Final Regs on Indebtedness Acquired by a Related Party

 [4830-01]

 ACTION: Final regulations.

 SUMMARY: This document contains final income tax regulations under section 108(e)(4) of the Internal Revenue Code of 1986. These regulations provide rules concerning the acquisition of outstanding indebtedness by a person related to the debtor from a person who is not related to the debtor. These regulations provide that the acquisition of outstanding indebtedness by a person related to the debtor from a person who is not related to the debtor results in the realization by the debtor of income from discharge of indebtedness (to the extent required by section 61(a)(12) and section 108). This rule also applies to transactions in which a holder of outstanding indebtedness becomes related to the debtor, if the holder acquired the indebtedness in anticipation of becoming related to the debtor.

 DATES: The regulations are effective on December 28, 1992, and apply to direct or indirect acquisitions of indebtedness occurring on or after March 21, 1991.

 FOR FURTHER INFORMATION CONTACT: Victor L. Penico at (202) 622-7750 or Sharon L. Hall at (202) 622-4930 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

BACKGROUND

On March 22, 1991, the Internal Revenue Service published a notice of proposed rulemaking in the Federal Register (56 FR 12135) regarding the tax treatment of the acquisition of indebtedness by a person related to the debtor under section 108(e)(4). The preamble to that notice contains an explanation of the proposed rules. A public hearing was held on June 3, 1991. After consideration of the public comments regarding the proposed regulations, the regulations are adopted as revised by this Treasury decision.

EXPLANATION OF STATUTORY PROVISIONS

 Under section 61(a)(12) of the Internal Revenue Code (Code), gross income includes income from discharge of indebtedness. Section 108(e)(4)(A) provides that for purposes of determining income from discharge of indebtedness, to the extent provided in regulations prescribed by the Secretary, the acquisition of outstanding indebtedness by a person bearing a relationship to the debtor specified in section 267(b) or 707(b)(1) from a person who does not bear such a relationship to the debtor is treated as the acquisition of such indebtedness by the debtor. Thus, to the extent required by section 61(a)(12) and section 108, the debtor realizes discharge of indebtedness income upon the acquisition of its debt at a discount by a related party from an unrelated party.

 Section 108(e)(4) was enacted by section 2(a) of the Bankruptcy Tax Act of 1980 (Pub. L. No. 96-589, 94 Stat. 3389, 3392) to prevent taxpayers from avoiding discharge of indebtedness through acquisitions of outstanding indebtedness by related parties. The legislative history notes that, under prior law, "a related party (such as the parent corporation of a debtor) can acquire the taxpayer's debt at a discount and effectively eliminate it as a real liability to outside interests, but the debtor thereby avoids the tax treatment which would apply if the debtor had directly retired the debt by repurchasing it." H. Rep. No. 96-833, 96th Cong., 2d Sess. 9 (1980); S. Rep. No. 96-1035, 96th Cong., 2d Sess. 10 (1980)(the Senate Report).

PUBLIC COMMENTS

 A significant number of comments were received from the public on the scope and content of the proposed regulations. The following discussion summarizes the principal comments made, as well as the changes made in the final regulations in response to those comments.

 DIRECT AND INDIRECT ACQUISITIONS. Under the proposed regulations, section 108(e)(4) applies if indebtedness is acquired in a direct acquisition or an indirect acquisition. A direct acquisition occurs where a person related to the debtor acquires the indebtedness from a person unrelated to the debtor. An indirect acquisition is a transaction in which a holder of outstanding indebtedness becomes related to the debtor, if the holder acquired the indebtedness in anticipation of becoming related to the debtor.

 The final regulations provide that the Service may exclude certain transactions from the definition of a direct acquisition through the issuance of subsequent published guidance. In response to comments received, the Service intends to study the extent, if any, to which a direct acquisition should not occur if the indebtedness and an ownership interest in the debtor are acquired together from the same person, and that person was related to the debtor immediately prior to the transaction.

 Some commentators argued that the Secretary does not have the regulatory authority to apply section 108(e)(4) to indirect acquisitions, particularly where the holder acquires the debtor (because the holder then retains the power to require payment of the debt). However, the Service and Treasury continue to believe that section 108(e)(4) applies to indirect acquisitions of the type covered by these regulations.

 Under the proposed regulations, a holder is treated as having acquired indebtedness in anticipation of becoming related to the debtor, (1) if the holder acquired the indebtedness less than 6 months before the date the holder becomes related to the debtor or, (2) if, on the date the holder becomes related to the debtor, indebtedness of the debtor represents more than 25 percent of the fair market value of the total gross assets of the holder or of the holder group (the 25 percent test). Under the proposed regulations, a holder is presumed to have acquired indebtedness in anticipation of becoming related to the debtor if the holder acquired the indebtedness 6 months or more before the date the holder becomes related to the debtor but less than 24 months before that date (the 6 to 24 month test). This presumption is rebutted if the holder establishes that the acquisition was not made in anticipation of becoming related to the debtor.

