IRS PROVIDES SAFE HARBOR 'NOMINAL OR TOKEN STOCK' RULE APPLIED UNDER DEBT DISCHARGE REGS.

Rev. Proc. 94-26

SECTION 1. PURPOSE

This revenue procedure provides guidance on whether an exchange of common stock for unsecured indebtedness of a debtor that is insolvent or in a title 11 proceeding is nominal or token for purposes of section 108(e)(8)(A) of the Internal Revenue Code.

SEC. 2. BACKGROUND

.01 Section 61(a)(12) provides that gross income includes income from the discharge of indebtedness.

.02 Section 108(a)(1)(A) and (B) generally excludes discharged indebtedness from a taxpayer's gross income if the discharge occurs when the taxpayer is bankrupt or insolvent. Section 108(a)(3) limits the amount of income excluded by reason of insolvency under section 108(a)(1)(B) to the amount by which the taxpayer is insolvent. Section 108(b) requires bankrupt and insolvent debtors to reduce certain tax attributes in an amount equal to the excluded amount of discharge of indebtedness income.

.03 The courts have formulated an exception (the "stock-for-debt exception") to discharge of indebtedness income if the debtor exchanges its stock for its indebtedness. E.g., Commissioner v. Motor Mart Trust, 156 F.2d 122 (1st Cir. 1946), acq., 1947-1 C.B. 3. If the stock-for-debt exception applies, no reduction of the debtor's tax attributes is required.

.04 Section 108(e)(10)(A) provides that if the stock-for-debt exception does not apply, the debtor is treated as satisfying the indebtedness with an amount of money equal to the fair market value of the stock issued in exchange for the indebtedness.

.05 Section 108(e)(10)(B)(i) limits the stock-for-debt exception to a debtor in a title 11 case or to an insolvent debtor outside of a title 11 case to the extent of the insolvency. In addition, section 108(e)(10)(B)(ii) provides that the stock-for-debt exception does not apply to an exchange of disqualified stock for indebtedness. Section 108(e)(10)(B)(ii) defines disqualified stock as stock with a stated redemption price if the stock has a fixed redemption date, the issuer of such stock has the right to redeem such stock at one or more times, or the holder of such stock has the right to require its redemption at one or more times.

.06 Section 108(e)(8)(A) provides that the stock-for-debt exception does not apply to the issuance of nominal or token shares. Section 108(e)(8)(B) requires that, with respect to an unsecured creditor, the ratio of the value of the stock received by such unsecured creditor to the amount of his indebtedness cancelled or exchanged for stock in the workout is at least 50 percent of a similar ratio computed for all unsecured creditors participating in the workout.

.07 The stock-for-debt exception was repealed by section 13226 of the Omnibus Budget Reconciliation Act of 1993 (OBRA of 1993) for stock issued for indebtedness after December 31, 1994. The amendments made by section 13226 of OBRA of 1993 do not apply to stock transferred in satisfaction of any indebtedness if such transfer is in a title 11 or similar case (as defined in section 368(a)(3)(A)) that was filed on or before December 31, 1993.

SEC. 3. APPLICATION

.01 If common stock is issued for outstanding unsecured indebtedness in a title 11 case or insolvency workout, the Service will not treat the issuance of common stock as nominal or token under section 108(e)(8)(A) of the Code if the stock to total stock ratio is equal to at least 15 percent. The stock to total stock ratio is the ratio of (i) the value of all common stock issued for unsecured indebtedness in the title 11 case or insolvency workout to (ii) the value of all stock of the corporation outstanding after the title 11 case or insolvency workout (including preferred stock and disqualified stock). The terms "common stock," "preferred stock," "unsecured indebtedness," and "indebtedness" are defined in section 1.108-1 of the Income Tax Regulations. The term "disqualified stock" is defined in section 108(e)(10)(B)(ii).

SEC. 4. EFFECTIVE DATE

This revenue procedure is effective with respect to any issuance of stock for indebtedness:

(1) Pursuant to a plan confirmed by the court in a title 11 case on or after May 17, 1994 (the effective date of section 1.108-1 of the regulations); or

(2) If there is no title 11 case, pursuant to an insolvency workout in which all issuances of stock for indebtedness occur on or after May 17, 1994 (the effective date of section 1.108-1 of the regulations). No inference is intended concerning the interpretation of section 108(e)(8)(A) of the Code prior to the effective date of this revenue procedure.

Because OBRA of 1993 repealed the stock-for-debt exception for stock issued for indebtedness after December 31, 1994, this revenue procedure is not effective with respect to any issuance of stock for indebtedness after December 31, 1994, unless the stock was transferred in satisfaction of any indebtedness in a title 11 or similar case (as defined in section 368(a)(3)(A)) that was filed on or before December 31, 1993.

DRAFTING INFORMATION

The principal author of this revenue procedure is Annette M. Ahlers of the Office of Assistant Chief Counsel (Corporate). For further information regarding this revenue procedure, contact Ms. Ahlers on (202) 622-7750 (not a toll-free call).