June 16, 2016
The U.S. Department of the Treasury recently issued new rules to offset tax benefits afforded to companies that re-incorporate in foreign jurisdictions having lower corporate tax rates. In April 2016, the Department introduced temporary regulations to exclude the prior three years of mergers with U.S. companies when determining the size of a foreign company, thereby making it more likely for a company that has engaged in several inversions in recent years to continue being subject to U.S. taxes.
The Treasury is also proposing new rules allowing the Internal Revenue Service to require documentation about the nature of debt obligations from a U.S. subsidiary to its parent company, with the ability to reclassify some or all of the debt as equity if the loan does not meet certain qualifications. This change would limit the ability for the U.S. company to write off interest payments against that debt in an approach known as "earnings stripping." Partner and chair of Torys' Tax Practice, Corrado Cardarelli, was asked to comment on the effect these changes may have, in particular for Canadian companies with U.S. subsidiaries. Below is an excerpt from the article.
He [Cardarelli] says the changes mean "a shift in the way debt equity rules have been understood and applied." "This is a really big shift from the judge-made rules that we understood to these new proposed complex regulations, so it makes it harder to finance U.S. subsidiaries, it increases the rise of debt in those U.S. subsidiaries re-characterized as equity, says Cardarelli. "Lots of care and attention has to be paid to these new rules."
Cardarelli says the U.S. has been challenging inversions since about 2014, to make it harder for companies to invert and more difficult for companies to obtain the benefits.
Cardarelli says that can mean new challenges for Canadian companies that are not inverting but "trying to do the same thing they've always been able to do in terms of creating debt in the U.S. group…That's the advice we're giving Canadian corporations, 'You know, be careful, because things you thought you could do to create debt in the U.S. group you may not be able to do anymore or not successfully.’"
For the latest from our tax team on U.S. inversions, earnings strippings and more, read “U.S. and Canada Tax Developments,” available here.