Tax Implications of Debt  Restructuring, Debt   Forgiveness, and      Bankruptcy   27th Annual Real Estate Institute      ...
I. SEMINAR TOPICSA. DEBT RESTRUCTURING AND CODI  1.   Types of Debt Restructuring - (Not Exhaustive)  2.   Tax Consequence...
B. CHANGE OF OWNERSHIP OR CONTROL AND  LOSS CORPORATIONS 1.   Section 382 Basics 2.   Section 382 Generally 3.   What is E...
II. CONCLUSION
A. DEBT RESTRUCTING AND CODI 1. Types of Debt Restructuring      Repurchase or settlement of debt by issuer for       cas...
2. Tax Consequences of Debt RestructuringBorrower   COD income if and to extent face value of old debt is    greater than...
3. Cancellation of Indebtedness Income  (“CODI”)   How to measure – Two Types        Debt issues with OID        Debt i...
3(a). CODI - Tax Treatment to Debtor   Immediately taxable to debtor if no exclusion    applies; Debtor may (mostly) offs...
3 (b). CODI – Tax Treatment to Issuer – OID v.Market Discount   Original Issue Discount        Accrues daily        Con...
3 (c). CODI – Tax Treatment to Third Party –Purchase of Debt at Discount by Related Party      CODI recognized as though ...
4. COD Deferral Election Under ARRTA   American Recovery and Reinvestment Tax Act of    2009 (“ARRTA”) (Pub. L. No. 111-5...
5. Debt for Debt Exchange5(a). Non-Taxable    Debts securities – Tax-free recap    No gain or loss           Boot inclu...
5(b). Taxable     CODI where issue price of new debt is less than      adjusted issue price of old debt     Holder may r...
6. Issue Price and the Meaning of “PubliclyTraded”        “Issue price”              Publicly traded debt – Fair market ...
7. Significant Modification and the DeemedExchange   “Economically significant” alterations) of legal    rights/obligatio...
8. Modification of Debt to Equity   Modification resulting in “non-debt” is “significant”   Mere deterioration in abilit...
B. CHANGE OF OWNERSHIP ORCONTROL AND LOSS CORPORATIONS1. Section 382 Basics      Limits a “loss corporation”           T...
2. Section 382   Loss Corporation        NOL, tax credit, capital loss, or other attribute carryforward        Net Unre...
3. What is Equity Under 382   What generally counts as “equity” when   determining a Section 382 ownership   change?     ...
4. NOL Poison Pills   Protect your NOLs with a NOL poison pill plan        Shareholder rights plans deter new 5% sharehol...
5. Section 382 Limitation Value     Does not include any new investment being      made on the change value     Value of...
   5 (a). Adjustments to Value    Holding “substantial nonbusiness assets” (1/3 of total    asset value) immediately afte...
5(b). Calculation of the Section 382 Limitation Section 382 Limitation Example:   Value immediately before change        ...
6. Successive Ownership Changes     If two or more successive ownership changes,      then each Section 382 limitation is...
7. Section 382 in Bankruptcy7(a). Special Rules     Assuming that the loss corporation has NOLs and      other attributes...
7(b). Section 382 in Bankruptcy - 382(1)(5)   In title 11 immediately before the change   Continuity of interest (tests ...
7©. Section 382 in Bankruptcy    382(1)(5) Effects and Consequences   The use of pre-change losses is not subject to limi...
7(d). Section 382 in Bankruptcy Example:   A loss corporation enters bankruptcy with $500M    in NOL   $300M of debt is ...
7(e). Section 382 in Bankruptcy - 382(1)(6)   Certain tax-free reorganizations; or   Title 11 case; and   382(1)(5) doe...
7(f). Section 382 in Bankruptcy382(1)(6) Effects    382 limit applies    Limitation is based on enhanced value following...
7(g). Section 382 in Bankruptcy   Choosing between (1)(5) and (1)(6)      Compare amount of NOLs      Compare amount of ...
