Debt-Equity Rules Harmful, Overbroad, Tax Attorney Tells IRS

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

May 18 — The government's controversial debt-equity rules are bad news for taxpayers and spell immediate trouble for ordinary intercompany cash loans, a tax partner at a major law firm told the Internal Revenue Service.

In many cases, the rules would severely disrupt routine ways companies finance their operations, James Peaslee of Cleary Gottlieb Steen & Hamilton LLP said in a May 18 letter to the IRS representing his own views.

Chorus of Concern

Peaslee added his voice to a growing chorus of concern about the rules (REG-108060-15). He stressed that the government needs to ensure that these forms of financing remain intact and to narrow the reach of the rules to transactions that are genuine concerns.

Proposed April 4 under tax code Section 385, the regulations are intended to curb companies from moving profits out of the U.S. through loans to subsidiaries. They give the IRS the power to recast loans as equity instead of debt, axing interest deductions on loan payments and imposing withholding taxes on those payments (24 Transfer Pricing Report 1560, 4/14/16).

The rules apply to related members of expanded affiliated groups.

In the Cross-Hairs

Peaslee said generally, the rules are taking aim at cross-border debt instruments that are issued to the holder either (1) as a dividend or other type of distribution, or (2) in exchange for stock of another expanded group.

Where the regulations get too broad, he said, is that they apply to loans between domestic companies or between foreign companies. He criticized a “funding rule” that would apply the regulations to debt that isn't distributed by a corporation or used to buy group member stock.

Because of the “per se” rule that allows conversions of entire loans to stock instead of debt in some circumstances, taxpayers can't show any facts and circumstances to prevent those recasts under the funding rule, Peaslee said.

More Bad News

In addition to losing interest deductions and facing withholding taxes, the practitioner said it's possible taxpayers could lose foreign tax credits and face uncertainty in calculating earnings and profits, among other bad news under the rules.

He spelled out actions the government should take to scale back the impact of the rules, with changes to the funding rule a major focus.

The rule shouldn't be separate, Peaslee said. Rather, it should only be an anti-abuse measure that would act as a backstop to rules aimed at corporate distributions or stock purchases.

Peaslee said the government should also change the “per se” rule to a “presumption” rule, where taxpayers can use “clear evidence” to rebut loan recasts. The time period for the presumption should shrink from six years to four, he said.

Peaslee said he didn't prepare the letter on behalf of a client.

To contact the reporter on this story: Alison Bennett in Washington at

To contact the editor responsible for this story: Brett Ferguson at

For More Information

Text of Peaslee's letter is available at

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