[Code of Federal Regulations]
[Title 26, Volume 1]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.249-1]

[Page 417-419]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.249-1  Limitation on deduction of bond premium on repurchase.

    (a) Limitation--(1) General rule. No deduction is allowed to the 
issuing corporation for any ``repurchase premium'' paid or incurred to 
repurchase a convertible obligation to the extent the repurchase premium 
exceeds a ``normal call premium.''
    (2) Exception. Under paragraph (e) of this section, the preceding 
sentence shall not apply to the extent the corporation demonstrates that 
such excess is attributable to the cost of borrowing and not to the 
conversion feature.

[[Page 418]]

    (b) Obligations--(1) Definition. For purposes of this section, the 
term obligation means any bond, debenture, note, or certificate or other 
evidence of indebtedness.
    (2) Convertible obligation. Section 249 applies to an obligation 
which is convertible into the stock of the issuing corporation or a 
corporation which, at the time the obligation is issued or repurchased, 
is in control of or controlled by the issuing corporation. For purposes 
of this subparagraph, the term control has the meaning assigned to such 
term by section 368(c).
    (3) Comparable nonconvertible obligation. A nonconvertible 
obligation is comparable to a convertible obligation if both obligations 
are of the same grade and classification, with the same issue and 
maturity dates, and bearing the same rate of interest. The term 
comparable nonconvertible obligation does not include any obligation 
which is convertible into property.
    (c) Repurchase premium. For purposes of this section, the term 
repurchase premium means the excess of the repurchase price paid or 
incurred to repurchase the obligation over its adjusted issue price 
(within the meaning of Sec. 1.1275-1(b)) as of the repurchase date. For 
the general rules applicable to the deductibility of repurchase premium, 
see Sec. 1.163-7(c). This paragraph (c) applies to convertible 
obligations repurchased on or after March 2, 1998.
    (d) Normal call premium--(1) In general. Except as provided in 
subparagraph (2) of this paragraph, for purposes of this section, a 
normal call premium on a convertible obligation is an amount equal to a 
normal call premium on a nonconvertible obligation which is comparable 
to the convertible obligation. A normal call premium on a comparable 
nonconvertible obligation is a call premium specified in dollars under 
the terms of such obligation. Thus, if such a specified call premium is 
constant over the entire term of the obligation, the normal call premium 
is the amount specified. If, however, the specified call premium varies 
during the period the comparable nonconvertible obligation is callable 
or if such obligation is not callable over its entire term, the normal 
call premium is the amount specified for the period during the term of 
such comparable nonconvertible obligation which corresponds to the 
period during which the convertible obligation was repurchased.
    (2) One-year's interest rule. For a convertible obligation 
repurchased on or after March 2, 1998, a call premium specified in 
dollars under the terms of the obligation is considered to be a normal 
call premium on a nonconvertible obligation if the call premium 
applicable when the obligation is repurchased does not exceed an amount 
equal to the interest (including original issue discount) that otherwise 
would be deductible for the taxable year of repurchase (determined as if 
the obligation were not repurchased). The provisions of this 
subparagraph shall not apply if the amount of interest payable for the 
corporation's taxable year is subject under the terms of the obligation 
to any contingency other than repurchase prior to the close of such 
taxable year.
    (e) Exception--(1) In general. If a repurchase premium exceeds a 
normal call premium, the general rule of paragraph (a) (1) of this 
section does not apply to the extent that the corporation demonstrates 
to the satisfaction of the Commissioner or his delegate that such 
repurchase premium is attributable to the cost of borrowing and is not 
attributable to the conversion feature. For purposes of this paragraph, 
if a normal call premium cannot be established under paragraph (d) of 
this section, the amount thereof shall be considered to be zero.
    (2) Determination of the portion of a repurchase premium 
attributable to the cost of borrowing and not attributable to the 
conversion feature. (i) For purposes of subparagraph (1) of this 
paragraph, the portion of a repurchase premium which is attributable to 
the cost of borrowing and which is not attributable to the conversion 
feature is the amount by which the selling price of the convertible 
obligation increased between the dates it was issued and repurchased by 
reason of a decline in yields on comparable nonconvertible obligations 
traded on an established securities market or, if such comparable traded 
obligations do not exist, by reason of a

[[Page 419]]

decline in yields generally on nonconvertible obligations which are as 
nearly comparable as possible.
    (ii) In determining the amount under subdivision (i) of this 
subparagraph, appropriate consideration shall be given to all factors 
affecting the selling price or yields of comparable nonconvertible 
obligations. Such factors include general changes in prevailing yields 
of comparable obligations between the dates the convertible obligation 
was issued and repurchased and the amount (if any) by which the selling 
price of the nonconvertible obligation was affected by reason of any 
change in the issuing corporation's credit rating or the credit rating 
of the obligation during such period (determined on the basis of widely 
published ratings of recognized credit rating services or on the basis 
of other relevant facts and circumstances which reflect the relative 
credit ratings of the corporation or the comparable obligation).
    (iii) The relationship between selling price and yields in 
subdivision (i) of this subparagraph shall ordinarily be determined by 
means of standard bond tables.
    (f) Effective date--(1) In general. Under section 414(c) of the Tax 
Reform Act of 1969, the provisions of section 249 and this section shall 
apply to any repurchase of a convertible obligation occurring after 
April 22, 1969, other than a convertible obligation repurchased pursuant 
to a binding obligation incurred on or before April 22, 1969, to 
repurchase such convertible obligation at a specified call premium. A 
binding obligation on or before such date may arise if, for example, the 
issuer irrevocably obligates itself, on or before such date, to 
repurchase the convertible obligation at a specified price after such 
date, or if, for example, the issuer, without regard to the terms of the 
convertible obligation, negotiates a contract which, on or before such 
date, irrevocably obligates the issuer to repurchase the convertible 
obligation at a specified price after such date. A binding obligation on 
or before such date does not include a privilege in the convertible 
obligation permitting the issuer to call such convertible obligation 
after such date, which privilege was not exercised on or before such 
date.
    (2) Effect on transactions not subject to this section. No 
inferences shall be drawn from the provisions of section 249 and this 
section as to the proper treatment of transactions not subject to such 
provisions because of the effective date limitations thereof. For 
provisions relating to repurchases of convertible bonds or other 
evidences of indebtedness to which section 249 and this section do not 
apply, see Sec. Sec. 1.163-3(c) and 1.163-4(c).
    (g) Example. The provisions of this section may be illustrated by 
the following example:

    Example. On May 15, 1968, corporation A issues a callable 20-year 
convertible bond at face for $1,000 bearing interest at 10 percent per 
annum. The bond is convertible at any time into 2 shares of the common 
stock of corporation A. Under the terms of the bond, the applicable call 
price prior to May 15, 1975, is $1,100. On June 1, 1974, corporation A 
calls the bond for $1,100. Since the repurchase premium, $100 (i.e., 
$1,100 minus $1,000), was specified in dollars in the obligation and 
does not exceed 1 year's interest at the rate fixed in the obligation, 
the $100 is considered under paragraph (d) (2) of this section to be a 
normal call premium on a comparable nonconvertible obligation. 
Accordingly, A may deduct the $100 under Sec. 1.163-3(c).

[T.D. 7259, 38 FR 4254, Feb. 12, 1973, as amended by T.D. 8746, 62 FR 
68182, Dec. 31, 1997]

                          Items Not Deductible