On October 13, 2016, the Treasury Department and IRS issued final and temporary earning stripping regulations under IRC Section 385 (TD 9790, Final regulations and temporary regulations). This release comes six months after the release of the proposed regulations. In response to a multitude of comments on the proposed regulations, the final and temporary regulations considerably revised the scope of the regulations. For additional information on the proposed regulations, please see our International Tax Alert: IRS Tightens Rules on Inversions, Earnings Stripping.
Like the proposed regulations, the final regulations continue to establish documentation requirements that must be satisfied if a debt instrument is to constitute indebtedness for U.S. tax purposes. Additionally, the final regulations continue to allow a debt instrument to be recharacterized as stock if the debt instrument is issued in a “tainted transaction” or funds a “tainted transaction.”
While the basis of the regulations is the same in both the proposed and final regulations, the IRS and Treasury Department incorporated several noteworthy changes to the final regulations, as detailed below.
- The final and temporary regulations limit the scope of the regulations to apply only to domestic corporations (and those treated as domestic corporations for U.S. income tax purposes). The final and temporary regulations reserve on debt instruments issued by foreign corporations.
- The final and temporary regulations have modified the definition of an expanded group to exclude S Corporations and non-controlled regulated investment companies (RICs) and real estate investment trusts (REITs). Additionally, the IRS and Treasury Department have decided to reserve on the application of the final and temporary regulations to brother-sister groups.
- The IRS and Treasury Department have removed the Bifurcation Rule from the final and temporary regulations. This means that consistent with common law, the debt versus equity classification will remain an “all or nothing” determination.
- The final and temporary regulations include a delayed implementation period for the Documentation Rule. Taxpayers will now have until the filing date (including extensions) of their taxable year that includes January 1, 2018, to complete the documentation requirements detailed in the regulations.
- The IRS and Treasury Department incorporated several additional changes to the Documentation Rule related to the type of instruments that are included under the rule, clarification of the ability to satisfy the Documentation Rule, and the introduction of a rebuttable presumption.
- The final and temporary regulations limited the scope of the Recharacterization Rule to exclude qualified short-term debt instruments.
- The IRS and Treasury Department included several exceptions to the Recharacterization Rule in the final and temporary regulations. Specifically, the final and temporary regulations include exceptions based on the earnings and profits of the issuer, as well as capital contributions to the issuer. Additionally, the final and temporary regulations limit the application of the Recharacterization Rule.
For a more comprehensive review of the regulations under IRC §385, read the extended version of this tax alert. Please contact your Elliott Davis Decosimo advisor or a member of our international tax team at email@example.com to discuss how these regulations could impact you.