Final U.S. Treasury Regulations Disappoint By Retaining Broad Debt-Equity Recharacterization Rules

The U.S. Treasury Department has issued regulations for debt-equity recharacterization under section 385 of the Internal Revenue Code (the Final Regulations) that finalize without substantive change proposed regulations promulgated in October 2016 (the 2016 Proposed Regulations).

Section 385 recharacterizes certain issuances of related-party debt as equity for U.S. federal tax purposes. (See our prior bulletin titled Final U.S. Debt-Equity Regulations Are Not as Sweeping as Feared.) Under section 385's general recharacterization rule, debt issued by a corporation to an affiliated corporation (or a partnership controlled by an affiliated corporation) is recharacterized as equity if the debt is issued (i) in a distribution, (ii) in exchange for stock of an affiliate or (iii) in certain exchanges for property in an asset reorganization (collectively referred to as Specified Transactions).