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27th real estate_institute_seminar_slide_show_(powerpoint)

  1. 1. Tax Implications of Debt Restructuring, Debt Forgiveness, and Bankruptcy 27th Annual Real Estate Institute Joel A. Lebewitz Thomas G. Wallrich Steven A. Silton
  2. 2. I. SEMINAR TOPICSA. DEBT RESTRUCTURING AND CODI 1. Types of Debt Restructuring - (Not Exhaustive) 2. Tax Consequences of Debt Restructuring 3. Cancellation of Indebtedness Income (“CODI”) a. CODI – Tax Treatment to Debtor b. CODI – Tax Treatment to Issuer – OID v. Market Discount c. CODI – Tax Treatment to Third Party – Purchase of Debt at Discount by Third Party 4. CODI Deferral Election under “ARRTA” 5. Debt for Debt Exchange 6. Issue Price and the meaning of “Publicly Traded” 7. Significant Modification and the Deemed Exchange 8. Modification of Debt to Equity
  3. 3. B. CHANGE OF OWNERSHIP OR CONTROL AND LOSS CORPORATIONS 1. Section 382 Basics 2. Section 382 Generally 3. What is Equity Under Section 382 4. NOL Poison Pills 5. Section 382 Limitations Value a. Adjustment to Value b. Calculation of the Section 382 Limitation 6. Successive Ownership Changes and the Section 382 Limitation 7. Section 382 in Bankruptcy
  4. 4. II. CONCLUSION
  5. 5. A. DEBT RESTRUCTING AND CODI 1. Types of Debt Restructuring  Repurchase or settlement of debt by issuer for cash or other property (Including stock)  Actual exchange of old debt for new debt with significantly modified terms  Significant modification of old debt (deemed exchange)  Purchase of old debt by “related party” of issuer (deemed exchange)  “Related party” – described in §267(b) or 707(b)(1); attribution rules apply
  6. 6. 2. Tax Consequences of Debt RestructuringBorrower COD income if and to extent face value of old debt is greater than cash, FMV of property, or issue price of new/modified debt given in settlement Possible OID deductions over term of new/modified debtHolder Taxable vs tax-free Generally capital gain or loss (loss may not be recognizable) Possible OID (ordinary) income inclusions over term of new/modified debt No OID if/to extent basis is > amounts payable (other than qualified stated interest) and > issue price
  7. 7. 3. Cancellation of Indebtedness Income (“CODI”) How to measure – Two Types  Debt issues with OID  Debt issues without OID Character of income Traditional exceptions to recognition of CODI  Bankruptcy  Insolvency  Contribution to capital  No more debt for equity exclusion (including equity of partnerships) Modifications Authorized Under Rev. Proc. 2009-45 (Attached) ARRTA Deferral (Below)
  8. 8. 3(a). CODI - Tax Treatment to Debtor  Immediately taxable to debtor if no exclusion applies; Debtor may (mostly) offset with available NOLs  Exclusion for bankruptcy, insolvency, or non- corporate qualified real property indebtedness: reduce tax attributes (NOLs, asset basis – subject to “liability stop”) by amount of COD (§ 108(a), (b))  Elect to defer COD income under American Recovery and Reinvestment Tax Act of 2009 (Pub. L. No. 111-5) (“ARRTA”) (Principal IRC provisions: §§ 108(i); 163(e)(5)(F)
  9. 9. 3 (b). CODI – Tax Treatment to Issuer – OID v.Market Discount Original Issue Discount  Accrues daily  Constant yield basis  Taken into income currently  Generally deductible by issuer (subject to AHYDO and certain related party timing rules) Market Discount  Accrued market discount generally treated as interest income  Accrues daily  Ratable basis unless elect constant yield  Only taken into income only payment or sale  Not deductible by issuer
  10. 10. 3 (c). CODI – Tax Treatment to Third Party –Purchase of Debt at Discount by Related Party  CODI recognized as though issuer repurchased  Traditional exceptions to CODI available  Election to defer CODI  Deemed reissuance of note from issuer to related party  Effectively converts market discount to OID
  11. 11. 4. COD Deferral Election Under ARRTA  American Recovery and Reinvestment Tax Act of 2009 (“ARRTA”) (Pub. L. No. 111-5)  Implicates IRC §§ 108(i) and 163(e)(5)(F)  Debtor can elect to defer COD income on 1009 or 2010 reacquisitions of an “applicable debt instrument” (§ 108(i)(4)(B):  Buy-back of debt for cash by issuer/related party  Actual (or deemed) exchange of debt for debt of issuer or related party  Defer OID deduction to extent defer CODI inclusion  Exchange of debt for stock or partnership interest  Contribution of debt to capital  Complete forgiveness of debt