 A number of comments were received with respect to these rules. Several commentators criticized the proposed regulations for not permitting the debtor to establish that the acquisition was not made in anticipation of becoming related to the debtor under the 25 percent test. Others suggested that certain transactions should be excepted from the test. In response to these comments, the final regulations eliminate the presumptions relating to the 25 percent test and 6 to 24 month test. In those cases, the determination as to whether the acquisition was in anticipation of becoming related to the debtor will be based on the facts and circumstances of the particular case. However, if either the 25 percent test or the 6 to 24 month test is met and the debtor does not treat the transaction as an indirect acquisition, the final regulations require the debtor to disclose the circumstances of the acquisition on its income tax return (or on a qualified amended return within the meaning of section 1.6664-2(c)(3)) for the taxable year in which the debtor becomes related to the holder. This disclosure is in addition to any applicable disclosure required under section 6662, 6664 or 6694. If the debtor fails to make this disclosure in a timely manner, the holder will be presumed to have acquired the indebtedness in anticipation of becoming related to the debtor.

 The final regulations also make technical changes in the mechanics of the 25 percent test and with respect to the tacking of holding periods for measuring the time elapsed from the date of the acquisition of the indebtedness until the date the holder becomes related to the debtor.

 MEASURE OF DISCHARGE OF INDEBTEDNESS INCOME. The proposed regulations provide that in a direct or indirect acquisition, discharge of indebtedness income is measured by reference to the fair market value of the indebtedness. Several commentators urged that the amount of discharge of indebtedness should be measured by reference to the related holder's cost of acquiring the indebtedness.

 In most cases (for example, where an affiliate of the debtor buys the indebtedness for cash), the holder's cost should equal, or at least approximate, the fair market value of the indebtedness. However, disparities could potentially arise in three significant cases. One is where the related party acquires the indebtedness in exchange for its own indebtedness (a debt swap) and the issue price of the related party's indebtedness is not determined by reference to the fair market value of either instrument. Another is in an indirect acquisition, where the value of the indebtedness can change between the time the holder acquires the indebtedness and the time the holder becomes related to the debtor. The third is where the indebtedness is acquired in a nonrecognition transaction, in which case the holder's basis generally reflects the transferor's earlier cost rather than the current economic cost to the debtor group of acquiring the indebtedness.

 The proponents of a cost standard argued that the treatment of an indebtedness acquired by a related person under section 108(e)(4) should mirror the treatment of an acquisition of indebtedness by the debtor itself. In the latter case, under section 1.61-12 and section 108(e)(11), the amount of income from discharge of indebtedness is generally determined by reference to the debtor's cost of acquiring the indebtedness.

 As noted above, in most cases subject to section 108(e)(4), the cost and fair market value standards should produce similar results. The Service and Treasury believe that, where the two standards would differ, the correct economic measure of the cost of acquiring the debt (and, thus, of discharge of indebtedness income) is by reference to fair market value. However, the Service and Treasury have concluded that, in most circumstances, the related holder's cost of acquiring the indebtedness is a reasonable measure for determining the amount of discharge of indebtedness income. For example, because discharge of indebtedness income in debt swaps by the debtor is measured by reference to the debtor's cost rather than always measured by reference to fair market value, the Service and Treasury are persuaded that the cost standard should generally apply in debt swaps by debtor affiliates. Moreover, the use of cost is significantly less burdensome because it eliminates the need to value the indebtedness.

 Consequently, the final regulations adopt a cost standard in computing discharge of indebtedness income for most transactions subject to section 108(e)(4). Except in certain special cases, this rule applies as long as the related holder (or a holder that becomes related to the debtor) acquires the debt "by purchase" on or less than six months before the acquisition date. For this purpose, a purchase occurs if the indebtedness in the hands of the holder is not substituted basis property within the meaning of section 7701(a)(42) (e.g., if the holder has a cost basis under section 1012 or a fair market value basis under section 301(d)).

 Where the holder's basis is not established by purchase within the six month period, the final regulations retain the fair market value measuring standard. In that case, the holder's cost of acquiring the indebtedness provides a less reliable measure of the debtor's discharge of indebtedness, i.e., that cost would be less likely to bear a reasonable relationship to the fair market value of the debt and, thus, to the economic cost to the debtor group of reacquiring its debt. It is expected that this rule will apply infrequently because of the limited scope of the indirect acquisition rules.

 The final regulations reserve on the treatment of an acquisition of indebtedness in a nonrecognition transaction, such as a merger of the creditor into a subsidiary of the debtor in a reorganization under section 368(a)(1)(A). As stated in the preamble to the proposed regulations, the Treasury Department intends to issue regulations clarifying the measurement and treatment of income from discharge of indebtedness in certain nonrecognition transactions in which the debtor acquires its own indebtedness, or the creditor assumes a debtor's obligation to the creditor. It is anticipated that those regulations will also provide guidance on the amount of discharge of indebtedness income in a nonrecognition transaction that constitutes a direct or indirect acquisition of debt under section 108(e)(4).

