Bloomberg Tax
March 10, 2023, 9:45 AM

Pillar Two Debt-Discharge Rule Considers Cash-Flow Insolvency

Alan S. Lederman
Alan S. Lederman

When large US corporate debtors restructure their debt, they face tax concerns about the availability of an exclusion from cancellation of debt income. Historically, US corporations focused on the COD-related exclusion from regular corporate tax gross income in Section 108(a).

Starting this year, large corporations also must consider the scope of the COD-related exclusion from corporate alternative minimum tax adjusted financial statement income in IRS Notice 2023-7 and any superseding regulations. Moreover, if OECD Pillar Two becomes effective, large corporations will have to consider the scope of the COD-related debtor-elective exclusion from Pillar Two GloBE income, contained in guidance released by the OECD in February.


Where the corporate debtor receives a debt discharge in a US federal bankruptcy case, Section 108(a), Notice 2023-7, and the 2023 GloBE COD rule all generally provide an exclusion for COD income.

However, the amount of the GloBE exclusion may favorably exceed the amount of the exclusion allowed by Section 108(a) and Notice 2023-7. Even where the bankrupt debtor’s financial accounting COD income exceeds the amount excludable for federal income tax purposes under Section 108(a), the GloBE COD rule allows the full financial accounting COD income to be excluded.

By contrast, Notice 2023-7 limits the AFSI exclusion to the amount excluded for regular corporate income tax purposes under Section 108(a). Notice 2023-7 does, however, request comments on whether the AFSI exclusion should be extended in the future to cover the entire financial accounting gain where such amount exceeds the Section 108(a) exclusion.

Cash-Flow Insolvency

To determine whether a non-bankrupt corporate debtor is eligible to exclude COD income—and, if so, to determine the amount of such exclusion—Section 108(a) and Notice 2023-7 rely exclusively on an excess immediately before the discharge of the debtor’s liabilities over the fair market value of the debtor’s assets (called here negative FMV equity). Where there is negative FMV equity, Section 108(a) and Notice 2023-7 allow an exclusion for it.

The GloBE COD rule incorporates another concept (called here cash-flow insolvency) which doesn’t appear in either Section 108(a) or Notice 2023-7. Under the GloBE COD rule, cash-flow insolvency occurs where an independent expert reasonably concludes that, within 12 months, the debtor would be unable to pay its debts due to unconnected creditors as they become due, but for the debt cancellation.

Where a non-bankrupt debtor suffers from cash-flow insolvency, the GloBE COD rule allows the debtor to entirely exclude the financial accounting COD income, just like a bankrupt debtor. The GloBE COD rule full exclusion granted to cash-flow-insolvent corporations, unlike the Section 108(a) and Notice 2023-7 COD exclusions, is allowable whether the debtor has negative FMV equity, and, when available, isn’t limited to such equity.

Negative FMV Equity but Not Cash-Flow Insolvent

Where a non-bankrupt US corporate debtor has negative FMV equity but isn’t cash-flow-insolvent, the GloBE COD rule provides some COD income exclusion. However, such exclusion is much more limited than the blanket exclusion granted by the GloBE COD rule to bankrupt or cash-flow-insolvent companies. In some cases, it’s smaller than the negative FMV equity exclusion granted by Section 108(a) and Notice 2023-7.

Where a non-bankrupt US corporate debtor has negative FMV equity but isn’t cash-flow-insolvent, the GloBE COD rule, like Section 108(a) and Notice 2023-27, limits the income exclusion to the negative FMV equity. But unlike Section 108(a) and Notice 2023-7, the GloBE COD rule provides that the exclusion can’t exceed the reduction in the debtor’s tax attributes by reason of the tax exclusion.

Sometimes, the regular Section 108(a) exclusion exceeds the corresponding reduction in tax attributes required under Section 108(b). Such excess exclusion is characterized by Notice 2023-7 as black hole excluded COD income, because such income simply disappears without reducing the Section 108(a) exclusion or the Notice 2023-7 AFSI exclusion. By contrast, black hole excluded COD income of a non-bankrupt US corporate debtor that has negative FMV equity, but which isn’t cash-flow-insolvent, won’t be eligible for a GloBE COD exclusion.


The GloBE COD rule won’t do a lot to assuage criticism by some members of Congress that Pillar Two can contradict US tax policy—consider debtors that are neither in bankruptcy nor are cash-flow-insolvent but have negative FMV equity and black hole excluded COD income. The GloBE COD rule can deny such a debtor a COD exclusion for its black hole excluded COD income even though such exclusion is allowed by the US by Section 108(a) and Notice 2023-7.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Alan S. Lederman is a shareholder at Gunster, Yoakley & Stewart, P.A. in Fort Lauderdale, Fla.

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