June 21, 2016

IRS and Treasury to Hold Hearing on Jointly Proposed Debt-Equity Regulations (Fed. Reg.)

The IRS and the U.S. Treasury Department ("Treasury") scheduled a public hearing to discuss proposed regulations under section 385 of the Internal Revenue Code. The proposed regulations recharacterize certain debt instruments issued to related parties as equity for U.S. federal income tax purposes. The possible consequences of such a recharacterization include denial of interest deductions, the imposition of withholding tax, changes in entity classification for tax purposes, and loss of tax-free status for planned transactions. In general, the proposed rules (i) allow the IRS to treat debt instruments issued to certain related parties as partly debt and partly equity, (ii) impose stringent new documentation requirements for debt instruments issued to certain related parties (and redefine such debt instruments as equity if taxpayers failed to comply with the requirements), and (iii) reclassify a broad range of debt instruments issued to related parties as equity, inclusive of numerous debt instruments issued within 36 months of the distributions or acquisitions of related party stocks by the issuer.

The proposed regulations have generated intense debate among analysts, taxpayers and the government, with several parties calling for an extension to the comment period.

The public hearing will be held on Thursday, July 14, 2016, at 10:00 a.m. Comments on the hearing and the topics to be discussed must be submitted by July 7, 2016.

Commentary

If enacted in their current form, the proposed regulations would initiate significant changes to longstanding U.S. tax principles. The proposed regulations would overwrite foundational assumptions about the treatment of debt and equity for U.S. tax purposes, and also would necessitate substantial compliance costs for many companies. Even some common business arrangements, such as intercompany cash-pooling systems, would become difficult to administer under the proposed regulations as drafted.

Changes of this magnitude warrant careful consideration and analysis. It is unclear whether the July 7 comment deadline, the hearing one week later on July 14, and the proposed finalization date of September 5 (Labor Day) will allow enough time for a discussion that truly explores the complexity and depth of the issues.

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