United States: New Intercompany Debt Rules Shock Multinational Companies


On April 4, 2016, the United States Treasury and the Internal Revenue Service ("IRS") issued proposed regulations under §385 of the Internal Revenue Code (the "Code"). The §385 regulations were issued in tandem with new inversion regulations, but are much broader in their application (for example, they apply to all U.S. multinationals) and would have a significant negative impact on multinational companies that desire to issue intercompany debt. The proposed regulations extend beyond prescribing rules to determine whether an interest should be treated as stock or indebtedness. As described below, some aspects of the new rules are applicable beginning on April 4, 2016.

Documentation Requirements

Proposed Treasury Regulation §1.385-2 imposes new threshold documentation requirements to treat an instrument between members of the same expanded group ("EGI") as debt. Once the threshold documentation requirements are satisfied, the instrument is still subject to the debt-equity factors set out in case law. If the contemporaneous documentation requirements are not satisfied, the instrument is treated as stock. There is a reasonable cause exception.

An "expanded group" is based on an 80% vote or value relatedness standard. A consolidated group is treated as one corporation for purposes of these rules. The Treasury has stated that the definition of expanded group may get narrower, among other possible modifications to these new proposed regulations.

Additionally, the documentation requirements only apply to expanded groups if the stock of any member is publicly traded, or financial statements of all or any portion of the expanded group show total assets exceeding $100 million or annual total revenue exceeding $50 million.

There are four documentation requirements—the first three must be in place within 30 days of issuance of the instrument and the fourth must be in place within 120 days of the payment due date or an event of default.

First, the parties must have written documentation establishing that the issuer entered into an unconditional and legally binding obligation to pay a sum certain on demand or at one or more fixed dates. Second, the written documentation needs to establish that the holder has the rights of a creditor to enforce the obligation. Typically, a creditor's rights include, but are not limited to, the right to trigger an event of default or acceleration and the right to sue to enforce payment. Creditor's rights must include a superior right to shareholders to share in the issuer's assets upon dissolution. For cash pooling and revolving credit arrangements, these first two requirements could be satisfied with a master agreement.

Third, written documentation must be prepared, as of the date of issuance, containing information establishing that the issuer's financial position supported a reasonable expectation that the issuer intended to, and would be able to, meet its obligations under the instrument. The documentation could include cash flow projections, financial statements, business forecasts, asset appraisals, determination of debt-to-equity and other relevant financial ratios, and other relevant information.

Fourth, ongoing written documentation must be prepared evidencing the issuer's payments or, in the case of non-payment, the holder's exercise of a creditor's diligence and judgment. The Treasury is considering modifying these rules as they relate to cash pooling.

Notably, the four substantiation requirements do not contain an ordinary trade or business exception. Thus, the day-to-day operations of U.S.-based multinational companies and U.S. subsidiaries of foreign based multinational companies would be significantly impacted, resulting in possible delays of funding and the potential need for restructuring of current business operations.

The documentation requirements will apply to any applicable instrument issued or deemed issued on or after the date the regulations are published as final, which is expected to be sometime this year, and to any applicable instrument treated as indebtedness issued or deemed issued before the date these regulations are published as final if and to the extent it was deemed issued as a result of an entity classification election filed on or after these regulations are published as final.

Certain Blacklisted Debt Instrument Transactions and the Funding Rule

Under the "general rule" of Proposed Treasury Regulation §1.385-3, a debt instrument would automatically be treated as stock to the extent it was issued by a corporation to a member of the corporation's expanded group in any of the following blacklisted transactions: (1) a distribution; (2) in exchange for stock of an expanded group member; and (3) in exchange for property pursuant to an asset reorganization within the expanded group.

Under the "funding rule" of Proposed Treasury Regulation §1.385- 3, a debt instrument would be treated as stock to the extent it were issued by a corporation to a member of its expanded group in exchange for property with a principal purpose of funding any of the three blacklisted transactions from the general rule. However, a per se rule establishes a nonrebuttable presumption of failing the principal purpose test. Under the per se rule, a debt instrument issued beginning three years before a blacklisted transaction and ending three years after a blacklisted transaction is automatically treated as stock. Thus, a dividend generally cannot be paid within three years of a blacklisted note issuance.

A few exceptions are available, including an exception for debt that arose in the ordinary course of the issuer's trade or business in connection with purchase of property or receipt of services to the extent it is reflected as an obligation to pay an amount currently deductible under §162 or included in the issuer's cost of goods sold or inventory. Additionally, the aggregate amount of any distributions or acquisitions are reduced by an amount equal to the member's current year earnings and profits and a debt instrument is not treated as stock under the general rule or the funding rule if immediately after it is issued the aggregate adjusted issue price of debt instruments held by all members of the expanded group do not exceed $50 million. Certain anti-abuse rules would apply.

These rules are applicable to any debt instruments issued or reissued (consider Treas. Reg. §1.1001-3) on or after April 4, 2016 and to any debt instrument treated as issued before April 4, 2016 as a result of an entity classification election that is filed on or after April 4, 2016. However, if a debt instrument issued before the regulations are finalized were recharacterized under the general rule or funding rule as stock, it would be treated as debt until 90 days after the regulations are issued as final.

Part Debt-Part Equity

Proposed Treasury Regulation §1.385-1 allows the IRS to treat a modified expanded group related party debt instrument as partly debt and partly stock. For this purposes, a modified expanded group is defined as an expanded group, except 80% is substituted with 50%. The proposed regulations provide no objective standards for the partly debt-partly equity recharacterization. IRS examining agents would be able to subjectively recharacterize debt based on "the relevant facts and circumstances ... under general tax principles." The ability for IRS examining agents to subjectively recharacterize debt creates uncertainty for taxpayers.

Originally published in the 2nd edition of Euromoney Legal Media Group's Expert Guides for the LMG Rising Stars 2016.

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 Mondaq.com.

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

Events from this Firm
17 Oct 2017, Conference, California, United States

Women are a more powerful presence in business than ever, as entrepreneurs and corporate leaders. Join us for a half-day packed with real-worl​d know-how, firsthand experiences and an in-depth look at the entrepreneurial climate today – all designed to help entrepreneurial women take their businesses (and their careers) to the next level.​​

17 Oct 2017, Seminar, California, United States

Ivy Associates presents the annual All Hands Meeting in coordination with the Silicon Valley Association of General Counsel, an association of chief legal officers from more than one hundred leading technology and life science companies.​

17 Oct 2017, Seminar, California, United States

TEDx Wilmington is holding the first TEDx Salon dedicated to ideas worth spreading in transportation on Tuesday, October 17, 2017 in Wilmington, Delaware.

In association with
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
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). 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 & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd 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 or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.