Debt or equity? New pathways - another dead end or the yellow brick road?
Tax Executive › Vol. 42 Nbr. 2, March 1990
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Debt or equity? New pathways - another dead end or the yellow brick road?
Debt or Equity? New Pathways - Another Dead End or The Yellow Brick Road?
The Omnibus Budget and Reconciliation Act of 1989 intensely examined the debt-equity conundrum and adopted some creative new pathways to deal with it. First, Congress developed irrebuttable presumptions to distinguish debt from equity in connection with the provisions dealing with high-yield discount debentures and earnings stripping. Second, a system of bifurcation, for limited purposes, was devised for certain high-yield discount debentures, with the Department of the Treasury being given the green light to bifurcate other obligations into debt and equity components. This article summarizes the new rules and analyzes the implications. High-Yield Discounts Bonds A. Overview Tax and economic policy prompted Congress to make a rather prophetic statement on leverage. Concerned about certain high-yield bonds - particularly those calling for interest to be paid with additional debt(1) - the House Committee on Ways and Means concluded that certain high-yield bonds "resemble equity for tax purposes" and, further, that the availability of the interest deduction for such instruments was resulting in "highly leveraged corporate financial structures that impose an undesirable level of risk on investors and the economy."(2) As a result, important new debt-equity "safe harbor" rules were adopted. Surprisingly, the rules are not limited to leveraged acquisitions; for example, they may apply to high-yield debt issued by high-tech ventures or real estate enterpreneurs, if they operate through a corporate vehicle. B. The Basic Bifurcation Rule Believing that a "portion of the return on certain high-yield OID obligations is simila...See the full content of this document
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