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Dec. 13 — U.S. multinational corporations will be closely watching the fate of intense efforts to stop overseas income shifting under the new administration—with a sharp focus on critical regulations to curb earnings stripping.
The coming year promises pressure on President-elect Donald Trump to revoke the rules—the center of a firestorm of criticism for most of 2016. The rules crack down on companies that use offshore loans to move income out of the U.S., threatening interest deductions and raising the specter of withholding taxes.
The controversy surrounding the rules remains on several fronts, tax attorneys told Bloomberg BNA.
Congress is working on tax overhaul that could take away interest deductions on loans even as it exempts foreign earnings—and despite that benefit, the transition could be rocky, some said. At the same time, the Internal Revenue Service crackdown on earnings stripping is alive and well. IRS agents are already raising issues on audit under the new regulations, and it is too soon for companies to breathe a sigh of relief, they said.
“It’s an entirely new ballgame,” said Thomas A. Humphreys, a tax partner with Morrison & Foerster LLP who works on domestic and international capital markets issues.
Many—but not all—practitioners specializing in international tax issues interviewed by Bloomberg BNA said the rules will likely be pulled or rewritten before 2017 is over. But the outlook remains uncertain, and it isn’t time for taxpayers to rest easy, practitioners said.
The final regulations (T.D. 9790) are designed to stop efforts by multinationals to “strip” income out of the U.S. via loans to subsidiaries. They give the IRS the power to recast loans as equity rather than tax-favored debt. Even though the new rules lifted much of the burden from U.S. multinationals, criticism remains.
Some tax attorneys say the incoming president will yank the rules immediately, while others say the Trump administration may take a more measured approach.
While that prospect remains murky, practitioners across the board said one thing is certain: Taxpayers shouldn’t gamble on the chance the regulations will go away quickly. They are advising their clients to get going on compliance.
“These are final regulations,” said David Golden, director of Ernst & Young LLP’s capital markets tax practice. “Until and unless they are revoked, they are final regulations.”
Tax attorneys said the No. 1 issue their clients need to focus on is documenting whether their loans involve genuine debt—a major part of the final rules.
Even though that requirement doesn’t technically go into effect until 2018, Golden said agents are already questioning companies on documentation. That likely won’t go away, he said.
“Robust documentation” is the most critical part of compliance right now, with the rules imposing a complex set of requirements, said Joe Calianno, a partner and international technical tax practice leader at BDO USA LLP in Washington.
Every practitioner interviewed said taxpayers shouldn’t take a chance. But some predicted that the unpopular rules will be history sooner rather than later because of the massive efforts to reshape the tax system expected under the new administration. “Treasury is likely to repeal the Section 385 rules as one of its first official acts to allow Congress to address interest stripping as part of tax reform,” said Jeff Paravano, managing partner at Baker & Hostetler LLP.
Both Paravano and Paul Schmidt, tax chair at Baker & Hostetler, said dealing with interest stripping will have to be part of the picture if Congress moves to a territorial system or another system that exempts foreign income.
“It would be inequitable to allow debt that supports exempt foreign earnings to be deducted in the U.S.,” said Schmidt, who deals extensively with international structuring.
Moving to such a new framework could be rocky on the earnings-stripping front, some said.
Lisa Zarlenga, a tax partner at Steptoe & Johnson LLP, said tax overhaul that addresses earnings-stripping issues could leave taxpayers facing possible conflicts during the transition. “If you’re implementing a tax reform system, you’re going to have this period where the old rules apply,” and that could spell complications for taxpayers, she said.
House Ways and Means Committee Chairman Kevin Brady (R-Texas) said in mid-November that he wants the rules gone, but didn’t say whether Congress might take specific action.
Challenges remain for taxpayers even as possible tax overhaul takes shape. Practitioners said more hurdles remain in 2017, despite the fact that the final rules exempt U.S. companies that issue foreign debt.
There are still deals that could get caught, according to Brian Kittle, co-leader of Mayer Brown LLP’s tax controversy and transfer pricing practice in New York. “Taxpayers are definitely looking at their intercompany debt structures,” he said.
They are looking to see if they have enough time to manage those structures within the deadlines in the rules, Kittle said. If they don’t, the question is “Are there provisions in the code that give us some flexibility?”
In the years ahead, practitioners said, the government’s enforcement focus on debt-equity issues is likely to continue no matter what happens to the rules or what Congress does.
“I have never seen that IRS exam has felt particularly influenced by legislative proposals or activity,” Golden said. “We’re already seeing an uptick in IRS exam activity regarding related-party debt.”
The rules will continue to be under an intense microscope as Trump takes office.
John Harrington, an international tax partner at Dentons US LLP who has served as Treasury international tax counsel, said in order for taxpayers to get any comfort that the rules could be repealed in the near term, the administration would have to act fast.
“They need to send a very clear signal before the inauguration that they plan to suspend these rules,” Harrington said.
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