the amount of loans made to Z, the 5,000x dollars equity investment by Y in Z will not adversely affect the 5 to 1 debt-to-equity ratio of Y.

Accordingly, in the instant case, the interest paid by Y on each debt obligation issued by Y will be considered to be interest paid on the bona fide indebtedness of Y so long as such debt obligation is held by a person other than X or its affiliates.