Final Consolidated Return Regs. on Transactions Involving Intercompany Debt

By Angela Kegerreis, CPA, Houston, TX

Editor: Lorin D. Luchs, CPA, J.D., LL.M.

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 satisfactionreissuance 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-reissuance 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 interest income to X and interest expense to B under the OID rules of Sec. 1272.

Regarding the FMV component, it is important to note that the IRS and Treasury are considering the appropriateness of this requirement given the complexities in valuing intercompany obligations, and they may add simplifying language at a later date.

The final regulations include a number of exceptions for certain transactions, such as those involving intragroup and outbound transactions. Because the costs associated with determining the instrument’s FMV in applying the deemed satisfaction-reissuance model generally exceed the resulting benefits, certain transactions have been exempted. A few of these exceptions include those relating to debt modifications involving a single issue, gain, or loss as it relates to an intercompany obligation and outbound exceptions for newly issued intercompany obligations when dealing with a reorganization.

In addition, anti-abuse provisions such as the tax benefit rule and the off-market issuance rule are intended to prevent disproportionate taxable income when items of built-in gain shift from the obligation or an off-market interest rate is used, resulting in a tax benefit that is material to the company. The final regulations focus on the party’s principal purpose or intent, replacing the “reasonably foreseeable” test. The rules will be applied using a “with a view” standard, the result being that the tax benefit is no longer required to be material.

Regs. Sec. 1.1502-13(g)(7), Example (9), illustrates the off-market issuance rule.

Example 2: T is a member with a separate return limitation year (SRLY) loss. T ’s sole shareholder, P, borrows cash from T in return for a note that provides for a material above-market interest rate. P’s note is issued to generate additional interest income to T over the note’s term to facilitate the absorption of T ’s SRLY loss.

Because T issues the note to shift interest income from the off-market obligation with the intention to secure a tax benefit that the group or its members would not otherwise receive, the intercompany obligation is treated as originally issued at its FMV, so T is treated as purchasing the note at a premium. P and T are required to treat the difference between the original loan amount and the FMV as a capital contribution from P to T at the date T issues the note. T will report interest income and bond premium, and P will report interest expense and bond issuance premium.

The final Regs. Sec. 1.1502-13(g) applies to transactions involving intercompany obligations occurring in consolidated return years beginning on or after December 24, 2008.


Lorin Luchs is a partner in National Tax Services of BDO Seidman, LLP in Bethesda, MD.

Unless otherwise noted, contributors are members of or associated with BDO Seidman, LLP.

For additional information about these items, contact Mr. Luchs at (301) 634-0250 or

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