States May Follow Treasury's Lead on Debt-Equity Rules

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By Alex M. Parker

May 6 — Now that the Treasury Department has issued new regulations strengthening rules on the classification of intercompany debt and equity, states may soon follow, a Multistate Tax Commission official said.

“It's going to pique states' interest, not diminish it. States have been very interested in the debt-equity issue,” said Bruce Fort, counsel to the MTC, an intergovernmental tax agency. “We've had a lot of discussions now in the past month or so just on that very issue.”

Fort spoke May 6 at a panel on issues relating to base erosion and state and local taxes during an American Bar Association Section of Taxation conference.

Treasury proposed new rules under Section 385 designed to curb so-called earnings stripping by expanding the government's power to classify intercompany debt as equity.

The proposal, issued April 4, was part of a package of new rules meant to limit the incentives for companies to expatriate through inversions (65 DTR GG-1, 4/5/16).

The rules have come under criticism for their broad scope, possibly implicating ordinary operations, such related companies' pooling of global cash into a central account on a regular basis (88 DTR GG-1, 5/6/16).

Cash management would be a similar issue between states, according to practitioners.

Cash Management

“Literally every single one of my clients has a cash pool. They have an international cash pool, and they have a domestic cash pool. Cash pools are a common treasury technique—we'll have to see how the IRS comes down on the cash pool aspect,” said Keith Robinson, a principal in transfer pricing at PricewaterhouseCoopers LLP in Atlanta. “From a state perspective, not being able to combine your cash within the United States, to cut down on your tertiary costs associated with debt in general, just seems perhaps a little overreaching.”

Karl Friedan, general counsel for the Council on State Taxation, a trade association representing taxpayers in state tax issues, warned of “unanticipated consequences” of rules that recharacterize debt as ownership equity. For instance, he said, they could run afoul of rules based on ownership thresholds.

“While it's somewhat ancillary, it's going to increase interest,” Friedan said.

It isn't clear what state laws could enforce recharacterizations similar to those being used under Section 385. Many states have passed laws that mirror federal tax enforcement laws—including Section 482, which deals with transfer pricing—and some states have already enforced debt-equity rules in some cases.

Friedan said that, while states have little if any transfer pricing capacity, on many other tax issues—such as the “consequences of the digital economy,” limiting interest deductions and creating a nexus with broader reach than permanent establishment—they are far ahead of the federal government.

“The question is, on transfer pricing, where they're way behind—in fact, they don't build their whole regime around it—is it worth catching up, and what are they going to do to catch up?” Friedan said.

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To contact the editor responsible for this story: Molly Moses at

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