FLASH UPDATE — One-Year Delay! Controversial Debt-Equity Regulations “Documentation”


Internal Revenue Code Section 385 deals with the classification of certain interests in corporations as either “debt” or “equity” interests. The Code Section was originally enacted over 40 years ago, and later amended twice. The Code section itself provides scant guidance on the subject and gives the US Internal Revenue Service (IRS) authority to issue Treasury Regulations to determine whether an interest in a corporation should be classified as debt or stock (equity) in the corporation.

The history of the IRS’ Treasury Regulations projects dealing with Code Section 385 confirm that this is a difficult topic to grasp and on which to provide guidance.  You can read more here.

On October 13, 2016, the IRS issued Final and Temporary Regulations (“Regulations”) under Section 385 (TD 9790).  The Regulations restrict the ability of corporations to strip earnings by treating financial instruments that purport to be “debt”, instead as “equity” under certain circumstances.

The Regulations also require that documentation be maintained by the corporate issuer. Among other things, the Regulations contain timing requirements for preparation and maintenance of documentation required of certain companies issuing any interests (note that foreign corporate issuers are exempt from the rules). The Regulations also provided for delayed implementation of the documentation requirements by making them applicable only to debt instruments issued on or after Jan. 1, 2018.

President Trump’s Mandate

On April 21, 2017, President Donald Trump signed an Executive Order requiring the Department of the Treasury to review “significant” tax regulations issued during the Obama administration and to determine if they should be modified or repealed.  Treasury included the debt-equity Regulations issued under Code Section 385 on its list for evaluation.

“Documentation” Regulations -The Latest News- One Year Delay

Notice 2017-36 announced that the Department of the Treasury and the Internal Revenue Service intend to amend Treas. Reg. § 1.385-2 (the “Documentation Regulations”) to apply only to interests issued or deemed issued on or after January 1, 2019. This amendment has the effect of delaying the application of the Documentation Regulations by 12 months. The Notice also requests comments concerning whether the proposed amendment and delay of the application of the Documentation Regulations affords adequate time for taxpayers to develop any necessary systems or processes to comply with the Documentation Regulations.

I expect practitioners will be reviving their criticism of the Regulations!

Notice 2017-36 will be in IRB: 2017-33, dated  August 14, 2017.

Further Information

You can read more about debt/equity, loans to foreign corporations at my tax blog posts here, here and here.


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