  12. 12. 5. Debt for Debt Exchange5(a). Non-Taxable  Debts securities – Tax-free recap  No gain or loss  Boot includes excess principal amount on new debt  CODI not gain, so can have CODI  Depending on issue price (discussed below), new debt can have OID  One debt not security – Fully taxable
  13. 13. 5(b). Taxable  CODI where issue price of new debt is less than adjusted issue price of old debt  Holder may recognize gain or loss  Amount realized deemed equal to issue price of new debt
  14. 14. 6. Issue Price and the Meaning of “PubliclyTraded”  “Issue price”  Publicly traded debt – Fair market value  Nonpublicly traded – Face value if adequate stated interest  Current depressed market prices for publicly traded debt likely cause COD on debt exchanges even if new debt face equals old debt face “Publicly traded” is broadly construed:  Listed on exchange or interdealer quotation system,  Traded on board of trade or interbank market,  Appears in system of general circulation (including by subscription) providing reasonable basis for determining FMV, or  Readably quotable price from dealers, brokers, or traders Syndicated bank debt can be considered publicly traded!
  15. 15. 7. Significant Modification and the DeemedExchange “Economically significant” alterations) of legal rights/obligations  Safe harbor: customary accounting/financial covenant changes  What is covered? Lack of authority; covenant waivers risky Deemed exchange likely is:  Change in yield of greater than 25 bps or 5% of existing yield  Count fees/interest paid to lenders for amendment/forbearance  Deferral of payment (e.g. beyond lesser of 5 yrs or 50% of original term)  Change in obligor, credit support, or priority  Possibly requiring “change in payment expectations”  From “primarily speculative” to “adequate” or vice versa  Change from recourse to nonrecourse  Change from debt to equity
  16. 16. 8. Modification of Debt to Equity  Modification resulting in “non-debt” is “significant”  Mere deterioration in ability to pay not taken into account in determining if modification results in “non-debt,” unless change in obligors in connection with modification  Section 382 effect
  17. 17. B. CHANGE OF OWNERSHIP ORCONTROL AND LOSS CORPORATIONS1. Section 382 Basics  Limits a “loss corporation”  That undergoes an “ownership change”  An ownership change occurs if immediately after an owner shift or an equity structure shift – The percentage by value of stock of the loss corporation owned by one or more 5-percent shareholders has increased by more than 50 percentage points over the lowest percentage ownership of such shareholders  During a 3-year “testing period”  From utilizing “pre-change losses” or other tax attributes
  18. 18. 2. Section 382 Loss Corporation  NOL, tax credit, capital loss, or other attribute carryforward  Net Unrealized Built-In Loss (“NUBIL”) Testing Period  Begins on the first day of the tax year when carryforward begins  3-year “rolling” period unless change occurs
  19. 19. 3. What is Equity Under 382 What generally counts as “equity” when determining a Section 382 ownership change?  Common voting stock  Convertible preferred stock  Voting preferred stock
  20. 20. 4. NOL Poison Pills Protect your NOLs with a NOL poison pill plan  Shareholder rights plans deter new 5% shareholders  Can prohibit existing shareholders from buying more without board approval  Board can waive  Watch out – Selectica, Inc. v. Versata Enterprises, Inc., No. 4241-VCN (Del. Ch. January 3, 2009)
  21. 21. 5. Section 382 Limitation Value  Does not include any new investment being made on the change value  Value of pure preferred (1504(a)(4) stock) is included in the limitation calculation  Even though not tracked for equity shifts  Market capitalization of a public company may be the starting point  Does a control premium matter? See TAM 200513027
