On April 4, 2016, Treasury and the Internal Revenue Service released proposed regulations under Section 385 that would treat as stock certain related-party interests that otherwise would be treated as debt for federal income tax purposes. The proposed regulations extend far beyond inversion transactions and apply to instruments issued by one corporation in an expanded affiliated group to another corporation in an expanded affiliated group. If finalized in their current form, these proposed regulations could affect routine financing transactions, including investments by foreign corporations in related U.S. corporations. However, the proposed regulations exempt transactions within a U.S. consolidated group. They also generally would not apply to a loan to a U.S. corporation from a foreign partnership that is not otherwise 80% owned by members of the same expanded affiliated group as the U.S. corporation.
The proposed regulations also contain extensive documentation requirements, which apply (i) if stock of any member of the expanded group is traded on (or subject to the rules of) an established financial market, (ii) on the date the instrument is issued or otherwise becomes an expanded group instrument, total assets exceed $100 million, or (iii) on the date the instrument is issued or otherwise becomes an expanded group instrument, annual revenue exceeds $50 million. It is not clear if the total asset or annual revenue tests apply to the expanded affiliated group as a whole or to the corporation making or receiving the purported loan. Failure to comply with these documentation requirements will result in any interest being treated as per se debt.
The proposed regulations will undoubtedly be subject to extensive comments.
The proposed regulations provide that the final regulations will be effective as of the date of issuance of the proposed regulations.