In April 2016, the Treasury proposed broad and controversial debt-equity regulations designed to limit erosion of the United States corporate tax base. The final and temporary regulations issued Oct. 13, 2016, significantly improve upon the proposed regulations and place the focus squarely on certain areas in which the Treasury and the Internal Revenue Service (IRS) have viewed issuance of related party debt as inappropriate or abusive.
Under new regulations, many related party debts issued by US C corporations could be characterized as equity, thereby eliminating the tax shield provided by interest deduction on the recharacterized debt. In general, the regulations apply only to debt issued by US C corporations, so most debt issued by flow through portfolio investments would be exempt from equity recharacterization. In addition, only debt issued to another corporation (and certain controlled partnerships) is subject to characterization, so debt issued to a private equity (PE) fund or related entity that is a partnership for tax purposes is also exempt. Another PE-favorable position exempts debt issued amongst commonly controlled US corporations where the common control is held through a partnership or other non-corporate entity.
As a result, a large number of small and midsized portfolio investments will be exempt from the rules, which is a favorable outcome. However, where the portfolio investment is a multinational group with multiple corporate entities and related party debt, the new regulations are likely to require consideration.
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As always, the regulations include a number of exceptions to every rule, so consult your tax advisor to determine if and how the new rules will impact your investments.
Read more on the new debt-equity regulations and how they may impact your investments.
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Article by By Nick Gruidl, Partner with the Washington National Tax practice at RSM – via PitchBook