The proposed amendment of Section 385 of the Internal Revenue Code was introduced in April as part of the US Treasury Department’s drive to tackle corporate inversions.

The proposal would allow the Internal Revenue Service (IRS) to decide whether a corporate's debt obligations should be treated as debt or equity – a move that could prevent companies from using loans to subsidiaries as a way of moving income out of the US.

The move has caused much debate and members of the corporate treasury community predict a negative impact for company cash management. The change is likely to affect in-house banking structures, cash pooling as well as increase the tax compliance burden.

Many complications

In an article in AFPonline, Bob Stark of Kyriba wrote that “In many cases, in-house banking transactions would be reconsidered equity instead of intercompany debt/investment. This presents many complications, not the least of which are the knock-on effects of a parent company being considered to have taken an equity position in an overseas subsidiary, which in turn manages regional and local cash pools.”

The AFP has already written to the IRS to voice its concerns, saying the proposal would “cripple MNC treasury management”. It wrote that changes to Reg 385 “would significantly increase the cost of doing business for American companies”.

Regulations are 'overly broad'

Another industry group, Financial Executives International (FEI), has also voiced its concerns, saying that: “the proposed regulations are overly broad, noting that the vast amount of corporate debt that would be recharacterized as equity under the new rules are not involved in earnings stripping.”

A group of committees within the FEI have proposed that the rules, if they are to become reality, should be implemented from the beginning of 2019, giving companies time to prepare. They also recommended:

• creating an exemption for the debts of affiliates which meet the Foreign Account Tax Compliance Act’s (FATCA) definition of a treasury centre;
• distinguishing cash management debt from longer-term financing;
• and enacting an exception for working capital.

The FEI states: “These burdens are far out of proportion to the harm Treasury is trying to prevent.”