IRS Eyes Taxes in Debt - Equity Swaps

Fortnightly Magazine - December 1996
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According to Chadbourne & Park, LLP, the Internal Revenue Service (IRS) is auditing U.S. companies that bought shares in foreign utilities in recent privatizations to determine whether they should have paid U.S. taxes.

All of the transactions involve debt-equity swaps, which can take many forms. For example, a U.S. company interested in buying shares in a foreign utility first goes into the market to buy bonds of the foreign government. The bonds were issued years earlier when the foreign country had a stronger currency, but years of economic problems have diminished their value, enabling the U.S. company to buy the bonds at a steep discount.

Then, since the foreign government is forbidden by covenants in its loan agreements from repurchasing its own debt, the U.S. company offers to swap the bonds for shares in a government utility being sold to the private sector. The government benefits since its debts get extinguished at a discount.

But according to the IRS, if the bonds were purchased at a 50-percent discount and the foreign government credits the company toward the purchase price of shares for 85 percent of the face amount, then the company earned income. A U.S. company may only make a direct exchange of debt for shares in a utility privatization. t

Lori A. Burkhart is an associate legal editor of PUBLIC UTILITIES FORTNIGHTLY.

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