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Oct. 19 — U.S. companies aren’t out of the woods despite a range of exceptions under the government’s new earnings-stripping rules, Ernst & Young LLP practitioners said.
Although most are now likely to be largely out of the scope of the rules, “it’s dangerous to assume that you can walk away from this,” Donald W. Bakke, a principal in EY’s Transaction Advisory Services group, said during an Oct. 19 webcast.
The Treasury Department’s final regulations (T.D. 9790) are intended to stop multinational companies from “stripping” income out of the U.S. via loans to offshore subsidiaries. The department significantly narrowed the controversial rules it proposed in April that would have entirely recharacterized a broad range of loans from tax-favored debt to expensive equity, but the decks aren’t clear for U.S. multinationals, Bakke said.
Loans could still be recast for some transactions between U.S. multinationals and their controlled foreign corporations, Bakke said.
He and other practitioners, including panel moderator David Golden, cautioned that the structure of the rules allowing for entire loan recasts is still fundamentally the same, even though their impact has been significantly lessened.
Taxpayers should be taking stock of debt instruments that could be impacted by the rules and doing a risk assessment, said Golden, Americas director for EY’s capital markets practice. He said companies should do what they can to “remediate” debt instruments that might otherwise be recharacterized, and look at “alternative strategies” for their transactions to pass muster at the Internal Revenue Service.
Golden said that despite an extended effective date and lighter requirements, taxpayers still need to carefully consider what they need to do to document their loans to convince the IRS they are genuine debt.
The fact that the documentation rule doesn’t take effect until Jan. 1, 2018, “doesn’t mean that you can scramble around and get everything you need at the last minute,” Golden said. Taxpayers still should be tracking and documenting their debt instruments along the way, even as they develop what might be complicated systems to meet the requirements once they hit in January, he said.
He also said taxpayers need to be aware that “satisfying documentation requirements doesn’t automatically prove you have debt.” It only gives taxpayers the chance to prove to the government that a loan involves a genuine debt instrument because it meets the common-law requirements set out in the rules.
Both Golden and Jose Murillo, director of EY’s International Tax Services group, said taxpayers need to carefully monitor what the IRS is doing in regard to the widely praised exception for foreign debt issuers—an area where the government “reserved” in the final rules.
The panel also discussed the controversial area of cash pooling, a common cash-management technique used by multinationals involving the use of a central bank account for lending and borrowing by foreign affiliates.
The issue was addressed in proposed rules (REG-130314-16) accompanying the final rules. The proposed rules served as the text of temporary rules.
While Treasury provided an exception for cash-pooling techniques that look like short-term loans and other short-term financing arrangements, Golden said the rules contain a “disturbing” discussion of notional cash pooling.
That technique involves the offset of income and expense resulting from varying cash positions in separate accounts held at the same bank.
Another big question under the final rules is how they might affect states.
Keith Anderson, a partner in EY’s Indirect/State and Local group, said Treasury has acknowledged there are issues, but the rules “haven’t alleviated the possible problems with state compliance.”
It isn’t yet clear how states will cope with the provisions on loan recasts and documentation, Anderson said. Loans excluded under the federal regulations may not get the same result at the state level, he said.
“It doesn’t appear that Treasury has alleviated those concerns,” he said.
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