Good News for Foreign Parented Multi-Nationals
Background
In October of 2016, Treasury issued final regulations under Section 385. The final regulations were a pared down version of the proposed regulations that were issued just months earlier in April of 2016. The proposed regulations had received much criticism from the Multi-National Enterprise (MNE) community, who decried the regulations as being overly burdensome and far reaching.
In response to the overwhelming wave of comments on the proposed regulations, Treasury exempted U.S. parented MNEs from the regulations and created a safe harbor rule for certain cash-pooling transactions. However, the final regulations imposed a harsh set of rules on foreign parented MNEs.
Specifically, the regulations imposed onerous documentation requirements on loans from a foreign parent or foreign related party to its U.S. subsidiary. The regulations also created a category of related party debt transactions that would automatically be recast as equity investment. Because the guidelines for this category of transactions were written broadly many transactions which are common cash management transactions for MNEs would be recast as equity transactions under these regulations.
Good News
Last month, the Treasury Department identified the Section 385 Regulations as one of the eight significant tax regulations that qualify for burden relief under President Trump’s Presidential Executive Order released on April 21, 2017.
The order instructed the Treasury Secretary to review all “significant tax regulations” issued on or after January 1, 2016, and identify which impose an undue financial burden on U.S. taxpayers; add undue complexity to federal tax laws; or exceed statutory authority of the IRS. The order further instructed the Secretary to submit a report to the President by September 18, 2017, recommending “specific actions to mitigate the burden imposed by regulations identified.”
The Section 385 regulations were identified as creating a financial burden of compliance particularly with respect to more ordinary course business transactions. Treasury requested a longer delay in the effective date.
More Good News
On July 28, 2017, the IRS announced a one-year delay in the effective date of the final Section 385 regulations.
Notice 2017-36 indicates that Treas. Reg. Section 1.385-2 will apply only to interests issued or deemed issued on or after January 1, 2019.
The notice stated, “In response to the concern that taxpayers have continued to raise with the application of the [documentation regulations] to interests issued on or after January 1, 2018, and in light of further actions concerning the final and temporary regulations under [Section] 385 in connection with the review of those regulations, the Treasury Department and the IRS have determined that these concerns warrant a delay in the application of the [documentation regulations] by 12 months.”
More Good News to Come?
Based on the guidelines in President Trump’s Executive Order, there is a possibility that the final regulations issued in October 2016 may be substantially revamped or repealed entirely.
What Does this Mean for You?
While we anticipate a significant revision in the Section 385 Regulations, the much litigated Section 385, which allows the IRS to treat debt transactions as equity, is not going away. Only the question of how it is interpreted and administered remains unanswered.
U.S. taxpayers should take heed to properly document their related party transactions so that the IRS respects their intended treatment. In particular, debt transactions should be documented as such. The debt instrument should contain specific provisions that the IRS has historically looked for in debt instruments so that the IRS will not treat the transaction as equity. If an instrument were to be treated equity by the IRS, the payments on the instrument, which the taxpayer considers repayment of principal or interest, becomes a dividend subject to withholding and the deduction for interest paid on the instrument is lost.
If you have any questions or would like to discuss this further, fill out the form below and someone from Withum’s International Tax Services Team will reach out to you.
Ask the Experts
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Chaya Siegfried, CPA, MST, Lead, International Business Tax T (732) 759 6835 [email protected]
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To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
