Corporates Get Relief on Section 385

Treasury and IRS lighten the load on some of Section 385’s heavier lifts. Big pooling win.
 

They asked for comments, they got them and they listened. The Treasury and IRS Thursday released their much anticipated – and feared – tax rules under Section 385 and some of corporate treasurers’ worst fears weren’t realized.

“The comment process worked,” said Peter Connors, a tax law partner with Orrick, Herrington & Sutcliffe LLP. “The IRS narrowed the scope of the regulations dramatically, and targeted them to their legitimate concerns. Debt issued by foreign persons is completely outside of the rules, completely narrowing the scope of the regulations. The documentation requirement still exists but it has been relaxed. However, the 72 month look-back funding rule remains, which means that companies will still have to set up internal processes to avoid unintended footfalls.”

While the law has many carve outs for corporations, perhaps the best news for treasurers is that their pooling structures will stay intact. “In response to thoughtful feedback, Treasury is providing a broad exemption for cash pools, which are essentially common funding accounts for related businesses,” the Treasury said in its statement. ”Treasury is also providing an exemption for loans that are short-term in both form and substance.”

Still treasurers will have their work cut out for them in terms of monitoring pooling structures for tax purposes. According to a note from KPMG, the Final 385 rules, “do not provide a holistic definition of a cash pooling arrangement for US income tax purposes, and do not exempt cash pooling arrangements (including notional cash pooling arrangements) from the Documentation Rules.” Therefore there still remain some burdensome aspects to the final rules regarding pooling.

And in terms of overall documentation, Treasury decided in the end to relax the intercompany loan documentation rules for US borrowers. “Treasury has relaxed the intercompany loan documentation rules for US borrowers to ease compliance burdens while still fulfilling their purpose, including by moving the deadline for required documentation to when the tax return is due,” Treasury said in a Factsheet. “The regulations also extend the effective date of the documentation rules by one year to January 1, 2018.”

The proposed regs were widely criticized for doing more harm than good, and many industry groups challenged the Office of Management and Budget’s impact analysis of the proposal. This analysis forecast that the rules would bring an estimated $843 million a year in extra corporate tax revenue over the next 10 years and possibly beyond. It also projected that doing the documentation would require on 35 hours per return and impact only 21,000 business returns each year. They estimated this would all cost about $13 million total.

But according to many estimates more than 10 million intercompany transactions each year would have been subject to the documentation requirements and that the costs for each loan could be between $35,000 and $50,000.

The final 385 reg also exempted all debt issued by foreign corporations, including both controlled foreign corporations and non-US controlled foreign corporations. According to KPMG, the change is implemented “by limiting the current application of the rules to debt issued by a ‘covered member,’ meaning a member of the expanded group that is a domestic corporation.”

“The significance of this carveback cannot be overstated, particularly for US multinationals,” KPMG wrote. “The restricted definition also exempts debt issued by partnerships from the scope of the Documentation Rules, although debt of a covered member that is held by a controlled partnership is still subject to the rules.”

Meantime final 385 regs did keep the controversial 72-month rule and the inability to rebut the presumption of a “principal purpose” for debt issued within that period (36 months before the issuance and 36 months afterward). This rule stipulated that any debt instrument issued within 36 months before or after a taxpayer’s implementation of a transaction would be recharactorized or recast as stock if it fell into the following categories:

But experts and Treasury itself said the other exemptions would lessen the possibility of tripping these categories. “Taking foreign-to-foreign off, adding a generous cash pool exception — we think it’s a balance,” said Robert Stack, Treasury deputy assistant secretary for international tax affairs, according to reports. And in its note, KPMG offered that the “narrower scope of the final rules should reduce the number of loans that must be monitored for purposes of the Recast Rules.”

So all in all, some reprieve for treasurers and corporations in general. And perhaps more importantly, their voices were heard and Treasury came up with what many consider a fair, well-thought-through response. “We engaged extensively with businesses, tax experts, the public, and lawmakers and carefully considered their comments and recommendations,” Treasury Secretary Jacob Lew said in a statement. “As a result of this process, the final rule effectively addresses stakeholder concerns by more narrowly focusing the regulations on aggressive tax avoidance tactics and providing certain limited exemptions.”