Brokerage Company Suggests Refinements to Debt-Equity Regs

Commissioner of Internal Revenue

The preamble to the Proposed Regulations requests comments on "all aspects of the proposed rules, including comments on the clarity of the proposed rules and how they can be made more administrable." We believe that the Proposed Regulations, in their current form, are too broad and would cause immediate and unnecessarily harmful disruptions to routine business functions.

We are writing to suggest ways in which the Proposed Regulations could be refined so as to address the U.S. base erosion issues identified in the preamble of the Proposed Regulations, while allowing ordinary course business transactions that are essential to our day-to-day operations to remain unaffected. Specifically, we highlight five types of transactions that are not abusive and that allow us to manage cash efficiently and in light of regulatory and other business constraints.

Our customers include many of the world's largest banks, broker-dealers, investment banks, trading firms, hedge funds, governments, corporations, property owners, real estate developers and investment firms. We have offices in dozens of major markets around the world. As of December 31, 2015, Cantor employed 3,855 brokers, salespeople, managers and other front-office personnel.

In the case of the Transactions identified above, we undertake each of these Transactions for legitimate, non-tax business reasons. Our treasury team strongly prefers to use debt and other intercompany payables over cash and equity in intragroup transactions because debt offers greater flexibility. This is particularly the case in the context of regulated subsidiaries where once amounts are contributed as capital, local regulatory rules may prohibit or defer for extended periods the ability of the subsidiary to return such amounts making the cash unavailable for other business needs for an indefinite period. Also, as explained more fully below, because most of our subsidiaries have a significant ownership interest not held by our parent company, using debt rather than having the parent contribute the stock in exchange for an increased interest in the subsidiaries is necessary to avoid disruption to our legal economic ownership structure. The burdens placed upon our ordinary business operations by the requirements of the Proposed Regulations could be significantly curtailed by implementing a handful of narrow exceptions, as detailed below. We respectfully urge Treasury to consider such narrow exceptions prior to finalizing the Proposed Regulations.

Accordingly, we propose an exception from the Documentation Requirements, the General Rule, and the Funding Rule where debt is required to be repaid or is repaid within 183 days.

In order to deliver shares under the award plan, the executive's employer may purchase newly issued BGC Partners, Inc. stock in exchange for debt and deliver the BGC Partners, Inc. stock to the employee. It appears that these debt instruments would be recharacterized as stock under the Proposed Regulations because the instruments are issued in exchange for expanded group stock.⁸

The Preamble expresses the following concerns with respect to debt issued in exchange for related-party stock:

Second, issuing shares as compensation does not generate significant federal tax benefits compared to awarding cash, and purchasing those shares with debt does not generate significant federal tax benefits compared to purchasing them for cash. BGC's use of debt rather than cash is driven primarily by the cash needs of its subsidiaries, not by tax considerations. Third, the expanded group member's ownership of the BGC Partners, Inc. stock is transitory -- the shares are paid to the employee(s) as part of the same prearranged plan. Awards under the equity plan introduce new ownership interests of BGC Partners, Inc. in individuals who are not members of the expanded group.

BGC uses debt rather than cash in these internal acquisitions because it considers it a good business practice to preserve cash for the needs of the business whenever possible. In addition and as discussed above in many cases, its regulators impose restrictions on the use of cash because each regulated entity must have a base capital amount and liquidity as prescribed by the various regulators. Under many regulatory regimes, it is easier for a company to repay debt than to return contributed capital. Furthermore, because BGC owns substantially less than 100% of its operating subsidiaries, it is not economically indifferent to contributing rather than selling its stock to the operating subsidiaries. A significant percentage of the equity of the operating subsidiaries of BGC, historically in excess of 20%, is owned through partnership interests by Cantor Fitzgerald, L.P. (which is owned mostly by individual taxpayers) and by numerous employees of BGC. A contribution of shares by BGC to its operating subsidiaries would require an increase in BGC's ownership of the operating subsidiaries and would therefore alter the ownership relationship between BGC and the other equity owners.

Accordingly, we propose that an acquisition of expanded group stock be disregarded for purposes of Prop. Treas. Reg. § 1.385-3(b)(2)(ii) and (b)(3)(ii)(B) where:

Cantor's subsidiaries acquired the BGC shares from BGC primarily in exchange for newly issued debt. It appears that the Proposed Regulations would have recharacterized the debt issued to acquire BGC shares as stock upon issuance, even though the BGC shares were transferred outside the expanded group as part of the same transaction.⁹

We use a mix of cash and equity in these acquisitions because many of the former owners of our acquired companies become valued employees and we offer them equity interests to better align their future economic interests with those of Cantor. As with our Equity Plan, we issue intercompany debt to support these third-party acquisitions for legitimate business reasons. Our use of internal debt to transfer the shares to the acquirer does not generate US tax benefits in excess of those that would exist if we acquired the acquisition companies for cash. The issuer's ownership of the expanded group stock is transitory.

