Integration of Convertible Note Hedge
In recent years, companies that issue convertible notes often seek to hedge against the possibility of excessive dilution from the conversion of the Convertible Notes into the stock of the company. United States Treasury regulations under section 1275 of the Code provide that under certain circumstances a qualifying debt instrument – in this case the Convertible Note – and the related hedge may be integrated for federal income tax
purposes to create a synthetic debt instrument. The resulting Synthetic Debt Instrument typically has no conversion right and is deemed issued at a discount equal to the cost of the hedge, giving rise to original issue discount deductions over the term of the Synthetic Debt Instrument. This memorandum discusses the application of the
Regulations to the integration of a typical Convertible Note and qualifying hedge.