 The final regulations also provide that discharge of indebtedness income is measured by the fair market value of the indebtedness if a principal purpose of the acquisition is the avoidance of federal income tax. Such an avoidance purpose may be inferred, for example, in a transaction that shifts the discharge of indebtedness income of a domestic corporation to a foreign affiliate.

 DEEMED ISSUANCE. In general, the proposed regulations treat indebtedness acquired in a direct or indirect acquisition as new indebtedness of the debtor for all purposes of the Code with an issue price equal to its fair market value. This deemed issuance creates original issue discount (OID) that is generally deductible by the debtor and includible in income by the related holder. To correlate with the revised measure of discharge of indebtedness income in a section 108(e)(4) transaction, the final regulations provide that the issue price of the new indebtedness is equal to the amount used to compute the debtor's discharge of indebtedness. As discussed above, this amount is generally the related holder's cost of acquiring the indebtedness but, in certain cases, may be the fair market value of the indebtedness.

 As noted above, under the proposed regulations, the deemed issuance applies for all purposes of the Code. In the preamble to the proposed regulations, the Service invited comments on whether the deemed issuance should not apply for purposes of specific provisions of the Code. Several commentators argued that the deemed issuance should not apply for purposes of the applicable high yield discount obligation (AHYDO) rules of section 163(e)(5) and the earnings stripping rules of section 163(j).

 The final regulations provide that the Commissioner may provide by Revenue Procedure or other published guidance that the indebtedness is not treated as newly issued indebtedness for purposes of designated provisions of the income tax laws. The Service and Treasury are currently of the view that providing an exception from section 163(j) (or its effective date provisions) would permit taxpayers to convert non-earnings stripping debt into earnings stripping debt, and do not contemplate providing relief for that case. The Service is studying the possibility of publishing guidance with respect to other contexts (including AHYDO) and invites comments as to where the deemed issuance results in inappropriate consequences.

 TREATMENT OF THE HOLDER IN AN INDIRECT ACQUISITION. The proposed regulations treat the holder of indebtedness in an indirect acquisition as if it sold the indebtedness to an unrelated party on the day before the acquisition date for an amount of money equal to the fair market value of the indebtedness on the acquisition date (deemed sale rule).

 Comments were received to the effect that the holder should not be treated as selling the indebtedness, and that the holder's basis in the indebtedness should be treated as acquisition premium that offsets the OID to be earned by the holder as a result of the deemed issuance.

 By adopting cost as the measuring standard for discharge of indebtedness income for most transactions under section 108(e)(4), the final regulations have substantially diminished the underlying basis for the deemed sale rule. Even where the final regulations measure discharge of indebtedness income by reference to the fair market value of the indebtedness, the Service and Treasury have concluded, in response to the comments received, that it is appropriate not to cause the holder to recognize gain or loss, and instead to treat the holder's basis as acquisition premium that offsets the OID otherwise includible as a result of the deemed issuance.

 Accordingly, the final regulations have eliminated the deemed sale rule. In addition, the final regulations provide that the related holder does not recognize any gain or loss on the deemed issuance and its adjusted basis in the indebtedness is equal to its adjusted basis immediately before the deemed issuance. The deemed issuance is treated as a purchase of the indebtedness by the related holder for purposes of sections 1272(a)(7) and 1276, enabling the holder to use any basis in excess of the new issue price as an offset against the OID of the reissued indebtedness.

 SUBSEQUENT DISPOSITIONS. Under the proposed regulations, the deemed issuance rule continues to apply after the related holder disposes of the indebtedness to an unrelated holder or ceases to be related to the debtor. Under this rule, the debtor continues to deduct and the unrelated holder must include in income the OID attributable to the deemed issuance. The preamble to the proposed regulations requested comments whether a different rule should apply, e.g., a rule that suspends the debtor's deduction of OID (and does not require holder inclusion) attributable to the deemed issuance until maturity.

 Although one commentator partially endorsed the alternative proposal, the final regulations retain the rule of the proposed regulations. The Service and Treasury believe that a subsequent disposition of the indebtedness by a related party would not be a common business transaction. Thus, the complexity involved in the alternative proposal was not considered justified.

 Under the final regulations, a special anti-abuse rule applies to certain subsequent dispositions of indebtedness by the related holder if the related holder acquired the indebtedness in exchange for its own indebtedness and the issue price of the related holder's indebtedness is not determined by reference to fair market value.

 As noted above, the final regulations generally measure discharge of indebtedness income under section 108(e)(4) by reference to the holder's cost. This rule was adopted, in part, to provide parity with the treatment that would apply if the debtor acquired its own indebtedness in exchange for new indebtedness. However, in the situation outlined above, absent this special rule, the debtor group might be able to obtain better treatment than would be available if the debtor acquired its own debt in exchange for its indebtedness and then resold its acquired obligation (which, for income tax purposes, would be treated as the issuance of a new obligation). In that case, the timing of the debtor's deductions with respect to the newly issued indebtedness (stated interest or OID) would match that of the holders' income inclusion. By contrast, in the transaction outlined above, the debtor group would have the benefit of a current deduction (the related holder's loss on the disposition of the indebtedness) while the unrelated holder would generally defer its corresponding market discount income until the debt is satisfied.

