The U.S. income tax system may soon undergo the most profound regulatory change in 20 years. So companies need to start preparing.
The change primarily would be aimed at a transaction known as a corporate inversion, which usually involves a U.S. company acquiring a smaller foreign company and then relocating to that company’s home country, where taxes are lower.
But the Treasury Department’s proposed debt-equity regulations, also known as the section 385 regulations indicating the relevant part of the tax code, would go much further.
Issued in April, they also would hit U.S. and foreign corporations that have never inverted as well as companies that have already inverted. The biggest tax burden likely would fall on U.S. multinationals simply because of their size.
The changes would affect financing and M&A activity and force companies to reconsider aspects of their internal financing, cash management and tax planning.
Under the proposed debt-equity regulations, the Treasury Department would limit the use of related party debt by treating some of such debt as stock, thus reclassifying the interest payments as dividends, which aren’t tax deductible.
The proposed rules are complex and likely to have broad ramifications, but the time to prepare for these changes seems fairly limited. We have inferred from various public statements that the Treasury Department aims to finalize the package before the President Obama leaves office early next year.
So how should companies prepare? Here are some key steps to consider:
In the short term:
- Set up or enhance existing lines of communication among tax, treasury function, legal and other stakeholders within your organization.
- Take an inventory of existing intercompany debt, cash pooling arrangements and related policies and controls.
- Take steps to make sure that you are fully compliant with the new documentation and monitoring policies and procedures. That includes new legal agreements, controls and technology solutions.
- Develop and execute appropriate “unwinding” of post-April 3 transactions that are subject to the debt-to-equity rules.
That project, which involves more than 100 countries, attempts to close gaps and mismatches in tax rules that allow companies to shift profits from high tax to low or no-tax locations. Such tactics are known as Base Erosion and Profit Shifting, or BEPS. (Learn more about BEPS.)
When asked in a KPMG survey to identify the biggest impact the new Treasury Department debt rules might have, 25 percent of respondents cited a need for new tax planning, 15 percent cited additional resources and another 15 percent said a reduced use of debt. Thirty-four percent said they weren’t sure.
The survey was conducted during a KPMG Tax Governance Institute webcast in May. Among survey participants were tax directors, vice presidents of tax, chief tax officers, chief financial officers, controllers, treasurers, audit committee members and chairs, and board members and chairs.
Learn more about section 385.
The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
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