The Big Four firms have sent a letter to Treasury Secretary Jacob Lew asking for withdrawal of proposed regulations on the tax treatment of corporate debt and equity.
The proposed rules have generated significant concern ever since the Treasury proposed them in April as a way to curb corporate tax inversions and earnings stripping (see Treasury Takes Further Action to Limit Tax Inversions). To address earnings stripping, the regulations targeted intercompany transactions that generate large interest deductions by simply increasing related-party debt without financing new investment in the U.S. The proposed rules, under Section 385 of the Tax Code, would allow 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 either one or the other.
The proposed regulations would also establish threshold documentation requirements that would need to be satisfied in order for certain related-party interests in a corporation to be treated as indebtedness for federal tax purposes. In addition, they would treat as stock certain related-party interests that otherwise would be treated as indebtedness for federal tax purposes.
Last Thursday, the American Institute of CPAs sent a comment letter asking the Treasury and the IRS to delay the proposed rules (see AICPA Urges Treasury and IRS to Delay Effective Date of Section 385 Proposed Regulations). The Big Four firms also filed a joint comment letter the same day asking Lew to withdraw the proposed regulations or, at a minimum, not finalize them until all the comment letters have been thoroughly considered and addressed and to delay the effective date to give the affected companies enough time to comply with the regulations.
“We believe that the Proposed Regulations create a number of consequences that are severe and far-reaching in nature,” said the July 7 letter, signed by Deloitte Tax LLP, Ernst & Young LLP, KPMG LLP, and PricewaterhouseCoopers LLP. “Companies face great uncertainty concerning their ability to apply these regulations given the numerous technical issues raised by the Proposed Regulations and the cost of building systems to respond to a regulation that is in a proposed format. Because the Proposed Regulations require taxpayers to identify, analyze, document and report a broad number of transactions in a manner that is not otherwise required in its existing tax and financial reporting system, the regulation should not be made effective until both technical and systems issues could be resolved. We believe the prudent course of action for Treasury includes withdrawal of the Proposed Regulations and reissuance of a more targeted package of proposed rules that takes into account the many comments submitted to Treasury regarding the Proposed Regulations.”
A group of large banks, including Bank of America, Citigroup and JPMorgan Chase, have also filed a comment letter asking the Treasury and the IRS to reconsider the proposed regulations. “Debt permeates every aspect of a bank’s and a broker-dealer’s activities,” they wrote. “While companies in other industries use debt to finance their core businesses, debt is the core of a financial services business. Intercompany debt is an important and unavoidable subset of this debt: it allows the group to manage cash—its inventory—in an optimal manner to satisfy the financing demands of customers, reducing cost and risk. Banks and broker-dealers need intercompany deposits and other borrowings in order to perform core financing functions in the ordinary course of business. Debt—including intercompany debt—is fundamental to their liquidity and is a necessary component of the overall capital structure.”
The IRS is holding a public hearing Thursday to allow for oral statements on the public regulations to be heard.