International impact of the proposed debt-equity regulations
TAX BLOG |
Controversial proposed regulations allowing the IRS to recast certain related-party debt as equity may cause unintended international tax consequences.
Although the new rules were intended to limit certain tax planning techniques involving related-party financing arrangements, the reclassification of debt into equity required by the new rules could have significant adverse tax consequences.
For example, reclassifying foreign-issued debt as equity could affect the availability of foreign tax credits and withholding tax exemptions and could result in the current taxation of certain types of income otherwise not currently taxable. Additionally, in some situations, a mere distribution of previously taxed foreign income could trigger unfavorable consequences under the new rules.
The new rules could encourage leveraged buyouts of U.S. companies by foreign groups because foreign acquirers would be able to finance acquisitions with higher debt loads than any potential U.S.-based buyer. The proposed regulations have a general effective date of April 4, 2016, but certain documentation requirements would generally not be effective until final regulations are issued.
While the Treasury continues to take comments on the proposed regulations, it has indicated the intent to finalize the new rules as soon as possible. In light of the numerous concerns raised by the public, it is unlikely the regulations will fully address the issues raised if they are finalized in short order.
Multinationals with intercompany debt should evaluate the potential impact the proposed regulations may have on their business operations. For more details, see our article, IRS issues guidance on inversions and earnings stripping.