The IRS is Still Targeting Debt-Equity Swaps

The IRS is Still Targeting Debt-Equity Swaps

March 03, 1999 | By Keith Martin in Washington, DC

THE IRS IS STILL TARGETING DEBT-EQUITY SWAPS involving foreign government debt.

An example of a swap is where a US company buys government debt issued by a Latin American government at a discount to face value in the market. It then trades the debt for shares in a utility that the government has put up for sale in a privatization. If the US company is credited with greater value in the trade than it paid in the market for the government bonds, then the IRS will require that tax be paid on the gain.

The IRS lost a case in September 1997 called GM Trading involving a swap of Mexican government debt for pesos to be used by a maquiladora.

The IRS released a “field service advice” last month in which it rejected a refund claim from a company with similar facts to the taxpayer in GM Trading. The agency said it disagrees with the decision in GM Trading. It also cited another argument it plans to use in litigation with the taxpayer seeking the refund that it had not used in GM Trading. The taxpayer appears to have had its US parent buy the Mexican government debt. The parent then contributed it to a Mexican subsidiary before the swap with the Mexican government. The US collects toll charges whenever appreciated property is transferred offshore. Thus, even if the swap did not trigger a tax, the IRS intends to argue that the outbound transfer of the debt instruments did.