Investment Likely to Plummet Under Debt-Equity Rules: Groups

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By Alison Bennett

July 7 — Investment by both U.S.-based and foreign-based multinational companies would drop like a rock under the IRS's controversial rules to combat earnings stripping, two major business groups said.

In a July 7 report provided exclusively to Bloomberg BNA, the Organization for International Investment and the Business Roundtable said the threat that loans could be recharacterized as stock instead of debt would cause economic havoc on both sides of the ocean.

“These regulations will increase the cost of investment so much that some of the investment just won't happen,” Nancy McLernon, OFII president and chief executive officer, said in an interview. She said foreign investment in the U.S. could drop by as much as 72 percent.

The rules are intended to stop multinational companies from shifting income out of the U.S. via loans to subsidiaries. They would permit entire loans to be recast as equity, causing loan interest deductions to vanish and potentially saddling companies with a high price tag of withholding taxes.

Matthew Miller, vice president of the Business Roundtable, said ideally, the rules should be withdrawn. “These proposed regulations overturn decades of settled law,” he said in an interview shared with McLernon. “This is just a fundamental shift and it really does get to investment and the cost of company operations.”

Devastating Consequences

The rules could have devastating consequences for transactions that passed muster before the guidance came out, McLernon and other executives sharing the interview said.

Prepared by PricewaterhouseCoopers LLP, the report looked at four examples of inbound and outbound investments and found all four would be hit by the rules, including:

  •  an expansion of U.S. manufacturing operations by a foreign-headquartered company;
  •  a foreign-headquartered company consolidating two lines of business under subsidiaries in two different countries;
  •  a foreign cash-pooling arrangement by a U.S.-based multinational; and
  •  a foreign currency hedging transaction by a U.S.-based multinational.

According to Peter Merrill, a principal for PwC, all these transactions would have had a green light before the rules came out. Now, he said, they face harsh treatment under the section of the rules that allows the IRS to entirely recast loans between related members of an expanded affiliated group as stock.

Vanishing Deductions

Loan recharacterization in these examples would drive up the cost of capital, increase taxes and make companies less competitive, Merrill said. The transactions “don't look in any way abusive,” he said.

PwC principal Drew Lyon, also speaking to Bloomberg BNA, said even if companies restructure their transactions so as not to trip the rules, they could still face negative outcomes. “If the companies had known, they wouldn't have undertaken the investment,” he said.

Lyon said another tough impact of the rules is the cost of compliance, including requiring a wide range of very specific documentation to show the government that loans involve actual debt.

Lyon said PwC worked with a Fortune 100 company to estimate the cost of that documentation, and the company predicted it would cost $4 million in the first year and $1.25 million in each subsequent year.

The government proposed the rules (REG-108060-15) in April (65 DTR GG-1, 4/5/16).

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

To contact the editor responsible for this story: Brett Ferguson at bferguson@bna.com

For More Information

Text of the OFII, Business Roundtable report is in TaxCore.

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