Treasury Dropping Hints on Earnings Stripping

Treasury Department officials are stating publicly the potential methods it is considering to reduce the benefit of inversion transactions through so-called “earnings stripping.”  According to reports of an October 29 panel discussion, Treasury is considering cutting back on interest deductions under section 163(j), or treating certain instruments as equity rather than debt under section 385.

Treasury issued Notice 2014-52 in September (see our prior post), announcing forthcoming regulations which would impact what mergers would be within the purview of section 7874, the tax code’s primary section addressing inversion transactions, and reducing the benefit of certain transactions which may occur after an inversion.  In the Notice, the IRS said they were considering guidance to address strategies on earnings stripping and sought comments, but provided no details.  The recent public statements hint at the specific means Treasury is considering.

One approach would be to enact a provision similar to section 163(j), reducing the availability of an interest deduction for U.S. corporations that are subject to the 7874 rules.  Another discussed option is to reclassify, under section 385, certain instruments as equity rather than debt, thereby eliminating any interest deduction on those instruments.  This section option has been widely mentioned following its proposal by Harvard professor Stephen Shay (see Shay’s Tax Notes article, subscription required).

The Treasury Dept. officials acknowledged that nothing has been issued yet and perhaps may not be necessary if Congress addresses inversions in the coming months.

Read more information on the panel discussion at Tax Analysts and BNA (both subscription required).

Read Notice 2014-52

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