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Tax Implications of the Original Issue Discount

The tax implications of a corporate bond issuance should be carefully considered by a company’s legal counsel before proceeding with a bond offering. In particular, the original issue discount (OID) has significant tax consequences.

 

OID represents the difference between the face value of the bond when it was originally issued and the price paid for the bond at maturity. If bonds have an original issue price that is less than the stated redemption price of the bonds on the maturity date by more than a de minimis amount, the bonds will be considered issued with OID. OID is considered a form of interest under the tax rules. The Foreign Account Tax Compliance Act (FACTA) imposes U.S. withholding taxes on certain forms of interest.

 

OID and Tack-On Offering Bond Offerings

 

A company that previously issued bonds may want to issue additional bonds with identical terms. In such circumstances the company may prefer to do a tack-on bond offering, in which the additional bonds will have the same CUSIP number as the original bonds. A CUISP number is a nine-digit identification number assigned to securities. As a result of having the same CUSIP number, the original and additional debt will be able to trade together on a fungible basis. The additional debt will also be issued under the same indenture, and be subject to identical terms and conditions, as the original debt.

 

Tax Fungibility Analysis

 

The tax fungibility analysis in tack-on offerings involves assessing whether a number of conditions are met. Two debt instruments with identical terms may face different tax treatment if one of the debt instruments is issued with OID.

 

If the additional debt issuance occurs within 13 days of the original debt issuance, it will be subject to safe harbor protections. This 13-day safe harbor allows the additional debt instrument to be treated as part of the same issuance as the original debt instrument for tax purposes. In order to qualify for this safe harbor, the additional debt must have the same credit and payment terms. The original and additional debt instruments must also be issued pursuant to a common plan or as part of related transactions.

 

Additional debt that is not issued within 13 days of the original debt issuance may still be treated as part of the same issuance for tax purposes if the additional debt is issued in a “qualified reopening.” One of three tests must be satisfied in order for the additional debt issuance to be treated as a “qualified reopening.”

 

Under the first test, the additional debt must be issued with no (or de minimis) OID and either (i) the original debt is publicly traded or (ii) the additional debt is issued for cash to unrelated parties for an arm’s length price.

 

Under the second test, the additional debt must be issued within 6 months of the issuance of the original debt and either (i) the original debt is publicly traded or (ii) the additional debt is issued for cash to unrelated parties for an arm’s length price.

 

Under the third test, the additional debt is issued more than 6 months after the issuance of the original debt and either (i) the original debt is publicly traded and the yield on the additional debt is not in excess of 100% of the yield on the original debt on its issuance date or (ii) the additional debt is issued for cash to unrelated parties for an arm’s length price and the yield on the additional debt is not in excess of 100% of the yield on the original debt on its issuance date.

 

The ability to create fungible tack-on debt instruments has facilitated corporate tack-on bond offerings. However, it is important for a company to understand the fungibility analysis for OID purposes before undertaking a tack-on debt offering.

 

 

 

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