Impact of the proposed 385 regulations on US inbound investments

Thursday, 20 October 2016

In line with a lot of European countries, the US is also adjusting their tax law regarding the deductibility of interest in case of related party-debt, as the US is afraid that their tax base will be eroded.

The deductibility of interest on related-party debt for US federal income tax purposes is a significant tax issue for foreign businesses investing in the United States (US inbound) because it impacts cost of capital and return on investment.

On October 13th, the US Treasury and the Internal Revenue Service (IRS) issued regulations under the Internal Revenue Code Section 385 (*1). The regulations will require companies to change how they approach intercompany financing and cash management and aim to characterize broad categories of related-party financing as equity, which could result in a higher US tax burden, a higher cost of capital, and a lower return of the investment into the US. The regulations are expected to be effective on 21 October 2016. This alert contains a very short summary of the rules.

The regulations;

  • treat certain related party-interests as stock that would otherwise be treated as indebtedness (it does not apply to debt instruments issued prior to 5 April 2016 and before the finalization of the proposed regulations would not be subject to automatic recharacterization until 90 days after the proposed regulations are finalized, so January 1st 2017.);
  • Impose strict documentation requirements on certain related party debt instruments to retain their treatment as debt (applies to debt instruments issued on or after 1 January 2018).

While Treasury’s primary target might have been large multinationals, the breadth of the proposed regulations under Section 385 will affect US inbound businesses all sizes, whether public or private.

This news alert is produced by the Dutch desk of Banning in New York. As Dutch tax lawyers, we are not authorized to advice on this, but we work closely together with US tax lawyers who can. So if you have investments in the US, please do not hesitate to contact us, so we can figure out what the impact of the new issued rules is on your situation.

 

John Linders
Elise Houtgraaf

Author
J.P. (John) Linders
J.P. (John) Linders Partner International Tax/Transfer Pricing