Pepsico, Inc., and Pepsico Puerto Rico, Inc. v. Commissioner, T.C. Memo 2012-269, ruled that the U.S. holder of an ambiguous security issued by its foreign affiliate did not have to treat the periodic payments received as interest, even though the affiliate was deducting interest paid under Dutch tax law.
Keys to taxpayer victory. The keys to the taxpayer victory were the following: (1) the issuer was a corporation and not a partnership; taxpayers have lost all recent debt-equity disputes with the IRS in the partnership context; (2) the hybrid security was carefully crafted to have equity-like characteristics in some factual circumstances; (3) the court was unwilling to ignore the possibility that those circumstances would not arise because the holder effectively controlled the issuer; and (4) the tax benefit achieved by the taxpayer was not in one of the hot button areas like foreign tax credit generators or “sale” of historic rehabilitation tax credits.
Two features of the opinion are out of the ordinary: (1) the taxpayer actually got credit for carefully negotiating different treatment of debt and equity in the United States and Holland, and (2) the relatedness of the parties did not count against the taxpayer.