Another hit to US productivity by the IRS - New rule 385 - ACTION

Rule 385 - Read Up: On April 4 Treasury proposed a new set of regulations under Internal Revenue Code Section 385 that would grant the Internal Revenue Service latitude to reclassify inter-company debt as equity investment in the borrower. Last Thursday was the deadline for companies to comment to Treasury on these proposed regulations; this coming Thursday Treasury is planning to hold a hearing on all this, after which all indications are Treasury will finalize its intentions very quickly.

The alleged problem motivating these new regulations is that, post-inversions, U.S. affiliates of foreign companies pay too little U.S. taxes on their U.S. income by “stripping” away those earnings by incurring too much debt and thus interest payments to foreign parents. But for decades, U.S. law (under IRC 163) has already been limiting how much interest U.S. affiliates can pay to foreign parents. Any business in America, regardless of nationality of ownership, must pay U.S. taxes on its income earned in America. The major tax consideration of inversions is income earned around the world, not income earned in America.

What is so worrisome about the proposed new 385 rules are their expanded breadth and depth relative to long-standing tax policy and case law. Empowering the IRS to reclassify debt as equity would raise a thicket of fundamental questions about the capital structure and overall operations of global companies. Would interest payments reclassified as dividends be subject to withholding taxes? And the IRS would be granted a six-year window within which to deploy this new power, including three retrospective years.

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Steve - Tea Party Founder August 15, 2016 at 9:16am

Rule 385 - Read Up: On April 4 Treasury proposed a new set of regulations under Internal Revenue Code Section 385 that would grant the Internal Revenue Service latitude to reclassify inter-company debt as equity investment in the borrower. Last Thursday was the deadline for companies to comment to Treasury on these proposed regulations; this coming Thursday Treasury is planning to hold a hearing on all this, after which all indications are Treasury will finalize its intentions very quickly.

The alleged problem motivating these new regulations is that, post-inversions, U.S. affiliates of foreign companies pay too little U.S. taxes on their U.S. income by “stripping” away those earnings by incurring too much debt and thus interest payments to foreign parents. But for decades, U.S. law (under IRC 163) has already been limiting how much interest U.S. affiliates can pay to foreign parents. Any business in America, regardless of nationality of ownership, must pay U.S. taxes on its income earned in America. The major tax consideration of inversions is income earned around the world, not income earned in America.

What is so worrisome about the proposed new 385 rules are their expanded breadth and depth relative to long-standing tax policy and case law. Empowering the IRS to reclassify debt as equity would raise a thicket of fundamental questions about the capital structure and overall operations of global companies. Would interest payments reclassified as dividends be subject to withholding taxes? And the IRS would be granted a six-year window within which to deploy this new power, including three retrospective years.

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