Proposed Section 385 Regulations

In April 2016, IRS issued proposed regulations under IRC section 385 which would dramatically change the treatment of intercompany debt issued among the members of certain corporate groups. The proposed regulations would apply to debt instruments issued on or after April 4, 2016 if finalize. Based on the President’s public remarks targeting corporate inversions, tax professionals expect IRS to finalize this package before the end of the Obama Administration. In general, the proposed regulations would:

• Treat as stock certain related-party interests that otherwise would be treated as indebtedness for federal tax purposes.
• Authorize the IRS to treat certain related-party interests in a corporate as indebtedness in part and stock in part for federal tax purposes.
• Established extensive documentation requirements in order for certain related-party interest in a corporation to be treated as indebtedness for federal tax purposes.

If the documentation and information requirements are not satisfied on a timely basis, then the instrument will be treated as equity for federal income tax purposes. The documentation and information that must be prepared on a timely basis to satisfy the requirements of this section include written documentation establishing:

• That the issuer has entered into an unconditional and legally binding obligation to pay on demand at one or more fixed dates,
• That the holder has the rights of creditor to enforce the obligation,
• That, as of the date of issuance of the instrument and taking into account all the relevant circumstances, the issuer’s financial position supported a reasonable expectation that the issuer intended to, and would be able to, meet its obligations pursuant to the terms of the instrument,
• Evidence of payments of principal and interest, and in the event payments were not made, the holder’s efforts to assert its rights as creditor.

Take Away

When companies issue debt instruments to related corporations and partnerships, the instruments must have characteristics in form and in substance, and must fulfill documentation requirement provided under the 385 regulations to avoid any complicit with taxing authorities.

FATCA Reporting Requirement for Domestic Entities

IRS has announced about the final regulations of 6038D requiring a “specific domestic entity” to make an annual disclosure of its specific foreign financial assets. This regulation is effective for taxable years beginning after December 31, 2015.

The final regulations extend the Form 8938 reporting requirement to specific domestic entities. A specific domestic entity is defined as a domestic corporation, domestic partnership or a domestic trust “formed or availed” of for purposes of holding (directly or indirectly) specific financial assets.

An entity is “formed or availed” for purpose of this regulation if below two conditions are met:

1. The entity must be closely held – 80% constructive ownership requirement.
2. At least 50 percent of income or assets are passive in nature.

It is anticipated that the IRS will modify current Form 8938 to incorporate entity filers. Please refer to the Regulation section 6038D-6 (attached below) or contact our office for further detail.

6038D Final Reg.pdf

Increase Enforcement of IRC Section 6038B Disclosure Requirements

The IRS Large Business and International (LB&I) division publicly announced that it will increase enforcement of IRC section 6038B disclosure requirement. A formal training material has been distributed to field agents, and each entity needs to ensure that it is in compliance of the disclosure requirement. https://www.irs.gov/pub/int_practice_units/fen9433_01_12r.pdf

Here is a quick summary of IRC section 6038B.

Under IRC section 6038B, a disclosure must be made with annual return when:

(1) US person (i.e. individuals, corporations, estates and trusts) transfer property to a foreign corporation in exchange for sections 332, 351, 354, 355, 356 or 361 (mainly stock related exchanges – see additional info below);
(2) US person contributes property to a foreign partnership; or
(3) US person makes a distribution under 336 to a person who is not a US person

Failure to comply with the reporting requirement may result in a penalty equal to 10 percent of the value of transferred property up to $100,000. Please ensure that you file Form 926 to fulfill the 6038B reporting requirement when applicable.

332 – liquidation
351 - in exchange for stock
354 – Reorganization
355 – Distribution
356 – Additional consideration
361 – nontaxable distribution
721 – partnership contribution
336 – property distribution in a complete liquidation

If you have any question regarding this update, please contact our office.