[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.163-3]

[Page 829-831]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.163-3  Deduction for discount on bond issued on or before 
May 27, 1969.

    (a) Discount upon issuance. (1) If bonds are issued by a corporation 
at a discount, the net amount of such discount is deductible and should 
be prorated or amortized over the life of the bonds.

[[Page 830]]

For purposes of this section, the amortizable bond discount equals the 
excess of the amount payable at maturity (or, in the case of a callable 
bond, at the earlier call date) over the issue price of the bond (as 
defined in paragraph (b)(2) of Sec. 1.1232-3).
    (2) In the case of a bond issued by a corporation after December 31, 
1954, as part of an investment unit consisting of an obligation and an 
option, the issue price of the bond is determined by allocating the 
amount received for the investment unit to the individual elements of 
the unit in the manner set forth in subdivision (ii)(a) of Sec. 1.1232-
3(b)(2). Discount with respect to bonds issued by a corporation as part 
of investment units consisting of obligations and options after December 
31, 1954, and before Dec. 24, 1968--
    (i) Increased by any amount treated as bond premium which has been 
included in gross income with respect to such bonds prior to Dec. 24, 
1968, or
    (ii) Decreased by any amount which has been deducted by the issuer 
as discount attributable to such bonds prior to Dec. 24, 1968, and
    (iii) Decreased by any amount which has been deducted by the issuer 
prior to Dec. 24, 1968 upon the exercise or sale by investors of options 
issued in investment units with such bonds,

should be amortized, starting with the first taxable year ending on or 
after Dec. 24, 1968 over the remaining life of such bonds.
    (b) Examples. The rules in paragraph (a) of this section are 
illustrated by the following examples:

    Example (1). M Corporation, on January 1, 1960, the beginning of its 
taxable year issued for $95,000, 3 percent bonds, maturing 10 years from 
the date of issue, with a stated redemption price at maturity of 
$100,000. M Corporation should treat $5,000 ($100,000-$95,000) as the 
total amount to be amortized over the life of the bonds.
    Example (2). Assume the same facts as example (1), except that the 
bonds are convertible into common stock of M Corporation. Since the 
issue price of the bonds includes any amount attributable to the 
conversion privilege, the result is the same as in example (1).
    Example (3). Assume the same facts as example (1), except that the 
bonds are issued as part of an investment unit consisting of an 
obligation and an option. Assume further that the issue price of the 
bonds as determined under the rules of allocation set forth in 
subdivision (ii)(a) of Sec. 1.1232-3(b)(2) is $94,000. Accordingly, M 
Corporation should treat $6,000 ($100,000-$94,000) as the total amount 
to be amortized over the life of the bonds.
    Example (4). Assume in example (3), that prior to Dec. 24, 1968, M 
Corporation had only treated $5,000 as the bond discount to be amortized 
and deducted only $4,000 of this amount. Starting with the first taxable 
year ending on or after Dec. 24, 1968, M Corporation should amortize 
$2,000 ($6,000 discount, less $4,000 previously deducted) over the 
remaining life of the bonds.
    Example (5). N Corporation, on January 1, 1956, for a consideration 
of $102,000, issued 20-year bonds in the face amount of $100,000, 
together with options to purchase stock of N Corporation. The issue 
price of the bonds as determined under the rules of allocation set forth 
in subdivision (ii)(a) of Sec. 1.1232-3(b)(2) is $99,000. Until Dec. 
24, 1968, N Corporation has treated as bond premium, $2,000, 
representing the excess of the consideration received for the bond-
option investment units over the maturity value of the bonds, and has 
accordingly prorated and included in income $1,200 of such amount. 
Starting with the first taxable year beginning on or after Dec. 24, 
1968, N Corporation may amortize as a deduction over the remaining life 
of the bonds the amount of $2,200 ($1,000 discount, plus $1,200 
previously included in income).
    Example (6). O Corporation, on January 1, 1956, for a consideration 
of $100,000, issued 20-year bonds with a $100,000 face value, together 
with options to purchase stock of O Corporation, which could be 
exercised at any time up to 5 years from the date of issue. The issue 
price of the bonds as determined under the rules of allocation set forth 
in subdivision (ii)(a) of Sec. 1.1232-3(b)(2) is $98,000. O 
Corporation, upon the exercise of the options prior to Dec. 24, 1968, 
had deducted from income their fair market value at the time of 
exercise, which is assumed for purposes of this example to have been 
$3,000. Even though the bonds are considered to have been issued at a 
discount under paragraph (a)(1) of this section, O Corporation would 
have no deduction over the remaining life of the bonds, inasmuch as O 
Corporation, in computing the amount of such deduction, is required 
under paragraph (a)(2)(iii) of this section to reduce the amount which 
would otherwise be treated as bond discount, $2,000 ($100,000-$98,000), 
by the amount deducted from income upon the exercise of the options, in 
this case, $3,000.

    (c) Deduction upon repurchase. (1) Except as provided in 
subparagraphs (2) and (3) of this paragraph, if bonds are issued by a 
corporation and are subsequently repurchased by the corporation

[[Page 831]]

at a price in excess of the issue price plus any amount of discount 
deducted prior to repurchase, or (in the case of bonds issued subsequent 
to Feb. 28, 1913) minus any amount of premium returned as income prior 
to repurchase, the excess of the purchase price over the issue price 
adjusted for amortized premium or discount is a deductible expense for 
the taxable year.
    (2) In the case of a convertible bond (except a bond which the 
corporation, before Sept. 5, 1968, has obligated itself to repurchase at 
a specified price), the deduction allowable under subparagraph (1) of 
this paragraph may not exceed an amount equal to 1 year's interest at 
the rate specified in the bond, except to the extent that the 
corporation can demonstrate to the satisfaction of the Commissioner or 
his delegate that an amount in excess of 1 year's interest does not 
include any amount attributable to the conversion feature.
    (3) No deduction shall be allowed under subparagraph (1) of this 
paragraph to the extent a deduction is disallowed under subparagraph (2) 
of this paragraph or to the extent a deduction is disallowed by section 
249 (relating to limitation on deduction of bond premium on repurchase 
of convertible obligation) and the regulations thereunder. See paragraph 
(f) of Sec. 1.249-1 for effective date limitation on section 249.
    (d) Definition. For purposes of this section, a debenture, note, 
certificate other evidence of indebtedness, issued by a corporation and 
bearing interest shall be given the same treatment as a bond.
    (e) Effective date. The provisions of this section shall not apply 
in respect of a bond issued after May 27, 1969, unless issued pursuant 
to a written commitment which was binding on that date and at all times 
thereafter.

[T.D. 6984, 33 FR 19175, Dec. 24, 1968, as amended at 36 FR 24996, Dec. 
28, 1971; T.D. 7259, 38 FR 4253, Feb. 12, 1973]