Do Contingent Interest Convertible Debt Instruments Work as Advertised? Probably Not
Posted: 1 Feb 2002
Promoters suggest that with recently popular convertible securities, issuers may deduct interest payments at rates higher than are typical with traditional contingent debt instruments. Tax-sensitive investors will generally find that the consequences of purchasing such instruments will be less favorable than owning typical contingent debt instruments, and it is likely that many of these instruments are being sold to, or quickly migrating to, tax-insensitive investors, such as tax-exempt organizations and foreign persons. The article describes the typical structure of these types of instruments (often referred to as "Contingent LYONS" or "co-LYONS" because of the popularity of one particular issue), then analyzes the various statutory and regulatory provisions that the IRS may apply to deny the purported benefits of these convertible securities. The author believes it is unclear whether the original issue discount anti-abuse regulation should apply, and believes that Section 163(l)(3)(A) probably should not apply to deny interest deductions on the instruments, but that Section 163(l)(3)(B) and (C) probably should apply to do so. In addition, Section 249 "certainly should apply to disallow any deductions for repurchase premium incurred in connection with a conversion." This article provides a thorough analysis of an instrument that is currently very popular with institutional investors, but which clearly comes with a high level of tax risk to issuers.
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