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Treasury & Taxation

Documentation Regs in Section 385 Get 86’d

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October 06, 2017

Treasury recommends replacing minimum documentation requirements in Section 385 with simpler ones.

IRS and dollarThe US Treasury announced it will pull rules on documentation within Section 385 of the tax code and replace them later with simpler more streamlined rules. However, Treasury has decided that until further notice, or if and when a broader tax reform package is decided, to keep rules dealing with distributions and inversions.

Although softening the application of the tax rules under Section 385 back in October 2016, Treasury decided to keep the documentation rules, which required companies to establish “minimum documentation” for debt obligations among related parties and that it be "treated as debt for federal tax purposes." But after review, Treasury added the documentation rules to a list of eight tax rules it deemed burdensome. Many commenters suggested that companies would have to build systems to comply with the documentation rules.

"Treasury and the IRS now agree with commenters that some requirements of the documentation regulations departed substantially from current practice and would have compelled corporations to build expensive new systems to satisfy the numerous tests required by the regulations," Treasury said in its announcement. Although scotching the documentation requirements in their current form, Treasury said it will eventually replace them with rules that specifically target “reasonable expectation of ability to pay indebtedness." This, it said, "proved particularly problematic" and added that treatment of ordinary trade payables under the rules was also being reexamined.

Distribution rules staying
Another aspect of the Section 385 that Treasury wants to amend are rules that treat as stock debt issued by a corporation. Commenters complained about the complexity and breadth of the distribution rules, however Treasury has decided to keep them in place, concluding that revoking them now could make existing problems worse.

"Treasury understands that the distribution rules are a blunt instrument for accomplishing their tax policy objectives, and continues to consider how the distribution rules might be made more targeted and compliance with the regulations made less onerous," Treasury said in its statement. "At the same time, Treasury continues to believe firmly in maintaining safeguards against earnings-stripping and diminishing incentives for inversions and foreign takeovers."

The distribution rules will likely be dealt with under fundamental tax reform. "Tax reform is expected to obviate the need for the distribution regulations and make it possible for these regulations to be revoked," Treasury said. As for documentation rules, Treasury is considering an effective date that would allow time for comments and compliance.

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