Internal Revenue Code (Code) §385(a) authorizes the Treasury to prescribe regulations “to determine whether an interest in a corporation is to be treated for purposes of [title 26] as stock or indebtedness (or as in part stock and in part indebtedness).” Section 385(b) sets forth factors that may be included in regulations distinguishing creditors from shareholders, and §385(c) generally requires the holders of an instrument issued by a corporation to treat that instrument consistently with the issuer’s characterization of the instrument as stock or debt. Section 385 (apart from subsection (c)) has been a dead letter since its enactment in 1969; regulations issued in 1980 were withdrawn in 1983 (without coming into effect), and no further regulations were proposed until earlier this month.
On April 4, the Internal Revenue Service and Treasury issued a notice of proposed rulemaking (REG-108060-15) setting forth Proposed Regulations under §385. The Proposed Regulations would characterize certain debt instruments issued by corporations (or certain related non-corporate entities) to related persons as stock for federal tax purposes. The Preamble suggests that the Proposed Regulations’ underlying rationale is found in statements in IRS Notices 2014-52 and 2015-79 to the effect that Treasury and the IRS were considering “guidance to address strategies,” such as corporate inversions, “that avoid U.S. tax on U.S. operations by shifting or ‘stripping’ U.S.-source earnings to lower-jurisdictions, including through intercompany debt.” However, the Proposed Regulations are not limited to cross-border transactions, and they apply to many situations involving exclusively domestic parties.
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