IRS Proposes Earnings-Stripping Rules, Issues Other Inversion Guidance

By Sally P. Schreiber, J.D.

The IRS issued a package of proposed and temporary regulations designed to reduce the tax benefits and incentives for corporate inversions. These new rules aim to curtail an inverted company's ability to access foreign subsidiaries' earnings without paying U.S. tax. In a corporate inversion, a multinational company based in the United States replaces its U.S. parent with a foreign parent, usually in a lower-tax jurisdiction.

According to Treasury, the new rules make it more difficult for companies to invert by disregarding—for purposes of computing the ownership percentage when determining if an acquisition is treated as an inversion—foreign parent stock attributable to certain prior inversions or acquisitions of U.S. companies. This is done under temporary regulations under Secs. 304, 367, 956, 7701, and 7874. These rules are added to existing rules that had been issued in earlier notices (Notices 2014-52 and 2015-79) and are now consolidated and formalized in T.D. 9761.

The new rules also address earnings stripping in proposed regulations targeting transactions that increase related-party debt that does not finance new investment in the United States (REG-108060-15). These rules are the first rules the IRS has issued in many years attempting to distinguish between debt and equity. According to Treasury, the proposed regulations, issued under Sec. 385, address earnings stripping by:

  • Targeting transactions that increase related-party debt that does not finance new investment in the United States;
  • Allowing the IRS on audit to divide a purported debt instrument into part debt and part stock; and
  • Requiring documentation for members of large groups to include key information for debt-equity tax analysis.
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