Corporate Cancellation of Indebtedness Income and the Debt-Equity Distinction
63 Pages Posted: 29 Jul 2004
This article considers whether a corporation should have cancellation of indebtedness income (COD income) when it issues new stock or debt in exchange for its outstanding debt. It challenges the conventional wisdom about our current tax treatment of these exchanges and suggests alternative approaches. It also stresses the relationship between the COD income rules and the corporate interest deduction rules, and highlights the error correction function of the COD income rules. The current COD income rules applicable in debt-for-debt and stock-for-debt exchanges were enacted without regard for certain economic incentives they create. Consideration of these economic incentives may warrant a different set of tax rules for COD income in debt-for-debt and stock-for-debt exchanges, especially where the corporate issuer is financially distressed.
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