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April 29 — Some arrangements that companies use to “pool” cash for use by subsidiaries might get a break in final rules intended to stop companies from shifting income out of the U.S. through tax-favored loans, Treasury and IRS officials said.
But that process is going to take work and the government wants input, they said. “The challenge is to identify the sympathetic cases that could be excluded,” Raymond J. Stahl, assistant to the chief of Branch 5 of the IRS Associate Chief Counsel (International), said April 29.
Special Bank Structures
The arrangements involve a special bank structure known as a “treasury center” where companies put excess cash to be used by subsidiaries. Taxpayers say the proposed “earnings stripping” rules could sweep up arrangements designed to minimize excess borrowing and perform other functions that aren't designed to lower taxes, by recharacterizing debt as equity.
Speaking on a panel hosted by the Practising Law Institute Inc., Stahl and other officials said they understand the concerns about the rules, but need to be convinced before they decide which transactions will get a green light.
There is a significant question of when cash pooling arrangements are only designed for short-term liquidity, versus arrangements that look more like loans, said Brenda Zent, a special adviser in the Treasury Department's Office of International Tax Counsel.
Debt Versus Equity
Issued April 4, the rules (REG-108060-15) allow the Internal Revenue Service to treat loans made by foreign companies to their U.S. subsidiaries as equity instead of debt. This would tax deductions on interest payments and saddle taxpayers with a withholding tax (65 DTR GG-1, 4/5/16).
Under the rules, the government can recast entire transactions as equity, or split debt instruments into part debt and part equity under tax code Section 385.
Impact on Routine Distributions
Joshua Odintz, a partner at Baker & McKenzie LLP who moderated the panel, said the rules could impact routine distributions coming up chains of subsidiaries. As proposed, the rules mean that debt going between the treasury center and the subsidiaries could all be recharacterized as equity, he said.
Stahl said one feature of the rules that might alleviate some concerns is the exception for current-year earnings and profits.
John Merrick, a senior-level counsel in the IRS Office of Associate Chief Counsel (International), said the government is going to look hard at taxpayers' reasons for doing the transactions.
He said Treasury and the IRS will scrutinize “why in fact was the note distribution made?” and taxpayers should consider whether they have a good non-tax reason for doing it. “There are many reasons it was issued that may make you more or less comfortable,” Merrick said.
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