Debt-Equity Regs Are 'Stealth Attack' on Alleged Abuses, T-Mobile Says

Re: IRS REG-108060-15 (Section 385 Proposed Regulations)

 

a. Proposed Regulation Section 1.385-1(d). This provision provides the Service with discretion to recharacterize debt between members of a modified expanded group as part equity and part debt (the so-called "bifurcation rules"). The only guidance provided is that the Service's determination should be based on "relevant facts and circumstances" applying "general federal tax principles." An example is included that provides that debt could be treated as part equity if the Service's analysis supports only a portion of the debt as being repayable by the taxpayer taking into account regulation section 1.385-2, if applicable, and after applying general federal tax principles. This new rule is particularly worrisome given the lack of meaningful guidance provided by the Internal Revenue Service ("the Service") regarding the specific facts and circumstances, or lack thereof, that should be considered by the Service before debt is partially recast. Merely referencing general federal tax principles is of limited guidance and use to taxpayers and the Service. Having no effective guidance risks inconsistent and arbitrary enforcement by the Service.

We would recommend that the Service provide (i) safe harbors exempting certain taxpayers from this rule where there is limited or remote opportunity for abuse and (ii) specific guidance regarding the circumstances under which the Service would recast debt as equity in part.

In terms of a safe harbor, as this provision in the regulation applies to modified expanded groups, we suggest that (i) where no parent guarantee is provided and, (ii) the debt issuer is owned less than 80% by its foreign parent, or (iii) the debt issuer's equity is actively traded on a national stock exchange at the time the debt is issued, the Service cannot apply this portion of the regulation. Where a taxpayer-issuer has a material public investor base and is subject to market regulation and public disclosure rules, there is limited (or no) need for the Service to have expanded authority to bifurcate a taxpayer's debt. The taxpayer-issuer's ability to track, manage, and repay the debt will be tested and regulated by the market and securities' regulators. Alternatively, a safe harbor could be provided where (i) the taxpayer-issuer is owned less than 80% by its foreign parent and (ii) it has debt-to-equity ratio after the issuance of such debt within fifteen percent (15%) of the average debt to equity ratio of the combined companies representing seventy-five percent (75%) of the revenues reported by companies in the industry segment. If a taxpayer-issuer has outstanding equity and is leveraged within industry norms, there is no reasonable justification for the Service to have expanded authority to recast the issuer's debt.

In order to assist the Service and taxpayers regarding the application of the regulation, Treasury should identify the facts and circumstances that may justify the application or non-application of this portion of the regulation. This would also include prioritizing or weighting those factors that Treasury believes are most significant or material in considering whether debt should be recast. In addition, currently, the proposed regulation section 1.385-2 documentation requirements are not generally applicable to taxpayers that are less than 80% owned by a foreign parent. Treasury should clarify that failure to maintain such documentation does not provide the Service with a basis for invoking the "bifurcation" rules. Treasury should also provide examples illustrating the circumstances where it believes bifurcation would be appropriate. The more guidance Treasury provides up front, the better equipped taxpayers and the Service will be to comply with and enforce the regulations, thereby avoiding unnecessary disputes.

Lastly, although there was no discussion in the preamble to the Proposed Regulations or by Service personnel subsequent to their publication, we do not expect that Treasury would expand the application of the remaining aspects of the Proposed Regulations to taxpayers in a modified expanded group (nor can we reasonably envision any justification for doing so).

b. Proposed Regulation Sections 1.385-2(b)(2) and (3). Prop. Reg. Sec. 1.385-2(b)(3) requires taxpayers to prepare extensive documentation within 30-days of the issuance of an expanded group debt instrument ("EGI"). It is not clear why such extensive documentation must be prepared in such a short time frame. In the intercompany debt context, much of this supporting documentation is often not developed or needed since the financial condition of the issuer is known in detail given the close relationship of the parties. Consequently, the new rules effectively require taxpayers to develop new information that would not be needed in the ordinary course of an intercompany debt issuance. As such, it would seem that the rules applicable to transfer pricing documentation under section 482, which specifies that intercompany documentation has to be compiled at the time the taxpayer's return is filed, would be appropriate here. Specifically, the regulation should be modified to provide that the documentation required in the regulation need only be completed by the date the issuing taxpayer files the tax return for the year in which the EGI is issued. This approach would serve the purpose of the regulation and would allow taxpayers sufficient time to develop a compliance package that satisfies the regulation.

Further, Prop. Reg. Sec. 1.385-2(b)(2) identifies the types of information that must be included in the documentation. While Prop. Reg. Secs. 1.385-2(b)(2)(iii) and (iv) provide some examples of the types of documentation required by this section, it would be helpful for Treasury to expand upon the list of examples to address each area of required documentation, including evidence of an unconditional obligation to pay a certain sum and evidence of creditor's rights. Additionally, Treasury should provide guidance illustrating how extensively a taxpayer must document each area in order to be in compliance with this portion of the regulation. The additional detail and examples illustrating both the types of documentation and volume of documentation needed to satisfy each area would assist taxpayers and the Service in assessing compliance with this part of the regulation.

c. Proposed Regulation Section 1.385-3(d). The Proposed Regulation's "per se" funding rule creates an irrebuttable presumption that, subject to limited exceptions, an EGI is recast as equity if issued within the period beginning 36 months before or ending 36 months after a distribution or related-party acquisition by the issuer of the EGI. The preamble claims this is justified because money is fungible and the Service would find it difficult to prove a principal purpose of tax avoidance. We believe that a six year rule (i.e., the period spanning 36 months both before and after the EGI issuance) is overbroad and overly harsh, and reflects a presumption that inbound corporate taxpayers are guilty -- and are not even afforded the opportunity to prove their innocence. Given the six year time period for the rule, it is quite likely that economic and business circumstances may have changed such that automatically applying this rule to corporate financing activities is extreme and unwarranted. For example, a U.S. subsidiary of a foreign corporation may pay a dividend to its parent in year one in a transaction that has no abusive intent or purposes. Three years later, in a transaction completely unrelated to the prior distribution, the U.S. subsidiary may have an opportunity to acquire a new business or make an investment in the United States, and may wish to borrow funds from an affiliate to do so. This too is a transaction with no abusive intent or purpose; indeed it is precisely the type of new investment in the United States that the regulations claim to want to encourage. Nonetheless the "per se" funding rule would treat the new borrowing as equity, thereby increasing the cost of the new investment and potentially causing the U.S. subsidiary to forego or limit its new investment in the United States.

To mitigate the unnecessary harshness of the "per se" funding rule, we recommend that the rule be changed to a rebuttable presumption that allows taxpayers to explain or justify the non-tax purposes for their financing activities with clear evidence or support, and that the relevant time frame be limited to 24 months, rather than 36 months.

d. Due Date for Comments, July 7, 2016. The preamble provides that comments on the Proposed Regulations are due 90-days after the date the regulations were published in the Federal Register. The July 7 date is too short a time period for the taxpaying community given the unexpected nature and broad scope of the Proposed Regulations. The short comment period does not allow taxpayers sufficient time to review the proposed regulations and consider their application in order to provide meaningful comments thereto. Accordingly, we request that Treasury extend the comment period to October 5, 2016.

Chris Miller

 

Vice-President Tax

 

T-Mobile US, Inc.

 

Bellevue, WA