Canada: Proposed U.S. Regulations Have Broad Implications For Related Party Corporate Debt

Monday, as part of the Obama administration's announcement of a crackdown on inversions and the release of temporary regulations aimed at tightening the inversion rules (a separate Osler Update on which will be forthcoming), the U.S. Treasury issued proposed regulations that would dramatically change the taxation of corporate debt issued to related corporations having nothing to do with inversions or foreign acquisitions.  Most significantly, the regulations impose new rules under which certain purported related-party debt instruments are deemed to be equity for U.S. federal tax purposes. These new rules have evoked a groundswell of both praise and criticism.

In addition, the regulations (i) authorize the IRS to treat certain related-party interests in a corporation as indebtedness in part and stock in part for U.S. federal tax purposes, and (ii) establish documentation requirements that must be satisfied in order for certain related-party interests in a corporation to be treated as indebtedness for U.S. federal tax purposes. 

These proposed regulations would be a fundamental shift in how U.S. debt/equity analysis is performed and dramatically increase the risk of having debt re-characterized as equity for U.S. tax purposes.  Because certain of these rules have retroactive effect to April 4, 2016, Canadian corporations financing their U.S. subsidiaries with debt (whether that debt is used to finance an acquisition, finance growth or expansion in the U.S. market, or for any other reason) should immediately begin analyzing the potential effect of these rules on their operations.

The proposed regulations apply to related party debt without regard to whether the parties are domestic or foreign, but generally do not apply to transactions among members of a U.S. consolidated group.

Deemed equity treatment for certain related party debt

Under these regulations, debt issued by a corporation is treated as equity for all U.S. federal tax purposes if the debt is not issued for cash or property, but is instead (i) issued in a distribution to a related corporate shareholder, (ii) issued in exchange for stock of a member of the same affiliated group or (iii) issued in an asset reorganization between members of the same affiliated group.  An affiliated group for these purposes is generally a group of corporations (including non-U.S. corporations) in which 80 percent of the vote or value of the stock of each member is owned directly or indirectly by other members of the affiliated group.  Thus, a note distributed from a U.S. subsidiary to its foreign parent in order to "right-size" the subsidiary's capital structure will no longer produce the intended tax consequences.

More broadly, corporate debt issued to a related party for cash or property is generally treated as equity if it is issued with a principal purpose of funding (i) a distribution of cash or property on stock held by another member of the affiliated group, (ii) an acquisition of stock of an affiliated group member, or (iii) an acquisition of property from an affiliated group member in an asset reorganization.  A debt instrument may be treated as having such a principal purpose regardless of whether it is issued before or after the distribution or acquisition in question. 

This "principal purpose" test is subject to an extremely broad, non-rebuttable presumption of a principal purpose to fund a transaction described above if the debt instrument is issued during the period beginning 36 months before a distribution or acquisition described above and ending 36 months after such a distribution or acquisition. There is an exception from the presumption for certain debt instruments that arise in the ordinary course of the issuer's trade or business in connection with the purchase of property or the receipt of services.

These "deemed equity" rules are not applicable with respect to distributions and acquisitions described above in a given year that do not exceed the corporation's current year earnings and profits.  An exception is also provided where the aggregate issue price of all related party debt instruments issued by a corporation that otherwise would be treated as stock under these proposed regulations does not exceed $50 million.  A final exception applies to acquisitions of affiliate stock where debt was issued in a separate transaction if the acquisition results from a transfer of property in exchange for stock, and, for the 36-month period following the issuance, the transferor holds, directly or indirectly, more than 50 percent of the vote and value of the issuer of the debt (e.g., a corporation can invest in its own subsidiary without the acquisition being treated as a described acquisition).

An anti-abuse rule provides a debt instrument or other interest not in form debt is treated as stock if it is issued with a principal purpose of avoiding the application of these proposed regulations.

These rules represent dramatic departures from case law and prior regulations and rules relating to the creation of intra-group debt and are completely different in approach from the proposals to restrict deductions of affiliated debt interest expense that have emerged from the OECD BEPS initiative.

