1. TAX ISSUES AT $50 OIL
ALEX PEREZ &
KEN KRASNY
May 21, 2015

2. Unique Tax Issues Affected by the Price of
Oil??
• Debt Modifications
• Debt-for-Equity Exchanges
• Tax Attribute Limitations due to Equity Transfers
• Net Operating Loss Planning Opportunities
• Mezzanine Debt
• Partnership/Joint Venture Planning Opportunities
2

3. Cash Flow Issues at $50 Oil
• 50% Decline in the price of oil since June 2014, low natural gas
prices
• Despite the need to adjust to lower commodity prices, Exploration
and Production companies often must continue to produce in order
to avoid termination of a mineral lease, etc.
• Drilling and production is expensive, many companies challenged
with servicing existing debt obligations, let alone obtaining new
financing for operations
•  Modifying the terms of existing debt to reduce associated costs
is a common reaction
3

4. Debt Modifications to reduce associated
expenses
• Companies negotiate with lenders to modify existing credit terms
including: value of collateral, maturity date extensions, changes to
interest rates, changes to covenants
•  But modification of existing credit terms may cause a tax
effect(s) if the change is “significant”:
– Deemed Exchange of the “Old Debt” for the “New Debt”
– Recognition of Gain or Loss
– Cancellation of Indebtedness Income
– Original Issue Discount created in the “New Debt”
– Re-characterization of Debt as “Equity” for tax purposes
4

5. Debt Modifications: Recognition of Gain or
Loss
If Debt is “Significantly Modified”:
• Treated as an exchange of “Old Debt” for “New Debt”
• Debtor satisfies Old Debt for money equal to the Issue Price of
the New Debt
– Issue Price = market value if publicly traded debt
– Issue Price = stated principal amount if not publicly traded debt
• If stated interest is inadequate, must discount all payments due
under the new debt at the “applicable federal rate”
• OID may result if Issue Price is less than Stated Principal Amount
5

6. Debt Modifications: Recognition of Gain
Example
EXAMPLE:
• Holder acquires Old Debt with a face amount of $100 in the
secondary market for $50 and exchanges its Old Debt for New Debt
with an Issue Price of $75. Holder Recognizes $25 of gain though no
cash received
OR
Gain recognition is usually not an issue unless the holder bought the
“Old Debt” at a discount
6

7. Debt Modifications: Tax Free
Reorganization
• Generally: an existing creditor’s (deemed) exchange of “Old Debt”
for “New Debt” is a tax free exchange of securities for securities if
Debtor is a C-Corporation. Section 368(a)(1)(E)
– Note that a “security” has a different meaning for these purposes than
under securities laws
– Can exchange stock, warrants or debt instruments as “securities”
– Gain is recognized to the extent of “boot”
7

8. Debt Modifications: Cancellation of Debt
Income (CODI)
Any exchange of Old Debt for New Debt at a discount results in
Cancellation of Debt Income for the Debtor
• Debtor acquires old debt for cash or other property
• Debt-for-debt (deemed) swap where new debt issue price is less
than Old Debt’s adjusted issue price
• Debtor swaps old debt for new stock or partnership interests
• Cancellation or forgiveness of Debt
8

9. What is a “Significant Modification”
• Change in Yield of New Debt vs. Old Debt
• Principal Amount Change
• Change in Timing of payments: if “material deferral of scheduled
payments”
• Change in Collateral: if there is a resulting change in payment
expectations
• Re-characterization of Debt as “Equity” for tax purposes
– Significant impairment of collateral, financial condition of debtor,
subordination to other instruments
9

10. Debt-for-Equity Exchanges
When Debt is converted to Equity of a debtor company:
• If the debtor company is a C-Corporation, and the value of the
equity received equals the value of the debt exchanged, the
transaction should qualify as a tax free reorganization to both the
Debt holder and the Company
• If the debtor company is a partnership (LLC), Section 721 treats the
exchange as tax-free if the value of equity received is equal to the
value of the debt relinquished
HOWEVER
• Gain is recognized by the holder to the extent he receives “boot”,
CODI recognized by debtor if equity value is less than value of debt
10

11. Debt-for-Equity Exchange: CODI and Gain
If Debtor treated as receiving CODI due to a difference in the
value of equity received versus value of relinquished debt:
• Partnerships: CODI is ordinary income to each of the partners
– NOTE: Insolvency exception may apply to exempt recognition of CODI, but
insolvency is tested at the PARTNER level, not the partnership
• Corporation: CODI is income to the corporation
– Note that NOL planning can reduce effect of CODI
– Must be careful with Section 382 ownership change upon exchange of
debt for equity
11

12. San Antonio
Weston Centre
112 East Pecan
Suite 700
San Antonio, TX 78205
T: 210.820.2625
F: 210.820.2609
Pittsburgh
Southpointe Town Center
1900 Main Street
Suite 201
Canonsburg, PA 15317
T: 724.746.6644
F: 724.746.6645
Midland
Midland Tower
223 W. Wall Street
Suite 400
Midland, TX 79701
T: 432.253.8600
F: 432.253.8601
Houston
Pennzoil Place
700 Milam Street
Suite 1100
Houston, TX 77002
T: 713.358.1700
F: 713.358.1717
Denver
Wells Fargo Center
1700 Lincoln Street
Suite 1300
Denver, CO 80203
T: 303.801.3200
F: 303.801.3201
New Orleans
Poydras Center
650 Poydras
Suite 1400
New Orleans, LA 70130
T: 504.299.3427
F: 504.299.3411
THANKS!
ALEX PEREZ
KEN KRASNY