A Simpler Debt-Equity Test

Abstract

It is usually a straightforward tax question: is an advance of capital to a business debt or equity? But in some cases the question gets harder to answer, mostly because of the tangled multi-factor test we use. Long ago most tax practitioners gave up trying to clean up the process of answering hard debt-equity questions. But recent developments show the Internal Revenue Service (IRS), practitioners, and courts moving towards a simpler way to decide these cases in the form of a single question: Did the parties to the transaction reasonably expect the funds would be repaid in full? The article discusses the development of recent debt-equity caselaw on structured financing arrangements including Pritired, Castle Harbour, Hewlett-Packard, Schering-Plough, PepsiCo, and the Scottish Power cases.