Companies opposed to the US Treasury Department’s proposed Section 385 debt/equity regulations cannot be too pleased about a recent hearing on the proposal. The upshot is that 385 could be here to stay.
According to transcripts and those in attendance at Thursday’s public hearing, “Treatment of certain Interests in Corporations as Stock or Indebtedness,” organized by Treasury and the IRS, panelist from both departments barely responded to comments from those gathered to voice their concerns about the rule’s impact. The hearing drew 18 presenters or groups of presenters that requested to speak before a panel of four attorneys from the IRS and two attorneys from Treasury.
Presenters were given 10 minutes to speak and panelists, except for on one occasion, merely said thank you for their presentations. The lone speaker who elicited any response from the panel was Lou Greenwald, a partner from law firm Mayer Brown. After addressing concerns regarding 385’s rules on bifurcation, documentation, funding, credit analysis among others; and further seeking “like everyone else” an exception for qualified pooling arrangements due to struggles he and others had in “how to define qualified pooling arrangement,” one panelist from the IRS, Filiz Serbes, special counsel, Office of Associate Chief Counsel, raised hope when she interrupted Mr. Greenwald with a question near the end of his 10 minutes. But it was a false alarm. From the transcript:
MS. SERBES: Actually, I have a question.
MR. GREENWALD: Please. Does that mean the time stops? [Mr. Greenwald’s time to present].
MR. NICHOLS [Treasury]: I think we’re out of time.
MR. DIAMOND-JONES [IRS]: It’s 41 […] seconds.
MS. SERBES: Is there anything that you would like to say that is not in your written comment?
That was the most any presenter got. Mr. Nichols is Kevin Nichols, senior counsel, Office of International Tax Counsel at Treasury and Mr. Diamond-Jones is Austin Diamond-Jones, attorney, Branch 5, Office of Associate Chief Counsel at the IRS.
One member of the 200 or so people in attendance said the panel sat stone-faced throughout and at one point, someone on the panel rolled their eyes.
But the rules are no rolling-eye matter for many multinational corporations and certainly no small beer when it comes to costs. Companies stand to lose millions or spend millions complying with the rules. According to a comment letter submitted by Procter & Gamble, this includes millions in lost benefits if they are unable to utilize pooling structures. The concern for P&G, according to its letter, “is that the per se funding rule risks recharacterizing a large number of cash pool loans as equity, and that these recharacterizations in turn would give rise to further recharacterizations of other cash pool loans as equity, in a self-replicating process that would result in countless unplanned deemed equity investments throughout a group’s corporate structure.”
The cost of this replication? P&G estimates the pre-tax costs of lost benefits from cash pooling could be around $220 to $340 million per year.. What will drive those costs is “a combination of increased borrowing costs, reduced investment income, lost hedging benefits from netting and larger scale transactions, and higher treasury and accounting operating costs required by increased controls and employees to manage the exponential increase in external transaction flows. Also impactful would be transition costs required to unwind the pooling arrangements and replace them with alternative arrangements, as well as significant systems modifications to monitor the volume of transactions for accounting, tax and controls purposes. P&G would be forced to incur all of these costs despite the fact that its pooling arrangements, evolved over the past twenty plus years, have no tax motivation.”
Since it now appears that Section 385 is here to stay, companies should start preparing if they haven’t already. Peter Frank, Principal, Financial & Treasury Management at PwC, said in a June interview with iTreasurer that MNCs should now be getting their arms around the number of transactions they have outstanding, and doing an impact assessment of current portfolio transactions. And given that, ask themselves, “If the rules were put in place how would we respond? What new strategies might we put in place to optimize our outcomes, given the proposed rules and given what we have today?”
Other questions might involve policy, technology and process. Given what they understand to be in the rules, Mr. Frank said, they might ask, “What changes might we need to make to our existing process, including changes to the organization? Do we need more resources? Do we need a new policy? Do we need new tools or technology to help manage this?”