Recently released proposed regulations that would classify certain intragroup loans as equity for U.S. tax purposes could have very significant consequences for M&A transactions, private equity investments and restructurings. If adopted in their present form, the proposed regulations would eliminate strategies that have been widely used in cross-border transactions. However, the proposal could also have unpredictable consequences for the day-to-day funding practices of both U.S. and foreign-owned multinational groups. Moreover, the proposal would impose burdensome documentation and substantiation requirements on intragroup loans as a necessary condition to having the loans respected as debt for tax purposes (regardless of whether as a legal and economic matter the loans are debt).
The proposed regulations are part of Treasury’s and the IRS’s efforts to combat inversion transactions, but they have a broader anti-“earnings stripping” objective and effect. Hopefully, after receiving comments, the drafters will moderate features of the proposed regulations that are unworkable, cause unintended consequences or adversely affect conventional, non-tax motivated funding practices of multinational groups. However, because some of the rules are proposed to apply to instruments issued on or after April 4, 2016, taxpayers will need to take them into account starting now.