 Accordingly, under the anti-abuse rule, the related holder's loss is deferred until the date the debtor retires the indebtedness. Comparable treatment is also provided for less direct forms of disposition (e.g., where the holder contributes the indebtedness to a subsidiary and either the subsidiary sells the debt or the former holder sells the subsidiary) that would otherwise result in a tax benefit similar to the loss.

 MISCELLANEOUS COMMENTS. Additional comments were received from the public. The Service and Treasury were requested, among other things, to provide a de minimis dollar exception to the application of section 108(e)(4), to clarify the applicability of the stock-for- debt exception to cancellation of indebtedness income, and to clarify the treatment of the acquisition by an affiliate of portions of stripped bonds. The Service and Treasury concluded that a de minimis exception would not be appropriate and would add undue complexity (including aggregation rules and similar provisions).

 The regulations (both proposed and final) require the realization of income "to the extent required by section 61(a)(12) and section 108." They do not address the extent to which the stock- for-debt exception might apply when a person related to the debtor issues its stock in exchange for the indebtedness. The Service is currently working on guidance regarding triangular stock-for-debt exchanges within a consolidated return context.

 The question regarding coupon stripping transactions should be addressed with respect to acquisitions by the debtor as well as by its affiliates. Accordingly, it is believed that such guidance should await future guidance under section 1286 generally.

 Additional comments were received prior to the publication of the proposed regulations as to the scope of the relationship rules. However, the Service and Treasury believe it would be inappropriate to address the scope of section 267(b) or 707(b) solely in the context of section 108(e)(4) and, thus, those issues are not addressed in the final regulations.

 EFFECTIVE DATES. The proposed regulations state that the regulations are proposed to apply to direct or indirect acquisitions on or after March 21, 1991. In addition, the proposed regulations state that section 108(e)(4) is effective for any transaction after December 31, 1980, subject to the rules of section 7 of the Bankruptcy Tax Act of 1980 (Pub. L. No. 96-589, 94 Stat. 3389, 3411). Several commentators argued that the statute should not be considered effective before the effective date of regulations because the statutory language of section 108(e)(4) states that the section applies to the extent provided in regulations.

 It remains the position of the Service and Treasury that section 108(e)(4) is effective from the date of its enactment. The statutory language of section 108(e)(4) is reasonably clear in its primary application. However, the final regulations clarify that taxpayers may use any reasonable method of determining the amount of discharge of indebtedness income and the treatment of correlative adjustments for acquisitions of indebtedness before March 21, 1991, if such method is applied consistently by both the debtor and related holder. In addition, pursuant to a notice being published separately in the Internal Revenue Bulletin, the Service will permit taxpayers to apply the proposed regulations to acquisitions occurring on or after March 21, 1991 and before December 28, 1992.

SPECIAL ANALYSES

 These rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. It has also been determined that section 553(b) of the Administrative Procedures Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to any part of these regulations other than section 1.108-2(g). Furthermore, the rules of section 1.108-2(g) generally apply only to extraordinary transactions, primarily by larger issuers of indebtedness and their affiliates. Thus, they will generally not have a significant impact on a substantial number of small entities, nor will they significantly alter the reporting or recordkeeping duties of small entities. Therefore, although this Treasury decision was preceded by a notice of proposed rulemaking that solicited public comments, a final Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f)(1) of the Internal Revenue Code, the notice of proposed rulemaking for the regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small businesses.

DRAFTING INFORMATION

 The principal authors of these regulations are Victor L. Penico of the Office of Assistant Chief Counsel (Corporate), Internal Revenue Service, and Sharon L. Hall of the Office of Assistant Chief Counsel (Income Tax and Accounting), Internal Revenue Service. Other personnel from the Internal Revenue Service and the Treasury Department participated in their development.

LIST OF SUBJECTS IN 26 CFR 1.101-1 THROUGH 1.133-1T

 Income taxes, Reporting and recordkeeping requirements.

Treasury Decision 8460

ADOPTION OF AMENDMENTS TO FINAL REGULATIONS

Accordingly, 26 CFR part 1 is amended as follows:

PART 1 -- INCOME TAX; TAXABLE YEAR BEGINNING AFTER DECEMBER 31, 1953

Paragraph 1. The authority citation for part 1 is amended by adding the following citation:

Authority: 26 U.S.C. 7805 * * * Section 1.108-2 also issued under 26 U.S.C. 108. * * *

Par. 2. Section 1.108-2 is added to read as follows:

SECTION 1.108-2 ACQUISITION OF INDEBTEDNESS BY A PERSON RELATED TO THE DEBTOR.

