No adjustment is made for the value of the conversion feature of a bond convertible into stock or another debt instrument of the issuer or a related party in calculating the bond’s issue price for purposes of determining whether the bond was issued at an original issue discount.
1 Under regulations, the issue price of a bond convertible into stock or another debt instrument of the issuer includes any amount paid for the conversion privilege, even if the privilege may be satisfied for the cash value of the stock or other debt instrument.
2 For debt instruments issued on or after February 5, 2013, this includes the equity interests of entities classified as partnerships as well as those classified as corporations for tax purposes. Although the regulations are effective for bonds issued after April 3, 1994, taxpayers may rely on the regulations for bonds issued after December 21, 1992. (However, under amendments (issued February 28, 1991) to the 1986 proposed regulations, a portion of the bond’s issue price was allocable to the conversion feature if the conversion feature could have been satisfied in cash. This amendment was modified by further proposed regulations (issued December 22, 1992) and is not mentioned in the final regulations (adopted January 27, 1994).)
Bonds that are convertible into stock or a debt instrument of a corporation other than the issuer are valued under the noncontingent bond method.3 This method provides for a projected payment schedule consisting of all noncontingent payments and a projected amount for each contingent payment.4 Except in the case of a contingent payment that is fixed more than six months before it is due, the projected payment schedule generally remains fixed throughout the term of the debt instrument and any income, deductions, gain, or loss attributable to the debt instrument is based on this schedule.5 (Proposed regulations formerly provided for valuing the bond and conversion feature separately and allocating the issue price to the separate components.) The Service has ruled that the noncontingent bond method applied to a debt instrument that was convertible into stock of the issuer and that also provided for one or more contingent cash payments.6
1. Treas. Reg. §§ 1.1232-3(b)(2)(i); 1.1273-2(j).
2. Treas. Reg. § 1.1273-2(j).
3. Treas. Reg. § 1.1275-4(b)(1).
