The regulations are intended to address the treatment of related party debt for US tax purposes.
In April 2016, proposed anti-inversion and ‘debt-equity’ rules were released by the US Treasury Department. Following a consultation period, the US Treasury released final and temporary section 385 regulations (Final 385 Regulations) on 13 October, which are expected to be effective from 21 October 2016. The Final 385 Regulations, which address the treatment of related party debt for US tax purposes, when compared with the original proposals offer significant relief for US multinational groups, and offer some, but less significant, relief for non-US multinational groups.
The proposed rules have been described as one of the most significant changes, and potentially burdensome new regimes, in the US international tax system in decades. After much speculation and concern, the final product reflects a significant effort by the US Treasury and the Internal Revenue Service (IRS) to limit in certain aspects the scope and burden of the rules, particularly for US multinationals. However, for foreign multinationals contemplating related party debt financings, to include certain related-party distributions and acquisitions, the Final 385 Regulations will require significant analysis and close scrutiny.
The original proposals contained a ‘bifurcation authority’ which would have given the IRS the authority to treat a debt instrument as part debt and part equity. This controversial rule has been dropped from the final proposals. An additional significant change in the Final 385 Regulations is that there is a broad exemption for all debt issued by foreign corporations. This change will greatly reduce the impact for US multinationals and will also provide significant relief for cash pooling arrangements.
Of particular note is a relaxation of the start date for the ‘Documentation Rules’, which will now generally apply to debt issued on or after 1 January 2018, rather than the date the regulations became final as initially proposed. The Documentation Rules apply substantive documentation requirements to related-party debt transactions.
However, the ‘Recast Rules’ still apply to transactions occurring and debt issued on or after 4 April 2016. The recast rules broadly re-characterise an intercompany debt instrument as equity, unless the intercompany debt is issued in exchange for cash or other assets that increase the gross assets of the issuer, taking into account related transactions.
There is also a complicated ‘final transition period’ that generally exempts debt from the Recast Rules if it is settled within 90 days of the publication of the Final Regulations (expected on 21 October). A number of other changes have also been made following the consultation.
KPMG in the US have prepared a Tax News Flash with further information on the Final Regulations.
Please speak to your usual KPMG contact if you would like further advice on the impact of these rules.
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