Tax Type
Corporation Income Tax
Description
Qualified Equity and Subordinated Debt Investments Tax Credit
Topic
Constitutional Provisions
Subtractions and Exclusions
Date Issued
10-09-2001
October 9, 2001
Re: Request for a Ruling
Dear *****
This letter will reply to your request for a ruling on behalf of your client, ***** ("Taxpayer") concerning the Qualified Equity and Subordinated Debt Investments Tax Credit ("the "Credit").
FACTS
The Taxpayer, a limited liability company, plans to issue a subordinated nonnegotiable promissory note that will be convertible, at the investors' option, into membership units of the limited liability company. You request a ruling as to whether such an investment would qualify for the Credit and, if it may qualify, how the Credit's recapture provisions would be applied.
RULING
In this case, the Taxpayer contemplates issuing a nonnegotiable promissory note that could be converted into a stipulated number of membership interests in a limited liability company. Convertible debt instruments offer an investor a steady interest income and, at the same time, an opportunity to exchange the debt for ownership in the business.
The statute allows a taxpayer to claim the Credit for qualified equity or subordinated debt investments. Under Code of Virginia § 58.1-339.4(A), a qualified debt investment must be indebtedness that (1) by its terms requires no repayment of principal for the first three years after issuance; (2) is not guaranteed by any other person or secured by any assets of the issuer; and (3) is subordinated to all indebtedness and obligations of the issuer to national or state-chartered banking or savings and loan institutions.
A qualified equity is defined as common stock or preferred stock, regardless of class or series, of a corporation; a partnership interest in a limited partnership; or membership interest in a limited liability company, which is not required or subject to an option on the part of the taxpayer to be redeemed by the issuer within five years from the date of issuance.
The statute does not cover convertible instruments. However, in keeping with the intent of the Credit, which is to stimulate long-term investment in small business in Virginia, the department will allow convertible instruments to qualify for the Credit under the following conditions:
1. the debt meets the definition of subordinated debt under Code of Virginia § 58.1-339.4(A),
2. the equity investment would meet the definition of equity under Code of Virginia §58.1-339.4(A); and
3. the instrument does not include a call provision by which the issuer may force the conversion or retirement of the instrument.
As for the holding period, a convertible subordinated debt instrument would not be subject to the recapture provisions of the Credit so long as no portion of the subordinated debt is converted, retired or repaid during the first three years after being issued. In the case of a conversion, the equity would not be subject to any holding period if the subordinated debt were held for three or more years.
In addition, the conversion of such an instrument to qualified equity before the three-year period runs would not be considered as a repayment requiring a recapture of the Credit. However, if a subordinated debt instrument is converted to equity before the three-year period has run, the equity must be held for at least five calendar years following the calendar year in which the convertible debt was issued. In other words, subordinated debt converted within the three-year holding period would trigger the holding period for the equity, but the five calendar year holding period would be deemed to have started when the convertible instrument was issued.
As such, if the Taxpayer's nonnegotiable convertible promissory note meets the three tests enumerated above, the instrument would be a qualified investment for purposes of earning the Credit, and would be subject to the holding period requirements set forth in this ruling.
This ruling has been made subject to the facts presented to the department as summarized above. Any change in these facts or the introduction of facts by another party may lead to a different result. If you have any additional questions regarding this ruling, please feel free to call in the Appeals and Rulings Office at .
Sincerely,
Danny M. Payne
Tax Commissioner
ARO/35620
Rulings of the Tax Commissioner