January 23, 2009
Recent instability in the debt markets has increased the tax risks associated with amending loan terms. Proposed amendments to any loan should be examined to determine whether the amendment will result in a deemed exchange of the unmodified debt obligation for the modified debt obligation for U.S. federal income tax purposes.
Events that may result in a deemed exchange include:
- Changing the yield by more than the greater of 25 basis points or 5% of the existing yield. Amounts paid to lenders as consideration for the amendment generally are considered in calculating the yield of the modified debt instrument.
- A material deferral of payments.
- Changing loans from recourse to nonrecourse, or vice-versa, and changes in the priority of a debt.
- Changes in the obligor or changes in credit support.
- Forbearances greater than two years plus certain grace periods.
- Other changes that, taken together, are economically significant.
If there is a deemed exchange, the issuer is treated as if it issued a new debt instrument with the modified terms in cancellation of the old debt instrument. If a debt instrument is not treated as "publicly traded," a deemed exchange does not typically result in adverse tax consequences to the issuer unless the principal amount of the modified debt instrument is less than the "adjusted issue price" of the original debt instrument. If a debt instrument is treated as "publicly traded," a deemed exchange that occurs in connection with an amendment may generate cancellation of indebtedness income to the issuer. A deemed exchange also may have adverse tax consequences to holders of the debt.
In many cases, a debt instrument may be treated as publicly traded even if not listed on an exchange. Debt generally will be treated as publicly traded if, at any point during the period beginning 30 days before and ending 30 days after the amendment, it:
- is listed on a national securities exchange, an interdealer quotation system, or a similar exchange outside the United States;
- is traded either on a board of trade or on an interbank market;
- appears in a system of general circulation that provides a reasonable basis to determine fair market value; or
- subject to certain exceptions, has a readily quotable price from dealers, brokers, or traders.
Current market conditions increase the likelihood that modifications of publicly traded debt will result in cancellation of debt income and other adverse tax consequences. For instance, lenders will likely require substantial fees or increased interest rates before consenting to any amendments, and such fees or increases may increase the yield above the applicable threshold. Also, debt that is treated as publicly traded often is trading significantly below its issue price, even in the case of healthy issuers. Thus, it is important to consider the potential U.S. federal income tax consequences of amending publicly traded debt instruments.
Legislation has been proposed that would permit the exclusion of cancellation of indebtedness income arising from the amendment of publicly traded debt instruments originally issued by corporations or partnerships. The bill has been referred to the Senate Finance Committee for further consideration. Whether such legislation will be enacted is uncertain at this time.
To ensure compliance with requirements imposed by the internal revenue service, we inform you that any tax advice contained in this communication was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the internal revenue code or (ii) promoting, marketing or recommending to another party any matters addressed herein.
If you have any questions regarding the tax consequences of an amendment to a credit agreement or any other modification of a debt instrument, please contact one of the Gibson, Dunn & Crutcher LLP attorneys listed below, or your regular Gibson Dunn contacts.
New York
David B. Rosenauer (212-351-3853, [email protected])
Jeffrey M. Trinklein (212-351-2344, [email protected])
Romina Weiss (212-351-3929, [email protected])
Washington D.C.
Art Pasternak (202-955-8582, [email protected])
Los Angeles
Hatef Behnia (213-229-7534, [email protected])
Stephen L. Tolles (213-229-7502, [email protected])
Paul S. Issler (213-229-7763, [email protected])
Dora Arash (213) 229-7134, [email protected])
Orange County
Gerard J. Kenny (949-451-3856, [email protected])
Scott Knutson (949) 451-3961, [email protected])
Dallas
David Sinak (214) 698-3107
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