The IRS and Treasury on April 4 announced their latest action to limit inversion transactions and address earnings stripping. As part of this announcement, the government issued final and temporary (T.D. 9761
), as well as proposed (REG-135734-14
), regulations that address transactions that are structured to avoid the purposes of Sections 7874 and 367. The text of the temporary regulations also serves as the text of concurrently issued proposed regulations.
Packaged together with the inversion regulations, proposed regulations (REG-108060-15
) authorize the IRS to, among other things, treat certain related-party interests in a corporation as part indebtedness and part stock for U.S. federal tax purposes, and establish threshold documentation requirements that must be satisfied for certain related-party interests in a corporation to be treated as indebtedness.
If made final, the proposed regulations addressing certain related-party interests could significantly affect a wide range of ordinary business transactions that involve related-party lending. Because the proposed regulations included a retroactive effective date, taxpayers should carefully consider the regulations’ potential impact on all prospective related-party lending transactions.
Regarding inversion transactions, the temporary regulations adopted with some amendments the rules included in the prior inversion notices (Notice 2014-52
and Notice 2015-79
). The temporary regulations also added several new rules and clarified certain rules.
These rules would do the following:
- Identify a foreign acquiring corporation when a domestic entity acquisition involves multiple steps
- Disregard stock of the foreign acquiring corporation that can be attributed to certain prior domestic entity acquisitions
- Require a controlled foreign corporation (CFC) to recognize all realized gain upon certain transfers of assets described in Section 351 that shift the ownership of those assets to a related foreign person that isn’t a CFC in a post-inversion transaction
- Clarify the definition of group income for purposes of the substantial business activities test
The final and temporary regulations generally apply to transactions on or after April 4, 2016. The rules described in the 2014 and 2015 notices, however, apply to transactions occurring on or after the effective date included in the respective notice (i.e., Sept. 22, 2014, and Nov. 19, 2015, respectively).
Regarding the treatment of related-party debt transactions, the proposed regulations broadly apply to many normal-course related-party debt transactions and are not limited in scope to inverted companies or cross-border transactions. The IRS noted in the preamble to the proposed regulations that while the regulations are motivated in part by transactions that result in excessive indebtedness in cross-border transactions, federal income tax liability can also be reduced or eliminated with excessive indebtedness between domestic related-parties.
The proposed regulations provide rules permitting the IRS to bifurcate interests that are indebtedness in part but not in whole. The proposed regulations also require that certain due diligence and documentation be undertaken to substantiate the treatment of certain interests issued between related-parties as indebtedness. Finally, the regulations provide specific rules that treat certain debt instruments as stock that would otherwise be treated as indebtedness for U.S. federal income tax purposes.
The effective dates for the proposed regulations vary and are specific to respective operating provisions. The regulations permitting the IRS to bifurcate interests that are indebtedness in part but not in whole and the regulations pertaining to timely documentation requirements will generally be effective on or after the final regulations are published. However, the rules regarding distributions of debt instruments and related transactions generally apply to debt instruments issued on or after April 4, 2016, but would not treat interests as stock until 90 days after the final regulations are published.
The regulations, which are hundreds of pages long, reflect the Obama administration’s most significant effort to combat inversion transactions. If finalized, the related-party debt transaction regulations could also result in major changes to internal business financing and corporate tax planning beyond inversion transactions. Treasury Secretary Jacob Lew said on April 4 that the government’s action “takes away a significant amount of the tax benefits” of “serial inverters.”
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