14 October 2016 EY Center for Tax Policy: This Week in Tax Reform for October 14 Final Section 385 regulations: On October 13, the Internal Revenue Service and Treasury Department released much-anticipated final and temporary regulations (TD 9790) under Section 385. The regulations, expected to be effective on October 21, make substantial changes to the proposed regulations that were released in April. Recharacterization Rule. The Recharacterization Rule, which would treat as stock certain related-party interests that otherwise would be treated as indebtedness for federal tax purposes, 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 April 5, 2016. Documentation Rule. The Documentation Rule to establish extensive documentation requirements with respect to related-party indebtedness generally applies to debt instruments issued on or after January 1, 2018. Foreign issuers. The final and temporary regulations exclude foreign issuers and apply only to domestic corporations (including certain partnerships and disregarded entities with domestic corporate owners). Financial institutions. The Recharacterization Rule generally does not apply to debt instruments issued by certain regulated financial entities, financial groups and insurance companies. 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. The final and temporary regulations contain numerous other changes to the proposed regulations including a widely-anticipated cash pooling exception, expanded earnings and profits 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. Lew comments on 385 regs: In announcing the release of the regulations on a press conference call, Treasury Secretary Jacob J. Lew said the Department "engaged extensively with businesses, tax experts, lawmakers, and the public and listened to their comments and recommendations on ways to potentially improve and better focus the regulations," and also heard from companies that the rules could constrain ordinary business practices. "After carefully considering this feedback, we have addressed stakeholder concerns by more narrowly focusing the final regulations on aggressive tax avoidance tactics and providing certain limited exemptions," he said. More broadly, Lew said inversions and earnings stripping cannot be fully addressed through Administrative action and require business tax reform. Still, "coupled with our previous actions to address corporate inversions, these changes balance the operational needs of companies while preventing the erosion of our U.S. corporate tax base," he said. Lew noted the President's Framework For Business Tax Reform and said the Administration will continue to make a case for the issue, and that he is "hopeful that Congress will take action on fixing our business tax system in the early days of the next administration." Lawmakers' reactions: The release of the Section 385 regulations was met with continued scrutiny on Capitol Hill, where members had long urged the Treasury Department to delay and modify the regulations, and to release any revisions in proposed form. House Ways and Means Committee Chairman Kevin Brady (R-TX) said, "By rushing the review process — despite the extensive comments received — and finalizing these regulations so quickly, it appears that the Obama Administration has ignored the real concerns of people who will be most impacted by these far-reaching rules." Ways and Means Ranking Member Sander Levin (D-MI) said the final rules make "sensible changes to the proposed regulations, ensuring it does not unintentionally interfere with ordinary business transactions, such as transactions related to cash management, transactions where there is a low risk of earnings stripping (e.g., between highly regulated companies), and other issues Democratic Ways and Means Members raised in a June letter to Secretary Lew." Senate Finance Committee Chairman Orrin Hatch (R-UT) said it is "immensely concerning that, despite stark bipartisan concern," the Administration chose to move forward with the rules. "While Treasury has indicated they have attempted to address some of the major concerns such as cash pooling transactions, foreign subsidiary-to-foreign-subsidiary transactions, and Subchapter S Corporation financing, among others, the devil's in the details," Hatch said. "And, we'll now have to carefully examine whether the regulations will make the policy less intrusive on some categories of legitimate business transactions." Finance Committee Ranking Member Ron Wyden (D-OR) said the regulations reflect "a lot of input and careful study" and will help protect the corporate tax base. "What this does not change is the need for tax reform. For too long Congress has sat on a broken and outdated tax system, which is why the U.S. has resorted to rule changes to respond to wave after wave of tax avoidance," he said. Sperling notes uncertainty of Clinton business tax reform plan: Asked during an October 13 Tax Policy Center event, "The Presidential Campaigns Discuss the Candidates' Tax Plans," whether it is a bad idea to have a base-broadening lower-rate business tax reform, Gene Sperling (former National Economic Council Director under Presidents Bill Clinton and Barack Obama, now an adviser to Hillary Clinton) acknowledged that Hillary Clinton is perhaps "not showing her hand on exactly where she would be" on the issue, but she is communicating what her principles are. Those principles include incentives for investment in the United States and not being indifferent to whether corporations locate a factory overseas or in the United States, he said. Sperling said Clinton is not going to engage in a multi-trillion corporate tax cut and does not subscribe to the notion that the only way to do corporate tax reform is to raise even less revenue. "We just extended all of the corporate extenders without paying for them," Sperling said, and a very strong case could be made for having "sound corporate tax reform" that still provides revenue for priorities like infrastructure, manufacturing, small businesses, and housing. Asked more directly whether Clinton will reduce the statutory corporate tax rate, alluding to statements by other advisers that she would not, Sperling said he did not have much to add to his previous answer but believes that while the 35% corporate tax rate might be higher than most competitors, the effective rate paid by US companies puts us right in the middle. He said a principle-based plan of protecting the tax base and a providing a bit of extra revenue to help support a strong jobs plan and to build infrastructure is a better way to approach the tax debate than a preexisting strategy focused on rates. Clarifying Trump's positions: At the same event, Wilbur Ross, chairman and chief strategy officer, WL Ross & Co., represented the Trump campaign and attempted to clarify a few of the proposals that he said have been misunderstood. Ross said Donald Trump made clear directly to him that Ross' carried interest and everyone else's will not be eligible for the 15% rate set for corporations and pass-through entities; it will be taxed at the personal income tax rate, presumably 33%. Regarding the 15% rate for pass-through entities, Ross said: "Executives and others whose income is now taxed as personal income will remain so taxed. There will be no structure that converts personal income to business, nor will private company executive owners be permitted to reclassify as business income what normally would be compensation." Clinton child tax credit: On October 11, Hillary Clinton announced a proposal to double the child tax credit to $2,000 through age four and to make the credit refundable beginning with the first dollar of earnings, rather than the current $3,000 threshold. The campaign said the cost of the proposal would be offset by tax increases on Wall Street, wealthy individuals, and corporations. At an October 12 campaign event in Las Vegas, Clinton promoted her proposed claw-back of tax benefits and exit tax on companies that outsource jobs, and said her proposal to double the child tax credit responds to the need for middle class and working families to have the necessary resources to take care of their kids. "It currently gives middle class families $1,000 per child; I want to double that, because I know it's expensive. It's expensive to take care of little kids, and you ought to have some help," she said. "For the remainder of the administration we will continue to make the case for business tax reform. There is a growing bipartisan consensus about the urgent need to act. Recent developments, such as the European Commission's State aid investigations, have brought additional attention to the issue. I am hopeful that Congress will take action on fixing our business tax system in the early days of the next administration." - Treasury Secretary Jacob J. Lew, October 13
Document ID: 2016-1760 | |||||
