IRS issues final debt-equity rules

by Dentons


On October 13, 2016, the US Internal Revenue Service (IRS) released final and temporary regulations that recharacterize certain debt between related corporations as stock. These "debt-equity" regulations generally adopt in final, and in some cases temporary, form the controversial proposed regulations issued in April of this year, with some modifications in response to the hundreds of comments received from affected parties.

Modification to the rules of the proposed regulations

The proposed regulations released in April were detailed, but they fundamentally included three different (but interacting) sets of rules that would cause debt between related corporations to be treated instead as equity.

  • The Bifurcation Rule would generally permit the IRS not just to recharacterize debt of a corporation as stock of a corporation, but also to treat an interest in a corporation as in part stock and in part debt
  • The Documentation Rule would impose extensive substantiation and documentation requirements on corporate groups that are publicly traded or whose total assets or revenues exceeded certain thresholds
  • The Distributions Rule would treat as stock certain debt that is distributed to or received by another group member or exchanged for stock or assets in another group member, or that is treated as "funding" a distribution covered by the "funding rule"

Many commenters expressed alarm that their day-to-day transactions would be significantly impacted by the proposed regulations, and urged that the final regulations be more narrowly tailored to address perceived abuses.

The final regulations issued on October 13 do respond to certain criticisms of the proposed regulations. In particular, the final regulations

  • Omit the Bifurcation Rule
  • Generally limit the Documentation Rule and Distributions Rule to domestic borrowers
  • Generally exempt S corporations and non-controlled regulated investment companies (RICs) and real estate investment trusts (REITs) from the new rules
  • Clarify that a "snapshot" approach is taken when determining the status of a corporation as a member of an expanded group
  • Relax the timing requirements set forth in the Documentation Rule and replace its "per se" characterization rule for failures to meet the documentation and substantiation requirements with a "rebuttable presumption" recharacterization rule
  • Alter the treatment under the Documentation Rule of an “expanded group instrument” issued by certain disregarded entities and partnerships, treating the recharacterized expanded group instrument as stock in the "regarded" corporate owner of the disregarded entity or a partnership interest
  • Provide exemptions from the Distributions Rule for cash pooling and other short-term loans and generally for regulated financial entities, financial groups, and insurance entities
  • Make substantial modifications to the Distributions Rule by expanding the exception for distributions of earnings and profits, exempting the first US$50 million of debt (i.e., not treating the US$50 million threshold as a "cliff"), permitting netting of distributions and contributions in certain cases, and providing an exception for stock issued as equity compensation to employees, directors and independent contractors

Of particular note to multinational groups, the IRS has postponed indefinitely the application of the final regulations to instruments issued by foreign corporations, which for this purpose includes US branches of foreign issuers. By electing to “reserve” for the time being, the final regulations as drafted generally do not apply to foreign issuers.

Welcome changes were made to the Documentation Rule. This rule generally imposes extensive substantiation and documentation requirements on corporate groups that are publicly traded or whose total assets exceed US$100 million or whose total revenues exceed US$50 million. While generally retaining the substance of the documentation and substantiation requirements, the final regulations eliminate the 30-day preparation requirement that was contained in the proposed regulations and instead impose a deadline that such documentation must be prepared by the time the issuer files its federal income tax return (which includes all applicable extensions). Further, the final regulations provide for a rebuttable presumption in instances in which the taxpayer evidenced substantial compliance with the documentation requirements.

As noted above, extensive changes were made to the Distributions Rule. One feature of the proposed regulations that was a common target of commenters’ criticism was the “per se funding rule.” Under this rule, certain distributions were per se considered to be within the scope of the funding rule if such distribution is made either 36 months following, or was made 36 months prior to, the issuance of the expanded group instrument. While several potential alternatives were suggested by commenters, such as the inclusion of a rebuttable presumption, the IRS decided that it was appropriate to retain the per se funding rule largely as originally proposed.

Finally, the omission of the Bifurcation Rule significantly shrinks the pool of taxpayers subject to the final regulations, as the omission takes with it the concept of a "modified expanded group" that was, in essence, an expanded version of the "expanded group."

Who is affected by the regulations

Section 385 of Internal Revenue Code, the main authority under which the regulations were promulgated, addresses when stock should be treated as debt and vice versa. It, and the regulations, generally do not cause debt to be treated as another kind of equity, such as an interest in a partnership. As such, the regulations primarily apply to corporations that have other corporate affiliates.

Nonetheless, the rules include special rules to deal with partnerships and disregarded entities that have corporate owners, or that own corporations and therefore are included in the corporation’s expanded group. Importantly, the final regulations reduce the scope of the expanded group as compared to the proposed regulations, in part by narrowing certain attribution rules and choosing to "reserve" as to the application of the attribution rules to brother-sister groups. However, while the final and temporary regulations certainly will apply to fewer taxpayers and instruments than the proposed regulations would have, the scope of the final and temporary regulations is still significantly broad.

Effective date

The final regulations generally apply to taxable years ending on or after 90 days after October 21, 2016 (i.e., January 19, 2017). For taxpayers with a calendar year fiscal year, the new rules will be effective beginning in 2017. Further, the new Documentation Rule applies only to interests issued (or deemed issued) on or after January 1, 2018. The Distributions Rule will apply to debt instruments issued on or after April 5, 2016, subject to a detailed transition rule, but the 90-day delay in the effective date is intended to give affected taxpayers time to readjust their funding structure before becoming subject to the new rules.


The final regulations require corporate groups with significant operations and US members of the group to review and likely change their practices regarding transfer of funds between affiliates. Even though the regulations include exceptions and special rules that exempt many corporations and issuances of debt from the new rules, corporations must document—and show that they continue to maintain—eligibility for any such exemption or special rule.

Those corporations fully subject to the new regulations will need to adopt new procedures and mechanisms to meet the new documentation and compliance requirements. Yet that will be only the start; corporate transactions must be carefully monitored to ensure that a distribution or other transaction does not inadvertently trigger the new rules. Also, there will inevitably be transactions that cause what was thought to be debt to be treated instead as stock. For this reason, before undertaking transactions in which stock ownership thresholds are relevant, corporations must analyze prior transactions to determine whether those prior transactions have inadvertently triggered the new regulations, thereby changing the ownership and relationship of the parties engaged in the planned transaction.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Dentons | Attorney Advertising

Written by:


Dentons on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.