Proposed regulations would establish a sweeping framework to treat debt as equity in an effort to curb the use of “excessive” related-party debt.

On April 4, 2016, the US Department of the Treasury (Treasury) and the Internal Revenue Service (the IRS) announced proposed regulations (the Proposed Regulations) under Section 385 to address certain related-party debt transactions perceived as producing significant tax benefits but lacking meaningful non-tax significance. These transactions include “earnings stripping” techniques and repatriation planning that remove certain intragroup payments from the US federal income tax net. Section 385, enacted almost 50 years ago and largely dormant since an amendment in 1992, grants Treasury the authority to prescribe regulations to determine whether an interest in a corporation is properly treated as debt or stock. Regulations were issued in the early 1980s, but their effective date was delayed several times and the regulations were finally withdrawn without ever entering into force. Although the Proposed Regulations were issued as part of a package related to inversion and post-inversion transactions (for more detail regarding those regulations, please see the concurrently published Latham & Watkins Client Alert “Treasury Issues Stringent Inversion Regulations, Proposes Far-Reaching Related-Party Debt Rules”), the Proposed Regulations extend beyond the inversion context, applying generally to taxpayers in both the cross-border and even the purely domestic context.