Hybrid Instruments and the Debt-Equity Distinction in Corporate Taxation

Abstract

Debt and equity are treated differently for many purposes in federal tax law. The most important difference is that payments made on debt may be deducted in computing a corporation's taxable income, while payments made on equity may not. Although this distinction is well-settled, it has little theoretical basis and is not clearly drawn in the tax law. As a result, there has for a long time been confusion over how to classify, for tax purposes, instruments that do not closely resemble "ordinary" debt or "ordinary" equity.