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Proposed 385 Regs: IRS Will Look Back 3 Years at Your Loans

  • By Ira Apfel
  • Published: 5/25/2016
Proposed 385 Regs: IRS Will Look Back 3 Years at Your Loans Ira Apfel 2016-05-25

Imagine a scenario where the IRS looks back three years at an intercompany loan you made to a foreign subsidiary and determines that it is equity. At the very least, you would have to pay more taxes and re-state your financial statements.

That’s just one nightmare scenario envisioned under proposed changes to IRS section 385 rules. The proposals, which came out April 4, are designed to thwart corporate tax inversions. Treasury and finance executives are just now beginning to understand that the rule changes could completely change how they treat foreign subsidiaries.

A group of increasingly frustrated treasury and finance executives voiced their concerns about the potential fallout from the 385 rule changes at the CTC Corporate Treasurers Forum on Monday. The session was led by Melissa Cameron, head of global treasury services for Deloitte, and Steve Blore, an international tax partner with Deloitte and, the more they explained the changes, the angrier attendees became.  

“This is incredible. They don’t understand what we do at all and how this would affect us,” one treasurer of a Global Fortune 500 company said. “It’s bizarre. If I loan our Brazilian subsidiary money, and we’re actually paying income taxes on it in the United States, if I convert that to capital because the IRS deemed it equity the IRS would actually lose taxes in the U.S. It’s crazy.”

More documentation will be required

Perhaps even worse than not knowing for three years if an instrument is debt or equity, treasury departments will need to compile much more documentation on every intracompany loan. Treasury departments will need to put together a file to show that the instrument is debt and why one subsidiary would lend to another, and why the company deemed the instrument debt or equity at the time it was created.

And, of course, the IRS could still look back three years and determine the opposite. And, as was noted in the CTC Forum session, companies that fail to follow these rules will see their instrument treated as equity—no exceptions.

“Imagine a subsidiary that can’t make payments and needs more capital,” a session attendee said. The IRS could look at the time when the intracompany loan was put in place and ask, What would an outside lender do? They would call in the debt. You and your company would, of course, choose not to call into default your own subsidiary.”

Under the proposed changes to section 385, this could happen.

AFP is preparing a reply to the IRS. You can add your concerns here.

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