(a) GENERAL RULES. The acquisition of outstanding indebtedness by a person related to the debtor from a person who is not related to the debtor results in the realization by the debtor of income from discharge of indebtedness (to the extent required by section 61(a)(12) and section 108) in an amount determined under paragraph (f) of this section. Income realized pursuant to the preceding sentence is excludible from gross income to the extent provided in section 108(a). The rules of this paragraph apply if indebtedness is acquired directly by a person related to the debtor in a direct acquisition (as defined in paragraph (b) of this section) or if a holder of indebtedness becomes related to the debtor in an indirect acquisition (as defined in paragraph (c) of this section).

(b) DIRECT ACQUISITION. An acquisition of outstanding indebtedness is a direct acquisition under this section if a person related to the debtor (or a person who becomes related to the debtor on the date the indebtedness is acquired) acquires the indebtedness from a person who is not related to the debtor. Notwithstanding the foregoing, the Commissioner may provide by Revenue Procedure or other published guidance that certain acquisitions of indebtedness described in the preceding sentence are not direct acquisitions for purposes of this section.

(c) INDIRECT ACQUISITION -- (1) IN GENERAL. An indirect acquisition is a transaction in which a holder of outstanding indebtedness becomes related to the debtor, if the holder acquired the indebtedness in anticipation of becoming related to the debtor.

(2) PROOF OF ANTICIPATION OF RELATIONSHIP. In determining whether indebtedness was acquired by a holder in anticipation of becoming related to the debtor, all relevant facts and circumstances will be considered. Such facts and circumstances include, but are not limited to, the intent of the parties at the time of the acquisition, the nature of any contacts between the parties (or their respective affiliates) before the acquisitions, the period of time for which the holder held the indebtedness, and the significance of the indebtedness in proportion to the total assets of the holder group (as defined in paragraph (c)(5) of this section). For example, if a holder acquired the indebtedness in the ordinary course of its portfolio investment activities and the holder's acquisition of the indebtedness preceded any discussions concerning the acquisition of the holder by the debtor (or by a person related to the debtor) or the acquisition of the debtor by the holder (or by a person related to the holder), as the case may be, these facts, taken together, would ordinarily establish that the holder did not acquire the indebtedness in anticipation of becoming related to the debtor. The absence of discussions between the debtor and the holder (or their respective affiliates), however, does not by itself establish that the holder did not acquire the indebtedness in anticipation of becoming related to the debtor (if, for example, the facts and circumstances show that the holder was considering a potential acquisition of or by the debtor, or the relationship is created within a relatively short period of time of the acquisition, or the indebtedness constitutes a disproportionate portion of the holder group's assets).

(3) INDEBTEDNESS ACQUIRED WITHIN 6 MONTHS OF BECOMING RELATED. Notwithstanding any other provision of this paragraph (c), a holder of indebtedness is treated as having acquired the indebtedness in anticipation of becoming related to the debtor if the holder acquired the indebtedness less than 6 months before the date the holder becomes related to the debtor.

(4) DISCLOSURE OF POTENTIAL INDIRECT ACQUISITION -- (i) IN GENERAL. If a holder of outstanding indebtedness becomes related to the debtor under the circumstances described in paragraph (c)(4)(ii) or (iii) of this section, the debtor is required to attach the statement described in paragraph (c)(4)(iv) of this section to its tax return (or to a qualified amended return within the meaning of section 1.6664-2(c)(3)) for the taxable year in which the debtor becomes related to the holder, unless the debtor reports its income on the basis that the holder acquired the indebtedness in anticipation of becoming related to the debtor. Disclosure under this paragraph (c)(4) is in addition to, and is not in substitution for, any disclosure required to be made under section 6662, 6664 or 6694.

(ii) INDEBTEDNESS REPRESENTS MORE THAN 25 PERCENT OF HOLDER GROUP'S ASSETS -- (A) IN GENERAL. Disclosure under this paragraph (c)(4) is required if, on the date the holder becomes related to the debtor, indebtedness of the debtor represents more than 25 percent of the fair market value of the total gross assets of the holder group (as defined in paragraph (c)(5) of this section).

(B) DETERMINATION OF TOTAL GROSS ASSETS. In determining the total gross assets of the holder group, total gross assets do not include any cash, cash item, marketable stock or security, short-term indebtedness, option, futures contract, notional principal contract, or similar item (other than indebtedness of the debtor), nor do total gross assets include any asset in which the holder has substantially reduced its risk of loss. In addition, total gross assets do not include any ownership interest in or indebtedness of a member of the holder group.

(iii) INDEBTEDNESS ACQUIRED WITHIN 6 TO 24 MONTHS OF BECOMING RELATED. Disclosure under this paragraph (c)(4) is required if the holder acquired the indebtedness 6 months or more before the date the holder becomes related to the debtor, but less than 24 months before that date.

