Earnings-Stripping Rules Ease Impact on Day-to-Day Business

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By Alison Bennett

Oct. 13 — The Obama administration’s long-awaited final earnings-stripping regulations offer exceptions for cash pooling and transactions between foreign subsidiaries of U.S. multinationals—features many taxpayers have eagerly sought.

In announcing the rules Oct. 13, Treasury Secretary Jacob J. Lew said the rules are intended to protect the U.S. tax base and stop tax evasion, while minimizing the impact of the rules of daily business operations.

Emphasizing the administration has worked carefully to consider taxpayer comments, Lew said the guidance “effectively addresses stakeholder concerns by more narrowly focusing the regulations on aggressive tax avoidance tactics and providing certain limited exemptions.”

The final and temporary rules (T.D. 9790, RIN:1545-BN40) aim to prevent multinational companies from “stripping” income out of the U.S. through loans to offshore subsidiaries. They allow recharacterization of some tax-favored loans to expensive equity.

Range of Exceptions

According to a Treasury fact sheet, the regulations provide a broad exception for cash pools and other loans that are short-term in both form and substance and don’t pose an earnings-stripping risk.

In cases where the risk of earnings stripping is low, the guidance also provides limited exceptions for transactions between:

  •  foreign subsidiaries of U.S. multinational companies;
  •  Subchapter S corporations;
  •  regulated financial companies;
  •  regulated insurance companies; and
  •  mutual funds such as regulated investment companies (RICs) and real estate investment trusts (REITs).

Treasury said the rules expand exceptions for ordinary business transactions, such as distributions, to generally include future earnings and allowing corporations to net distributions against capital contributions. The rules also include exceptions for ordinary course transactions such as stock acquisitions associated with employee compensation plans.

Documentation Effective Date Extended

In addition, the rules extend the effective date for tough documentation requirements by one year, to take effect Jan. 1, 2018.

In addition to the final and temporary rules, Treasury issued proposed rules (REG-130314-16, RIN:1545-BN68) addressing the treatment of instruments issued by partnerships, consolidated groups, and certain transactions involving qualified cash-management arrangements.

The text of the temporary regulations also serves as the text of proposed regulations.

One tax practitioner gave the rules mixed reviews but praised Treasury for listening to comments on the rules proposed in April.

“The rules are an improvement over those proposed but leave a number of problematic features,” said Ronald Dabrowski, a principal in the Washington National Tax practice of KPMG LLP.

“On the plus side, the documentation rules’ applicability date of Jan. 1, 2018, and the exception—for the time being at least—for foreign issuers were responsive to comments and were absolutely necessary. The carve outs for S corps, RICs, REITs and certain regulated industries were also welcome.”

Dabrowski added: “But the rules’ general response regarding cash pooling will still be highly burdensome where they apply, as will the retroactive application of the recharacterization rules.”

He said the focus will now shift to the states and their implementation of tax code Section 385.

House Ways and Means Committee Chairman Kevin Brady (R-Texas) said in an Oct. 13 news release that he was concerned about the quick finalization of the rules and said he plans to study them in the days ahead (see related story in this issue).

To contact the reporter on this story: Alison Bennett in Washington at abennett@bna.com

To contact the editor responsible for this story: Meg Shreve at mshreve@bna.com

For More Information

Texts of REG-130314-16 and T.D. 9790 are in TaxCore.

Text of Treasury’s fact sheet is at http://src.bna.com/jm7.

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