Debt in part/equity in part

Generally, the IRS and courts have tended to characterize an interest in a corporation either entirely as debt or entirely as equity.  The Treasury and the IRS expressed frustration that this "all-or-nothing" approach was problematic where the facts and circumstances provide only slightly more support for characterization of the entire interest as indebtedness rather than equity.  Under regulatory authority that was granted to the IRS in 1989 but not previously exercised, the new regulations permit but do not require the IRS to treat a purported debt instrument issued between related parties as in part debt and in part equity for U.S. federal tax purposes, consistent with the substance of the instrument.  The issuers and related holders of the debt are required to treat the instrument in manner consistent with the issuer's initial characterization.  For purposes of this rule, a 50-percent threshold for relatedness applies.

Required documentation and support for debt characterization

The new proposed regulations prescribe documentation and information that must be prepared and provided to the IRS on request with respect to arrangements that in form are traditional debt instruments issued by a corporation to a related party. These new requirements resemble in many ways the contemporaneous pricing support currently prepared for transfer pricing transactions.  The proposed regulations reserve with respect to documentation of interests that are not in form debt.  Failure to provide this support to the IRS when requested will result in the IRS treating the purported related party debt instrument as equity for U.S. federal tax purposes.  For purposes of these documentation rules, the 80 percent "affiliated group" rule described above is used.

The regulations require timely prepared written documentation that includes a form of debt that evidences legal rights of creditors, support relating to the reasonable expectation of repayment (e.g., cash flow projections, determination of debt-to-equity and other relevant financial ratios of the issuer) and evidence of payments made on the debt or, if the issuer has failed to comply with the terms of the instrument, evidence of the holder's reasonable exercise of the diligence and judgment of a creditor.

In general, the documentation must be prepared no later than 30 calendar days (120 calendar days in the case of evidence of an ongoing debtor-creditor relationship) after the date of the issuance or deemed issuance of the purported debt instrument or other relevant event and must be maintained until the expiration of the statute of limitations for any U.S. federal income tax return for which the treatment of the instrument is relevant.

These documentation requirements are intended to apply only to large taxpayer groups, and only apply if either (i) the stock of any member of the group is publicly traded, (ii) the group's financial statements show total assets exceeding $100 million, or (iii) the group's financial statements show annual total revenue that exceeds $50 million.

Effective dates

The regulations deeming related-party debt to be equity in distributions and similar transactions are generally proposed to be effective for debt instruments issued and distributions or acquisitions occurring on or after April 4, 2016, but, for transactions prior to the finalization of the regulations, any debt treated as equity under these rules would not be treated as debt until 90 days after the finalization of the regulations.  The regulations regarding the treatment of interests as part debt and part equity and the regulations requiring documentation and support for debt characterization are proposed to generally be effective for debt issued or deemed issued on or after the date final regulations are published. 


For non-U.S.-parented groups, the effect of the "deemed equity" rules on their U.S. subsidiaries that have issued debt to non-U.S. affiliates will be to deny any deduction for U.S. tax purposes for interest paid on related party debt treated as equity under these rules, as well as the imposition of dividend withholding tax on interest paid on such debt.  Because of the broad scope of the presumption rules, corporations issuing debt to affiliated group members on or after April 4, 2016 will generally not be able to rely solely on the fact that the proceeds from a related party loan are actually used to invest in the corporation's operations or to acquire assets from third parties (subject to the "ordinary course" exception).  Instead, consideration should be given to whether the corporation has engaged in any described distributions or acquisitions since April 4, 2016 (or may have such transactions in the future) that may taint the new related party loan and whether any exception may apply.

Due to the departure these regulations take from past tax law and practise, substantial comments and criticism are likely. However, the commitment of the U.S. Treasury to these new regulations was made clear in the public statements of Jack Lew, the U.S. Secretary of Treasury, and President Obama over the last two days.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
Davies Ward Phillips & Vineberg
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Davies Ward Phillips & Vineberg
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions