THE IRS PROVIDED A ROADMAP for how to draft a hybrid loan.

THE IRS PROVIDED A ROADMAP for how to draft a hybrid loan.

October 01, 2001
THE IRS PROVIDED A ROADMAP for how to draft a hybrid loan.

It is common for US power companies investing offshore to try to inject funds into the project company in a form that is considered equity for US tax purposes, but debt in the foreign country. This is done in an effort to “strip” earnings from the project country as interest so that they can be deducted against the local tax base, but still allow US taxes to be deferred. US taxes can only be deferred on certain equity returns.

The IRS national office released an internal memo in September analyzing “perpetual” instruments that a US manufacturing company had its offshore holding company use to reinvest cash in another offshore company. The instruments had no fixed maturity date. They were subordinated to all other creditors, but received payment ahead of the common shares. The holder was entitled to a cumulative fixed return, but it was only paid each year to the extent of the “distributable profits” that year and then could only be paid after formal approval by the board. Many other details are described in the internal memo. They make a good starting point for discussions with local counsel in other countries for anyone trying to structure a hybrid instrument. The US parent company treated the instruments as equity for financial purposes, but was inconsistent in its reporting for US tax purposes. The IRS national office said they were still equity. The memo is ILM 200134004.

Keith Martin