Similar to our request above, we propose that an acquisition of expanded group stock be disregarded for purposes of Prop. Treas. Reg. § 1.385-3(b)(2)(ii) and (b)(3)(ii)(B) where:

The General Rule and the Funding Rule apply to some of the most common techniques that might be required for post-acquisition structuring, including intra-group sales of newly acquired stock, statutory mergers, and debt push-downs. We propose an exception from the General Rule and the Funding Rule where:

While interest income and expense would not be offset where the issuer and holder are members of different consolidated groups, we believe that debt between related US corporations does not present the same policy concerns as cross-border debt, and that the potential for abuse arising from debt between two US corporations is very limited compared to the extreme disruption their application would cause to companies with multiple consolidated groups. Existing rules limit the opportunities for tax avoidance by issuing debt to a non-consolidated US corporation. For example, section 163(j) disallows a deduction for interest paid to a tax-exempt related party; section 279 disallows an interest deduction in certain debt-financed acquisitions of portfolio stock; section 246A disallows a deduction for dividends received on debt-financed portfolio stock; and section 512(b)(3) denies tax-exempt treatment of certain interest received by a tax-exempt corporation when received from a related party.

We believe targeted rules such as those listed above are a more appropriate way to combat specific abuses that could arise between US corporations. Accordingly, we propose an exception from the General Rule and the Funding rule where:

Cantor sincerely appreciates the opportunity to provide input on the Proposed Regulations. We look forward to continuing to work with the IRS and the Treasury on these Proposed Regulations and our suggested exceptions.

If you have further specific operational questions on these issues or any others, please feel free to contact the undersigned at 212.829-5237 or hwaizer@cantor.com.

² 81 Fed. Reg. 20912, 20915 (Apr. 8, 2016) (quoting Cuyuna Realty Co. v. United States, 382 F.2d 298, 301 (Ct Cl. 1967).

³ Under current federal income tax principles, an obligation to pay may not be treated as indebtedness when the term of the obligation is short. Courts have used maturity date as a primary factor in deciding whether a debt instrument constitutes a "security" within the meaning of the reorganization provisions. For example, in Pinellas Ice & Cold Storage Co. v. Commissioner, the Supreme Court held that short-term notes received in exchange for property did not constitute "securities" within the meaning of the reorganization provisions because they were the equivalent of cash. Pinellas Ice & Cold Storage Co. v. Comm'r, 287 U.S. 462, 469 (1933) (emphasis added). See also NSAR 08489 ("Debt instruments with long terms are akin to investments; whereas, debt instruments with short terms tend to resemble only temporary money management.") (citing Washington-Oregon Shippers Cooperative, Inc. v. Comm'r, T.C. Memo. 1987-32); L. & E. Stirn, Inc. v. Comm'r, 107 F.2d 390, 392 (2d Cir. 1939) ("The question is always whether bonds or notes which are exchanged represent an investment in the business of the transferee or are a practical substitute for a cash sale. . . ."); Comm'r v. Sisto Financial Corp, 139 F.2d 253 (2d Cir. 1943); Pacific Public Service Co. v. Comm'r, 4 T.C. 742 (1945), aff'd 154 F.2d 713 (9th Cir. 1946); Turner Construction Co. v. United States, 270 F. Supp. 918 (S.D.N.Y. 1964). Short-term bonds and debentures with an average due date of two and a half years which were paid off in ten months were not considered securities, see Stirn Inc. v. Comm'r, 107 F.2d 390 (2d Cir. 1939)., nor were short-term notes of two, three, four, and five years. See Neville Coke & Chemical Co. v. Comm'r, 148 F.2d 599 (3d Cir. 1945); Lloyd-Smith v. Comm'r, 116 F.2d 642 (2d Cir. 1941).

⁴ See Treas. Reg. §§ 1.1441-2(a)(3), 1.1441-1(b)(4)(iv); section 871(g)(1)(B).

⁵ See Treas. Reg. § 1.1473-1(a)(4)(i).

⁶See section 1272(a)(2)(C).

⁷ Section 1278(a)(1)(B)(i).

⁸See Prop. Treas. Reg. § 1.385-3(b)(2)(ii).

⁹See Prop. Treas. Reg. § 1.385-3(b)(2)(ii), (g)(3) example 2.

¹⁰See Prop. Treas. Reg. § 1.385-1(e) ("For purposes of the regulations under section 385, all members of a consolidated group (as defined in § 1.1502-1(h)) are treated as one corporation.").

¹¹ The rules for attributing ownership from a shareholder to a corporation, on the other hand, (1) are subject to a 5% threshold to prevent any attribution from very small shareholders, and (2) apply proportionately to the shareholder's interest in the corporation, if between 5% and 50%. See section 304(c)(3)(B).