Proposed Removal of Section 385 Documentation Regulations, 48265-48271 [2018-20652]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 83, Number 185 (Monday, September 24, 2018)]
[Proposed Rules]
[Pages 48265-48271]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-20652]


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Proposed Rules
                                                Federal Register
________________________________________________________________________

This section of the FEDERAL REGISTER contains notices to the public of 
the proposed issuance of rules and regulations. The purpose of these 
notices is to give interested persons an opportunity to participate in 
the rule making prior to the adoption of the final rules.

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Federal Register / Vol. 83, No. 185 / Monday, September 24, 2018 / 
Proposed Rules

[[Page 48265]]



DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-130244-17]
RIN 1545-BO02


Proposed Removal of Section 385 Documentation Regulations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document proposes removing final regulations setting 
forth minimum documentation requirements that ordinarily must be 
satisfied in order for certain related-party interests in a corporation 
to be treated as indebtedness for federal tax purposes (Documentation 
Regulations). This notice of proposed rulemaking also proposes 
conforming amendments to other final regulations to reflect the 
proposed removal of the Documentation Regulations. The final 
regulations to be amended and removed generally affect corporations 
that issue purported indebtedness to related corporations or 
partnerships.

DATES: Written or electronic comments and requests for a public hearing 
must be received by December 24, 2018.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-130244-17), Room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
130244-17), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW, Washington, DC 20224 or sent electronically via the Federal 
eRulemaking Portal at https://www.regulations.gov (IRS REG-130244-17).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed removal and 
amendments, Austin Diamond-Jones, (202) 317-6847; concerning 
submissions of comments or requests for a public hearing, Regina 
Johnson, (202) 317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act (44 U.S.C. chapter 
35), the information collection included in these regulations under 
control number 1545-2267 will be discontinued upon the adoption of a 
final rule.

Background

Overview

    Section 385 of the Internal Revenue Code (Code) authorizes the 
Secretary of the Treasury (Secretary) to prescribe rules to determine 
whether an interest in a corporation is treated for purposes of the 
Code as stock or indebtedness (or as in part stock and in part 
indebtedness) by setting forth factors to be taken into account with 
respect to particular factual situations.
    On April 8, 2016, the Department of the Treasury (Treasury 
Department) and the IRS published proposed regulations (REG-108060-15) 
under section 385 of the Code (proposed regulations) in the Federal 
Register (81 FR 20912 (April 8, 2016)) concerning the treatment of 
certain interests in corporations as stock or indebtedness. A public 
hearing on the proposed regulations was held on July 14, 2016. The 
Treasury Department and the IRS also received numerous written comments 
in response to the proposed regulations, all of which are available at 
https://www.regulations.gov.
    On October 21, 2016, the Treasury Department and the IRS published 
final and temporary regulations under section 385. TD 9790 (I.R.B. 
2016-46, 81 FR 72858 (October 21, 2016)). The preamble to TD 9790 
describes in detail the comments received on the proposed regulations 
and the thorough consideration given to each comment. The preamble to 
TD 9790 also explains the decisions reached by the Treasury Department 
and the IRS and the revisions that were made to the proposed 
regulations.
    The final and temporary regulations under section 385 are primarily 
comprised of (i) the Documentation Regulations, which establish minimum 
documentation requirements that ordinarily must be satisfied in order 
for purported debt obligations among related parties to be treated as 
debt for federal tax purposes; and (ii) rules that treat as stock 
certain debt that is issued by a corporation to a controlling 
shareholder in a distribution or in another related-party transaction 
that achieves an economically similar result (together, the Section 385 
Regulations).
    Under the proposed regulations, the Documentation Regulations would 
have been applicable with respect to interests issued or deemed issued 
on or after the date the regulations were finalized. However, when 
finalized, the Documentation Regulations were made applicable with 
respect to interests issued or deemed issued on or after January 1, 
2018. See Sec. Sec.  1.385-1(f), 1.385-2(d)(2)(iii), and 1.385-2(i). 
This delayed applicability date responded to taxpayer concerns of 
inadequate time to begin complying with the Documentation Regulations 
once they were finalized

Executive Order 13789

    Executive Order 13789, issued on April 21, 2017 (E.O. 13789), 
instructs the Secretary to review all significant tax regulations 
issued on or after January 1, 2016, and to take concrete action to 
alleviate the burdens of regulations that (i) impose an undue financial 
burden on U.S. taxpayers; (ii) add undue complexity to the federal tax 
laws; or (iii) exceed the statutory authority of the IRS.
    E.O. 13789 further instructs the Secretary to submit to the 
President within 60 days a report (First Report) that identifies 
regulations that meet these criteria. Notice 2017-38 (2017-30 I.R.B. 
147 (July 24, 2017)) included the Section 385 Regulations in a list of 
eight regulations identified by the Secretary in the First Report as 
meeting at least one of the first two criteria specified in E.O. 13789. 
E.O. 13789 further instructs the Secretary to submit to the President a 
second report (Second Report) that recommends specific actions to 
mitigate the burden imposed by regulations identified in the First 
Report.

Notice 2017-36

    As previously noted, the final Documentation Regulations were 
originally promulgated to be applicable with respect to interests 
issued or deemed issued on or after January 1, 2018. However, in 
response to continued taxpayer concern with the application of the 
Documentation

[[Page 48266]]

Regulations, and in light of contemplated further actions concerning 
the Section 385 Regulations in connection with the review of those 
regulations under E.O. 13789, the Treasury Department and the IRS 
determined that a further delay in the application of the Documentation 
Regulations would be appropriate. Accordingly, in Notice 2017-36 (2017-
33 I.R.B. 208 (August 14, 2017)), the Treasury Department and the IRS 
announced the intent to amend the Documentation Regulations to delay 
the applicability of the regulations for 12 months, making the 
regulations applicable only to interests issued or deemed issued on or 
after January 1, 2019.

