Trade Group: Tax Rules Would Crimp Cash Management

More than 20 trade organizations penned a letter May 12 to the US Department of the Treasury that raised a slew of concerns about the agency’s proposal to stem corporate use of simple cash management tools, and pleaded for at least an extension of the effective date.

The Treasury Department issued two sets of rules April 4 aimed at strategies it deems are simply ways corporates avoid paying taxes. One set, which likely halted Pfizer’s proposed acquisition of Ireland’s Allergan, targeted inversions, where a US company purchases a company overseas and moves its headquarters to the acquisition’s low-tax jurisdiction. The new rules would make it more difficult for a US company to achieve the necessary ownership percentage of the acquired company to pursue an inversion under Section 7874 of the tax code.

The second set, much more far reaching, is the focus of the trade group consortium. Those rules were issued under Section 385, which defines whether an interest in a company is debt or equity, and impacts all corporate groups, whether US- or foreign-based. The rules treat intercompany loans as equity under defined circumstances, including when a subsidiary distributes a note to a parent, or a subsidiary acquires the stock of another group member for a note, or it acquires the assets of an affiliate in a reorganization.

Treasury’s rules were aimed at the practice of earnings stripping, where the US subsidiary of an inverted company deducts interest payments to its inverted parent in a low-tax jurisdiction. The trade-group consortium’s letter says the proposed 385 regulations are designed to reduce the number of tax inversions by making them less attractive.

“Nonetheless, even a cursory review of these regulations clearly indicates that they go far beyond cross-border mergers and apply to a wide range of ordinary business transactions by global and domestic companies both in and outside the United States,” the letter states.

As proposed, the rule would affect debt instruments issued on or after April 4, although the re-characterization of debt as equity would not occur until 90 days after the rule is finalized, anticipated soon after the July 7 due date for comments. The trade group consortium’s letter requests that Treasury move the date when debt instruments are first affected to match the re-characterization date. It also asks for an extended comment period, until Oct. 5, and for the IRS to dedicate “adequate time and resources for a thorough review and analysis of the public comments on the proposal rather than seeking to finalize the regulations on an arbitrarily rapid timeline.”

Such a timeline would likely push the proposal well past the presidential elections.

The letter notes that whether a financial instrument is debt or equity significantly impacts a business beyond the interest deduction on the debt, and raises issues including the legal classification of an entity, eligibility for withholding tax exemptions under tax treaties, and the ability to file a consolidated tax return.

“The issues present a severe impediment to the use of intercompany financing for even normal operations and will significantly increase the cost of capital and limit the amount of capital available to invest in the United States,” the letter says.

The letter goes on to says that to better understand the effects of the proposed rules, corporate tax departments need additional time to confer with the corporate treasury counterparts located across the globe.

In addition, because of this retroactive effective date, companies have to plan and conduct their operations as if the proposed regulations were effective currently, at the same time as they try to analyze and understand the proposed rules,” the letter says. “Moreover, with the proposed April 4 effective date and the potential for existing debt to experience a ‘significant modification,’ even current finance structures of many businesses are at risk.”

The consortium, which includes a wide range of industry-specific trade groups as well as broader ones including the US Chamber of Commerce, the Business Roundtable, and Financial Executives International, states that its members have “only just begun” to identify the potential impact on their operations. They include:

The US Chamber says the analysis will continue and expects members will identify “other basic and routine transactions that are potentially impacted.”