The Tax Court, in American Metallurgical Coal Co., TC Memo 2016-139, recently held that financing of a sale of partnership interests by a foreign seller to a U.S. buyer was not debt, but equity. The court found that the parties failed to act consistent with an arm’s-length creditor-debtor relationship, despite the obvious U.S. tax advantages of debt treatment to both sides—the portfolio interest exemption for the foreign seller and interest deductions for the U.S. buyer. As the Treasury and IRS work to finalize the expansive anti-earnings stripping regulations proposed in April under Code Section 385, this case should be a warning to taxpayers that the government is already willing and able to challenge financing arrangements they think run afoul of arm’s-length debt standards.
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