Question

Your corporate client wants to issue 100-year bonds . The corporation 's CEO reads The Wall Street Journal regularly and has observed that similar bonds have been issued by several companies, including several Fortune 500 companies. He touts the fact that the interest rate on these bonds is slightly more than that for 30-year U.S. Treasury bonds . In addition, he expresses the belief that interest on the bonds would be deductible, whereas dividends on preferred or common stock would be nondeductible. You are concerned that the IRS might treat the bonds as equity because of their extraordinarily long term. If the IRS does treat the bonds as such, it might recharacterize the "interest" as dividends and deny your client an interest deduction. What advice would you give the client now regarding the bond issue? What advice would you give it when it prepares its tax return after the new bonds have been issued?

Answer 1

Facts of the case: In the given case, the corporate client wants to issue 100-year bonds. It has been observed that similar bonds have been issued by many of the Fortune 500 companies such as Coca Cola as well. These types of bonds are referred to as Century bonds and contain mixed characteristics of both debt and equity. Companies generally issue such types of bonds to avoid tax as interest on the bonds would is tax deductible, whereas dividends on shares would be non-deductible

Issue: Whether such bonds are to be treated as debt or as equity, by IRS.

Analysis: In 1995, the U.S. Treasury Department proposed changes in tax laws for the 1996 federal budget by eliminating tax deductibility of the interest paid on corporate bonds with a maturity of more than 40 years. Considering their long maturity, the Treasury argued that such bonds were issued for the purpose of avoiding taxa and that they should be considered as permanent equity instead of debt. However, two of the Congressional Committees declined the said proposal in order to avoid market disruption and proposed that the effective date of such changes should be that of congressional action on the proposal. Companies and Financial institutions fought against the said proposal and it was finally defeated in 1996. The Treasury Department made the proposal again during the 1997 federal budget but again, it was defeated.

Conclusion: The clients can issue the above-stated bond without any worries because the same will be treated as a bond and not as equity. Also, the interest paid on the said bond will be tax deductible and the company will be able to sabe tax.