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Corning Offers Suggestions for Revised Distribution Rules

JAN. 28, 2020

Corning Offers Suggestions for Revised Distribution Rules

DATED JAN. 28, 2020
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January 28, 2020

The Honorable Steven T. Mnuchin
Secretary of the Treasury
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

The Honorable Charles Retting
Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Dear Messrs. Mnuchin and Retting:

Corning Incorporated (“Corning”) is pleased to submit comments with respect to REG-123112-19, advance notice of proposed rulemaking (“Advance Notice”) related to Section 385.1

Corning is one of the world's leading innovators in material science with over 165-year history of developing life-changing innovations, such as optical fiber, precision glass for advanced displays, wireless technologies, and clean-air technology for automobiles and trucks. Corning is headquartered in the United States and employs more than 50,000 employees world-wide.

Corning respectfully makes the following comments regarding the Proposed Regulations:

  • Replace per se rule with a connection test

  • Application to a consolidated group

  • Impact of the characterization of debt

  • Application to domestic entities and foreign parents only

  • Threshold exception

Background

Treasury Decision 9790, issued in 2016, included rules under §§1.385-3, 1.385-3T, and 1.385-4T, which treat as stock certain debt that is issued by a corporation to a controlling shareholder in a distribution or in another related-party transaction that achieves an economically similar result (the “Distribution Regulations”). Although the temporary regulations §§1.385-3T and 1.385-4T have expired, the related proposed regulations (REG-130314-16) which cross-referenced the temporary regulations are reliable and have not expired.

Specifically, the Distribution Regulations provide a per se funding rule, which treats a debt instrument as funding a distribution to an expanded group member or other transaction with a similar economic effect if it was issued in exchange for property during the period beginning 36 months before and ending 36 months after the issuer of the debt instrument made the distribution or undertook a transaction with a similar economic effect. The Distribution Regulations include several exceptions limiting their scope.

The Distribution Regulations also address the classification of debt instruments that do not finance new investment in the operations of the borrower and therefore have the potential to create significant Federal tax benefits, including interest deductions that erode the U.S. tax base, without having meaningful non-tax significance.

In response to E.O. 13789 (which is described and discussed in the preamble to the Advance Notice), the Treasury and IRS have determined to propose more streamlined and targeted Distribution Regulations.

1. Replace per se rule with a connection test

Overview:

The revised Distribution Regulations should be based upon a facts and circumstances test, looking at whether there is a connection between the issuance of debt and a distribution in order to effectively function as an anti-abuse rule.

Analysis:

Corning appreciates Treasury and IRS' determination to remove the per se rule and the 72-month rolling debt window (that is, 36-months before to 36-months after a transaction) and provide more streamlined and targeted Distribution Regulations. The policy goals behind the Distribution Regulations should be to ensure that if a taxpayer issues debt, such debt reflects meaningful economic and non-tax considerations. We respectfully request that the Distribution Regulations are narrowed to target structured transactions and debt issued with respect to transactions that do not have non-tax considerations, rather than apply an anti-abuse rule to all debt. As such, the revised Distribution Regulations should properly function as an anti-abuse rule rather than as an overly-broad and all-encompassing rule.

Therefore, we recommend that the Distribution Regulations apply a fact and circumstances approach to determine the existence of a connection between a debt instrument and a distribution, rather than the broad approach applied under the existing Distribution Regulations. Such a facts and circumstances approach would remove from application debt and other liabilities generated in the ordinary course of business that are unrelated to the distribution, such as the roll-over of existing debt (that is, issuing of debt that replaces existing maturing debt), cash pooling arrangements, debt issued for general corporate purposes, common accounts payable, and similar ordinary course liability-related transactions.

2. Application to a consolidated group

Overview:

As an ordering rule, the consolidated regulations under §1502 should apply before the Distribution Regulations.

Analysis:

The facts and circumstances test recommended above should not apply where the debt is issued between members of a consolidated group for distributions made within the consolidated group. As interest income and interest expense received or paid within a consolidated group are eliminated upon consolidation, such eliminations should apply before application of the Distribution Regulations. Such treatment should simplify both U.S. federal and state tax compliance.

3. Impact of the recharacterization of debt

Overview:

The recharacterization of an instrument from debt into stock should be limited to the tax treatment of the periodic “interest” payments as “distributions.”

Analysis:

There are numerous Code provisions that are impacted or triggered by the amount of ownership held by taxpayers, including the 80% threshold for corporate consolidation, the more than 50% ownership required to apply the CFC and Subpart F rules, determining where there is 80% control for purposes of §351 capital contributions and §368 reorganizations, etc.

