A US PARENT THAT MADE A LOAN TO A SUBSIDIARY DID NOT HAVE TO ACCRUE INTEREST because the subsidiary only had to the repay the loan out of positive cash flow, the IRS said
The case opens the door to possible tax planning. The IRS concluded the loan was a “contingent debt” and, therefore, interest did not have to be reported as income by the parent until the contingencies arose requiring payment. The parent organized a special-purpose subsidiary to undertake a single real estate project. It advanced funds to the subsidiary as a loan at a stated interest rate. However, the loan agreement said the subsidiary had to make payments only out of “excess cash flow,” and unpaid interest would be added to the unpaid principal amount.
No payments were made on the loan. An IRS agent thought on audit that the parent should have accrued interest under so-called OID, or original issue discount, rules. The IRS national office said no in a field service advice made public recently. It advised conceding the interest accrual issue on grounds that the loan was a contingent debt. However, it also advised not to enter into any written settlement that characterizes the instrument as debt or equity in order to preserve future litigating options.