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ARTICLE · 15 NOVEMBER 2016

New Related-Party Debt Rules Target Earnings Stripping

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On October 13, 2016, the Treasury Department and Internal Revenue Service released Final and Temporary regulations under section 385 that broadly impact the tax treatment of certain related-party debt issued by U.S. corporate borrowers.

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Ropes & Gray LLP'S Tax Practice Group
Ropes & Gray LLP'S Tax Practice Group
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I. OVERVIEW.

On October 13, 2016, the Treasury Department and Internal Revenue Service released Final and Temporary regulations under section 385 (the "Regulations") that broadly impact the tax treatment of certain related-party debt issued by U.S. corporate borrowers. When applicable, the Regulations reclassify a related-party debt instrument as equity for tax purposes, including if the U.S. borrower fails to properly document the loan or substantiate its ability to make timely interest and principal payments.

The Regulations curb a range of transactions that use related-party debt to reduce a U.S. corporation's future taxable income. Although the Treasury Department had announced plans to prevent "earnings stripping" by "inverted" companies, these Regulations generally apply to borrowings of a U.S. corporate subsidiary from its non-U.S. corporate parent (or affiliate) regardless of whether the anti-inversion rules apply. The Regulations also apply to a

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