Guarantees and Payment of Debt Service

Aggregation of Instruments

Context: Is the guarantee a separate instrument from the bond, such that payments under the guarantee are not eligible for exemption to the recipient thereof?

Basic tax law concepts state that, even though a guarantee always represents a claim against a different party from the issuer of the underlying security, payments under the guarantee are treated as if they are payments under the guaranteed obligation.  See James M. Peaslee and David Z. Nirenberg, “Aggregation or Bifurcation of Property Interests, Tax Notes (December 12, 2011).  In other words, the basic tax rules state that the guarantee payment takes on the character of the actual debt service payment from the issuer (steps in the shoes concept).  See, e.g., Rev. Rul. 72-134, amplified by Rev. Rul. 72-575 and Rev. Rul. 76-78.

However, Rev. Rul. 94-42 describes a situation in which the IRS determined that the guarantee was separate from the bonds and, unlike in Rev. Rul. 72-134, as amplified, guarantee payments did not qualify for tax-exemption with respect to the interest components thereof.  The IRS in this ruling held that “amounts paid or accrued under an agreement for defaulted interest are not excludable from gross income under Section 103 if the agreement is not incidental or is in substance a separate debt instrument or similar investment when purchased.”

Guarantees and Private Activity Tests

Context:  What is the effect of a guarantee of debt service on the private activity tests?  See, e.g., PLR 8945032 (August 15, 1989).


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