Enter to open, tab to navigate, enter to select
IRS Issues Final and Temporary Earnings-Stripping Regulations
Practical Law Legal Update w-003-9844 (Approx. 3 pages)
IRS Issues Final and Temporary Earnings-Stripping Regulations
by Practical Law Corporate & Securities
| Published on 21 Oct 2016 • USA (National/Federal) |
The IRS released final and temporary earnings-stripping regulations significantly narrowing the scope of proposed regulations.
On October 13, 2016 the IRS issued final and temporary earnings-stripping regulations that address the treatment of certain related-party debt as equity for US tax purposes. The IRS issued proposed earnings-stripping regulations in April, 2016 together with additional anti-inversion guidance. The proposed regulations applied beyond the inversion context and recharacterized certain related-party debt as equity (other than debt between members of a US federal consolidated income tax group) if:
- The debt did not meet specified documentation requirements. The proposed regulations set forth threshold documentation preparation and maintenance requirements for intercompany debt to enable a debt-equity analysis to be made. The documentation requirements applied to intercompany debt instruments of groups that included a publicly-traded company, or groups with assets reported on a financial statement in excess of $100 million or reported annual total revenue in excess of $50 million.
- The debt was distributed to a related party (and therefore resulted in no new investment) or the debt was issued in exchange for stock of an affiliate (with limited exceptions) or in certain internal asset reorganizations (Debt Transaction Rules). The proposed regulations also contained a per se funding rule that treated certain intercompany debt instruments as equity if the debt instrument was issued within three years before or after certain distributions or acquisitions.
The proposed regulations also allowed the IRS to bifurcate a purported debt instrument into part debt and part equity.
The final and temporary regulations retain the basic structure of the proposed regulations, including the documentation rules and the Debt Transaction Rules. However, in response to taxpayer comments, the regulations make significant changes to the scope of the debt recharacterization rules. In particular, the regulations:
- Do not apply to debt instruments issued by foreign issuers, including foreign subsidiaries of US multinationals. The regulations reserve on the tax treatment of these instruments and the IRS continues to study whether debt issued by foreign issuers should be covered by the debt recharacterization rules. The current regulations are therefore primarily relevant to debt issued by US corporations to foreign affiliates.
- Do not apply to debt instruments issued by S-corporations, or non-controlled real estate investment trusts (REITs) or regulated investments companies (RICs).
- Eliminate the bifurcation rule.
- Relax the documentation rules by:
- postponing the effective date of the documentation rules to debt instruments issued on or after January 1, 2018;
- providing that failure to meet the documentation rules will create a rebuttable presumption (rather than automatic equity characterization) if the issuer's group is otherwise "highly compliant" with the documentation rules; and
- modifying the date when documentation must be prepared to the date the debt issuer's US federal income tax return is filed (taking into account applicable extensions).
- Limit the application of the Debt Transaction Rules by:
- excluding debt instruments issued by certain regulated financial companies, certain members of regulated financial groups, and regulated insurance companies;
- generally excluding deposits pursuant to a cash pooling arrangement as well as loans to finance short-term liquidity needs;
- expanding exceptions for distributions and acquisitions made out of specified earnings and profits and eliminating the cliff effect of the $50 million threshold for debt instruments subject to recharacterization; and
- providing an exception for stock acquired for delivery to employees, directors, and independent contractors as consideration for providing services.
The Debt Transaction Rules generally apply to debt instruments issued after April 4, 2016 and to taxable years ending on or after January 19, 2017. However, under a transition rule a debt instrument will not be recharacterized as equity under the Debt Transaction Rules until immediately after January 19, 2017.