NEW SECTION 385 PROPOSED REGULATIONS CHANGING THE DEBT-EQUITY LANDSCAPE

Transcription

1 @BDO_USA_Tax NEW SECTION 385 PROPOSED REGULATIONS CHANGING THE DEBT-EQUITY LANDSCAPE August 2, 2016 BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of themarket Sourcing & Apportionment Rules BDO KNOWLEDGE Webinar Series Navigating international BDO network of independent member firms. Page

2 Presenters Joseph Calianno Partner and International Technical Tax Practice Leader Washington National Tax Office Brad Rode Partner - International Tax Services Doug Poms Deputy Associate International Tax Counsel Department of the Treasury Page 1

3 Proposed 385 Regulations Broad application to certain related party transactions - Although intended primarily to reduce earnings-stripping opportunities in the cross-border context, including inverted companies, application is significantly more broad - Affects corporations that issue purported indebtedness to related corporations (rules also apply with respect to certain controlled partnerships) - Can apply to domestic-to foreign, foreign-to-foreign, and domestic-todomestic related party transactions - Generally excludes transactions between corporations in the same consolidated group Authorizes the IRS to - Treat certain related-party interests in a corporation as indebtedness in part and stock in part for U.S. federal tax purposes - Establish threshold documentation requirements - Treat as stock certain related-party interests Page 2

4 Proposed 385 Regulations In General On April 4, 2016, the IRS released REG , containing proposed regulations under section 385. Authorizes the IRS to treat certain related-party interests in certain corporations as indebtedness in part and as stock in part for U.S. federal tax purposes. Prop. Reg (d). Authorizes the IRS to establish threshold substantiation and documentation requirements that must be satisfied in order for certain related-party interests in a corporation to be treated as indebtedness for U.S. federal tax purposes. Prop. Reg Treats as stock certain related-party interests that otherwise would be treated as indebtedness for U.S. federal tax purposes. Prop. Reg Provides specific rules relating to the treatment of consolidated groups. Prop. Reg Page 3

5 Proposed 385 Regulations In General The proposed regulations generally affect corporations that issue purported indebtedness to certain related corporations (also special rules relating to certain controlled partnerships e.g., Prop. Reg (d)(5)). The proposed regulations include several operating rules (rules for defining when members of a group are related for purposes of applying rules, certain threshold exceptions and specific exceptions relating to application of rules, anti-abuse rules, predecessor and successor rules, anti-avoidance, coordination rules, etc.). Page 4

6 Proposed 385 Regulations Group Definitions The proposed section 385 regulations generally apply an 80 percent threshold for finding expanded group members. - An expanded group is defined by reference to the term affiliated group in section 1504(a), but broadens the definition in several ways. - Unlike an affiliated group, the expanded group includes certain corporations, such as S corporations, and foreign and tax exempt corporations, as well as corporations held indirectly, for example, through partnerships. - In determining relatedness, the proposed regulations adopt the attribution rules of section 304(c)(3). - The proposed regulations also modify the definition of affiliated group to treat a corporation as a member of the expanded group if 80 percent of the vote or value is owned by expanded group members (instead of 80 percent of the vote and value, as generally required under section 1504(a)). - See Prop. Reg (b)(3) for additional details. A modified expanded group (50% threshold) applies for purposes of the bifurcation rules (see Prop. Reg (b)(5) for additional details). Page 5

7 Proposed 385 Regulations Effective Dates The bifurcation rule of Prop. Reg generally applies to debt instruments issued on or after the date the regulations are finalized. The substantiation and documentation rules in Prop. Reg are generally applicable to debt instruments issued on or after the date the regulations are finalized. The automatic recast rules of Prop. Reg are generally applicable to debt instruments issued on or after April 4, 2016; however, recharacterization under these rules would occur 90 days after the date the final regulations are issued for instruments that would be treated as stock prior to regulations being finalized (see Prop. Reg (h) for additional details). The rules relating to consolidated groups are generally applicable to debt instruments issued on or after April 4, 2016 with special 90 day rule with respect to debt instruments that would be treated as stock prior to date of final regulations. The proposed section 385 regulations include rules to address CTB elections to avoid effective dates Page 6

8 Proposed 385 Regulations Documentation Requirements Documentation requirements are a necessary, but not sufficient, condition for treatment as indebtedness for federal tax purposes Legally binding obligation to pay Creditors rights to enforce the obligation Reasonable expectation of repayment at the time the interest is created Page 7

9 Proposed 385 Regulations Documentation Requirements Ongoing relationship during the life of the interest consistent with armslength relationships between unrelated debtors and creditors (genuine debtor-creditor relationship) is subject to documentation requirements. The proposed section 385 regulations include rules regarding when documentation must occur (i.e., the 30-day and 120-day rules) and also has provided some limitations to the applicability of the above documentation requirements. The documentation rules generally apply if: stock of any of expanded group is publicly traded; all or any portion of the expanded group s financial results are reported on financial statements with total assets exceeding $100 million; or the expanded group s financial results are reported on that reflect annual total revenue that exceeds $50 million. Page 8

