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Corporation Describes Impact of Debt-Equity Regs on Its Business

JUL. 6, 2016

Corporation Describes Impact of Debt-Equity Regs on Its Business

DATED JUL. 6, 2016
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July 6, 2016

 

 

The Honorable Jacob Lew

 

United States Treasury Secretary

 

U.S. Department of the Treasury

 

1500 Pennsylvania Ave., N.W.

 

Washington, D.C. 20220

 

Re: Proposed Regulations under Section 385 (Reg. 108060-15)

 

Dear Secretary Lew,

Tate & Lyle PLC, and its subsidiaries in the United States ("Tate & Lyle", also the "Company") respectfully submits comments on the proposed debt-equity regulations under Internal Revenue Code section 385 (the "proposed 385 regulations"), released by the Treasury Department on April 4, 2016. These proposed regulations, if finalized in current form, will have a significant adverse impact on Tate & Lyle and its ability to continue to invest in the United States. The aim of this comment letter is to inform interested parties on the impact of the proposed 385 regulations on the Company, note some of the particularly problematic aspects of the proposed 385 regulations for the Company, and offer up what will hopefully be viewed as practical suggestions on improving the administrability of the regulations (assuming they are not withdrawn entirely which is the Company's preference).

Background on Tate & Lyle and Foreign Direct Investment into the United States

Tate & Lyle is a global food ingredient manufacturer headquartered in London, England and traded on the London Stock Exchange under the symbol TATE. It maintains its U.S. headquarters in Hoffman Estates, Illinois where it also operates a state of the art innovation center and customer collaboration space. The Company has more than 4500 employees worldwide, over 2500 of whom are based in the United States. Tate & Lyle has a very large U.S. presence operating corn wet mills and other processing facilities throughout the country but with a particularly heavy presence in Illinois, Indiana, Tennessee, Alabama, Ohio, Maine, Arkansas, and Minnesota. Over the past 5 years Tate & Lyle has invested more than $600M in additional capital in the United States. In our corn wet mills we process corn, grown locally on farms in the U.S., into food ingredients and industrial products. In addition to creating direct jobs for hard working Americans, Tate & Lyle indirectly creates jobs in the farming, transportation, utility, and construction space via its capital intensive operations.

Tate & Lyle is a small but important part of the overall foreign direct investment ("FDI") into the U.S. FDI represents a very significant component of the U.S. economy. As of December 2014, there is almost $3 trillion of cumulative FDI into the United States. This investment supports more than 24 million workers in the United States, including 6.1 million American workers directly employed by U.S. subsidiaries. Importantly, employees of U.S. subsidiaries earn an annual compensation that is 33 percent higher than the private sector average.

Impact of Proposed 385 Regulations on Tate & Lyle

If the proposed 385 regulations are finalized in their current form they will have a significant impact on Tate & Lyle's operations. The effects would include:

Disincentive to invest in the United States

Investing in the U.S. will be more expensive if these regulations were to take effect. Currently Tate & Lyle's U.S. operations serve as a growth engine for expansion into developing markets like South America and Asia. Many of the food ingredients that are in high demand in those developing regions are supplied by the U.S. operations. Tate & Lyle's U.S. business currently exports more than $300M of U.S. produced product. Increasing the cost of doing business in the U.S. (which is what these regulations would do) only encourages us to rethink continued investment in our US operations with associated impacts on job creation and retention.

The proposed regulations create a bias towards third party lending and equity investments in lieu of intercompany debt. They would ignore the realities of doing business in a global economy. As a foreign parented company it is cheaper and more efficient for us to utilize the borrowing power and banking relationships of our global group, borrow at the parent UK company level and then subsequently push down that debt to subsidiaries than it is to borrow at a U.S. standalone level. Increased borrowing costs lengthen the payback period on projects and make the U.S. a less attractive place to invest additional manufacturing capacity.

Financial Statement Uncertainty

Tate & Lyle's effective tax rate will be less certain for two different reasons, the retroactive application of the regulations and the Per Se Recast rule. Effective rate uncertainty results from the potential retroactive effective date of the proposed regulations. Assuming they are neither finalized or withdrawn before the end of the next financial reporting period, Tate & Lyle and the business community at large is left no choice but to apply them as though they were law or consider booking uncertain tax contingencies for any areas of non-compliance.

