Final regulations addressing the treatment of certain related-party indebtedness as equity for US federal income tax purposes were released on May 13, 2020. The regulations finalize without material change regulations that were issued as temporary and proposed regulations in 2016. In finalizing the regulations, the Internal Revenue Service (IRS) eliminated uncertainty that resulted from the expiration of the temporary regulations at the end of 2019. The temporary and proposed regulations provided certain exceptions to rules that treat certain related-party indebtedness as “per se” equity for US federal income tax purposes, as well as rules for transactions involving partnerships and consolidated groups. In Notice 2019-58, the IRS advised taxpayers that they could continue to rely on the exceptions included in the temporary and proposed regulations after the expiration of the temporary regulations. The issuance of the final regulations means that taxpayers no longer need to rely on Notice 2019-58 for purposes of applying the rules contained in the proposed regulations.
The section 385 regulations as finalized treat certain related party indebtedness that is issued within three years of a distribution by the issuer as equity for US federal income tax purposes (the “Distribution Regulations”). A Notice of Proposed Rulemaking issued in November 2019 indicated that the IRS and Treasury intend to issue more streamlined and targeted Distribution Regulations. The preamble to the final regulations indicates that the IRS and Treasury believe the Distribution Regulations continue to be necessary, although reiterating the intention to issue more targeted rules.
| Eversheds Sutherland Observation: The final regulations provide additional certainty to taxpayers with respect to the application of exceptions to the Distribution Regulations that were included in the temporary and proposed regulations, but do not provide any additional relief from those rules. The Distribution Regulations continue to be a trap for the unwary, affecting many transactions that do not give rise to the stated concerns that were to be addressed by the section 385 regulations, as recognized by the IRS and Treasury in the 2019 Notice of Proposed Rulemaking. Hopefully, with the finalization of the proposed regulations there will be renewed focus on regulations that will streamline the Distribution Regulations. The final regulations do not give any indication as to when such regulations may be issued. |
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