Jul 07, 2016 - 8:00am

Chamber Addresses Treasury's Debt-Equity Debacle

Former Vice President, Tax Policy & Economic Development
Former Chief Tax Policy Counsel

Former Senior Vice President, Economic Policy Division, and Former Chief Economist


Photo credit: Ken Cedeno/Bloomberg News

The U.S. Chamber of Commerce on Wednesday submitted comments to the U.S. Department of Treasury regarding the newly proposed Section 385 regulations. Many individuals and organizations will be submitting their own comments, some narrowly focused, others broad, comprehensive, and highly technical. The comments submitted by the Chamber are unique in that they specifically reflect the greatest, most immediate concerns of Chamber members. These comments do not purport to address every issue, but they are unique in capturing a consensus of major concerns of the U.S. business community.

On April 4, the Treasury Department released regulations interpreting a long dormant section of the Internal Revenue Code, Section 385, addressing the recharacterization of debt as equity in some circumstances. In so doing, Treasury drove a truck through a mouse hole. 

Treasury’s stated intent was to minimize erosion of the federal income tax base. Whatever else Treasury intended, the effect has been to threaten to disrupt a whole host of normal business practices unrelated to any impression of tax avoidance or tax mismeasurement. The proposed Section 385 regulations are, without exaggeration, the most radical tax reform in many years.

The range of ordinary course business transactions affected by the proposed regulations is truly staggering, affecting everything from routine global finance management, the ability to repatriate money to invest in the United States, ordinary legal entity restructurings, equity compensation practices, and entity classification. They can increase the likelihood of double taxation, result in lost interest deductions, and bring myriad other challenges such as increased compliance burdens and the creation of hybrid instruments. Compounding the adverse effects of the proposed regulations is their cascading application. 

Even months after the initial release, businesses and their internal and external legal counsels are still attempting to understand how the new rules would work, and what changes in normal business practices these new rules would require if made effective. All of this is happening in the background, where brilliant minds toil away parsing tax code sections and nuanced tax concepts. This makes it easy for policymakers and even corporate boardrooms to underestimate the extent of the consequences.

The tax community immediately grasped a sense of the enormity of the complications raised by the new regulations, and so the Chamber quickly concluded the correct course would be for Treasury to withdraw the regulations in favor of a consultative process resulting in a more targeted approach to addressing Treasury’s concerns. 

Short of withdrawal, it was immediately obvious more time would be needed to digest the new regulations and their meaning, and to comment on them properly so Treasury could correct for unintended or inappropriate consequences. The Chamber was one of the first organizations to ask for an extension of the comment period, and many quickly followed. Despite repeated requests from business community requesting extension, none was granted. Nonetheless, the Chamber and its members worked quickly to finalize comments, which were as comprehensive as possible in the limited comment period. The final product was submitted to the Treasury as a formal comment on July 6.  While the submitted comments are extensive, the essentials can be summarized as:

  • If these regulations are not withdrawn, their scope should be significantly narrowed to the government’s original intent – “to further limit the benefits of post-inversion avoidance transactions.”  Some changes are necessary to make these proposed rules workable for businesses. For example:
    • Concerns over routine funding mechanisms, such as cash pools and revolver loan facilities, must be addressed, and clarity is needed on the exception for debt incurred in the ordinary course of business.
    • Foreign-to-foreign transactions, which do not reduce U.S. tax liabilities, should be exempted from the proposed rules.
    • The rules must be modified to mitigate the double taxation that results from the loss of foreign tax credits.
    • The current year E&P exception must be expanded.
    • Equity compensation should be excluded from the rules.
    • The period of the per se funding rule should be shortened
    • A rule to prevent a cascading effect must be adopted.
    • Modifications to the rules must be made to allow for ordinary legal entity restructurings to continue.
  • The new documentation requirements contained in the proposed rules are also expensive and impose substantial compliance burdens.  They essentially present a trap for the unwary. To be more workable, these rules must be modified to allow for a longer documentation period, a de minimis exception, and to clarify retesting.
  • The proposed bifurcation rules are problematic, providing only limited details regarding the application of the rules and their consequences, making identifying issues and proposing solutions difficult. Both the application and consequences need to be more clearly parsed out in these rules so taxpayers can better navigate their application.
  • Certain specialized issues must be addressed. The proposed rules must be modified so S corporation and REIT statuses are not threatened. Where debt recharacterization results in the formation of an unintended partnership must be addressed and the consolidated group definition must be expanded to prevent administrative complexity.

As the scope and complexity of this issues overview makes clear, much work needs to be done before these regulations should take effect. Thus, the Chamber strongly urges Treasury and the IRS to withdraw the rules so the Treasury, Congress, and the business community can have time to work together to address legitimate issues at stake.  Short of withdrawal, the Chamber strongly urges Treasury and the IRS to delay the effective dates of all provisions of the proposed rules until taxable years beginning after January 1, 2019, and to narrow the scope of the proposed rules. These changes are necessary to prevent unnecessary disruption to normal business operations, creating even more drag on an already struggling U.S. economy, as well as to ensure both that U.S. companies can compete globally and that foreign capital is welcomed within our borders.

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About the Authors

About the Author

Former Vice President, Tax Policy & Economic Development
Former Chief Tax Policy Counsel

Caroline Harris is former vice president, tax policy and economic development, and chief tax policy counsel at the U.S. Chamber of Commerce.

About the Author

Former Senior Vice President, Economic Policy Division, and Former Chief Economist

Dr. J.D. Foster is the former senior vice president, Economic Policy Division, and former chief economist at the U.S. Chamber of Commerce. He explores and explains developments in the U.S. and global economies.