10 Proposed 385 Regulations Presumed Equity Distributions of debt instruments by corporations to certain related corporate shareholders. Issuances of debt instruments by corporations in exchange for stock of certain affiliated corporations (including hook stock issued by certain related corporate shareholders). Certain issuances of debt instruments as consideration in an exchange part of to an internal asset reorganization. Page 9

11 Proposed 385 Regulations Presumed Equity The proposed section 385 regulations treat as stock certain related-party debt instruments (a principal purpose debt instrument) issued in a separate transaction to fund: A distribution of cash or other property to a related corporate shareholder An acquisition of stock from an affiliate Certain acquisitions of property from an affiliate pursuant to an internal asset reorganization Under a 72 month per se rule in the proposed section 385 regulations (subject to certain ordinary course debt if certain requirements are satisfied): a principal purpose is deemed to exist if the expanded group debt instrument is issued by the funded member during the period beginning 36 months before the funded member makes a distribution or acquisition and ending 36 months after the distribution or acquisition. Page 10

12 Proposed 385 Regulations Presumed Equity The proposed section 385 regulations include several special rules and numerous operating rules in applying the above rules and also include some exceptions to the applicability of the above rules. Exceptions: - Current E&P limitation - Funded subsidiary exception - Threshold exception Threshold exception provides that an expanded group debt instrument not treated as stock if when the debt instrument is issued, the aggregate issue price of all expanded group debt instruments that otherwise would be treated as stock under the proposed regulations does not exceed $50 million (but cliff effect if exceed limit) Page 11

13 Proposed 385 Regulations Potential Implications Potential implications of treating debt as stock for U.S. federal tax purposes - Loss of interest deductions to issuer - Loss of S corporation status - Withholding tax analysis for dividends vs. interest under treaty - Other treaty qualification issues (e.g., where stock ownership is a factor) - BEPS anti-hybrid rules (Action Item 2) - Characterization of various transactions for U.S. federal tax purposes (e.g., transaction otherwise treated as a section 304 transaction may not be treated as a section 304 transaction) - Foreign tax credit splitting transactions - U.S. GAAP and financial statement disclosure implications Page 12

14 Proposed 385 Regulations Examples Page 13

15 Per Se Stock Rule General Rule: Note Distribution Illustration Sub declares a dividend and distributes $100 note to Parent in payment thereof Parent Sub note treated as stock (absent application of any exceptions) $100 Note Sub (non-consolidated) Page 14

16 Per Se Stock Rule General Rule: Stock Acquisition Illustration USP owns 100% of each of CFC1 and CFC3 CFC1 USP Note CFC2 Stock CFC3 USP indirectly owns 100% of CFC2 (via its ownership of CFC1) CFC3 acquires stock of CFC2 in exchange for promissory note CFC3 promissory note treated as stock (absent application of any exceptions) Section 304 does not apply to the exchange CFC1 is treated as owning stock of CFC3 CFC2 CFC2 Page 15

17 Per Se Stock Rule General Rule: Acquisitive Asset Reorganization Illustration USP owns 100% of each of CFC1 and CFC3 USP USP indirectly owns 100% of CFC2 (via its ownership of CFC1) CFC3 acquires stock of CFC2 in exchange for promissory note CFC1 Note CFC3 CFC2 either liquidates under local law, or makes an election to be treated as a disregarded entity for U.S. federal tax purposes CFC2 CFC2 Stock DRE (Formerly CFC2) Deemed or actual liquidati on of CFC2 CFC3 promissory note treated as stock (absent application of any exceptions) CFC1 is treated as owning stock of CFC3 Page 16

18 Per Se Stock Rule Funding Rule: Funded Cash Distribution 1. Foreign Sub loans $100 to U.S. Sub in Year 1 Foreign Parent $ U.S. Sub issues a $100 debt instrument (the Note ) to Foreign Sub pursuant to the loan 3. U.S. Sub distributes $100 to Foreign Parent in Year 1 2 Absent the application of any exceptions, the Note is treated as stock Foreign Sub Note US Sub Suppose US Sub distributes the $100 to Foreign Parent in Year 2 (instead of Year 1) $100 Cash Absent the application of any exceptions, the Note is treated as stock in Year 2 1 Page 17

19 Selected Issues under Proposed 385 Regulations Implications on S corporations Implications on Cash Pooling Implications on Foreign-to-Foreign transactions Page 18

20 Section 385 Rules and Applicability to S Corporations Impact on S corporations U.S. Individual Possible implications under proposed section 385 regulations? S Corporation 1 S Corporation 2 Controlled Foreign Corporation C Corporation Page 19

21 Thank you. Joseph Calianno Partner and International Technical Tax Practice Leader Brad Rode Partner - International Tax Services brode@bdo.com Page 20

22 Disclosure This presentation is intended for educational and discussion purposes only and cannot be relied upon as tax or accounting advice. You should seek advice from a qualified advisor based on your specific facts and circumstances before taking any action. This document is not written tax advice directed at the particular facts and circumstances of any person. This document is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. If you are interested in the subject of this document we encourage you to contact an independent tax advisor to discuss the potential application to your particular situation. Page 21