Rolling Out Section 385 and Other Transfer Pricing Updates from the Fourth Quarter of 2016 (article)
Developments impacting transfer pricing activity continued to be prevalent during the fourth quarter of 2016.
Section 385 Regulations
After receiving public comments, the IRS released final and temporary regulations under Code Section 385, which drastically limited the scope of the proposed regulations on related party financing transactions that could possibly serve to dissolve the U.S. tax base. The extent of the final and temporary regulations is fundamentally narrower than the proposed regulations, as the new rules apply only to obligations in excess of $50 million that are issued by domestic C corporations to related parties.
The final and temporary regulations potentially recharacterize debt as equity for U.S. federal income tax purposes where the purported debt fails to meet new documentation requirements. Debt is also recharacterized where it is part of a distribution, an acquisition of member stock, or an exchange for member assets in certain types of reorganizations. A recharacterization curtails the amount of tax benefits (e.g., interest deductions) available to the debtor.
Generally, the final regulations apply to taxable years ending on or after Jan. 19, 2017. The new documentation requirements apply to instruments issued on or after Jan. 1, 2018. Further, recharacterization rules apply to debt instruments issued or deemed issued on or after April 4, 2016.
Country-by-Country Reporting Draft Form Released
The IRS released final regulations that require annual country-by-country reporting (CbCR) of certain income and tax payment data from United States persons who are the ultimate parent entity of a multinational enterprise group. The final regulations affect multinational enterprise groups that have annual revenue for the preceding accounting period of $850 million or more. These regulations took effect on June 30, 2016.
At the time of publication of the proposed regulations, the CbCR form described in the proposed regulations had not been officially designated. The final regulations amend the proposed regulations to reflect the official number of the Country-by-Country Report Form (Form 8975).
The Form 8975 draft tax form was posted by the IRS on Dec. 8, 2016. Also posted that day was the draft IRS Form 8975, Schedule A, Tax Jurisdiction and Constituent Entity Information.
This is an early release draft of Form 8975, which the IRS provides as a courtesy. Drafts of tax forms should not be used for actual taxpayer filings. IRS forms generally are subject to The Office of Management and Budget (OMB) approval before they can be officially released. Drafts of instructions and publications usually have some changes before being officially released.
The draft Form 8975 includes two parts. Part I requires identification of the filer, including its name, address, and EIN. Part II requires additional information related to the multinational enterprise group. Additionally, the draft Form 8975, Schedule A is to be completed for each tax jurisdiction of the multinational enterprise group, and includes three parts. Part I requires tax jurisdiction information, such as revenues, profit, income tax paid and accrued, stated capital, accumulated earnings, number of employees, and tangible assets other than cash and cash equivalents. Part II requires constituent entity information, including identification of constituent entities residing in the tax jurisdiction, associated tax identification numbers, the entity’s tax jurisdiction of organization or incorporation, and the entity’s business activity code. Finally, Part III provides space for additional information related to the information reported in the prior two parts.
Publication of Multilateral Instrument Regarding BEPS
To lessen the potential for tax avoidance by multinational businesses, more than 100 jurisdictions recently agreed to implement a series of tax treaty measures. More than 2,000 tax treaty measures were created to reflect provisions supported by the Organisation for Economic Co-Operation and Development (OECD) / G20 Base Erosion and Profit Shifting Project (BEPS). The OECD released the multilateral instrument, along with an Explanatory Statement on Nov. 24, 2016, to help improve the international tax system and implement the tax treaty-related BEPS measures.
Implementation of BEPS will require changes to model tax conventions, as well as the bilateral tax treaties based on those model conventions. The large number of bilateral treaties would make bilateral updates to the treaty network very burdensome, so in its Action 15 Report, BEPS outlined the creation of a multilateral convention.
The Action 15 Report concluded that a multilateral instrument provides an innovative approach to assist countries with swift modification to their bilateral tax treaties that will implement measures developed in BEPS. The Action 15 Report provided that this approach is both desirable and feasible and that negotiations for such an instrument should convene quickly.
Participating governments are preparing lists of treaties that will be covered by the multilateral instrument and will notify the OECD once they are finalized. The multilateral instrument was opened for signature on Dec. 31, 2016 and a signing ceremony will take place in June of 2017 by participating countries.
For More Information
For specific comments, questions or concerns about how Section 385 or the BEPS initiatives will affect your tax planning, please contact us.
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