New York Times Debt Setup Pays Off

More frequent interest payments kept the New York Times Company from triggering a high yield discount obligation that could have wiped out its tax ...
Robert WillensJanuary 27, 2009

Bob Willens 2

During the 1980s, scores of deals were financed in part with “deferred interest” securities. But, despite its name, the interest on the securities was tax deductible as it accrued, even though payment of such interest was delayed – frequently quite far into the future.

The accrued tax deduction was a function of the tax law’s original issue discount (OID) rules, and at the time Congress didn’t like the mismatch. Lawmakers felt that the rule was partially responsible for the proliferation of “uneconomic” deals that characterized the later stages of that particular takeover era. Accordingly, in selected cases – and as a way to prevent the current deduction of accrued interest – Congress created the concept of the “applicable high yield discount obligation” (AHYDO) in 1989.

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In a recent deal involving The New York Times Company, it seemed likely that the transaction would create an AHYDO and the Times would lose its associated tax deduction. But by shrinking its interest payments from one year to six months, the media company was able to avoid the tax hit. Here’s the rules and regulations behind the transaction.

The Background

On January 19, the Times announced that it had entered into a “private financing agreement” with entities affiliated with Mexican billionaire Carlos Slim Helu for an aggregate amount of $250 million in senior unsecured notes due 2015 with “detachable warrants.” These notes have a coupon of an astonishing 14.053 percent, of which the Times may elect to pay three percent “in kind” (i.e. in additional notes). The lenders also received detachable warrants for an aggregate amount of 15.9 million Class A (low vote) shares, at a strike price of $6.3572. Further, the warrants expire in 2015.

The notes described by the Times deals are considered to have been issued at a discount, which is important when determining what creates an original issue discount that, in turn, can create an AHYDO.

According to the tax code – specifically Section 1273(a)(1) -an original issue discount is the excess of a debt instrument’s “stated redemption at maturity” over its issue price. The instrument’s stated redemption at maturity is the sum of all payments provided by the debt, other than qualified stated interest. (See Reg. Sec. 1.1273-1(b).)

The portion of the interest that may be paid in kind is not qualified state interest and, therefore, is added to the stated redemption at maturity. In fact, by itself, the interest can lead to an excess of stated redemption at maturity over issue price and, hence, the original issue discount.
One more note about the Times the notes and the detachable warrants. They are part of an investment unit. That changes things a bit, because the purchase price for an investment unit must be allocated between the debenture and the warrants, which often increases the yield, creating or increasing the original issue discount. (See Ginsburg and Levin, Mergers, Acquisitions and Buyouts, Paragraph 13.031.)


Now let’s look out how the tax code defines an AHYDO. According to Section 163(i)(1), an AHYDO is any debt instrument that has the following features:

  • A maturity date that is more than five years from the date of issue;
  • A yield-to-maturity that equals or exceeds the sum of the applicable federal rate in effect for the calendar month in which the obligation is issued, plus five percentage points (500 basis points);
  • A significant original issue discount.

The Times notes have a maturity date more than five years from the date of issue and the yield to maturity soars well above the AHYDO ceiling. The relevant applicable federal rate is approximately 2.83 percent and, the yield to maturity is probably on the order of 16 percent. (The yield to maturity percentage takes into account the increase in the yield resulting from the fact that a portion of the issue price of the investment units must be apportioned to the warrants – the “time value” of which is substantial.) Accordingly, the yield to maturity for the Times notes appears to be some 800 basis points above the AHYDO ceiling.

That means that the issue of whether these notes are properly classified as AHYDOs depends exclusively on whether the notes have a “significant” original issue discount. If the notes are categorized as AHYDOs, certain penalties would be exacted. Indeed, under Section 163(e)(5) of the tax code, which addresses an AHYDO issued by a corporation, no deduction is allowed for the disqualified portion of the original issue discount, and the remainder of the discount is not allowable as a deduction until paid.2

“Significant” OID
Essentially, if the Times notes were issued with a “significant” original issue discount, the notes would constitute AHYDOs (in fact, they would be classified as super AHYDOs). As a result, a portion of the original issue discount accruing on the notes would never be tax-deductible3, and the balance of the discount would be deductible not when it accrues, but rather only when (and if) such interest is paid in cash or property (other than stock of the issuer or a related party).
The tax code is very specific about what it defines as a “significant” original issue discount, mainly focusing on whether the instrument’s aggregate amount exceeds the aggregate amount to be paid.