The Per Se Recast rule and the associated lookback feature effectively requires that Tate & Lyle know how much profit it is going to make and where, how much it is going to spend on new capital, and which mergers and acquisitions it is going to engage in 3 years before these things happen. This level of clairvoyance does not exist at any corporate enterprise.

Unintended Consequences

There are several unintended consequences that could occur if the proposed regulations are finalized as is. One such example, which is of particular importance to Tate & Lyle, is the collateral impact of a default. If a lending subsidiary must, as a condition of an arm's length lending agreement, declare a borrowing subsidiary in default in order to exercise its rights as a creditor, this may have unintended and potentially catastrophic collateral consequences such as triggering cross default clauses to other related or unrelated party group borrowings. The regulations are not clear if such action would be required by a lender exercising its rights.

Increased compliance costs

Thousands of additional man hours would need to be expended by the Company annually to comply with these new rules, especially considering that the scope of the regulations include global cash pooling arrangements and require the documentation to "contain the relevant legal rights and responsibilities of any members of the expanded group and any entities that are not members of the expanded group in conducting the operation of the cash pooling arrangement or internal banking service". The new documentation requirements would impact traditional functions including Treasury and Tax, but they would also impact Accounting, Credit, and Legal. The burden is particularly onerous in as much that failure to comply within a specified window (30 days) can result in an outsized penalty (reclassification of the instrument from debt to equity). These requirements would require paperwork, recordkeeping, and due diligence far beyond what is required under existing tax rules.

Specific Suggested Changes

 

1. Withdraw the regulations and study this properly

 

At 130 plus pages in length the proposed section 385 regulations and preamble are comprehensive to say the least. Some of the impacts on the business community are obvious, however there are also many unintended consequences that are not yet fully understood. Treasury understandably has an interest in protecting the public fisc and raising revenues. Treasury should also be interested in tax policy that balances revenue needs with overall U.S. competitiveness in the global economy and attracting foreign investment into the United States (a stated policy goal of the current administration). There has not been a 'revenue scoring' of this regulation by the Congressional Budget Office. There has not been an economic impact analysis on the impact to FDI conducted by the Commerce Department. There seemingly has not been any study conducted by a government agency on how these rules will impact existing and pending foreign tax treaties. Finally there seems to have been little regard for input from the business community. It is simply poor form to enact a regulatory change that is so impactful without fully understanding what those impacts are.

 

2. Documentation requirements

 

a. Use a 'tax return filing date' standard not a '30 day after the instrument is created' standard
Tate & Lyle is generally supportive of Treasury's efforts in the regulations to formalize what types of documentation and record-keeping are required to evidence a valid instrument. However, there are a few aspects of the documentation rules that the Company finds to be either a 'make-work' exercise, or just out of touch with how a large corporate operates.

First off, the '30 day' rule for creating documentation under Proposed Regulation Section 1.385-2(b)(3) is impractical to apply and does not seem to serve a real tax policy purpose. Consider, for example, a situation whereby there is an immediate need for a new debt instrument to finance an acquisition. Alternatively, there could be a need to create and draw down on a working capital facility to finance emergency repairs on a plant to keep it up and running and keep workers on the job. A working capital facility draw down could also be driven by a change in agricultural input prices (in our case principally corn prices) which can vary significantly from harvest to harvest and require significant financing flows from Group to operating subsidiary. The documentation rules of Proposed Regulation Section 1.385-3(b)(2) would require the existence of an executed instrument that evidences an unconditional obligation to repay and further documentation that memorializes creditors rights and the ability of the borrower to repay the lender. In each of the situations posited, it is not unreasonable for the lender to acquire the required documentation, it can, however, be impractical to acquire that documentation within 30 days after the instrument is created.

One of the Administration's concerns expressed in the preamble is around earnings striping. If the borrower in an arrangement does not have the wherewithal to repay, then the debt instrument should not be respected as a valid debt instrument. What difference does it make if that documentation is prepared 30 days after the instrument is entered into or before the tax return for that period is filed? One could argue that you would not be afforded such a grace period if the arrangement was with a true unrelated lender. An unrelated lender would not give you money and then figure out if they should have lent it to you or not after the fact. The difference is Tate & Lyle is not a bank. We are in the business of making food ingredients. Administrative graces should be afforded in such circumstances.

