Rev. Rul. 74-464

The purpose of this Revenue Ruling is to reconsider Rev. Rul. 69-377, 1969-2 C.B. 231, Rev. Rul. 69-501, 1969-2 C.B. 233, Rev. Rul. 70-645, 1970-2 C.B. 273, and Rev. Rul. 73-110, 1973-1 C.B. 454, in light of the expiration of the interest equalization tax (IET) on June 30, 1974.

The above described Revenue Rulings concern certain IET and Federal income tax consequences arising as a result of the issuance of debt obligations by wholly-owned domestic and foreign subsidiaries of domestic corporations (finance subsidiaries). The expiration of the IET on June 30, 1974, renders obsolete any holding in the above Revenue Rulings directly related to the IET. However, a question has been raised concerning the continued validity of the above Revenue Rulings with respect to the Federal income tax consequences of the financing arrangements covered by such Revenue Rulings.

Rev. Rul. 69-377, holds, in part, that the interest paid on debt obligations of a domestic subsidiary with a five to one debt to equity ratio, convertible into stock of its United States parent and guaranteed by such parent, is deductible under section 163 of the Internal Revenue Code of 1954 as long as the debt obligations are held by a person other than the parent or its affiliates. Rev. Rul. 69-377 also holds that no withholding is required under sections 1441 and 1442 by the subsidiary on its interest payments since the subsidiary meets the 20 percent gross income test of section 861(a)(1)(B).

Rev. Rul. 69-501, involves a foreign subsidiary and deals primarily with an IET question. However, the facts of Rev. Rul. 69-501 involve a financing arrangement almost identical with that in Rev. Rul. 69-377 and indicate the acceptance of a five to one debt to equity ratio.

Rev. Rul. 70-645 involves "tier borrowing" in an overseas financing arrangement and cites Rev. Rul. 69-377 as authority for the proposition that solely for purposes of the interest equalization tax and certain income tax purposes, 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.

Rev. Rul. 73-110 holds that, for IET exclusion purposes, a domestic parent corporation must recompute the debt to equity ratio of its wholly-owned foreign financing subsidiary at the current exchange rate whenever it withdraws equity capital or the subsidiary issues foreign debt obligations.

The favorable Federal income tax and withholding consequences accorded to the financing arrangements discussed in the above Revenue Rulings are dependent upon the recognition of the debt obligations issued by the finance subsidiaries as bona fide indebtedness of the finance subsidiaries and not their United States parent corporations. Such recognition was bottomed upon the maintenance by the finance subsidiaries of a five to one debt to equity ratio.

The concepts of the five to one debt to equity ratio and the resultant recognition of the debt obligations as indebtedness of the finance subsidiaries were introduced in Rev. Rul. 69-377. However, Rev. Rul. 69-377 and the other Revenue Rulings clearly indicate that these concepts are inextricably connected with the existence of the IET. That is, the recognition of the debt obligations as bona fide indebtedness of the finance subsidiaries was conditioned upon the imposition of the IET upon their acquisition by United States persons. The IET liability was designed to discourage United States persons from acquiring debt obligations issued by the finance subsidiaries.

In light of the inseparability of the IET and the five to one debt to equity ratio and resultant Federal income tax consequences, the expiration of the IET on June 30, 1974, eliminated any rationale for treating finance subsidiaries any differently than other corporations with respect to their corporate validity or the validity of their corporate indebtedness. Thus, the mere existence of a five to one debt to equity ratio, as a basis for concluding that debt obligations of a finance subsidiary constitute its own bona fide indebtedness, should no longer be relied upon.

Accordingly, Rev. Rul. 69-377, Rev. Rul. 69-501, Rev. Rul. 70-645, and Rev. Rul. 73-110 are hereby revoked. Pursuant to the authority contained in section 7805(b) of the Code, the revocation will not affect interest paid on debt obligations issued prior to the expiration of the IET on June 30, 1974, under financing arrangements which met the requirements set forth in the above Revenue Rulings.

¹ Also released as Technical Information Release 1306, dated August 27, 1974.