Tax & Accounting Blog

U.S. IRS Revises Chief Counsel Notice on Section 385

BEPS, Blog, Checkpoint, ONESOURCE, Transfer Pricing July 28, 2016

On June 30, 2016, the U.S. Internal Revenue Service (IRS) Chief Counsel issued Notice CC-2016-009. This notice alerts attorneys that the Chief Counsel Directives Manual (CCDM) has been revised to reflect updated requirements for coordinating issues, code sections, and documents with the appropriate Associate Chief Counsel in the National Office.

The Office of Chief Counsel recently reviewed the list of issues, code sections and documents requiring Associate office review contained in CCDM Exhibits 31.1.1-1 and 35.11.1-1 (Issues Requiring Associate Office Review). The two exhibits were also revised to emphasize to both Division Counsel offices and Associate offices that when an issue is identified as significant and requires coordination, it is the responsibility of the Division Counsel office to timely seek advice and the Associate office to timely provide advice. Coordination on these issues should take place prior to litigation.

Section 385 requires review by an Associate Office (and therefore National Office review) or the Special Counsel to the National Taxpayer Advocate. An issue on the Associate office review list must be coordinated regardless of the stage of the case in which the issue arises (e.g., whether in examination or in litigation). All issues raised by Section 385, including (i) bifurcating an instrument into part debt and part stock (Section 385(a)); (ii) analysis of debt-equity factors (Section 385(b)); and (iii) the issuer’s characterization of the instrument (Section 385(c)), require Associate Office Review.

On April 4, 2016, Treasury and the IRS issued proposed Section 385 regulations (the “Proposed Regulations”) addressing whether a direct or indirect interest in a related corporation is treated as stock, debt, or as in part stock and in part debt, for U.S. federal tax purposes. The Proposed Regulations generally target related parties that engage in certain transactions using U.S. debt to “strip” U.S.-source earnings (through interest deductions) to lower-tax jurisdictions, but may apply without regard to whether the related parties are domestic or foreign. See BEPS Action 4. They also require the preparation and maintenance of extensive documentation to substantiate debt treatment between related parties.

Although the Proposed Regulations were released as part of a larger package of anti-inversion measures, they apply to many routine financial transactions (including cash pooling arrangements) and common Subchapter C transactions of U.S.-  and non-U.S.-based multinational enterprises (MNEs).

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