Volume 5 Winter 2011 Number 2 - Charleston Law Review

2011] Tax Aspects—Financially Troubled Entitiesinstruments is stricter because the creditor can look only to thecollateral for repayment of interest and principal on theinstrument. However, a number of exceptions exist for situationsinvolving similarly valued collateral and improvements tocollateral. 10 For example, a significant modification does not takeplace where the collateral is fungible or where the units pledgedare not important as an economic matter, e.g., financialinstruments of a particular type and rating or improvements tothe property securing the nonrecourse debt instrument. 11B. Changes in Yield of Debt InstrumentPutting to one side contingent debt instruments, a significantmodification occurs with regard to a fixed-rate debt instrument,instruments with alternative payment schedules, debtinstruments such as demand loans that provide for a fixed yield,and variable-rate instruments if the interest rate varies from therate on the unmodified instrument by more than twenty-fivebasis points or five percent of the annual yield of the unmodifiedinstrument, whichever is greater. 12 Contingent debt instrumentsare tested under the “facts and circumstances” test. 13The yield on the modified debt instrument is equal to theadjusted issue price of the unmodified instrument, “increased byany accrued but unpaid interest and decreased by any accruedbond issuance premium” that has not been taken into account. 14The resulting figure is then increased or decreased “to reflectpayments made to the issuer or to the holder as consideration forthe modification.” 15 A reasonable prepayment penalty for a prorata prepayment is not considered as consideration for themodification. 16 As far as testing for the yield on a variable-debtinstrument is concerned, the annual yield is equivalent to thefixed-rate debt instrument, which is constructed based on the10. See, e.g., § 1.1001-3(e)(4)(iv)(B).11. Id.12. § 1.1001-3(e)(2)(ii)(A)(B).13. § 1.1001-3(e)(1).14. § 1.1001-3(e)(2)(iii).15. § 1.1001-3(e)(2)(iii)(A)(1).16. § 1.1001-3(e)(2)(iii)(B).233