New Proposed Regulations Increase Scrutiny on Related-Party Debt

April 28, 2016

The U.S. Treasury Department (“Treasury”) and Internal Revenue Service (“IRS”) recently issued proposed regulations (the “New Proposed Regulations”) governing the federal income tax treatment of debt between certain related parties. Part of the Treasury’s continued struggle with so-called “inversion” transactions, these proposed rules apply well beyond inversion transactions and may call into question the tax treatment of common, non-abusive transactions. The proposed regulations, if finalized, could cause debt between members who are part of an “expanded group” (as defined below) to be treated (in whole or in part) as equity for federal income tax purposes and would impose documentation requirements in order for a purported debt instrument to be treated as debt.

If finalized, the new rules regarding classification of certain debt as equity generally would apply to any purported debt instrument issued on or after April 4, 2016, but will not take into account distribution or acquisition transactions (which, as described below, are relevant under the new rules in determining debt/equity status) occurring prior to April 4, 2016. There is a grandfathering rule for debt instruments treated as equity, in whole or in part, under the New Proposed Regulations, whereby equity treatment will not be effective until the day that is 90 days after finalization of the rules. The new documentation requirements will apply to debt instruments issued on or after the date the New Proposed Regulations are finalized.

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