(iv) CONTENTS OF STATEMENT. A statement under this paragraph (c)(4) must include the following --

(A) A caption identifying the statement as disclosure under section 1.108-2(c);

(B) An identification of the indebtedness with respect to which disclosure is made;

(C) The amount of such indebtedness and the amount of income from discharge of indebtedness if section 108(e)(4) were to apply;

(D) Whether paragraph (c)(4)(ii) or (iii) of this section applies to the transaction; and

(E) A statement describing the facts and circumstances supporting the debtor's position that the holder did not acquire the indebtedness in anticipation of becoming related to the debtor.

(v) FAILURE TO DISCLOSE. In addition to any other penalties that may apply, if a debtor fails to provide a statement required by this paragraph (c)(4), the holder is presumed to have acquired the indebtedness in anticipation of becoming related to the debtor unless the facts and circumstances clearly establish that the holder did not acquire the indebtedness in anticipation of becoming related to the debtor.

(5) HOLDER GROUP. For purposes of this paragraph (c), the holder group consists of the holder of the indebtedness and all persons who are both --

(i) Related to the holder before the holder becomes related to the debtor; and

(ii) Related to the debtor after the holder becomes related to the debtor.

(6) HOLDING PERIOD -- (i) SUSPENSIONS. The running of the holding periods set forth in paragraphs (c)(3) and (c)(4)(iii) of this section is suspended during any period in which the holder or any person related to the holder is protected (directly or indirectly) against risk of loss by an option, a short sale, or any other device or transaction.

(ii) TACKING. For purposes of paragraphs (c)(3) and (c)(4)(iii) of this section, the period for which a holder held the debtor's indebtedness includes --

(A) The period for which the indebtedness was held by a corporation to whose attributes the holder succeeded pursuant to section 381; and

(B) The period (ending on the date on which the holder becomes related to the debtor) for which the indebtedness was held continuously by members of the holder group (as defined in paragraph (c)(5) of this section).

(d) DEFINITIONS -- (1) ACQUISITION DATE. For purposes of this section, the acquisition date is the date on which a direct acquisition of indebtedness or an indirect acquisition of indebtedness occurs.

(2) RELATIONSHIP. For purposes of this section, persons are considered related if they are related within the meaning of sections 267(b) or 707 (b)(1). However --

(i) Sections 267(b) and 707(b)(1) are applied as if section 267 (c)(4) provided that the family of an individual consists of the individual's spouse, the individual's children, grandchildren, and parents, and any spouse of the individual's children or grandchildren; and

(ii) Two entities that are treated as a single employer under subsection (b) or (c) of section 414 are treated as having a relationship to each other that is described in section 267(b).

(e) EXCEPTIONS -- (1) INDEBTEDNESS RETIRED WITHIN ONE YEAR. This section does not apply to a direct or indirect acquisition of indebtedness with a stated maturity date on or before the date that is one year after the acquisition date, if the indebtedness is, in fact, retired on or before its stated maturity date.

(2) ACQUISITIONS BY SECURITIES DEALERS. (i) This section does not apply to a direct acquisition or an indirect acquisition of indebtedness by a dealer that acquires and disposes of such indebtedness in the ordinary course of its business of dealing in securities if --

(A) The dealer accounts for the indebtedness as a security held primarily for sale to customers in the ordinary course of business;

(B) The dealer disposes of the indebtedness (or it matures while held by the dealer) within a period consistent with the holding of the indebtedness for sale to customers in the ordinary course of business, taking into account the terms of the indebtedness and the conditions and practices prevailing in the markets for similar indebtedness during the period in which it is held; and

(C) The dealer does not sell or otherwise transfer the indebtedness to a person related to the debtor (other than in a sale to a dealer that in turn meets the requirements of this paragraph (e)(2)).

(ii) A dealer will continue to satisfy the conditions of this paragraph (e)(2) with respect to indebtedness that is exchanged for successor indebtedness in a transaction in which unrelated holders also exchange indebtedness of the same issue, provided that the conditions of this paragraph (e)(2) are met with respect to the successor indebtedness.

(iii) For purposes of this paragraph (e)(2), if the period consistent with the holding of indebtedness for sale to customers in the ordinary course of business is 30 days or less, the dealer is considered to dispose of indebtedness within that period if the aggregate principal amount of indebtedness of that issue sold by the dealer to customers in the ordinary course of business (or that mature and are paid while held by the dealer) in the calendar month following the month in which the indebtedness is acquired equals or exceeds the aggregate principal amount of indebtedness of that issue held in the dealer's inventory at the close of the month in which the indebtedness is acquired. If the period consistent with the holding of indebtedness for sale to customers in the ordinary course of business is greater than 30 days, the dealer is considered to dispose of the indebtedness within that period if the aggregate principal amount of indebtedness of that issue sold by the dealer to customers in the ordinary course of business (or that mature and are paid while held by the dealer) within that period equals or exceeds the aggregate principal amount of indebtedness of that issue held in inventory at the close of the day on which the indebtedness was acquired.

