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Abstract: 

In two important 2012 Tax Court cases deciding whether an obligation is equity for income tax purposes, the court ruled in favor of one taxpayer and against another. In a case involving PepsiCo, the taxpayer prevailed and equity treatment was upheld; in another, involving Hewlett-Packard (HP), the taxpayer lost its argument for equity treatment. In the HP case, the court looked beyond the instrument at issue, also examining agreements between the shareholders in the transaction, in determining that debt treatment should prevail. HP appealed its loss earlier this year. While HP makes very compelling arguments--which this article compares to those in PepsiCo’s winning case--the appellate court, like the Tax Court, may focus more on the expanded, and perhaps inappropriate, use of foreign tax credits and less on traditional debt-equity factors.

Keywords: internally financed capital, related borrower, intercompany indebtedness, debt-equity analysis, source of payments

Affiliations:  1: Ruchelman P.L.L.C.; 2: Ruchelman P.L.L.C..