TREATMENT OF CERTAIN HIGH YIELD ORIGINAL ISSUE DISCOUNT OBLIGATIONS.

SEC. 7202. TREATMENT OF CERTAIN HIGH YIELD ORIGINAL ISSUE DISCOUNT OBLIGATIONS. (a) General Rule.—Subsection (e) of section 163 (relating to interest deductions on original issue discount obligations) is amended by redesignating paragraph (5) as paragraph (6) and by inserting after paragraph (4) the following new paragraph: “(5) Special rules for original issue discount on certain high yield obligations.— “(A) In general.—In the case of an applicable high yield discount obligation issued by a corporation— “(i) no deduction shall be allowed under this chapter for the disqualified portion of the original issue discount on such obligation, and “(ii) the remainder of such original issue discount shall not be allowable as a deduction until paid. For purposes of clause (ii), rules similar to the rules of subsection (i)(3)(B) shall apply in determining the time when the original issue discount is paid. “(B) Disqualified portion treated as stock distribution for purposes of dividend received deduction.— “(i) In general.—Solely for purposes of sections 243, 245, 246, and 246A, the dividend equivalent portion of any amount includible in gross income of a corporation under section 1272(a) in respect of an applicable high yield discount obligation shall be treated as a dividend received by such corporation from the corporation issuing such obligation. “(ii) Dividend equivalent portion.—For purposes of clause (i), the dividend equivalent portion of any amount includible in gross income under section 1272(a) in respect of an applicable high yield discount obligation is the portion of the amount so includible— “(I) which is attributable to the disqualified portion of the original issue discount on such obligation, and “(II) which would have been treated as a dividend if it had been a distribution made by the issuing corporation with respect to stock in such corporation. “(C) Disqualified portion.— “(i) In general.—For purposes of this paragraph, the disqualified portion of the original issue discount on 103 STAT. 2331any applicable high yield discount obligation is the lesser of— “(I) the amount of such original issue discount, or “(II) the portion of the total return on such obligation which bears the same ratio to such total return as the disqualified yield on such obligation bears to the yield to maturity on such obligation. “(ii) Definitions.—For purposes of clause (i), the term ‘disqualified yield’ means the excess of the yield to maturity on the obligation over the sum referred to subsection (i)(1)(B) plus 1 percentage point, and the term ‘total return’ is the amount which would have been the original issue discount on the obligation if interest described in the parenthetical in section 1273(a)(2) were included in the stated redemption price at maturity. “(D) Exception for s corporations.—This paragraph shall not apply to any obligation issued by any corporation for any period for which such corporation is an S corporation. “(E) Effect on earnings and profits.—This paragraph shall not apply for purposes of determining earnings and profits; except that, for purposes of determining the dividend equivalent portion of any amount includible in gross income under section 1272(a) in respect of an applicable high yield discount obligation, no reduction shall be made for any amount attributable to the disqualified portion of any original issue discount on such obligation. “(F) Cross reference.— “For definition of applicable high yield discount obligation, see subsection (i).” (b) Applicable High Yield Discount Obligation.—Section 163 is amended by redesignating subsection (i) as subsection (j) and by inserting after subsection (h) the following new subsection: “(i) Applicable High Yield Discount Obligation.— “(1) In general.—For purposes of this section, the term ‘applicable high yield discount obligation’ means any debt instrument if— “(A) the maturity date of such instrument is more than 5 years from the date of issue, “(B) the yield to maturity on such instrument equals or exceeds the sum of— “(i) the applicable Federal rate in effect under section 1274(d) for the calendar month in which the obligation is issued, plus “(ii) 5 percentage points, and “(C) such instrument has significant original issue discount. For purposes of subparagraph (B)(i), the Secretary may by regulation permit a rate to be used with respect to any debt instrument which is higher than the applicable Federal rate if the taxpayer establishes to the satisfaction of the Secretary that such higher rate is based on the same principles as the applicable Federal rate and is appropriate for the term of the instrument. 103 STAT. 2332 “(2) Significant original issue discount.