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How Proposed Regulation 385 Could Impact Corporate Treasury Although specific impact would of course vary by company, proposed regulation 385 could have a profound impact on a company’s ability to effectively and efficiently fund its operations and manage global liquidity.

How Proposed Regulation 385 Could Impact Corporate Treasury

How Proposed Regulation 385 Could Impact Corporate Treasury

by Rob Vettoretti, Managing Director, PwC Advisory


On 4 April 2016, the Internal Revenue Service (IRS) and the US Treasury Department issued proposed regulations under Section 385 targeting related party funding transactions, specifically addressing whether a debt instrument should be treated as debt, equity, or a combination thereof, for US federal income tax purposes. In addition, these proposed regulations would establish significant documentation requirements in order for certain related-party transactions to be treated as debt for US federal income tax purposes. 

Although these proposed regulations are intended to limit ‘earning stripping,’ using cross-border debt to reduce US income taxes, their application is so broad that they would impose prohibitive tax costs on many routine treasury activities and could have a profound impact on how treasury effectively deploys and manages cash globally. 

The proposed regulations, which could be finalised by late summer or early fall 2016, will be effective for transactions executed on or after 4 April, 2016 and apply to related party debt transactions of an “expanded group”; basically, intercompany financing for closely related parties.


The proposed regulations introduce the following key concepts: 

1. Treating related party debt as equity or partly debt and equity

a. Broad categories of related party debt could be re-characterised as equity. This includes (i) notes distributed to shareholders, (ii) notes issued to acquire related party shares, and (iii) notes issued in certain company reorganisations.
b.  Related party debts could also be re-characterised as equity to the extent the borrower pays dividends, acquires shares of affiliates, or participates in certain intercompany reorganisations within a three-year period either preceding or following the borrowing.

2. Documenting related party debt transactions

a. Companies would be required to prepare contemporaneous documentation to substantiate the debt treatment of all related party debt instruments. Legal agreements providing enforceable creditor’s rights and contemporaneous evidence of the borrower’s credit worthiness (via cash flow projections, financial statement analysis, ratios, etc.) would both be required.

b. Companies would be required, contemporaneously and over the outstanding debt period, to document payments of principal and interest and collection efforts in case the borrower does not make the required payments.

c. For revolvers and cash pools, companies would be required to provide and maintain relevant documents, such as board resolutions and credit agreements, and document arrangements governing the on-going operations, including internal banking services.


There are a few exceptions that would affect the above, most notably (1) adjustments based on the amount of current year earnings and (2) whether the total amount of expanded group debt is below $50 million. (For more detail, see PwC Tax Insights)

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