Change is coming to U.S. cross-border tax rules.
In a recent report, the U.S. Treasury recommends specific actions to ease certain complex or burdensome regulations involving transfers to foreign corporations and deductions for interest paid to related parties. As a result, Canadian taxpayers investing in the United States may benefit from recent U.S. tax recommendations to amend rules that affect certain cross-border transactions. These changes, while separate from those proposed in the recent U.S. tax reform bill, are also intended to help simplify the U.S. tax code.
As part of the report, the Treasury is reviewing the regulations in section 367, addressing the transfers of property to foreign corporations, and section 385, concerning deductions for interest paid to related parties. Both of these sections were implemented to address specific tax planning concerns and were controversial with taxpayers since they focused on bright line tests rather than facts and circumstances tests. Note that, until the United States decides to take further action, the recast rules still apply.
In July 2017, the IRS identified eight tax regulations as either imposing an undue financial burden on taxpayers, or adding excessive complexity to the tax system.
Among the regulations identified is section 367, which generally requires gains to be recognized where a U.S. person transfers property with accrued gains to a foreign corporation in a transaction that otherwise qualifies for tax-free treatment.
The IRS also identified the related party interest regulations issued under section 385 that address the classification of related-party debt as debt or equity for U.S. federal income tax purposes. These regulations limit the ability of corporations to generate additional interest deductions without new investment in the United States. The regulations include documentation regulations that establish minimum documentation requirements that ordinarily must be satisfied in order for purported debt obligations among related parties to be treated as debt for federal tax purpose. The IRS previously delayed the proposed documentation requirements so that they would only apply to interests issued or deemed issued on or after January 1, 2018.
As well, section 385 features distribution regulations that treat as stock certain debt that is issued by a corporation to a controlling shareholder in a distribution or in another related-party transaction that achieves an economically similar result as a distribution.
Transfers to foreign corporations
The report indicates that Treasury will consider substantially revising the final regulations in section 367 affecting certain cross-border transfers, and provide additional exceptions on the taxability of outbound transfers. Previously, changes to section 367 broadened the types of property to which the rule would apply and, at the same time, narrowed a commonly used exception for assets transferred for use in an active business outside the United States. This change was intended to address perceived abuses where U.S. taxpayers characterized certain intangibles as "foreign goodwill and going concern value" that the IRS believes to be "intellectual property" for use by the U.S. entity.
Deductions for interest paid to related parties
In the report, the U.S. Treasury indicates that it will revoke the section 385 documentation regulations and replace them with streamlined documentation rules. The proposed rule would include an effective date that would allow sufficient time for comments and compliance. The report notes that the streamlined documentation regulations will likely significantly modify the requirements related to the descriptions of a reasonable expectation of the debtor's ability to repay the indebtedness. It will also clarify whether accounts payable are covered by these rules.
The report also affirms Treasury's intention to safeguard the distribution regulations in section 385 against earnings-stripping and to diminish incentives for inversions and foreign takeovers. The earnings stripping rules in the U.S. tax reform bill that was released on November 2, 2017, include rules preventing base erosion that eliminate the need for these regulations.
For more information, contact your KPMG adviser.
Information is current to November 07, 2017. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500