On October 4, 2017, the U.S. Department of the Treasury ("Treasury") released a report (the "report") recommending actions to reduce certain tax regulatory burdens. The report highlighted eight tax regulations identified in a prior interim report and issued pursuant to Executive Order 13789.
The new report focused on the final and temporary Section 385 regulations (the "Section 385 regulations"), which deal with the classification of related-party debt as debt or equity for U.S. federal income tax purposes. The Section 385 regulations are primarily composed of (i) rules establishing minimum documentation requirements that ordinarily must be satisfied in order for purported debt obligations among related parties to be treated as debt for U.S. federal tax purposes (the "documentation regulations"); and (ii) rules that treat as stock certain debt that is issued by a corporation to a controlling shareholder in a distribution or in another related-party transaction that achieves an economically similar result (the "distribution regulations").
The report indicates that Treasury plans to propose revoking the documentation regulations and replacing them with streamlined documentation rules, with a prospective effective date that would allow time for comments and compliance. For purposes of the documentation regulations, the report also indicates that Treasury and the IRS are considering modifying the requirement of a reasonable expectation of the ability to pay indebtedness, and reexamining the treatment of ordinary trade payables.
The report does not propose to revoke the existing distribution regulations before the enactment of fundamental tax reform. Generally, the report notes that the distribution regulations address the inversions and takeovers of U.S. corporations by limiting the ability of corporations to generate additional interest deductions without new investment in the United States. The report indicates that, while fundamental tax reform is expected to obviate the need for the distribution regulations and make it possible for these regulations to be revoked, proposing to revoke the existing distribution regulations before the enactment of fundamental tax reform could make existing problems worse. The report notes that, if tax reform does not entirely eliminate the need for the distribution regulations, Treasury and the IRS may propose more streamlined and targeted distribution regulations.
Commentary / Edward S. Wei
Many commentators and politicians have clamored for the Treasury to revoke, limit or reconsider the distribution regulations under Section 385. (See, for example, Hatch's 2016 Statement on Treasury's Final Section 385 Debt-Equity Regulations.) Given the political and industry pressure to revise the distribution regulations, Treasury's approach to wait for fundamental tax reform before rendering a decision was unexpected.
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