  22. 22.  5 (a). Adjustments to Value Holding “substantial nonbusiness assets” (1/3 of total asset value) immediately after the ownership change May be required to back out value of capital contributions made within 2 years of ownership change if they are pursuant to a plan Annual limitation may become zero if continuity of business enterprise is violated within 2 years of change  A loss group is treated as a single entity for this test  Need at least one member loss group member to continue business Corporate contractions  PLR 200406027 no corporate contraction where target guaranteed debt
  23. 23. 5(b). Calculation of the Section 382 Limitation Section 382 Limitation Example:  Value immediately before change $1,820  Capital Contributions pursuant to plan ($200)  Adjusted value $1,620  Published rate (L.T. tax exempt) 5.00%  Annual NOL Limitation $81  Annual limitation accrues, even if unused
  24. 24. 6. Successive Ownership Changes  If two or more successive ownership changes, then each Section 382 limitation is applied independently (Reg. Section 1.382-5(d)  Later ownership changes may result in a lower, but not a higher, Section 382 limitation  Application of rule may result in layers of NOLs where each layer is subject to different limitations  A single low limitation can trap prior NOLs, and subsequent limitations can not create a higher limitation for previously limited NOLs
  25. 25. 7. Section 382 in Bankruptcy7(a). Special Rules  Assuming that the loss corporation has NOLs and other attributes that survive attribute reduction under Section 108(b), Section 382 will likely apply to the utilization of losses post bankruptcy  Consider the impact of an election under Section 108(b)(5)  382(1)(5) – generally provides for no limitation on use of NOLs if certain requirements are met  382(1)(6) – generally provides for increased limitation if certain requirements are met  (1)(6) is applicable if requirements for (1)(5) are not met or if debtor elects out of (1)(5)
  26. 26. 7(b). Section 382 in Bankruptcy - 382(1)(5)  In title 11 immediately before the change  Continuity of interest (tests pre-change shareholders and “qualified creditors”)  Post bankruptcy former creditors or historic shareholders must hold greater than 50% of the vote and value  Special option rules for determining ownership that may have retroactive effect  Example: options or warrants exercised by creditors and historic shareholders within three years of emergence from bankruptcy could allow a loss corporation to qualify for Section 382(1)(5) benefits back to the emergence from bankruptcy
  27. 27. 7©. Section 382 in Bankruptcy 382(1)(5) Effects and Consequences The use of pre-change losses is not subject to limitation under Section 382 If another ownership change occurs within 2 years, the Section 382 limitation with respect to the second ownership change will be zero Interest haircut:  NOLs & excess credits are reduced by:  Interest on the debt converted into equity in the bankruptcy proceeding (interest haircut) that was paid or accrued in:  Any taxable year ending during the three-year period preceding the taxable year in which the ownership change occurs, and  The period of the taxable year in which the ownership change occurs on or before the change date CCA 200915033 – (1)(5) not available for “pre-packaged bankruptcy”
  28. 28. 7(d). Section 382 in Bankruptcy Example:  A loss corporation enters bankruptcy with $500M in NOL  $300M of debt is cancelled and the creditors receive $100M worth of equity  $50M of interest was incurred on the converted debt during the look back period  $200M of COD is excluded, none of which relates to accrued interest on the converted debt  The NOLs are reduced to $250M ($500-$200-$50)
  29. 29. 7(e). Section 382 in Bankruptcy - 382(1)(6)  Certain tax-free reorganizations; or  Title 11 case; and  382(1)(5) doesn’t apply  Must continue the business for 2 years following the change date or the 382 limitation is 0
  30. 30. 7(f). Section 382 in Bankruptcy382(1)(6) Effects  382 limit applies  Limitation is based on enhanced value following surrender or cancellation of creditor’s claims  Interest haircut does not apply
  31. 31. 7(g). Section 382 in Bankruptcy Choosing between (1)(5) and (1)(6)  Compare amount of NOLs  Compare amount of COD income  Interest haircut  Comfort the transaction will qualify under (1)(5)  Application of Notice 2003-65  Future plans  Ownership change  Continuing the business  May want to modify bylaws/charter to prevent sales for 2 years

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