Proposed Tax Regulations Take U.S. in Wrong Direction

By at 26 August, 2016, 3:33 pm

 treasury seal

by Raymond J. Keating-

Remember all of the talk about bipartisan agreement that U.S. corporate taxes are non-competitive? Well, you wouldn’t know any of that was going on judging by the effort at the U.S. Treasury Department to impose more tax-related regulations in the hopes of increasing revenues from businesses.

What are we talking about here? It’s a proposal from the Treasury Department under Section 385 for authority to redefine business debt as equity under certain circumstances. As PWC explains: “The Proposed Regulations appear to be intended to limit the effectiveness of certain types of tax planning by characterizing related party financings as equity, even if they are in form straight debt instruments. The types of transactions targeted appear to include debt through note distributions in the inbound and outbound context, and debt repatriation in the outbound context.”

There are myriad concerns about the reach and cost of this effort.

For example, as PWC continued: “It is critical to note, however, that the application of these Proposed Regulations is not limited to these types of transactions; the Proposed Regulations would instead apply generally to characterize as equity broad categories of related party debt transactions that routinely arise in the ordinary course of operations in both the domestic and international context. The Proposed Regulations therefore could have a profound impact on a range of modern treasury management techniques, including cash pooling.”

On August 22, the Ways and Means Committee raised serious questions in a letter to Treasury Secretary Jack Lew. As reported:

“House Ways and Means Committee Chairman Kevin Brady (R-TX), Tax Policy Subcommittee Chairman Charles Boustany (R-LA), and all other Committee Republican Members sent a second letter to Treasury Secretary Jacob Lew reiterating their strong concerns about how Treasury’s proposed section 385 regulations could hurt American businesses, jobs, and our economy. The letter comes after House and Senate tax-writing Committee Members met with Treasury officials to discuss specific substantive problems with the proposal that must be addressed.”

Among the various points raised, it was pointed out that such an effort warrants full and deep consideration of its impact. As written:

“Treasury has received hundreds of pages of comments detailing concerns about the proposed regulations and stakeholders continue to identify additional concerns about the sweeping rules in the proposed regulations… As we stressed during our July 6 discussion, any proposal that would effectuate such a broad change to the U.S. tax law should be analyzed for the potential effects on the American economy before any finalization.  In light of the far-reaching effect that the proposed regulations would have on business operations in the United States and abroad, stakeholder input must be a part of such analysis. Moreover, as you well know, the conduct and submission of an economic cost-benefit analysis is a requirement under the guidelines for major rules outlined in the Congressional Review Act before regulations of this magnitude can be made effective.”

They concluded: “The proposal would have the effect of blocking the ability of businesses to operate effectively and efficiently and to grow and hire new workers. Ultimately, if the proposed regulations are not completely overhauled, they would damage our economy, increase the barriers to investment for American businesses and innovators, and interfere with the growth of the good-paying jobs American workers need and deserve.  We cannot allow this to happen.”

Indeed, many have weighed in the potential costs and ills. For example, Dorothy Coleman, vice president of tax and domestic economic policy for the National Association of Manufacturers, observed:

“It’s very clear to the NAM that the regulations are going to threaten economic growth, investment and jobs. The additional costs are going to take resources away from much-needed investment, and it’s also going to discourage companies from investing in the United States. And I think it’s also important to note that the proposal goes well beyond tax policy. Even though it came under the umbrella of anti-inversion guidance from Treasury…it’s obvious these [regulations] are very far reaching and really have a severe impact on a company’s finance and treasury functions, particularly their cash management.”

Small Businesses Threatened Too

And it’s not just big businesses that would be impacted. Smaller businesses are threatened as well. Consider points made in a letter to Secretary Lew from United States Senators Dean Heller (NV), Mike Crapo (ID), Pat Roberts (KS), John Cornyn (TX), John Thune (SD), Johnny Isakson (GA) and Tim Scott (SC):

• “Over the past few months, we have heard from numerous stakeholders, including small businesses, business associations, and companies with operations in our home states that would be impacted if the proposed regulations are implemented without significant alterations.”

• “Far from the stated intent of addressing abusive tax transactions, we are concerned that the actual effect of these regulations will be to drive investment and capital outside of America’s borders, further eroding the U.S. tax base.  In our view, creating obstacles to job creation and impeding economic growth should not be the outcome of any proposed Treasury regulations.”

• Among the reforms mentioned in the letter, some were directed at the impact on small businesses. For example: “Ensure that S corporations, a critical component of America’s small business community, do not lose their S corporation tax status by virtue of having their debt re-characterized as equity and are not penalized for their domestic-to-domestic transactions.” Also: “Expand the $50 million intercompany debt threshold so that more small businesses will be exempt from these rules.”

U.S. Treasury’s Authority Questioned 

Finally, in its conclusion, PWC raised questions about the Treasury’s authority, or lack thereof, to undertake such regulatory changes. It was noted:

“Although Treasury has had broad regulatory authority under Section 385 since 1969, it has been over 30 years since the Treasury’s last effort to promulgate regulations. The broad regulatory authority is not unlimited. It grants Treasury authority to write regulations distinguishing between debt and equity based on a series of factors that reflect the principles of long-standing common law. Rather than adopting the common law principles included in Section 385 in a coherent set of regulations, Proposed Regulations would treat debt that is clearly debt under common law principles as equity based solely on the common ownership of the issuer and holder.”

In a very real sense, this Treasury effort is another sign of why we need tax reform that reduces rates and burdens, simplifies and rationalizes the tax system, and makes it more pro-growth, rather than imposing more regulations and burdens. The seven senators noted above were correct in writing:

“As supporters of overhauling our broken tax code, we strongly believe that tax reform, done the right way, can promote job growth and strengthen our nation’s global competitiveness.  Given our concerns over job growth and global competitiveness, we are deeply concerned with the Treasury Department’s proposed debt-equity regulations under Internal Revenue Code section 385 … that were released on April 4, 2016.”

The idea should be to reform the tax code so that investors and businesses rush to invest and do business in the U.S., as opposed to imposing rates and regulations that create incentives to set up shop elsewhere.


Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

Keating’s latest book published by SBE Council is titled Unleashing Small Business Through IP:  The Role of Intellectual Property in Driving Entrepreneurship, Innovation and Investment and it is available free on SBE Council’s website here.

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