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Spotlight

In perhaps the most eagerly anticipated tax guidance in decades, Treasury and the IRS on 13 October issued final and temporary regulations (TD 9790) under Section 385. The regulations are expected to be effective on 21 October. Despite this effective date, portions of the regulations apply to instruments issued on or after 5 April 2016 (subject to complex transition rules). A Treasury fact sheet on the final regulations was released on the same day.

The final and temporary regulations:

— Treat as stock certain related-party interests that otherwise would be treated as indebtedness for federal tax purposes (the "Recharacterization Rule"); and

— Establish extensive documentation requirements with respect to related-party indebtedness (the "Documentation Rule").

The Recharacterization Rule generally applies to tax years ending on or after 90 days after the final regulations are published in the Federal Register (i.e., January 2017). It does not apply to debt instruments issued prior to 5 April 2016. The Documentation Rule generally applies to debt instruments issued on or after 1 January 2018.

The final and temporary regulations make substantial changes to the proposed regulations that were released in April 2016, including:

— Excluding foreign issuers. The final and temporary regulations apply only to domestic corporations (including certain partnerships and disregarded entities with domestic corporate owners).

— Excluding certain financial institutions. The Recharacterization Rule generally does not apply to debt instruments issued by certain regulated financial entities, financial groups and insurance companies.

— Eliminating the bifurcation rule. The final and temporary regulations do not include the "bifurcation rule" included in the proposed regulations, under which the IRS was permitted to characterize certain instruments within a "modified expanded group" as part debt and part stock.

— Delaying the Documentation Rule requirements. The Documentation Rule does not apply to debt instruments issued before 1 January 2018.

The final and temporary regulations contain numerous other changes to the proposed regulations including a widely-anticipated cash pooling exception, expanded exceptions for ordinary course transactions, exceptions for S-corporation and certain other entities subject to special treatment under the Internal Revenue Code such as REITS and RICs, and exceptions for statutory debt instruments such as regular REMIC interests and production payments. Like the proposed regulations, neither the Recharacterization Rule nor the Documentation Rule in the final and temporary regulations apply to debt instruments between two members of a US consolidated group.

An EY Tax webcast on the final and temporary regulations is scheduled for Wednesday (19 October, 12:00 p.m. ET) — register here. A Tax Alert is forthcoming.

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In Chief Counsel Advice (CCA) 201640018, the IRS recently concluded that a subsidiary of a US corporation is not eligible for a dividends received deduction (DRD) under Section 245 with respect to funds distributed from a regulated investment company (RIC) to the subsidiary through its own subsidiary. The Service disallowed the DRD under the economic substance doctrine, regardless of whether the literal requirements of Section 245 were satisfied. CCA 201640018 is useful reading in that it provides useful insight into the IRS's interpretation and use of common law doctrines and other anti-avoidance measures at its disposal to combat perceived tax arbitrage.

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The OECD held a public consultation on 11-12 October on the discussion drafts on Additional Guidance on Profit Attribution to Permanent Establishments and on Revised Guidance on Profit Splits that were released earlier this year. The consultation was an opportunity for stakeholders to engage directly with the OECD Secretariat and the country delegates who are responsible for the OECD's transfer pricing work. The OECD Working Party will discuss the comments and next steps at its next meeting in November 2016. A Global Tax Alert provides details.