Section 385 Proposed Regulations on Related Party Debt

Tax Summit – Sept. 26, 2016 Presenters:

Camille Evans – Eastman Chemical Company &

Tasheaya Ellison – Shell Oil Company

AGENDA

Background of Section 385 Stated Purpose for Proposed 385 Regulations Broad Application and Proposed Effective/Applicability Date General Provisions & Some Exceptions Documentation and Maintenance Requirements Some Key Provisions What Happens When Debt Turns to Equity? Unknowns, Issues and What’s Next?

Section 385

Section 385 provides the Secretary is authorized to prescribe such regulations as may be necessary or appropriate to determine whether an interest in a corporation is to be treated for purposes of this title as stock or indebtedness (or as in part stock and in part indebtedness.

Section 385 Overview

Section 385 Background Information:

• Original enactment 1969

• 1989 and 1992 Amendments

• 1992 Amendments

• Issuance and Withdrawal of 1980 regulations

• Case Law

Stated Purpose for Proposed Regulations

Section 385 Proposed Regulations included in Inversion Guidance

Address whether an interest in a related corporation is treated as stock or indebtedness, or as in part stock or in part indebtedness, for purposes of the Code.

Regulations respond to enhanced incentives for related parties to engage in excessive cross border debt.

Lack of Regulations under Section 385

• Interests in corporation treated as indebtedness or equity in part • Documentation of initial characterization of interest

Broad Application of the Proposed Regulations

Applicable to related party transactions between member of an “expanded Group”

“Expanded Group” includes foreign entities, tax exempts and corporations held indirectly through partnerships.

Not applicable to interest and transactions amongst members of a consolidated group.

Broad Application of the Proposed Regulations Applicable only to “large” taxpayer groups

• Member of expanded group is publicly traded

• Expanded groups has financial assets

exceeding $100 million (as reported on financial statements), or

• Expanded groups total annual revenue

exceed $50 million (as reported on financial reports)

Proposed Effective/Applicability Dates

The proposed regulations would be effective when issued as finalized regulations (including documentation requirements)

The proposed regulations would be applicable to debt issued on or after April 4, 2016. • 90 day transition period after the regulations are finalized for

recharacterization of debt as stock.

General Provisions & Some Exceptions

Recharacterizing as stock certain related party interest that would be treated as indebtedness for federal tax purposes

The proposed regulations are generally applicable to the following types of related-party transactions : • Transaction under the General Rules

Certain distributions of debt instruments to shareholders

Loans incurred to acquire related group stock (unless exempt exchange

Loans incurred in connection with certain asset reorganizations

• Funding Rule: Expanded group debt issued with a principle purpose of funding a transaction described above.

Some Exceptions • Current E&P and Threshold Exceptions

Documentation

Timely documentation and final analysis that demonstrates intent to create debtor-creditor relationship with respect to a bona fide indebtedness .

Documentation Requirement (4 key components) • Legally binding obligation to pay the debt

• Creditor’s right to enforce the obligation

• Reasonable Expectation of repayment

• Relationship during the life of the interest that is consistent with arm’s- length relationship between unrelated creditors and debtors

Documentation Maintenance

Maintenance of documentation for all taxable years the issuance is outstanding and until the period of limitations expires

Documentation is required, but not determinative of characterization of the issuance

Lacking details on the manner in which records are to be kept

Reasonable Cause Exception

Some Key Provisions

No affirmative use of the proposed regulations by taxpayers

Anti-Abuse Rule – Debt instrument issued with principal purpose of avoiding the proposed regulations

Coordination Rule – Coordinating between the General Rules and Funding Rules

What Happens When Debt Turns to Equity?

Indebtedness is deemed exchanged in whole or in part for stock

Issuer deemed to retire same portion of the indebtedness that is recharacterized as stock

Determination of the type and terms of the stock

Impact on federal tax benefits claimed with respect to the indebtedness

Many Unknowns and Issues

Cash Pools Related party payments and timing issues Implication of significant modifications to debt Implications of the recharacterization to equity Funding Rule – Non-Rebuttable presumption during 72-month

period Draconian Implications

What’s Next ? When will the final regulations be issued ??

Questions??