—For purposes of paragraph (1)(C), a debt instrument shall be treated as having significant original issue discount if— “(A) the aggregate amount which would be includible in gross income with respect to such instrument for periods before the close of any accrual period (as defined in section 1272(a)(5)) ending after the date 5 years after the date of issue, exceeds— “(B) the sum of— “(i) the aggregate amount of interest to be paid under the instrument before the close of such accrual period, and “(ii) the product of the issue price of such instrument (as defined in sections 1273(b) and 1274(a)) and its yield to maturity. “(3) Special rules.—For purposes of determining whether a debt instrument is an applicable high yield discount obligation— “(A) any payment under the instrument shall be assumed to be made on the last day permitted under the instrument, and “(B) any payment to be made in the form of another obligation (or stock) of the issuer (or a related person within the meaning of section 453(f)(1)) shall be assumed to be made when such obligation (or stock) is required to be paid in cash or in property other than such obligation (or stock). “(4) Debt instrument.—For purposes of this subsection, the term ‘debt instrument’ means any instrument which is a debt instrument as defined in section 1275(a). “(5) Regulations.—The Secretary shall prescribe such regulations as may be appropriate to carry out the purposes of this subsection and subsection (e)(5), including— “(A) regulations providing for modifications to the provisions of this subsection and subsection (e)(5) in the case of varying rates of interest, put or call options, indefinite maturities, contingent payments, assumptions of debt instruments, conversion rights, or other circumstances where such modifications are appropriate to carry out the purposes of this subsection and subsection (e)(5), and “(B) regulations to prevent avoidance of the purposes of this subsection and subsection (e)(5) through the use of issuers other than C corporations, agreements to borrow amounts due under the debt instrument, or other arrangements.” (c) Effective Date.— (1) In general.—Except as provided in paragraph (2), the amendments made by this section shall apply to instruments issued after July 10, 1989. (2) Exceptions.— (A) The amendments made by this section shall not apply to any instrument if— (i) such instrument is issued in connection with an acquisition— (I) which is made on or before July 10, 1989, (II) for which there was a written binding contract in effect on July 10, 1989, and at all times thereafter before such acquisition, or 103 STAT. 2333 (III) for which a tender offer was filed with the Securities and Exchange Commission on or before July 10, 1989, (ii) the term of such instrument is not greater than— (I) the term specified in the written documents described in clause (iii), or (II) if no term is determined under subclause (I), 10 years, and (iii) the use of such instrument in connection with such acquisition (and the maximum amount of proceeds from such instrument) was determined on or before July 10, 1989, and such determination is evidenced by written documents— (I) which were transmitted on or before July 10, 1989, between the issuer and any governmental regulatory bodies or prospective parties to the issuance or acquisition, and (II) which are customarily used for the type of acquisition or financing involved. (B) The amendments made by this section shall not apply to any instrument issued pursuant to the terms of a debt instrument issued on or before July 10, 1989, or described in subparagraph (A) or (D). (C) The amendments made by this section shall not apply to any instrument issued to refinance an original issue discount debt instrument to which the amendments made by this section do not apply if— (i) the maturity date of the refinancing instrument is not later than the maturity date of the refinanced instrument, (ii) the issue price of the refinancing instrument does not exceed the adjusted issue price of the refinanced instrument, (iii) the stated redemption price at maturity of the refinancing instrument is not greater than the stated redemption price at maturity of the refinanced instrument, and (iv) the interest payments required under the refinancing instrument before maturity are not less than (and are paid not later than) the interest payments required under the refinanced instrument. (D) The amendments made by this section shall not apply to instruments issued after July 10, 1989, pursuant to a reorganization plan in a title 11 or similar case (as defined in section 368(a)(3) of the Internal Revenue Code of 1986) if the amount of proceeds of such instruments, and the maturities of such instruments, do not exceed the amount or maturities specified in the last reorganization plan filed in such case on or before July 10, 1989.