Rev. Rul. 73-110

Advice has been requested whether under the circumstances described below the currency exchange rate in existence at the time the principal debt obligation was incurred is to be used in computing the debt to equity capital ratio when such indebtedness is reduced.

P, a domestic corporation, owns all of the capital stock of S, a foreign corporation. P also owns various other foreign subsidiaries. In order to provide working capital and funds for expansion for P and the other subsidiaries, S sold certain debt obligations to the public located outside the United States. The proceeds from the sale of such debt obligations were received in Swiss francs and were loaned to P at interest. P was obligated to repay S in the same currency as the latter is obligated to repay its foreign lenders. In addition to the above principal debt obligation S has from time to time incurred additional debt obligations which it has, in turn, loaned to P under the same terms.

Before the date on which the principal debt obligation was issued by S, P had purchased all of the capital stock of S for United States dollars in an amount equal to 20 percent of the principal amount of the total debt obligation to be issued by S. Each time S incurred additional indebtedness P made additional contributions in dollars to the equity capital of S so that the capital of S would remain equal to at least 20 percent of the principal amount of the outstanding indebtedness of S. See Revenue Ruling 69-377, 1969-2 C.B. 231; 69-501, 1969-2 C.B. 233; 70-645, 1970-2 C.B. 273, which provide, in part, that for the purpose of interest equalization tax the debt obligations issued by wholly-owned financing subsidiaries of domestic parent corporations will be deemed to be indebtedness of such subsidiaries if the amount borrowed by the financing subsidiary does not exceed five times its equity capital.

During the current taxable year S made a required sinking fund payment which reduced the amount of its principal indebtedness. P withdrew a part of its equity capital contribution to S in order to maintain an equity capital at least 20 percent of the outstanding indebtedness of S after such payment. The reduction in the equity capital was computed on the basis of the currency exchange rate in existence at the time the principal debt was incurred.

Also, during the current taxable year fluctuations in the value of the United States dollar relative to the Swiss franc resulted in an increase in the value of the borrowings by S in Swiss francs in relation to the equity capital of S which is totally in U.S. dollars. Thus, the debt to equity capital ratio was, after the withdrawal by P, greater than five times when based upon the actual currency exchange rate.

It is held that in determining whether the aggregate face amount of S's outstanding indebtedness will at all times not exceed five times the amount of its equity capital, the ratio must be recomputed, based upon the actual currency exchange rate in existence at the time one or more of the following occurrences: (1) additional borrowings by S and/or (2) withdrawals from S's equity capital by P for any reason, such as a reduction of S's outstanding indebtedness.