Taxpayer receives relief for late debt-and-hedge identification

Plain-English summary

A corporate group issued convertible notes and bought call options intended to hedge the notes' conversion feature. The taxpayer believed integrated tax treatment was automatic and did not timely create the identification statement required by the regulations. Its auditors later discovered the omission, after which the taxpayer prepared a statement and sought discretionary relief before the IRS found the problem. The IRS granted an extension to satisfy the late identification requirement for the notes and purchased calls. The ruling addressed only timeliness and did not decide whether the statement was adequate, whether the instruments actually qualified for integration, or whether the purchased calls and warrants should be combined.

Ruling snapshot

• Question: May the taxpayer satisfy the integration identification requirement after failing to document its convertible notes and hedge on time?
• Outcome: Approved as to timeliness only.
• Key authorities: Treas. Reg. §§ 1.1275-6(c)(1)(i), 1.1275-6(e), and 301.9100-1 through -3

Full text (IRS public release)

Internal Revenue Service                                         Department of the Treasury
                                                                 Washington, DC 20224

Number: 201614010                                                [Third Party Communication:
Release Date: 4/1/2016                                           Date of Communication: Month DD, YYYY]
Index Number: 1275.08-00, 9100.22-00
                                                                 Person To Contact:
-----------------------------                                    -----------------, ID No. -----------------
--------------------------------------                           Telephone Number:
------------------------------                                   ---------------------
 -------------------------------------------                     Refer Reply To:
                                                                 CC:FIP:3
                                                                 PLR-123410-15
                                                                 Date:
                                                                 December 31, 2015




LEGEND

Taxpayer                            =          --------------------------------------
Activity                            =          ------------------------
Year 1                              =          ------
Year 2                              =          ------
Date 1                              =          -------------------
Date 2                              =          -------------------
Date 3                              =          ------------------
Date 4                              =          -------------------
Percentage 1                        =          ----------
Z                                   =          --
Y                                   =          -----------
Banker                              =          ----------------
Counterparty                        =          ----------------------------------------
Tax Officer                         =          ------------------------------------------------------------------------
Auditors                            =          ------------------------------
Recent ID Statement                 =          -----------------------------------------



Dear ------------------:

       This letter is in response to a letter from your authorized representatives
requesting an extension of time under § 301.9100-3 of the Procedure and
Administration Regulations for Taxpayer to satisfy the requirements of
§ 1.1275-6(c)(1)(i) of the Income Tax Regulations relating to the identification
requirements of § 1.1275-6(e) for integration of a qualifying debt instrument and a
§ 1.1275-6 hedge.
PLR-123410-15                              -2-

                                         FACTS

      Taxpayer is the domestic parent of an affiliated group of corporations that files a
consolidated federal income tax return on a calendar-year basis.

       During the first Z months of Year 1, Taxpayer began to consider issuing
convertible notes to fund Activity as well as other business operations. Taxpayer’s long-
time advisor and investment banker, Banker, provided Taxpayer with materials
explaining the accounting and tax treatment of issuing convertible debt and entering into
a convertible bond hedging transaction to hedge the conversion feature. The
transaction consists of purchased call options that offset the conversion feature under
the convertible notes, together with written call options at a higher strike price. The
materials prepared by Banker explained that the economic dilution associated with
issuing convertible debt by effectively raising the conversion price to the strike price
under the warrants and that the cost of the purchased call options would be deductible
over the life of the convertible notes for tax purposes.

        Shortly before Date 1, Taxpayer’s board of directors approved a convertible note
offering and appointed a special pricing committee to review and approve the final terms
of the financing. On Date 1, the committee approved the terms of the financing,
including the purchase of call options and the sale of warrants.

      On Date 1, Taxpayer executed a confirmation with Counterparty for Taxpayer’s
purchase of Y call options with respect to its stock (“Purchased Call Options”)
corresponding to the convertible notes expected to be issued. The Purchased Call
Options are automatically exercised when a corresponding number of the convertible
notes have been converted. On Date 1, Taxpayer entered into a separate confirmation
with Counterparty under which Taxpayer sold warrants (“Warrants”) to Counterparty.