(f) AMOUNT OF DISCHARGE OF INDEBTEDNESS INCOME REALIZED -- (1) HOLDER ACQUIRED THE INDEBTEDNESS BY PURCHASE ON OR LESS THAN SIX MONTHS BEFORE THE ACQUISITION DATE. Except as otherwise provided in this paragraph (f), the amount of discharge of indebtedness income realized under paragraph (a) of this section is measured by reference to the adjusted basis of the related holder (or of the holder that becomes related to the debtor) in the indebtedness on the acquisition date if the holder acquired the indebtedness by purchase on or less than six months before the acquisition date. For purposes of this paragraph (f), indebtedness is acquired "by purchase" if the indebtedness in the hands of the holder is not substituted basis property within the meaning of section 7701(a)(42). However, indebtedness is also considered acquired by purchase within six months before the acquisition date if the holder acquired the indebtedness as transferred basis property (within the meaning of section 7701(a)(43)) from a person who acquired the indebtedness by purchase on or less than six months before the acquisition date.

(2) HOLDER DID NOT ACQUIRE THE INDEBTEDNESS BY PURCHASE ON OR LESS THAN SIX MONTHS BEFORE THE ACQUISITION DATE. Except as otherwise provided in this paragraph (f), the amount of discharge of indebtedness income realized under paragraph (a) of this section is measured by reference to the fair market value of the indebtedness on the acquisition date if the holder (or the transferor to the holder in a transferred basis transaction) did not acquire the indebtedness by purchase on or less than six months before the acquisition date.

(3) ACQUISITIONS OF INDEBTEDNESS IN NONRECOGNITION TRANSACTIONS. [Reserved]

(4) AVOIDANCE TRANSACTIONS. The amount of discharge of indebtedness income realized by the debtor under paragraph (a) of this section is measured by reference to the fair market value of the indebtedness on the acquisition date if the indebtedness is acquired in a direct or an indirect acquisition in which a principal purpose for the acquisition is the avoidance of federal income tax.

(g) CORRELATIVE ADJUSTMENTS -- (1) DEEMED ISSUANCE. For income tax purposes, if a debtor realizes income from discharge of its indebtedness in a direct or an indirect acquisition under this section (whether or not the income is excludible under section 108(a)), the debtor's indebtedness is treated as new indebtedness issued by the debtor to the related holder on the acquisition date (the deemed issuance). The new indebtedness is deemed issued with an issue price equal to the amount used under paragraph (f) of this section to compute the amount realized by the debtor under paragraph (a) of this section (i.e., either the holder's adjusted basis or the fair market value of the indebtedness, as the case may be). Under section 1273(a)(1), the excess of the stated redemption price at maturity (as defined in section 1273(a)(2)) of the indebtedness over its issue price is original issue discount (OID) which, to the extent provided in sections 163 and 1272, is deductible by the debtor and includible in the gross income of the related holder. Notwithstanding the foregoing, the Commissioner may provide by Revenue Procedure or other published guidance that the indebtedness is not treated as newly issued indebtedness for purposes of designated provisions of the income tax laws.

(2) TREATMENT OF RELATED HOLDER. The related holder does not recognize any gain or loss on the deemed issuance described in paragraph (g)(1) of this section. The related holder's adjusted basis in the indebtedness remains the same as it was immediately before the deemed issuance. The deemed issuance is treated as a purchase of the indebtedness by the related holder for purposes of section 1272(a)(7) (pertaining to reduction of original issue discount where a subsequent holder pays acquisition premium) and section 1276 (pertaining to acquisitions of debt at a market discount).

(3) LOSS DEFERRAL ON DISPOSITION OF INDEBTEDNESS ACQUIRED IN CERTAIN EXCHANGES. (i) Any loss otherwise allowable to a related holder on the disposition at any time of indebtedness acquired in a direct or indirect acquisition (whether or not any discharge of indebtedness income was realized under paragraph (a) of this section) is deferred until the date the debtor retires the indebtedness if --

(A) The related holder acquired the debtor's indebtedness in exchange for its own indebtedness; and

(B) The issue price of the related holder's indebtedness was not determined by reference to its fair market value (e.g., the issue price was determined under section 1273(b)(4) or 1274(a) or any other provision of applicable law).

(ii) Any comparable tax benefit that would otherwise be available to the holder, debtor, or any person related to either, in any other transaction that directly or indirectly results in the disposition of the indebtedness is also deferred until the date the debtor retires the indebtedness.

(4) EXAMPLES. The following examples illustrate the application of this paragraph (g). In each example, all taxpayers are calendar- year taxpayers, no taxpayer is insolvent or under the jurisdiction of a court in a title 11 case and no indebtedness is qualified farm indebtedness described in section 108(g).

