On September 19, 2017, the Internal Revenue Service (IRS) issued proposed regulations providing helpful guidance on whether a debt instrument is in “bearer” or “registered” form. (REG-125374-16). While the paradigm debt instrument in bearer form—an instrument payable to the “bearer” where legal title follows transfer of the physical instrument—is simple, the tax definition has been unclear since adoption as part of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) and has not kept up with developments in commercial law and practice.

Material negative tax consequences can result from issuing or holding bearer debt instruments, including denial of the portfolio interest exception from withholding for non-US holders, and, for “registration-required obligations,” denial of issuer interest deduction and imposition of excise tax, and ordinary gain treatment and denial of loss deduction on disposition by US holders.

The current proposed regulations are particularly helpful for issuers seeking to raise capital in certain markets that require issuance of bonds nominally in bearer form and purchasers of debt obligations issued by securitization vehicles and loan participations because they clarify that these obligations may satisfy the registration requirements. The current proposed regulations reaffirm prior IRS guidance, including IRS Notice 2006-99 and IRS Notice 2012-20, concluding that obligations will qualify as in registered form if they are transferable through a book entry system, including a “dematerialized book entry system” (i.e., a book entry system where no physical bonds exist and instead are represented solely by book entries), if ownership of the obligation is required to be recorded in an electronic or physical register maintained by the issuer of the obligation (or its agent) or by a clearing organization despite the holder having rights to obtain physical certificates solely in the event of:

  • A termination of business without a successor by the clearing organization that maintains the book entry system; or
  • The issuance of physical securities at the issuer’s request upon a change in tax law that would be adverse to the issuer but for the issuance of physical securities in bearer form.

While the IRS had provided private letter rulings reaching conclusions similar to the guidance in the proposed regulations with respect to pass-through certificates and participation interests, the proposed regulations provide comfort to taxpayers because they are not able to rely on such private letter rulings.

The current proposed regulations also helpfully consolidate the previously diffuse rules defining registered form and registration-required obligations into a single proposed regulation section—a boon to practitioners perhaps more than market participants. The proposed regulations also provide a cross reference to the “publicly traded” rules in the original issue discount regulations for purposes of determining the applicability of the exclusion from the registration-required obligation for obligations not of a type offered to the public.

The IRS will receive comments on the current proposed regulations until December 18, 2017. The portions of the proposed regulations that incorporate the guidance described in Notice 2012-20 will apply to obligations issued after March 18, 2012, and the remaining portions generally will apply only to obligations issued after the publication of a Treasury decision adopting these rules as final regulations in the Federal Register.