Republicans Protest Proposed Debt-Equity Tax Rules

Republican leaders of the Senate Finance Committee and the House Ways and Means Committee are asking the Treasury Department to go back to the drawing board on proposed regulations for changing the tax treatment of corporate debt and equity to curb corporate earnings stripping.

The Treasury Department issued the proposed regulations in April as part of its battle to stem the tide of corporate tax inversions, in which U.S. companies move their tax addresses overseas by merging with another company to lower their tax bills (see Treasury Takes Further Action to Limit Tax Inversions).

However, the proposed rules go well beyond inversion by targeting transactions that generate large interest deductions by simply increasing related-party debt without financing new investment in the United States. The new rules would amend Section 385 of the Tax Code to curb the practice of earnings stripping, allowing the IRS during an audit to divide debt instruments into part debt and part equity, rather than the current system that generally treats them as wholly one or the other.

Some lawmakers in Congress have expressed opposition to the proposed rules, and the Big Four accounting firms have also asked Treasury Secretary Jacob Lew to withdraw them (see Big Four Protest Proposed IRS Regulations on Tax Treatment of Corporate Debt and Equity).

On Monday, Senate Finance Committee chairman Orrin Hatch, R-Utah, sent a letter to Lew calling on the Treasury to rethink the proposed rules.

“I ask you to re-propose the regulations not because I wish for there to not be any section 385 regulations,” he wrote. “Rather, I am seeking to ensure that, should the Treasury Department issue regulations under IRC section 385, the Department does so in a thoughtful, prudent, and legal manner.”

Hatch warned against unintended consequences for U.S. businesses if the Obama administration moves too quickly. He also questioned the regulatory transparency of the proposed rules and whether the requirements for executive orders and statutes were being properly followed.

On the other side of the Capitol, GOP members of the House Ways and Means Committee, including chairman Kevin Brady, R-Texas, and Tax Policy Subcommittee chairman Charles Boustany, R-La., sent their second letter to Lew reiterating their continuing concerns about how the proposed regulations could affect U.S. businesses, jobs and the economy. They too called on the Obama administration to completely overhaul the proposed regulations. They had earlier met with Lew to convey their concerns but felt the Treasury was moving too quickly to finalize the proposals.

“We appreciate the Treasury Department’s expressed commitment to making modifications to address some of the identified adverse effects of the proposed regulations,” they wrote. “However, based on the information provided by Treasury to date, we are not confident that any such modifications would be sufficient to eliminate the harm that the proposed regulations would inflict on businesses and American workers if they were to be finalized in their current form.”