The US Treasury Department on Thursday released final earnings stripping regulations under section 385, resisting calls by business groups and lawmakers to slow down and re-propose the rules.
Under the regulations, a note issued by a US subsidiary to its foreign parent in a dividend or an economically similar transaction will be reclassified as equity if the debt does not finance new US investment.
The provision is designed to reduce the incentive to invert because groups would no longer be able to load a US subsidiary with related-party debt to strip income out of the US through tax deductions, and, at the same time, arrange for the related interest income to be recognized in a low or no-tax jurisdiction.
Business groups complained that the proposed section 385 regulations, issued in April, were over-broad, hitting many ordinary business transactions and imposing onerous documentation requirements on corporations that claim interest deductions on related-party loans. Lawmakers advocated for the proposed regulations to be scrapped and reproposed.
Treasury has nonetheless finalized the rules, but with many modifications. According to Treasury Secretary Jacob Lew, businesses’ concerns have been addressed in the final regulations.
“We engaged extensively with businesses, tax experts, the public, and lawmakers and carefully considered their comments and recommendations. As a result of this process, the final rule effectively addresses stakeholder concerns by more narrowly focusing the regulations on aggressive tax avoidance tactics and providing certain limited exemptions,” Lew said in a statement.
A good first look at the 518-page document, provided by KPMG, concludes that that the final rules “offer significant relief for US multinational groups, and offer some, but less significant, relief for foreign multinational groups.”
Significant changes made to the proposed regulations in the final version, as highlighted by Treasury, are as follows:
- Debt issued by foreign issuers is exempt from all aspects of the final regulations. Treasury has reserved on this topic.
- S-corporations and non-controlled RICs and REITs are also exempt.
- Cash management arrangements and other short-term debt is excluded from rules on distributions of debt instruments and similar transaction under reg. section 1.385-3.
- Debt instruments issued by certain regulated financial groups and insurance entities are excluded from rules on distributions of debt instruments and similar transaction under under reg. section 1.385-3.
- The final regs do not include a general bifurcation rule allowing for recharacterization of an instrument as part-debt and part-equity. Treasury reserved on that topic.
- The effective date of the documentation requirements is extended to 2018.
- Documentation is considered timely prepared if complete at the time the tax return is filed, replacing the 30-day rule.
The text of the new rules can be accessed below.
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