       On Date 2, Taxpayer issued senior convertible notes that pay interest at
Percentage 1 and mature on Date 4 (“Convertible Notes”). On Date 2, Taxpayer also
paid the premium for the Purchased Call Options from the proceeds of the Convertible
Notes.

        From the presentation and communications with Banker and its legal advisor,
Taxpayer did not become aware that it must take any affirmative action such as
identifying the Convertible Notes and Purchased Call Options under § 1.1275-6 in order
to treat them as an integrated transaction. Taxpayer believed that integrated treatment
was the default tax treatment for the Convertible Notes and the Purchased Call Options.
Tax Officer declared that Taxpayer intended to integrate the Convertible Notes and the
Purchased Call Options.

       As part of Taxpayer’s financial audit for Year 1, Auditors reviewed Taxpayer’s tax
provision in Year 2 and requested a copy of its documentation meeting the
PLR-123410-15                              -3-

requirements of § 1.1275-6(c)(1)(i) and (e). Taxpayer’s sole tax professional was
unaware of the requirements and had not prepared the documentation.

       On Date 3, Taxpayer prepared and retained, as part of its books and records,
documentation that it believes meets the requirements of § 1.1275-6(c)(1)(i) and (e), the
Recent ID Statement. Taxpayer has requested an extension of time under
§ 301.9100-1 to satisfy the requirements of § 1.1275-6(c)(1)(i) and (e), using the Recent
ID Statement.

       Taxpayer makes the following additional representations, treating the
requirements of § 1.1275-6(c)(1)(i) and (e) as a regulatory election:

      1. The request for relief was filed before the failure to make the regulatory
      election was discovered by the Internal Revenue Service (“Service”).

      2. Granting the relief requested will not result in Taxpayer having a lower tax
      liability in the aggregate for all years to which the regulatory election applies than
      Taxpayer would have had if the election had been timely made (taking into
      account the time value of money).

      3. Taxpayer did not seek to alter a return position for which an accuracy-related
      penalty has been or could have been imposed under section 6662 of the Internal
      Revenue Code at the time Taxpayer requested relief, and the new position
      requires or permits a regulatory election for which relief is requested.

      4. Being fully informed of the required regulatory election and related tax
      consequences, Taxpayer did not choose to not file the election.

      5. Taxpayer is not using hindsight in requesting this relief.

In addition, affidavits on behalf of Taxpayer have been provided as required by
§ 301.9100-3(e).

                                  LAW AND ANALYSIS

       Section 1.1275-6 generally provides for the integration of a qualifying debt
instrument within the meaning of § 1.1275-6(b)(1) (“QDI”) with a § 1.1275-6 hedge or
combination of § 1.1275-6 hedges if the combined cash flows of the components are
substantially equivalent to the cash flows on a noncontingent debt instrument that pays
interest at a fixed rate or qualified floating rate. See § 1.1275-6(a).

        Section 1.1275-6(c)(1) provides generally that a QDI and a § 1.1275-6 hedge are
an integrated transaction if the requirements in § 1.1275-6(c)(1)(i) through (vii) are
satisfied. Section 1.1275-6(c)(1)(i) requires that the taxpayer satisfy the identification
PLR-123410-15                                -4-

requirements of § 1.1275-6(e) on or before the date the taxpayer enters into the
§ 1.1275-6 hedge.

       Section 1.1275-6(e) provides that for each integrated transaction, a taxpayer
must enter and retain as part of its books and records the following information: (1) the
date the QDI was issued or acquired (or is expected to be issued or acquired) by the
taxpayer and the date the § 1.1275-6 hedge was entered into by the taxpayer; (2) a
description of the QDI and the § 1.1275-6 hedge; and (3) a summary of the cash flows
and accruals resulting from treating the QDI and the § 1.1275-6 hedge as an integrated
transaction.