Recharacterizing a debt instrument into stock for all purposes of the Code due to a taxpayer simply borrowing to pay a dividend would cause a host of collateral issues, including providing taxpayers a mechanism to manipulate into or out of various Code provisions. However, treating the recharacterized instrument as stock only with regard to the treatment of distributions would resolve base erosion policy concerns without opening the door for taxpayer manipulation of Code provisions. Further, limiting the scope of application to distributions would eliminate substantial complexity from tracking among an expanded affiliated group fractional shares of ownership that exists only for U.S. tax purposes, but not for legal or accounting purposes. This concern is especially important in the foreign subsidiary context.

Therefore, we recommend that the recharacterization of an instrument from debt into stock be limited only to recharacterize the treatment of the payment of “interest” into “distributions.”

Alternately, if Treasury and the IRS determine that, similar to the existing regulations, the characterization of a debt instrument into equity should apply for all purposes of the Code, then carveouts are requested where possible. Such carveouts could apply when determining the 80% threshold for inclusion within a consolidated regime, the 80% threshold for a §332 liquidation, the 80% control requirement for a §351 capital contribution or a §368 reorganization, the impact on §304 transactions, the impact on §355 and §356 transactions, and other situations where the classification of a debt instrument into an equity instrument may trigger an impact to a statutory ownership threshold simply upon the issuance of recharacterizable debt but otherwise without any meaningful economic consideration.

4. Application to domestic entities and foreign parents only

Overview:

The revised Distribution Regulations should be limited to domestic entities and any foreign parent entities.

Analysis:

Treasury's stated purpose in 2016 for issuing the §385 regulations was to make “it more difficult for companies to undertake an inversion and reduce the economic benefits of doing so.”2

Generally, the deductibility of interest by a CFC should not impact whether a U.S. taxpayer undertakes an inversion. In fact, today, a CFC can generally make a dividend distribution to the U.S. tax-free, assuming the distribution is subject to a 100% dividend received deduction (“DRD”) per §245A. As such, the borrowing by a CFC to pay a dividend to the U.S. should not be an abusive situation as the dividend would generally be received into the U.S. tax-free. Any interest deducted by the CFC would reduce that CFC's earnings and profits (“E&P”), but as the E&P is not taxable when repatriated to the U.S., such reduction in E&P should not impact the U.S. tax base. Similarly, borrowing to pay a distribution from a lower-tier CFC to a higher-tier CFC should not impact whether a U.S. taxpayer undertakes an inversion. As such, borrowing to pay a dividend at the CFC level does not appear within the scope of issues leading to the issuance of the regulations: to discourage inversions and reduce their economic benefits.

Thus, it appears that the §385 Distribution Regulations should not apply to CFCs of a U.S. taxpayer, as distributions from and borrowings by CFCs are apparently not the target of the Distribution Regulations. Further, to impose complexity upon a taxpayer by recharacterizing as equity any CFC debt issued to pay a dividend would appear to add complexity with no meaningful benefit. Such reduction in complexity and cost/benefit issues were a key driver behind E.O. 13789.

Therefore, we respectfully request that the revised Distribution Regulations be limited to domestic entities and any foreign parent entities.

5. Threshold exception

Overview:

Retain the $50 million threshold exception of §1.385-3(c)(4).

Analysis:

Existing §1.385-3(c)(4) provides a threshold exception whereby the first $50 million of indebtedness that may otherwise be reclassified as stock retains its classification as debt. This threshold exception was particularly helpful under the per se rule as it was intended to prevent the reclassification of ordinary course debt into equity. When revising the Distribution Regulations, such a threshold exception is still important as such exception acts as a de minimis threshold to avoid reclassification of small transactions.

* * * * * * *

We appreciate your consideration of these comments and welcome the opportunity to discuss these issues further. If you have questions, please contact Tymon Daniels, Senior Tax Director, at (607) 974-4995 or DanielsT@Corning.com, or me at (607) 974-5690 or LemkeJA@Corning.com.

Regards,

Judith Lemke
Vice President of Tax
Corning Incorporated

cc:
The Honorable Lafayette “Chip” G. Harter III, Deputy Assistant Secretary (International Tax Affairs), Department of the Treasury
Mr. Michael J. Desmond, Chief Counsel, Internal Revenue Service 
 Mr. Thomas A. Barthold, Chief of Staff, Joint Committee on Taxation

FOOTNOTES

1Unless otherwise stated, all references to “Internal Revenue Code,” “IRC,” “Section” or “§” are to the Internal Revenue Code of 1986, as amended (the “Code”), or to the Treasury Regulations (“Treas. Reg.” or “Regulations”) thereunder.

2Fact Sheet: Treasury Issues Inversion Regulations and Proposed Earnings Stripping Regulations, dated April 4, 2016. Accessed January 3, 2020.

END FOOTNOTES

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