Intercompany Debt Transfers at Risk with New IRS Proposal

The whole issue of tax inversions, or companies relocating to offshore locations to gain better tax treatment has been front and center this presidential election. But a shot was heard around the USA when the Department of Treasury, on 4 April 2016, proposed new regulations when very few in the market were aware anything was under consideration.  Not only did these new regs address corporate inversions, but the proposal extended to intercompany debt.

The issue

Companies have tax advantages when using debt vs equity (e.g., primarily the deductibility of interest and the tax free repayment of principal). The use of intercompany financing to repatriate profitability from global operations has definetly caught the Internal Revenue Service’s eye.

Impact on In-House Bank and POBO Structures

As Bob Stark, VP of Strategy for Kyriba explains, “The issue for US treasurers is that global cash pooling managed within an in-house bank, perhaps inadvertently, falls within the crosshairs of Section 385. In many cases, in-house banking transactions would be reconsidered equity instead of intercompany debt/investment.”

PwC has written about the profound impact on Corporates here

KPMG talks about the proposed "debt-equity" regulations here

Implementation of this initiative will certainly impact make Treasury’s consideration of moving debt to equity and as Bob Stark says, could restrict treasurers use of in-house banking for cash and liquidity management. The word is that the Treasury Department is working to carve out cash pooling arrangements from its proposal, but the carve-out is supposed to be for daily cash positions, not long term arrangements.

The Financial Executives International (FEI) recommended that should Section 385 be implemented, that certain rules be effected, including:

  • creating an exemption for the debts of affiliates which meet the Foreign Account Tax Compliance Act’s (FATCA) definition of a treasury centre;
  • distinguishing cash management debt from longer-term financing;
  • and enacting an exception for working capital.

The implementation of this rule will certainly be of great interest to those involved in business credit, as liquidity for various subsidiaries of companies could greatly be affected.

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