        Section 301.9100-1(c) provides, in part, that the Commissioner has discretion to
grant a reasonable extension of time to make a regulatory election, or a statutory
election (but no more than 6 months except in the case of a taxpayer who is abroad),
under all subtitles of the Code except subtitles E, G, H, and I. Section 301.9100-1(b)
provides in part that the term "election" includes an application for relief in respect of
tax; a request to adopt, change, or retain an accounting method or accounting period;
but does not include an application for an extension of time for filing a return under
section 6081. Section 301.9100-1(b) also provides in part that the term "regulatory
election" means an election whose due date is prescribed by a regulation published in
the Federal Register, or by a revenue ruling, revenue procedure, notice, or
announcement published in the Internal Revenue Bulletin.

       Section 301.9100-3(a) through (c)(1)(ii) sets forth rules that the Service generally
will use to determine whether, under the facts and circumstances of each situation, the
Commissioner will grant an extension of time for regulatory elections that do not meet
the requirements of § 301.9100-2 for an automatic extension.

        Section 301.9100-3(b) provides that, subject to paragraphs (b)(3)(i) through (iii)
of § 301.9100-3, when a taxpayer applies for relief under § 301.9100-3 before the
failure to make the regulatory election is discovered by the Service, the taxpayer will be
deemed to have acted reasonably and in good faith.

       Section 301.9100-3(c) provides that the interests of the Government are
prejudiced if either granting relief would result in the taxpayer having a lower tax liability
in the aggregate for all years to which the regulatory election applies than the taxpayer
would have had if the election had been timely made (taking into account the time value
of money) or the taxable year in which a timely regulatory election should have been
made is closed.

       Section 301.9100-3(b)(3)(iii) provides that a taxpayer is deemed to have not
acted reasonably and in good faith if the taxpayer uses hindsight in requesting relief. If
specific facts have changed since the due date for making the election that make the
election advantageous to a taxpayer, the Service will not ordinarily grant relief. In such
PLR-123410-15                                 -5-

a case, the Service will grant relief only when the taxpayer provides strong proof that
the taxpayer's decision to seek relief did not involve hindsight.

                                     CONCLUSIONS

        Based on the information submitted and representations made, we conclude that
Taxpayer has satisfied the requirements for granting a reasonable extension of time
under § 301.9100-3 to satisfy the requirements of § 1.1275-6(c)(1)(i) relating to the
identification requirements of § 1.1275-6(e) for integration of the Convertible Notes and
the Purchased Call Options.

                                          CAVEATS

        This ruling is limited to the timeliness of satisfying the requirements of
§ 1.1275-6(c)(1)(i) relating to the identification requirements of § 1.1275-6(e) in order to
treat the Convertible Notes and the Purchased Call Options as integrated transactions.
This ruling's application is limited to the facts, representations, Code sections, and
regulations cited herein. Except as expressly provided herein, no opinion is expressed
or implied concerning the tax consequences of any aspect of any transaction or item
discussed or referenced in this letter. In particular, no opinion is expressed or implied
concerning the integration of the Convertible Notes and the Purchased Call Options,
including but not limited to: (1) whether the Recent ID Statement is adequate for
purposes of § 1.1275-6(e); (2) whether the Purchased Call Options and Warrants
should be treated as a single instrument; or (3) whether the Commissioner could
integrate, under § 1.1275-2(g)(2), the Convertible Notes, the Purchased Call Options
and the Warrants as a single synthetic position.

       Moreover, no opinion is expressed with regard to whether the tax liability of
Taxpayer is not lower in the aggregate for all years to which the regulatory election
applies than such tax liability would have been if the election had been timely made
(taking into account the time value of money). Upon audit of the federal income tax
returns involved, the director's office will determine such tax liability for the years
involved. If the director's office determines that such tax liability is lower, that office will
determine the federal income tax effect.

       The ruling contained in this letter is based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

      This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3)
provides that it may not be used or cited as precedent.
PLR-123410-15                                -6-

         In accordance with the Power of Attorney on file with this office, a copy of this
letter is being sent to your authorized representatives.

                                       Sincerely,




                                       Charles W. Culmer
                                       Senior Technician Reviewer, Branch 3
                                       Office of the Associate Chief Counsel
                                       (Financial Institutions & Products)



Enclosure
      Copy of this letter for section 6110 purposes