On November 16, 2016 we posted Treasury Issues Final & Temporary Section 385 Regs - But May Not Last Under President Trump? where we discussed that the Obama administration’s announcement of a crackdown on inversions the U.S. Treasury issued final & temporary proposed regulations that would dramatically change the taxation of corporate debt issued to related corporations having nothing to do with inversions or foreign acquisitions.
In a 518-page Treasury Decision, IRS issued final and temporary regs under Code Sec. 385. Under these regulations, debt issued by a corporation is treated as equity for all U.S. federal tax purposes if the debt is not issued for cash or property, but is instead
- (i) issued in a distribution to a related corporate shareholder,
- (ii) issued in exchange for stock of a member of the same affiliated group or
- (iii) issued in an asset reorganization between members of the same affiliated group.
The new regulations restrict the ability of corporations to engage in earnings stripping by treating financial instruments that taxpayers purport to be debt as equity in certain circumstances. They also require that corporations claiming interest deductions on related-party loans provide documentation for the loans, similar to the common practice for third-party loans. The ability to minimize income tax liabilities through the issuance of related-party financial instruments is not, however, limited to the cross-border context, so these rules also apply to related U.S. affiliates of a corporate group.
Now on April 21, 2017, President Donald Trump signed an Executive Order requiring the U.S. Department of the Treasury (Treasury) to review all "significant" tax regulations issued in 2016, to determine if they should be modified or repealed. This will include review of the temporary and final debt-equity regulations (TD 9790) under Code Sec. 385 that address earnings stripping and corporate inversions, among other Treasury regulations.