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New tax rules aim to end corporate practice of “earnings stripping,” P.1

Back in October, the U.S. Treasury Department announced new regulations aimed at addressing corporate tax avoidance, particularly through the use of tax inversion. The term refers to common corporate practice of acquiring small foreign competitor companies in nations with low tax rates and then relocating the corporation’s legal domicile to the foreign nation.

The aim of tax inversion is to avoid tax liability. Companies that engage in tax inversion often make use of interest deductions to foreign corporate headquarters in order to reduce their corporate taxes in the United States. This is known as earnings stripping, and is a practice that the new rules seek to discourage.

Extensive and complex documentation is one of the centerpieces of the new rules. Corporations will be required to file paperwork related to interest deductions on loans from related parties, such as those between corporations and major shareholders or between corporations and business affiliates. That beings said, the final rules landed on a more relaxed approach regarding the timing of documentation requirements than was initially proposed, and also extended the time required to come into compliance.

The Treasury Department also included certain exemptions to the rules. One noted area of exemption is for cash pooling in overseas accounts and short-term overseas loans. Exemptions will also be applied to some entities for which the risk of earnings stripping is low, including some foreign subsidiaries of U.S. multinational corporations and regulated financial institutions.

The Treasury Department refused, however, to roll back the rules altogether as was widely requested by the corporate world. In our next post, we’ll continue looking at this topic and at the importance of companies working with experienced legal counsel to engage in offshore tax planning, both with respect to the new rules and in general.

Source: CNBC, “Treasury takes new step to keep corporate taxes in the US,” Christine Wang, Oct. 13, 2016. 

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