New rules on taxation of intercompany debt

Federal regulation of businesses is poised to change with the new administration, with important implications for tax compliance.

President-elect Trump has promised to roll back business regulation across the board. And with his surprising victory this week, he is in a position to put that promise into practice.

But it doesn’t necessarily take a change of administration for there to be changes in tax rules to benefit businesses. In this post, we will inform you about one such change. It concerns “cash pooling,” a technique that raises concern for regulators about so-called “earnings stripping.”

Last month, the Treasury Department announced changes to new rules on transactions that use intercompany debt as a strategy to avoid taxes in the U.S.

The rules are broader of a broader initiative by Treasury announced in April to make it more difficult for companies to use cross-border inversion transactions to avoid U.S. taxes. In an inversion transaction, a U.S. company acquires a partner abroad and reincorporates there to minimize its tax obligations in the U.S.

Business groups in Texas and elsewhere have challenged those rules as exceeding the department’s legal authority under the tax code. We wrote about that in our August 20 post.

In October, Treasury relaxed the new rules by creating several exemptions. The exemptions apply to certain foreign subsidiaries, as well as banks and insurance companies with financial interests in companies.

The exemptions that took effect in October also apply to a practice called “cash pooling.” Cash pooling is technique for managing their cash by which companies in effect make short-term loans to subsidiaries to avoid taxes on earnings. The concern among regulator is that these transactions can be used to avoid taxes through “earnings stripping.”

The rules that took effect in April imposed detailed reporting requirements for cash-pooling transactions. The relaxation of the rules announced in October will lighten those obligations. For example, transactions that occur among members of a consolidated group will receive an exemption.

There is considerable uncertainty, however, about how state revenue agencies will view these transactions. Some state tax codes are automatically tied to the federal code, but others are not.

And of course, with the new federal administration coming in January, federal rules could change again soon as well.