The rule detail is even more precise: The aggregate amount of an instrument is the total that is includible in gross income for periods before the close of any “accrual period” ending after the date that is five years after the date of issue. To qualify as having a significant discount, the aggregate amount must exceed the aggregate amount of interest to be paid under the instrument before the close of the accrual period, plus the product of the instrument’s issue price and its yield to maturity.

Again, Congress felt that in these cases, the accrued interest was “excessive” compared to the amount of interest actually paid, therefore a penalty, in the form of wiping out the tax deduction, was warranted.

A Different Tack
An accrual period, on the other hand, “may be of any length and may vary in length over the term of the term instrument, provided that each accrual period is not longer than one year, and each scheduled payment of principal or interest occurs either on the final day or on the first day of an accrual period.” (See Reg. Sec. 1.1272-1(b)(1)(ii). )

It seemed reasonable to expect the Times to elect the one year accrual period so the notes would not bear a significant original issue discount and, therefore avoid being classified as AHYDOs. To be sure, the notes would not have had a significant original issue discount because the debt would be scheduled to pay all interest and principal by the close of the first (and only) accrual period ending after the fifth anniversary of issuance. (See Ginsburg and Levin, supra.)

However, the Times chose to take a more conventional tack to avoid AHYDO status. Immediately prior to the end of the “initial measurement period” (the first accrual period ending after the fifth anniversary of issuance) the Times will duly pay all interest accrued on the notes – except an amount equal to the first 12 months’ yield accrued after issuance). Accordingly, the notes will not be AHYDOs because the debt will not bear a significant original issue discount.
That is the case because at the time the test is required to be made, there will be an “insufficient” excess of accrued interest on the notes, over interest actually paid. Indeed, the accrued interest will not exceed the interest actually paid by more than the product of the instrument’s issue price and its yield to maturity.

As a result, the interest accrued during the period prior to the end of the initial measurement period can be currently deducted. Thus, the Times should secure a tax deduction for all of the interest, including the original issue discount, paid or accrued, with respect to the “Slim” notes.

Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for


1 See Regulation Section 1.1273-2(h); an investment unit is treated as if it was a debt instrument. The issue price of the investment unit, determined in the same manner as if the unit was a debt instrument, is required to be allocated between the debt instrument and the property right (or rights) that comprise the investment unit based on their relative fair market values. The effect of this allocation is to reduce the issue price of the debt instrument element of the investment unit and, therefore, increase the spread between its stated redemption at maturity and issue price thus creating or increasing original issue discount with respect to the instrument.

2For this purpose, the disqualified portion of the OID is the lesser of the amount of the original issue discount or the portion of the “total return” on the obligation which bears the same ratio to such total return as the “disqualified yield” bears to the yield on the same obligation. The disqualified yield, in turn, is the excess of the yield to maturity on the obligation over the applicable federal rate plus 600 basis points. In these cases, the AHYDO is said to be a “super AHYDO.” In the instant case, taking into account the portion of the issue price of the investment unit which is properly allocable to the warrants, the notes would have a yield to maturity well in excess of the sum of the applicable federal rate plus 600 basis points.

3Solely for purposes of the intercorporate dividends received deduction available with respect to dividends received by one corporation from another domestic corporation, the “dividend equivalent portion” of any amount includible in gross income of a corporation under Sec. 1272(a) in respect of an AHYDO shall be treated as a dividend received by such corporation from the corporation issuing such obligation. For this purpose, the dividend equivalent portion of the amount so includible is the portion thereof which is attributable to the disqualified portion of the OID on such obligation but only to the extent that such amount would have been a dividend if it had been made by the issuing corporation with respect to stock in such corporation. See 163(e)(4)(B).