Final Regulations Under Section 385 Released

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Last Thursday, October 13, 2016, the Treasury Department and the Internal Revenue Service released the final regulations under Section 385, resisting calls by business groups and lawmakers to slow the process and reissue proposed regulations. The proposed regulations were issued in April of 2016 and were met with strong public reaction.

In comments on Thursday, Treasury Secretary Jacob J. Lew noted that throughout the rulemaking process, the Treasury sought comments and engaged with businesses, tax experts, the public and lawmakers. He insisted the Treasury carefully considered their comments and recommendations before issuing the final regulations.

The intent of the regulations are 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. Treasury has nonetheless finalized the rules, but with many modifications.

Upon first glance the primary beneficiaries of the modification are U.S. based multi-nationals which is consistent with Treasury’s intent to limit inversion activity. Significant modifications made to the regulations in the final form are as follows:

  • Foreign issuers are exempt from all aspects of the final regulations.
  • S-corporations and non-controlled RICs and REITs are also exempt.
  • Certain financial organizations are excluded
  • Cash pooling arrangements and other short-term debt are excluded from the rules
  • The final regulations do not include a general bifurcation rule allowing for re-characterization of an instrument as part-debt and part-equity.
  • The effective date of the documentation requirements is delayed to 2018.
  • The regulations apply to tax years ending on or after January 31, 2017. A more in depth analysis is forth coming.

For more information or questions, please reach out to our National Tax Services Team at [email protected]thum.com.

Withum-placeholder Chaya Siegfried, CPA, MST
T (742) 842 3113
[email protected]LinkedIn

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