Treasury Identifies 3 International Tax Regulations as Potentially Burdensome

In Executive Order 13789 issued earlier this year, President Trump ordered the Secretary of the Treasury to review all “significant” tax regulations issued on or after January 1, 2016, and identify those that either a) imposed an undue financial burden on taxpayers, b) added undue complexity to the federal tax laws, or c) exceeded the statutory authority of the Internal Revenue Service (IRS).

The Treasury has examined 52 regulations and identified eight regulations that met the criteria of the president’s order and qualified as “significant” in view of the presidential priorities of tax regulation. Of the eight regulations deemed “significant,” three (outlined below) have a direct impact on the U.S. taxation of certain international transactions.

The Treasury plans to propose reforms – potentially ranging from streamlining problematic rule provisions to full repeal – to mitigate burdens of these regulations in the final report to be submitted to the president.

1. Related-party debt

Final and Temporary Regulations under IRC Section 385 on the Treatment of Certain Interests in Corporations as Stock or Indebtedness (T.D. 9790; 81 F.R. 72858)

These final and temporary regulations, effective October 21, 2016, address the treatment of related-party debt as debt or equity for federal tax purposes.

These regulations primarily discuss:

• Rules establishing threshold documentation requirements that ordinarily must be satisfied in order for certain related party interests in a corporation to be treated as debt for federal tax purposes; and
• Transaction rules that treat as stock certain debt issued by a corporation to a controlling shareholder in a distribution or in another related-party transaction that achieves an economically similar result.

These regulations are limited to expanded group instruments (EGIs) and debt instruments issued by domestic corporations. In addition, the regulations only apply to non-U.S. issuers and, therefore, do not apply to debt instruments issued by foreign corporations, including controlled foreign corporations (CFCs).

The Treasury Department and the IRS received a variety of comments in response to these regulations, including:

• Criticism of the financial burdens of compliance, particularly with respect to more ordinary-course transactions;
• Request for a longer delay in the effective date of the documentation rules;
• Criticism of the complexity associated with tracking multiple transactions through a group of companies; and
• Criticism of the increased tax burden on inbound investments.

2. Qualified business unit

Final Regulations under IRC Section 987 on Income and Currency Gain or Loss with Respect to a Section 987 Qualified Business Unit (T.D. 9794; 81 F.R. 88806)

These final regulations, effective as of December 7, 2016, offer guidance under Internal Revenue Code Section 987 regarding the determination of taxable income or loss of a taxpayer with respect to a Qualified Business Unit (QBU). A QBU includes any separate and clearly identified unit of a trade or business of a taxpayer that maintains separate books and records.

Specifically, the regulations provide rules for:

• Translating income from branch operations conducted in a currency different from the branch owner’s functional currency;
• Calculating foreign currency gain or loss with respect to the branch’s financial assets and liabilities; and
• Recognizing such foreign currency gain or loss when the branch makes a transfer of any property to its owner.

In addition, under a mandatory “fresh start” transition method, all IRC Section 987 QBUs that have not already implemented the 2006 proposed regulations will be deemed to terminate on the day before the new regime’s adoption, but no Section 987 gains or losses will be recognized on these terminations. Much of the pre-existing Section 987 attributes will simply disappear. For calendar-year taxpayers, unrecognized Section 987 losses will therefore be largely eliminated as of December 31, 2017, without producing a tax benefit.

Comments on the regulations included the following criticisms:

• The transition rule in the final regulations imposes an undue financial burden on taxpayers because it disregards losses calculated by the taxpayer for years prior to the transition but not previously recognized; and
• The method prescribed by the final regulations for calculating foreign currency gain or loss was unduly complex and costly to comply with, particularly where the final regulations differ from the financial accounting rules.

3. Property transfers

Final Regulations under IRC Section 367 on the Treatment of Certain Transfers of Property to Foreign Corporations (T.D. 9803; 81 F.R. 91012)

Section 367 of the Internal Revenue Code generally imposes immediate or future U.S. tax on transfers of property (tangible and intangible) to foreign corporations, subject to certain exceptions. These final regulations, effective as of December 16, 2016, eliminate the ability of taxpayers under prior regulations to transfer foreign goodwill and going concern value to a foreign corporation without immediate or future U.S. income tax. The regulations also combine sections of the existing regulations under IRC Section 367(a) into a single section.

Comments on these regulations included the following concerns:

• The final regulations would increase burdens by taxing transactions that were previously exempt under the Internal Revenue Code, noting in particular that the legislative history to Section 367 contemplated an exception for outbound transfers of foreign goodwill and going concern value
• An exception should be provided for transfers of foreign goodwill and going concern value in circumstances that would not lead to an abuse of the exception

Public invited to submit comments on regulations

The Treasury is currently requesting comments on whether the aforementioned regulations should be repealed or modified, and in the latter case, how the regulations should be modified in order to reduce burdens and complexity.

The public can submit comments through August 7, 2017.After the comment period, the Treasury will formulate a final report and submit it to the President by September 17, 2017, recommending specific actions to mitigate the burden of these regulations on taxpayers.

In addition to the regulations that have already been reviewed, the Treasury is also responsible for conducting a broader review of existing U.S. regulations issued before January 1, 2016, subject to certain exceptions, as per Executive Order 13777. The Treasury invited public comment concerning regulations that should be modified, eliminated, or streamlined in order to reduce unnecessary burdens on individuals and businesses. This commentary is due by July 31, 2017.

If you have questions about tax regulations and how these rules could affect you or your business, please contact our International Tax Services team.