Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 73-19

1973-1 C.B. 379

Sec. 1451

IRS Headnote

Scrip certificates issued by a domestic corporation for interest past due on tax-free covenant bonds represent payment of interest subject to withholding of income tax based on their fair market value; G.C.M. 14182 superseded.

Full Text

Rev. Rul. 73-19 /1/

The purpose of this Revenue Ruling is to update and restate, under the current statute and regulations, the position set forth in G.C.M. 14182, XIV-1 C.B. 152 (1935).

The question presented is whether income tax should be withheld at the source with respect to scrip certificates issued in payment of quarterly bond interest due in 1971.

The M Company, a domestic corporation, issued bonds during 1932 that qualify as "tax-free covenant bonds" within the meaning of section 1451 of the Internal Revenue Code of 1954. During 1971, M Company issued scrip certificates possessing market value to the holders of its tax-free covenant bonds in lieu of paying the interest due in cash. The scrip certificates were in the following form:

SCRIP CERTIFICATE No. ________________ $ ________________ FOR INTEREST ON __________________________________________________ OBLIGATIONS ________________________________________, M COMPANY.

This is to certify that __________ as the registered holder on January __, 1971, of $ principal amount of obligations, __________, of the M Company, a corporation of the State of R (hereinafter called the "Company"), or registered assigns, will be entitled on and after February __, 1976, and upon surrender of this certificate at the office or agency of the company __________ to __________ dollars (representing interest with respect to such __________ obligations, __________, for the quarterly interest period ending February __, 1971), together with interest on the principal sum hereof at the rate of 7 percent (7%) per annum from the date hereof to February __, 1976, unless this certificate be redeemed, as hereinafter provided, on or before February __, 1974, in which case interest shall be payable at the rate of 61/2 percent (61/2%) per annum from the date hereof to the date fixed for redemption. Interest shall be payable at the date of payment of the principal sum hereof, but the company reserves the right at any time to pay to the registered holder hereof all or any part of such interest at the time accrued hereon.

This certificate may, at the option of the company, be redeemed at any time before February , 1976, after 30 days' previous written notice to the registered holder of this certificate, upon payment to such registered holder, upon surrender hereof at the office or agency of the company of the principal sum hereof and accrued interest (at the rate applicable as hereinabove provided) to the date of redemption specified in said notice, and, anything herein to the contrary notwithstanding, no further interest hereon shall accrue on or after the date of redemption so specified, whether or not this certificate shall be so surrendered.

The rights and interests represented hereby are transferable * * *.

M COMPANY By Vice President

Scrip may or may not be the equivalent of cash. Where the scrip is merely the recognition of an existing liability for interest that the debtor promises to pay at a fixed date in the future, the fact that tangible written evidence of such liability is given the creditor is not sufficient to constitute the payment of interest. However, where the bondholder surrenders his right to receive cash in payment of interest due him, and accepts in lieu thereof an entirely new obligation of the corporation in the form of a negotiable scrip certificate that bears interest, such certificate is property, the equivalent of cash, and represents a payment of interest to the extent of its fair market value. See Antoinette D. Andrews (Charlotte L. Andrews) v. Commissioner, 46 B.T.A. 607 (1942), acquiescence and nonacquiescence, 1942-1 C.B. 1, 19, reversed and remanded on other grounds, 135 F. 2d 314 (1943)), certiorari denied, 320 U.S. 748 (1943).

Section 1451 of the Code provides, in part, that in any case where bonds, mortgages, or deeds of trust, or other similar obligations of a corporation, issued before January 1, 1934, contain a contract or provision by which the obligor agrees to pay any portion of the tax imposed by Subtitle A on the obligee, or to reimburse the obligee for any portion of the tax, or to pay the interest without deduction for any tax which the obligor may be required or permitted to pay thereon, or to retain therefrom under any law of the United States, the obligor shall deduct and withhold a tax equal to 2 percent of the interest on such bonds, mortgages, deeds of trust, or other obligations, whether such interest is payable annually or at shorter or longer periods, if payable to an individual, a partnership, or a foreign corporation not engaged in trade or business within the United States.

Section 1451(b) further provides that if the liability assumed by the obligor does not exceed 2 percent of the interest, then the deduction and withholding shall be at the rate of 30 percent in the case of a nonresident alien individual, any partnership not engaged in trade or business within the United States and composed in whole or in part of nonresident aliens, and a foreign corporation not engaged in trade or business within the United States.

Based on the facts in the present case it is held that the issuance of the scrip certificates for interest past due on the bonds of the M Company represents the payment of interest to the extent of the fair market value of the scrip certificates. Accordingly, such payment of interest is subject to withholding of income tax to the extent provided in section 1451 of the Code.

G.C.M. 14182 is superseded, since the position set forth therein is restated under current law in this Revenue Ruling.

/1/ Prepared pursuant to Rev. Proc. 67-6, 1967-1 C.B. 576.