United States

Proposed debt-equity regulations would disrupt tax planning


If finalized, recent proposed regulations would recharacterize certain related-party debt instruments as equity and cause a significant disruption to certain tax planning activities. The rules generally would apply to affiliated corporations, whether foreign or domestic.

The regulations target transactions with or among foreign corporations that can have significant tax effects due to introduction of related-company debt but that have limited nontax economic effects. These transactions include (but are not limited to) earnings stripping transactions.

Although the proposed regulations exclude transactions within federal consolidated groups, there could be significant state tax effects given that many states do not conform to the federal consolidated return rules.

The proposed rules would:

  1. Authorize the IRS (but not taxpayers) to conclude that an instrument should be characterized as part debt and part equity
  2. Require taxpayers to maintain documentation with respect to certain related-company debt
  3. Require equity treatment of debt issued to related companies in specified distribution, asset acquisition and stock acquisition contexts

For example, the distribution of a note from a subsidiary to its parent corporation would fall under category (3) above, and the note generally would be treated as equity, not debt. Certain exceptions would apply to categories (2) and (3) above, but not to category (1). The category (3) rule is proposed to apply retroactively to transactions occurring on or after April 4, 2016.

Stefan Gottschalk

Senior Director

Stefan guides businesses and their owners through M&A, corporate tax and financial instruments tax issues. Contact him at stefan.gottschalk@rsmus.com.

Areas of focus: Corporate TaxationMergers & AcquisitionsWashington National Tax