The most important difference in the tax treatment of debt and equity is the deductibility of current payments. Interest payments on debt securities are deductible to the payer, while no comparable deduction is allowed for distributions to shareholders. While the proposed rules have far-reaching implications for multinational enterprises in terms of documentation and other possible consequences, the proposed rules do not change the basic definition of what constitutes equity and what constitutes shares. Reverend Rul. Article 68-602 is such a trap that must be avoided before a member is reorganized. In the judgment, parent company P and its wholly-owned subsidiary S filed a consolidated federal declaration, and P had lent S funds, so S was considered insolvent. In order to resolve the insolvency and liquidate S tax-free, P cancelled S`s debts and treated the cancellation as a capital contribution in accordance with the Regulations. § 1.61-12. As part of a single plan, S then liquidated in P. However, the judgment concluded that the cancellation of S`s debt was temporary and an integral part of the liquidation and had no independent significance except to secure P the historical tax advantages of S`s net operating losses.
As Regs. Article 1.332-2(b) requires at least partial payment in exchange for the shares of the liquidating company, with failure to comply with the intercompany decision ultimately meaning that S was not solvent at the time of liquidation and was therefore not eligible for the treatment of Section 332, resulting in a taxable liquidation. Typically, a greater tax advantage arises when an instrument is treated as debt and not as capital. Therefore, taxpayers should work with their advisors to ensure that the transactions they treat as intercompany debt transactions are complied with as such by the IRS. Reverend Rul. 78-330 may offer some taxpayers an alternative to Reverend Rul. Problem 68-602. In that judgment, P owned two wholly owned two subsidiaries, S1 and S2, and intended to eliminate S2, a member in a situation similar to that of the subsidiary in rev. Rul. 68-602. In the present case, according to the intra-group decision, S2 was merged laterally with and into S1 as part of a statutory merger pursuant to Article 368(a)(1)(A).
Unlike Reverend Rul. 68-602, debt relief received independent economic importance, since the alleged contribution actually altered the previous debtor-creditor relationship between P and S2. The decision appears to provide for an exit for the elimination of a previously insolvent member, where a sister member can act as a purchaser. Given the magnitude of these tax concerns, a company that uses intercompany loans should be willing to submit to a tax audit focused on the underlying reasons and documentation of those loans. The use of intercompany loans can lead to tax problems, as the issuing business unit would have to enter the interest income on the loan, while the beneficiary unit would have to record the interest costs – both are subject to tax regulations. In addition, the interest rate associated with such a loan should be that which would be derived from an independent transaction with a third party. In this module, you will be introduced to other types of intercompany transactions as well as non-controlling participations. You will learn about consolidation adjustments for intercompany transactions with depreciable assets and intercompany liabilities. Non-controlling participation (NCI) is introduced. You will learn how to define, calculate and present non-controlling interests and consolidated result attributable to the NCI in the consolidated financial statements.
In addition, you will learn how to report consolidated retained earnings and the subsequent valuation of non-controlling interests. Finally, an example of consolidation with non-controlling holdings is presented. The application of the above-mentioned regulations should not be limited to intra-group restructuring, but may also be taken into account in the case of a sale to a third party. In particular, solvency may be a matter related to an asset sale transaction under Section 336(e) or Section 338(h)(10). In these cases, it is assumed that the “old” target will be liquidated after the hypothetical sale of its assets to the “new” target. Even liquidations considered as liquidations are subject to § 332, so the insolvency of the target company before the transaction is taken into account by Reverend Rul. 68-602 may require. This was the case at chief counsel advice 200818005, where the IRS, citing Reverend Rul. 68-602 and unlike reverend Rul. 78-330 concluded that a section 332 liquidation did not occur as part of an asset sale election, as the target member`s pre-sale intercompany balances led to its solvency.
The proposed rules in section 385 would not change the factors that are considered or the way in which debt and equity are generally distinguished. However, these proposed regulations add a class of debt securities that would be treated as equity per se by the IRS. These debt securities include instruments issued in the context of a corporate restructuring and/or distribution. Taxpayers filing consolidated federal returns often try to eliminate legal entities in order to reduce administrative costs and simplify the structure of the business. One of the first considerations in this process is how to resolve intercompany accounts. Once the balances have been cleared between members and the available money has been used for repayment, it may be necessary to transfer the receivables within the group of holders until they can be transferred to the debtor member as part of a capital contribution. While such decisions are usually made without a general impact on federal taxes, there are pitfalls for the unwary, especially when the eliminated businesses have experienced financial difficulties. Let`s take a look at the intercompany credit calculations: Even if the general arm`s length standard is met, the IRS can claim that a debt instrument based on the facts and circumstances surrounding the particular instrument consists of shares. Judicial precedence and informal IRS statements have given us guidance on the criteria the IRS will consider when distinguishing between debt and equity. Some of the following factors include: Prior to 1969, the issue of debt versus equity was addressed on a case-by-case basis, balancing the relevant facts and circumstances. With the passage of Section 385 in 1969, the Treasury Department was given the right to issue regulations that would provide guidance on what constitutes debt to shares. .