The requested change here is that the documentation rule in Proposed Regulation Section 1.385-2(b)(3) be reworded to say "by the time the tax return for the year the instrument is created is filed" as opposed to "within 30 days after the instrument is created". This accommodation allows the government to meet its objective around documentation and sets forth a more administrable standard for taxpayers.

b. Exempt certain transactions from the documentation requirement including trade payables and receivables entered into in the normal course and cash pooling arrangements
As a multinational engaged in business in over 30 countries around the globe, Tate & Lyle needs a functioning cash management strategy to keep its operations going. Like most similarly situated multinationals, Tate & Lyle engages in a physical hub and spoke model of cash pooling to meet global cash operating needs. This activity is critical for everyday non-tax business purposes. It is simply much less expensive to utilize excess cash within the worldwide group than it is to borrow locally at much higher rates from commercial banks. Furthermore, cash pooling is the only practical way to ensure sufficient visibility of the Company's global cash position. Having clear knowledge of the Company's cash position helps ensure that operations are funded efficiently and monies are invested safely. Additionally, complete and accurate visibility into cash positions helps our treasury function identify currency risk exposures and develop strategies to manage such matters. Tate & Lyle would suffer an enormous make work burden if their cash pooling arrangements had to meet the documentation requirements in the proposed regulations.

The requested change here is that the documentation rule in Proposed Regulation Section 1.385-2 be reworded to say that it doesn't apply to cash pooling arrangements. Cash pooling arrangements should be defined as "any mechanism used among members of an affiliated group of companies to pool cash balances in order to meet members' short-term cash needs and access short-term cash surpluses in a cost-efficient manner". Furthermore, cash pooling arrangements should be excluded from the Per Se re-characterization rules of Proposed Regulation Section 1.385-3. The exception is warranted as cash pooling and settling of ordinary course trade receivables and payables is a commonplace activity conducted by multinational enterprises that is conducted for non-tax business reasons not 'earnings striping'. Further, the inclusion of cash pooling would require a U.S. company to track all transactions of the members of the cash pool to determine if those entities engaged in a Funding Rule transaction. Otherwise, the U.S. company would not be able to properly classify its deposits or borrowings from the cash pool in accordance with Proposed Regulation Section 1.385-3. This would be a costly and onerous exercise for any U.S. company to undertake.

 

3. Remove the Per Se Recast Rule or at least expand the exception to include more than one year of earnings and profits

 

The 'Per Se Recast' rule of Proposed Regulation Section 1.385-3 works in such a way that it re-characterizes an instrument as equity if the issuance occurs within plus or minus 3 years from the date of a prohibited transaction. If a company makes an ordinary course dividend distribution and it has issued or issues a related party debt instrument within 3 years, then a portion, or all of that instrument, is converted into equity presumably pro-rata based on the size of the dividend. There is, among others, a current year earnings and profits exception to this Per Se Recast rule. It is our view that Treasury has overstepped their authority with this Per Se Recast rule. Section 385 of the Internal Revenue Code clearly grants Treasury regulatory authority, it also constrains that authority. The statute states "the regulations prescribed under this section shall set forth factors which are to be taken into account in determining with respect to a particular factual situation whether a debtor-creditor relationship exists or a corporation-shareholder relationship exists."1 Neither the legislative history nor the statute itself allow Treasury to enact regulations that allow the IRS to simply make per se determinations as to when debt is equity for tax purposes. The plain language of the statute -- "factors which are to be taken into account in determining with respect to a particular factual situation whether a debtor-creditor relationship exists" -- clearly contemplates debt-to-equity re-characterizations taking place on a case-by-case basis, even under specifying regulations. Proposed Regulation Section 1.385-3 does just the opposite however, determining that certain debt transactions in certain circumstances must be re-characterized as equity without regard to any specific characteristics of a taxpayer's debt instruments at issue. The plain language of Section 385(b) clearly does not provide for a per se debt-to-equity re-characterization. Treasury does not have the authority to enact such a rule.

