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ISSUE
For purposes of the definition of "qualified stated interest" in Sec 1.1273-1(c) of the Income Tax Regulations, are scheduled interest payments on a debt instrument "unconditionally payable" if, under the terms of the debt instrument, the failure to make interest payments when due requires (1) that the issuer forgo paying dividends, or (2) that interest accrue on the past-due payments at a rate that is 2 percentage points greater than the stated yield?
FACTS
Situation 1. On January 1, 1995, Y corporation issued a 15-year debt instrument to A for $100x. The debt instrument provides for a principal payment of $100n at maturity and for quarterly interest payments of $2x, beginning on March 31, 1995, and ending on the maturity date. Thus, the yield on the debt instrument is 8 percent, compounded quarterly. Under the terms of the debt instrument, if Y corporation fails to make one or more interest payments when due, interest will accrue on the past-due interest at the 8 percent yield. The failure of Y corporation to make interest payments when due for 12 consecutive quarters will entitle A to sue for payment.
If past-due interest is outstanding, the terms of the debt instrument provide that Y corporation may not declare or pay any dividend on, redeem, purchase, acquire, or make a liquidation payment with respect to, its stock. Y corporation has a policy and a long-established history of regularly paying dividends on its stock. Any failure of Y corporation to pay regular dividends on its stock is reasonably expected to result in a significant decline in the value of its stock.
Situation...