Reworking Intercompany Loan Rules a Mixed Blessing for States

Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...

By Che Odom

Treasury Department recommendations to simplify Obama-administration documentation requirements on intercompany lending may be good news and bad news for states deciding whether to conform.

Overall, states should welcome last week’s announcement that the department and the Internal Revenue Service are considering the development of revised documentation rules that would be substantially simplified and streamlined, Steve Wlodychak, principal with Ernst & Young LLP’s Indirect (State and Local) Tax Practice, told Bloomberg BNA.

“The problem from the state perspective was uncertainty as to whether states could apply these documentation requirements independent of the IRS and the broad exemption provided for transactions among members of a federal consolidated group,” Wlodychak said in an email.

But states may be inclined to go their own way on this issue, opting not to conform.

Treasury Secretary Steven Mnuchin announced the department’s intentions to streamline the documentation requirements Oct. 2 in a report to the White House on ways to reduce tax regulatory burdens. The goal is to make tax rules less onerous on U.S. corporations, while requiring “sufficient legal documentation and other information for tax administration purposes,” which was the intent behind the final and temporary rules ( T.D. 9790) released last year by the Obama administration for inclusion in Section 385 of the Internal Revenue Code.

The documentation rules were designed to help tax administrators determine whether an intercompany loan is debt or should be counted as an equity trade for federal tax purposes by providing details on the types of indebtedness and their history. While practitioners noted that T.D. 9790 lightened the burden on businesses compared to an earlier proposal, the federal debt-equity regime was still criticized over compliance difficulties.

Federal Review

President Donald Trump suspended the debt-equity rules and other regulations shortly after taking office in January until a review could be conducted to make sure they weren’t overly burdensome on business.

In place of any revoked regulations, the Treasury Department and the IRS would develop and propose streamlined documentation rules, with a prospective effective date that would allow time for comments and compliance, Mnuchin’s report said.

“Simplifying these documentation requirements makes sense, but we would hope that in substitute regulations the Treasury and the IRS do their best to narrow the requirements to avoid the uncertainty of treatment at the state level,” Wlodychak said.

Administrative Challenges

Though simplifying the rules would be helpful, states may be faced with a particular set of challenges of their own when the administration keeps federal rules in a state of flux.

“I think the continuing uncertainty over how the federal 385 regulations are going to work makes it more likely that states will fall back on the historic federal case law conceptions of what constitutes debt versus what constitutes equity,” Jamie Yesnowitz, principal and state and local tax practice and National Tax Office leader at Grant Thornton LLP, told Bloomberg BNA.

Bay State Way

Massachusetts courts have been willing to delve into the field of debt-equity issues, he said.

“States like Massachusetts, which have been active in this area prior to the proposed regulations, are likely to continue to rely on their own case law interpretations, which are substantially steeped in the historic federal case law,” he said.

Given the state of the rules regarding documentation, other states could become “more stringent” with respect to the application of their own documentation standards “in the event that the federal 385 regulations covering documentation requirements are stripped,” Yesnowitz said.

“From an administrative perspective, given the complexity of the proposed rules, I think the risk that states go their own way on these types of issues is relatively high,” he said.

To contact the reporter on this story: Che Odom in Washington at

To contact the editor responsible for this story: Jennifer McLoughlin at

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