Assuming Treasury does have the regulatory authority to issue a Per Se Recast rule, it is Tate & Lyle's suggestion that the current year earnings and profits exception be expanded to also include accumulated earnings and profits. Proposed Regulation Section 1.385-3(c)(1) creates an exception to the Per Se Recast rule by allowing for distributions up to current year earnings and profits. This exception provides little practical relief to companies for a few reasons. First off, companies do not know the full extent of current year earnings and profits until tax returns are complete. This uncertainty will hamper or make ineffective distribution and acquisition planning. Second, the current year only exception ignores the reality of fluctuating profits. Not permitting the distribution of some amount of accumulated earnings is an unwarranted burden on business motivated cash management decisions, which are based on a variety of commercial factors, including cash needs, projections, and currency considerations. It is impractical for Tate & Lyle or any corporate to precisely estimate the true amount of current earnings and profits until after their tax returns are filed, under the proposed rules we must choose between risking a distribution in excess of current earnings and profits, or making a smaller distribution. The latter would result in a portion of current earnings and profits each year being converted to accumulated earnings and profits which would be 'trapped' and rendered 'un-distributable' under the proposed regulations. Alternatively, the risk of 'trapped' profits could encourage us to make more frequent distributions and thereby prevent us from making further investments in the U.S.

 

4. Remove Part Stock Rule or at least establish some bright line tests around when it should be used

 

The rule under Proposed Regulation Section 1.385-1(d) (the "Part Stock Rule") as currently written in the proposed regulations is under-defined and will lead to a tidal wave of unnecessary tax controversy. Section 385(a) was amended in 1989 authorizing Treasury to write regulations indicating whether an instrument is stock or debt. In the absence of regulations, case law has developed which uses an 'all or nothing' approach. In other words, instruments are not bifurcated into part equity and part debt. The IRS has seemingly acquiesced to the 'all or nothing approach' because there were no regulations in place under Section 385 which allowed them to exercise their 'bifurcation power' under Section 385(a). Treasury's solution was to 'turn-on' these regulations and provide 'bifurcation power' to the IRS. The only guidance around when that power should be utilized is a simple example in the preamble that says if a taxpayer cannot demonstrate that a borrower can "reasonably be expected to repay" a portion of properly documented indebtedness, then the IRS can re-characterize it.

The ambiguity of the phase "reasonably be expected to repay" will lead to unnecessary tax controversy. Under the proposed regulation, the documentation that might validate a "reasonable expectation to repay" could include "cash flow projections, financial statements, business forecasts, asset appraisals, determination of debt-to-equity and other relevant financial ratios of the issuer relative to industry averages, and other information regarding the sources of funds enabling the issuer to meet its obligations pursuant to the terms of the applicable instrument". The taxpayer is left to decide which of these documents will prove a "reasonable expectation to repay". The IRS, of course, could decide that the taxpayer's documentation efforts are insufficient. The presence of the aforementioned documentation is not a safe harbor, but rather, a minimum floor that might or might not be respected by the IRS.

The requested change here is that the Part Stock Rule in Proposed Regulation Section 1.385-1(d) be removed. If Treasury's concern is that taxpayers have too much debt, then there is already a mechanism to counter this concern (at least for inbound companies that are subject to the thin capitalization rules), that is the interest deductibility limitation under Section163(j). If Treasury is unwilling to remove the Part Stock Rule all together, then at a minimum the rule should be amended to provide more clarity and a safe harbor indicating when the "reasonable expectation to repay" standard has been met.

Conclusion

Tate & Lyle appreciates the opportunity to make comments and participate in the guidance making process. As a proud member of the FDI community, Tate & Lyle appreciates having access to and operating in the largest and most important market in the world for food ingredients. We recognize our obligations to be a good corporate citizen and pay our fair share of taxes. As the market for food ingredients continues to grow globally, we would like to continue to service that growth in demand with U.S. produced product. A competitive and equitable tax system will enable and encourage that growth. The changes suggested to the proposed 385 regulations put forth in this letter will help both parties (Treasury and Tate & Lyle) meet their respective goals.

We appreciate the consideration of the comments provided and would welcome the opportunity to discuss the proposed regulations further.

Sincerely,

 

 

Lawrence A. Pociask

 

Vice President U.S. Tax

 

Tate & Lyle Ingredients

 

Americas, LLC

 

 

Chris Olsen

 

Vice President Government Affairs

 

Tate & Lyle Ingredients

 

Americas, LLC

 

 

Tate & Lyle

 

Hoffman Estates, IL

 

cc:

The Honorable Penny Pritzker, Secretary, U.S. Department of Commerce

The Honorable Mark Mazur, Assistant Secretary for Tax Policy, U.S. Department of Treasury

Mr. Robert Stack, Deputy Assistant Secretary for International Tax Affairs, U.S. Department of Treasury

 

FOOTNOTE

 

 

1 26 U.S.C. § 385(b).

 

END OF FOOTNOTE
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