SECTION 3. APPLICABLE LAW

.01 Under § 163(e)(5), in the case of an AHYDO, a corporation is not allowed a deduction for the disqualified portion of the original issue discount (“OID”) on the obligation, and the corporation’s deduction for the remaining portion of the OID is deferred until the OID is paid in cash or in property (other than debt of the issuer or a related person within the meaning of § 453(f)(1)).

.02 Section 163(i) defines an AHYDO as any debt instrument if:

(1) The maturity date of the debt instrument is more than five years from the date of issue;

(2) The yield to maturity of the debt instrument equals or exceeds the sum of the applicable Federal rate in effect under § 1274(d) for the calendar month in which the instrument is issued plus five percentage points; and

(3) The debt instrument has significant OID.

.03 Under § 163(i)(2), a debt instrument has significant OID if:

(1) The aggregate amount that would be includible in gross income with respect to the debt instrument for periods before the close of any accrual period (as defined in § 1275(a)(5)) ending after the date five years after the date of issue, exceeds

(2) The sum of the aggregate amount of interest to be paid under the debt instrument before the close of the accrual period, and the product of the issue price of the debt instrument (as defined in §§ 1273(b) and 1274(a)) and its yield to maturity.

.04 For purposes of determining whether a debt instrument is an AHYDO, § 163(i)(3) provides that any payment under the debt instrument is assumed to be made on the last day permitted under the debt instrument, and any payment to be made in the form of another debt instrument of the issuer (or a related person within the meaning of § 453(f)(1)) is

assumed to be made when such debt instrument is required to be paid in cash or in property other than such debt instrument.

.05 Section 1.1001–3 provides rules to determine whether a modification of the terms of a debt instrument results in an exchange of the original debt instrument for a modified instrument that differs materially either in kind or in extent. Section 1.1001–3 applies to any modification of a debt instrument, regardless of the form of the modification (including an exchange of a new debt instrument for an existing debt instrument).