TAX ISSUES IN RESTRUCTURING TROUBLED PARTNERSHIPS AND CORPORATIONS. Tax Group

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Charlene Wood
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1 TAX ISSUES IN RESTRUCTURING TROUBLED PARTNERSHIPS AND CORPORATIONS Tax Grup 2016

2 TOPICS Cancellatin f Indebtedness Incme Partnership Debt fr Equity Exchange Cnsequences t the Debtr Partnership and its Partners Cnsequences t the Creditrs Crpratin Debt fr Equity exchange Tax Cnsideratins f the Crpratin Tax Cnsideratins f the Creditrs Debt fr Debt Exchanges and Debt Mdificatins 2

3 I. CANCELLATION OF INDEBTEDNESS INCOME A taxpayer recgnizes cancellatin f Indebtedness Incme ( CODI ) when an indebtedness f the taxpayer is discharged r satisfied at a discunt. CODI is generally equal t excess f (i) the utstanding balance f the debt, ver (ii) the value f the cnsideratin paid, if any, t satisfy the debt. CODI is excluded frm grss incme if, amng ther things, the discharge ccurs in bankruptcy, r the discharge ccurs when the debtr is inslvent. Any CODI excluded frm grss incme will be applied t reduce the tax attributes f the taxpayer. 3

4 I. CANCELLATION OF INDEBTEDNESS INCOME (CONT D) CODI is triggered when a persn related t the debtr acquires the utstanding indebtedness. Related persns are, amng ther things Members f a family; An individual and a crpratin mre than 50% in value f the utstanding stck f which is wned, directly r indirectly, by such individual; A partnership and a persn wning, directly r indirectly, mre than 50% f the capital r prfits interest in such partnership; Tw crpratins in a cntrlled grup (50% wnership); A crpratin and a partnership if the same persns wn mre than 50% in value f the utstanding stck f the crpratin, and mre than 50% f the capita r prfits interest in the partnership; Tw partnerships in which the same persns wn, directly r indirectly, mre than 50% f the capital r prfits interest. 4

5 II. PARTNERSHIP DEBT FOR EQUITY EXCHANGE -- CONSEQUENCES TO DEBTOR PARTNERSHIP AND ITS PARTNERS CODI in the Partnership Debt fr Equity Exchange. CODI is equal t the excess f (i) the utstanding balance f the debt ver (ii) the fair market value f the partnership capital r prfits interest issued t the creditrs in satisfactin f the debt. CODI is allcated t the partners in the partnership immediately befre the exchange/discharge f partnership debt. CODI may be excluded if the individual partner is inslvent r in bankruptcy the inslvency/bankruptcy test is applied at the individual partner level, nt the partnership level. 5

6 II. PARTNERSHIP DEBT FOR EQUITY EXCHANGE CONSEQUENCES TO DEBTOR PARTNERSHIP AND ITS PARTNERS (CONT D) Determinatin f Fair Market Value f Partnership Capital r Prfits Interest Generally, all facts and circumstances are cnsidered in determining fair market value Liquidatin value safe harbr: the fair market value f the partnership capital r prfits interest is deemed t be equal t the liquidatin value f the equity interest, if the fllwing cnditins are satisfied Each creditr, the debtr partnership, and its partners cnsistently treat the liquidatin value as the fair market value; The terms f the exchange are cmparable t terms that wuld be agreed t by unrelated parties negtiating with adverse interests; and Subsequent t the debt fr equity exchange, the debtr partnership des nt redeem the equity interest, and n persn related t the debtr partnership r its partners purchases the equity interest, as part f a plan at the time f the exchange that has as a principal purpse the avidance f CODI by the debtr partnership. Definitin f liquidatin value. Liquidatin value equals the amunt f cash that the creditr wuld receive with respect t the equity interest received if, immediately after the exchange, the partnership sld all f its assets fr cash equal t the fair market value f thse assets and then liquidated. 6

