Using Software to Document and Analyze Impacts of Final Section 385 Regulations
At both the federal and state levels tax teams are taking steps to manage the impact of Section 385 regulations.
On October 13, 2016, the Department of Treasury and the Internal Revenue Service released the final Section 385 regulations, effective for transactions and debt issued on or after April 4, 2016. Largely a result of congressional inaction on tax reform, the 385 regulations seek to reduce the benefits of:
Corporate tax inversions - the practice of relocating a corporation's legal domicile to a lower tax country (usually while retaining operations in its high-tax country of origin).
Earnings stripping - a tactic by which a corporation tries to minimize U.S. taxes by paying deductible interest to the new foreign parent, or to one of its foreign affiliates in a low-tax country, which results in large interest deductions in the U.S.
At over 500 pages, the department claims the final regulations address key concerns by “narrowly focusing the regulations on aggressive tax avoidance tactics and providing certain limited exceptions.”
Speculation and uncertainty abound as the President Trump takes the reins. While campaigning, the President was very critical of companies that used inversion and/or earnings stripping tactics. The Trump tax plan for corporations (if put in place) reduces the U.S. tax rate to 15% and requires companies with money offshore to bring back those profits with a 10% repatriation tax. If passed, this essentially removes a big motivator for companies to use inversion and/or earning stripping methods. It could also mean that the new 385 regulations would stay in place just as finalized.
Now is the time for tax teams to take steps to define impacts and strategize at both the federal and state levels. Progressive companies are leveraging advanced corporate income tax software solutions that have robust document management functionality to help anticipate and manage the many requirements of Section 385 regulations. Specifically, they are analyzing the impacts of reorganizations, mergers, acquisitions, and restructuring. Additionally, these companies are taking a proactive stance to ensure they are not caught unexpectedly in the Section 385 regulations web by:
- Reviewing intercompany agreements and debt instruments to determine which ones are subject to the re-characterization rules.
- Putting procedures in place to keep tax teams apprised of restructuring, debt instruments, and intercompany transactions, so that tax impacts can be analyzed and a documentation best practice implemented that aligns with current case law.
- Strategizing proper legal structures by running what-if analysis, not only at the federal level but also at the state level (an often missed impact from 385 regulations).
With the right state and corporate planning and automation tools, companies can easily and quickly track the impacts of Section 385 regulations, meet the significant reporting requirements, and analyze the potential impact on tax liability at both the federal and state levels – across multiple states, multiple years, and multiple scenarios; thereby enabling tax teams to plan accordingly.