26 U.S.C. § 279 — Interest on indebtedness incurred by corporation to acquire stock or assets of another corporation

(a) General rule No deduction is allowed for interest a corporation pays or owes during the year on its "corporate acquisition indebtedness," to the extent that interest goes over a limit. Work out the limit like this: start with $5,000,000. Subtract the interest the corporation paid or owed that year on debt that helped pay for the same acquisition, but that isn't itself corporate acquisition indebtedness. What's left is the most interest the corporation can deduct on corporate acquisition indebtedness that year; anything above that isn't deductible. (b) "Corporate acquisition indebtedness" defined A bond, debenture, note, or similar debt issued by a corporation (the "issuing corporation") only counts as "corporate acquisition indebtedness" if it meets all four of these tests: (1) Purpose: the issuing corporation issued it to pay for buying stock in another corporation, or to pay for at least two-thirds (by value) of the trade or business assets of another corporation, under one plan. (2) Subordination: the debt is either behind the issuing corporation's regular trade creditors, or it's specifically stated to be paid only after a substantial amount of the issuing corporation's other unsecured debt (whether that debt already exists or comes later). (3) Convertibility: the bond either converts, directly or indirectly, into stock of the issuing corporation, or comes bundled with an option to acquire stock of the issuing corporation. (4) Debt load or earnings, tested as of the date described in (c)(1): either the issuing corporation's debt-to-equity ratio is over 2 to 1, or its projected earnings don't cover the annual interest on the debt at least 3 times over. (c) Rules for applying (b)(4) (1) Timing: this is tested as of the last day of whatever tax year the corporation issued the debt to help pay for the acquisition. (2) Debt-to-equity ratio: total debt divided by (money plus other assets, valued at their adjusted basis, minus total debt). (3) Projected earnings: normally this uses only the issuing corporation's average annual earnings. But if the issuing corporation has taken control of the acquired corporation (as defined in section 368(c)), or bought substantially all of its property, then both corporations' earnings are combined. "Average annual earnings" means earnings and profits over the 3 years ending with the test date, without subtracting interest paid, depreciation or amortization, tax owed, or certain distributions (except distributions from the acquired corporation to the issuing corporation) — then averaged over those 3 years. The Treasury writes rules for corporations that didn't exist the whole 3 years. (4) Annual interest to be paid or incurred: normally this is just the issuing corporation's interest on its total debt. If the earnings had to be combined under (3), the interest is combined too. (5) Special rule for banks and lenders: if the corporation is a bank or is mainly in the lending or finance business, three adjustments apply. First, when figuring the debt-to-equity ratio, subtract from both total debt and assets any debt owed to the corporation from its own banking, lending, or finance business. Second, when figuring annual interest, reduce it by the same proportion as that adjustment. Third, when figuring average annual earnings, reduce them by that same amount. "Lending or finance business" means making loans, or buying or discounting accounts receivable, notes, or installment contracts. (d) Which years this applies to (1) The interest deduction isn't denied until the first year in which the debt actually qualifies as corporate acquisition indebtedness under (b)(4). (2) Once debt qualifies as corporate acquisition indebtedness for a year, it stays that way for that year and every year after — unless (3), (4), or (5) changes that. (3) If debt qualified because the issuing corporation had taken "control" of the acquired corporation, but retesting it later — once the issuing corporation could instead use the combined-earnings test — would show it no longer qualifies, then the debt permanently stops being corporate acquisition indebtedness starting that later year. (4) If, for 3 straight years after debt qualified, retesting it under (b)(4) each year would show it no longer qualifies, the debt stops being corporate acquisition indebtedness for good after those 3 years. (5) For debt issued to buy stock, it only counts as corporate acquisition indebtedness for a year if, sometime before that year ends, the issuing corporation owns 5 percent or more of the acquired corporation's voting stock. (e) Certain tax-free deals If the issuing corporation already controls a corporation (as defined in section 368(c)) and acquires more of its stock in a deal where no gain or loss is recognized, that acquisition only counts under (b)(1) if, right before the deal, the acquired corporation already existed and the issuing corporation did not yet control it. (f) Exception for foreign corporations Debt doesn't count as corporate acquisition indebtedness if it was issued to buy stock or assets of a foreign corporation that got substantially all its income from outside the United States over the 3 years before the acquisition (or however long it existed, if less than 3 years). (g) Affiliated groups If the issuing corporation belongs to an affiliated group, Treasury regulations treat the whole group together as one "issuing corporation" — except that a group member's debt-to-equity ratio, projected earnings, and interest only count on a given day if it was actually a group member that day, and its earnings only count for the time it was in the group. "Affiliated group" has the meaning given in section 1504(a), except every corporation other than the acquired corporation counts as includible (without the usual exclusions in section 1504(b)), and the acquired corporation itself is never treated as includible. (h) Changes to the debt (1) Extending, renewing, or refinancing existing debt doesn't count as issuing a brand-new obligation. (2) If debt is corporate acquisition indebtedness for the issuing corporation, it's also corporate acquisition indebtedness for any other corporation that later guarantees it, endorses it, agrees to cover it, or takes over the debt in some transaction. (i) Effect on other rules Nothing in this section implies that a bond, debenture, note, or similar instrument actually represents a real debt of whoever issued it, for purposes of any other part of this title.