7 III. PARTNERSHIP DEBT FOR EQUITY EXCHANGE CONSEQUENCES TO CREDITORS Creditrs d nt receive any crrespnding lsses. Creditrs are treated as cntributing the partnership debt t the partnership in exchange fr the partnership equity interest in a tax-free cntributin transactin described in Sectin 721. N lsses are recgnized. Creditrs receive a high basis in the partnership equity equal t its basis in the debt bligatin. Character cnversin: Lss ultimately will be recgnized when creditrs subsequently sell their partnership interest with a high basis. But such lss generally wuld be capital lss, while a bad debt deductin generally wuld be rdinary lss. 7

8 III. PARTNERSHIP DEBT FOR EQUITY EXCHANGE CONSEQUENCES TO CREDITORS (CONT D). Creditrs have t recgnize rdinary incme fr unpaid rents, ryalties and interests. The tax free treatment des nt apply t transfer f a partnership interest t a creditr in satisfactin f a partnership s indebtedness fr unpaid rent, ryalties, r interest (including OID). The partnership equity interest transferred in satisfactin f any unpaid rent, ryalties r interest (including OID) accrued n r after the beginning f the creditr s hlding perid fr the indebtedness is taxable t the creditrs as rdinary incme. The debtr partnership will nt recgnize any gain r lss upn the transfer f a partnership interest t a creditr fr unpaid rent, ryalties, r interest. 8

9 III. PARTNERSHIP DEBT FOR EQUITY EXCHANGE CONSEQUENCES TO CREDITORS (CONT D). Creditrs Tax Planning Partial wrthless debt deductin Nn-security trade r business debt. Has t be in a transactin independent f and separate frm the debt-fr-equity exchange. Wrthless security deductin Existing partner cntributes partnership debt fr equity Authrity in the crprate cntext ensures there wuld be n CODI incme t the crpratin in this case. N similar authrity in the partnership cntext 108(e) n its face requires partnership t recgnize CODI between the excess f the face amunt f the debt ver the fair market value f the debt. Dcumenting the transactin as cntributing the cash equal t the debt t the partnership and then the partnership pays dwn the debt in full. 9

10 III. PARTNERSHIP DEBT FOR EQUITY EXCHANGE CONSEQUENCES TO CREDITORS (CONT D). Creditr Tax Planning A sale f the debt t a third party befre the debt fr equity exchange A significant mdificatin f the debt (which is treated as a taxable exchange fr tax purpses) befre the equity fr exchange Sectin 743(b) adjustment 10

11 IV. CORPORATION DEBT FOR EQUITY EXCHANGE TAX CONSIDERATIONS OF THE CORPORATION CODI calculatin. Exceptins fr CODI Tw exceptins n CODI inclusin fr cmpanies in financial distress. Grss incme des nt include any amunt which wuld be includible in grss incme by reasn f the discharge f indebtedness f the taxpayer bankruptcy exceptin: if the discharge ccurs in a title 11 case (i.e. bankruptcy). inslvency exceptin: if the discharge ccurs when the taxpayer is inslvent.» The tern inslvent means the excess f liabilities ver the fair market value f assets, determined immediately befre the discharge.» The amunt f CODI excluded shall nt exceed the amunt by which the taxpayer is inslvent. 11

12 IV. CORPORATION DEBT FOR EQUITY EXCHANGE TAX CONSIDERATIONS OF THE CORPORATION (CONT D) Reductin f Tax Attributes The amunt f CODI excluded frm grss incme must be applied t reduce the tax attributes f the taxpayer in the fllwing rder, unless an electin is made. Net perating lsses General business tax credits Minimum tax credits Capital lsses Basis in the assets Passive activity lsses and credits Freign tax credits The taxpayer may make an electin t first reduce the basis in the depreciable prperty. Amunt f reductin Other than tax credits, the reductin is ne dllar fr each dllar f CODI excluded Fr tax credits, the reductin is 33 1/3 cents fr each dllar f CODI excluded Timing f reductin The reductin is made after the determinatin f the tax fr the taxable year f the discharge. 12

13 CONTACT Vivian Ouyang Senir Cunsel T: E:

14 This presentatin is prvided fr infrmatinal purpses nly and shuld nt be cnsidered specific legal advice n any subject matter. Yu shuld cntact yur attrney t btain advice with respect t any particular issue r prblem. The cntent f this presentatin cntains general infrmatin and may nt reflect current legal develpments, verdicts r settlements. Use f and access t this presentatin des nt create an attrney-client relatinship between yu and Bracewell.

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