EXAMPLE 1. (i) P, a domestic corporation, owns 70 percent of the single class of stock of S, a domestic corporation. S has outstanding indebtedness that has an issue price of $10,000,000 and provides for monthly interest payments of $80,000 payable at the end of each month and a payment at maturity of $10,000,000. The indebtedness has a stated maturity date of December 31, 1994. On January 1, 1992, P purchases S's indebtedness from I, an individual not related to S within the meaning of paragraph (d)(2) of this section, for cash in the amount of $9,000,000. S repays the indebtedness in full at maturity.

(ii) Under section 61 (a)(12), section 108 (e)(4), and paragraphs (a) and (f) of this section, S realizes $1,000,000 of income from discharge of indebtedness on January 1, 1992.

(iii) Under paragraph (g)(1) of this section, the indebtedness is treated as issued to P on January 1, 1992, with an issue price of $9,000,000. Under section 1273(a), the $1,000,000 excess of the stated redemption price at maturity of the indebtedness ($10,000,000) over its issue price ($9,000,000) is original issue discount, which is includible in gross income by P and deductible by S over the remaining term of the indebtedness under sections 163(e) and 1272(a).

(iv) Accordingly, S deducts and P includes in income original issue discount, in addition to stated interest, as follows: in 1992, $289,144.88; in 1993, $331,286.06; and in 1994, $379,569.06.

EXAMPLE 2. The facts are the same as in EXAMPLE 1, except that on January 1, 1993, P sells S's indebtedness to J, who is not related to S within 'the meaning of paragraph (d)(2) of this section, for $9,400,000 in cash. J holds S's indebtedness to maturity. On January 1, 1993, P's adjusted basis in S's indebtedness is $9,289,144.88. Accordingly, P realizes gain in the amount of $110,855.12 upon the disposition. S and J continue to deduct and include the original issue discount on the indebtedness in accordance with EXAMPLE 1. The amount of original issue discount includible by J is reduced by the $110,855.12 acquisition premium as provided in section 1272(a)(7).

EXAMPLE 3. The facts are the same as in EXAMPLE 1, except that on February 1, 1992 (one month after P purchased S's indebtedness), S retires the indebtedness for an amount of cash equal to the fair market value of the indebtedness. Assume that the fair market value of the indebtedness is $9,022,621.41, which in this case equals the issue price of the indebtedness determined under paragraph (g)(1) of this section ($9,000,000) plus the accrued original issue discount through February 1 ($22,621.41). Section 1.61-12(c)(3) provides that if indebtedness is repurchased for a price that is exceeded by the issue price of the indebtedness plus the amount of discount already deducted, the excess is income from discharge of indebtedness. Therefore, S does not realize income from discharge of indebtedness. The result would be the same if P had contributed the indebtedness to the capital of S. Under section 108 (e)(6), S would be treated as having satisfied the indebtedness with an amount of money equal to F's adjusted basis and, under section 1272 (d)(2), P's adjusted basis is equal to $9,022,621.41.

EXAMPLE 4. (i) P, a domestic corporation, owns 70 percent of the single class of stock of S, a domestic corporation. On January 1, 1986, F issued indebtedness that has an issue price of $5,000,000 and provides for no stated interest payments and a payment at maturity of $10,000,000. The indebtedness has a stated maturity date of December 31, 1995. On January 1, 1992, S purchases P's indebtedness from K, a partnership not related to P within the meaning of paragraph (d)(2) of this section, for cash in the amount of $6,000,000. The sum of the debt's issue price and previously deducted original issue discount is $7,578,582.83. P repays the indebtedness in full at maturity.

(ii) Under section 61(a)(12), section 108 (e)(4), and paragraphs (a) and (f) of this section, P realizes $1,578,582.83 in income from discharge of indebtedness ($7,578,582.83 minus $6,000,000) on January 1, 1992.

(iii) Under paragraph (g)(1) of this section, the indebtedness is treated as issued to S on January 1, 1992, with an issue price of $6,000,000. Under section 1273(a), the $4,000,000 excess of the stated redemption price at maturity of the indebtedness ($10,000,000) over its issue price ($6,000,000) is original issue discount, which is includible in gross income by S and deductible by P over the remaining term of the indebtedness under sections 163(e) and 1272(a).

(iv) Accordingly, P deducts and S includes in income original issue discount as follows: in 1992, $817,316.20; in 1993, $928,650.49; in 1994, $1,055,150.67; and in 1995, $1,198,882.64.

(h) EFFECTIVE DATE. This section applies to any transaction described in paragraph (a) and in either paragraph (b) or (c) of this section with an acquisition date on or after March 21, 1991. Although this section does not apply to direct or indirect acquisitions occurring before March 21, 1991, section 108(e)(4) is effective for any transaction after December 31, 1980, subject to the rules of section 7 of the Bankruptcy Tax Act of 1980 (Pub. L. 96-589, 94 Stat. 3389, 3411). Taxpayers may use any reasonable method of determining the amount of discharge of indebtedness income realized and the treatment of correlative adjustments under section 108(e)(4) for acquisitions of indebtedness before March 21, 1991, if such method is applied consistently by both the debtor and related holder.