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International Tax

KPMG’s Joseph Pari on the U.S. Proposed Section 385 Regs.

Robert Sledz  

· 5 minute read

Robert Sledz  

· 5 minute read

Joseph M. Pari is the national principal-in-charge of the Washington National Tax practice of KPMG LLP. He is based in Washington, D.C.  Prior to joining KPMG, he was a partner at the law firms of Linklaters LLP and Dewey Ballentine/Dewey & LeBoeuf LLP. Mr. Pari answered the following questions for BEPS Global Currents on September 2, 2016, regarding the U.S. proposed Section 385 regs (REG-108060-15) issued by Treasury on April 4, 2016, which address whether a direct or indirect interest in a related corporation should be treated as stock, debt, or as in part stock and in part debt, for U.S. federal tax purposes:

Q: What can companies expect from the U.S. government in response to the recent comment period and public hearing on the proposed regulations?

A: While perhaps taken aback by the number and severity of the comments it received, the government appears intent on finalizing the proposed regulations with some modifications.

Some of the biggest issues that KPMG and other parties identified with the proposed regulations include the following:

  • Lack of a meaningful short-term and/or ordinary course exception to the documentation rules.
  • The similar lack of a meaningful short-term exception to the funding recast rules.
  • A “funding” recast rule that is an automatic bright-line test, with no exception for in-scope debt issued within a 72-month period, despite being called a “principal purpose” test.
  • Lack of a “relevance” filter to the rules’ application.
  • The vast scope of collateral consequences — really, damage — for other provisions, wholly unrelated to “earnings stripping,” in the U.S. tax system that depend on debt vs. equity determinations, including (1) S corporation eligibility, (2) corporate control for non-recognition provisions, (3) withholding taxes, and (4) foreign tax credits.

Cash-pooling is clearly the top priority for our clients.  The government has signaled a willingness to provide some relief there, although it remains unclear at this point in what form or how effective that will be.

Q: What should companies be doing now to prepare for the regulations being finalized?

A: We expect the rules to be finalized in modified form later this fall, and presumably before the presidential election.  Many companies are currently taking stock of their existing intercompany debt volume and mapping out where issues could arise.

On the documentation side, key areas would be reviewing and updating the terms of standard intercompany loan agreements to ensure flexibility and better processes to identify debt that is currently “undocumented.”  On the recast side, taxpayers should be reviewing their cash management, internal restructuring, and corporate development pipelines to identify funding sources and how the proposed rules might alter their expectations.

In general, any final section 385 regulations will create process and project management burdens for tax departments.  While there is at least a hope that Treasury will take into account the process demands created by the 385 rules and move the effective date back, companies are for now putting their plans together and identifying the necessary resources to address section 385 implementation.

Q: Due to the fact that the proposed Section 385 regs may significantly affect companies’ cash-pooling transactions, are clients making any changes to how internal cash transfers are being recorded/documented? And will the ways in which clients document short- and long-term intercompany loans change based on the proposed Section 385 regs?

A: Regarding cash-pooling, the proposed rules are unworkable for many companies.  It appears that the final regulations will make changes to the cash-pooling regime, but companies can’t afford to guess at what the final rules will contain.  So, at this point, taxpayers are just hoping for meaningful relief that will allow effective offshore cash management.

Generally, regarding documentation, the proposed regulations will undoubtedly change the ways that companies document and track their intercompany debt.  They will have to start doing this if they weren’t already, and they may have to do a more robust job of it even if they were.

Q: How are clients of LLCs, S Corps, and partnerships reacting to the proposed Section 385 regs?

A: These entities are understandably concerned that the rules, if finalized without change, could have some really disruptive results.  The government is at least considering relief for them.

Q: As a result of the proposed Section 385 regs, are your clients evaluating such areas as treaty withholding implications for cross-border financing transactions they may have, potential foreign tax credit and/or Subpart F implications, or any of their employee compensation structures?

A: There are numerous ancillary issues raised by the proposed regs. Taxpayers definitely are assessing what their exposure for these and other areas might be and, when possible, considering alternatives that might not implicate the rules when finalized. That’s simply prudent, but otherwise they are generally waiting to see what the final rules look like.

These comments represent the views of the author only, and do not necessarily represent the views or professional advice of KPMG LLP.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

KPMG LLP, the audit, tax and advisory firm (, is the U.S. member firm of KPMG International Cooperative (“KPMG International”). KPMG International’s member firms have 174,000 professionals, including more than 9,000 partners, in 155 countries.

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