Comments Received in Connection With E.O. 13789

    In response to Notice 2017-38 and Notice 2017-36, the Treasury 
Department and the IRS received approximately 40 comment letters 
submitted by professional and trade associations, private businesses, 
public interest groups, and trade unions, as well as over 68,500 
comments submitted by individual taxpayers on https://www.regulations.gov (website comments) regarding the Section 385 
Regulations. The approximately 40 comment letters reflect a wide range 
of opinions, advocating everything from strengthening to eliminating 
the Documentation Regulations. The individual taxpayer comments, 
however, uniformly urged that the Section 385 Regulations as a whole be 
retained or strengthened.
1. Supporting Retaining or Strengthening the Documentation Regulations
    At one end of the spectrum are comment letters from various public 
interest groups, trade unions, and other associations that, together, 
represent almost 500 organizations, comment letters from private 
citizens, and the 68,502 website comments. These comments strongly 
urged that the Section 385 Regulations be retained and enforced, if not 
strengthened. These commenters would not be subject to the 
Documentation Regulations. However, they are concerned with the 
possibility of their withdrawal because they view the Section 385 
Regulations as an important tool for maintaining the federal income tax 
base so that small, domestic businesses and working people and families 
would not be forced to bear an unfair and disproportionate portion of 
the cost of U.S. society and infrastructure. Further, these commenters 
view the Section 385 Regulations as an important step in leveling the 
playing field for small, domestic businesses that cannot take advantage 
of earnings stripping tax planning, thus allowing such domestic 
businesses to compete with large multinational companies based solely 
on their products and services, and not their ability to take advantage 
of tax planning. In addition, these commenters argued that allowing 
large multinational corporations to shift earnings offshore does not 
create jobs or economic growth in the United States and only serves to 
disadvantage domestic companies.
2. Supporting Limiting or Withdrawing the Documentation Regulations
    All of the remaining commenters raised concerns about the 
complexity, cost, and burden imposed by the Documentation Regulations. 
Most of these commenters made various suggestions for modifications 
that would reduce the scope and burden of the Documentation Regulations 
in ways they believed would make the rules more reasonable. Few 
disputed the Treasury Department's authority to promulgate the 
Documentation Regulations, however.
    Among the commenters that made suggestions for modifications to the 
Documentation Regulations, there was considerable consensus on the 
modifications being recommended. Most commenters urged that 
transactions done in the ordinary course of business, including trade 
payables, be removed from the application of the Documentation 
Regulations. Many also urged that ``market standards'' be broadly 
adopted as the test for determining whether the documentation 
requirements are satisfied.
    Another common concern raised by these commenters was that the 
consequences of failing to satisfy the Documentation Regulations are 
too harsh, and commenters suggested expanding the rules to make it 
easier to cure or avoid noncompliance and to modify the consequences of 
noncompliance to make these consequences more proportionate to the 
concerns addressed by the Documentation Regulations. For example, 
commenters noted that the time for curing defects in documentation 
could be expanded, the rules for establishing substantial compliance or 
reasonable cause could be expanded, and an exception could be added to 
excuse transactions that pose no base-erosion concern. In addition, 
there were comments suggesting that the consequences of failing to 
satisfy the regulations could be limited to a denial of interest 
deductions, which would avoid the collateral effects of re-
characterizing the interest as equity.
    Most of these commenters also requested that the application of the 
Documentation Regulations be delayed so that taxpayers would have 
adequate time to comply with the Documentation Regulations, taking into 
account any potential additional modifications. Some suggested delaying 
applicability for an additional year or two, while others suggested 
delaying applicability until a date that would presumably allow the 
effects of any tax reform legislation to be taken into account. But 
many urged that applicability simply be delayed until the Treasury 
Department and IRS have completed their review, to avoid the expense of 
putting systems in place that would not satisfy the Documentation 
Regulations that are ultimately applicable.
    There were also various other modifications suggested. Some 
modifications would apply to taxpayers generally, such as excluding 
transactions between commonly held consolidated groups, removing the 
``reserved'' sections, and replacing the entire rule with an anti-abuse 
rule. Other modifications were specific to the industry of the 
commenter or its constituents, such as raising the threshold amounts 
for certain businesses with higher gross asset levels and exempting 
industries that are perceived as less likely to engage in abusive 
transactions or more likely to engage in activities that further public 
policy.
    While a number of commenters supported the withdrawal of the 
Documentation Regulations, most of those commenters were among those 
also offering suggestions for modifications. However, there were a few 
commenters that argued only for withdrawal.

Explanation of Provisions

    On October 16, 2017, the Secretary published the Second Report in 
the Federal Register (82 FR 48013 (October 16, 2017)) stating that the 
Treasury Department and the IRS are considering revoking the 
Documentation Regulations and are actively considering developing and 
proposing streamlined regulations. After careful consideration of the 
comments received on the Documentation Regulations in connection with 
E.O. 13789, including with respect to Notice 2017-36 and Notice 2017-
38, this notice of proposed rulemaking proposes the removal of the 
Documentation Regulations.
    The Treasury Department and the IRS will continue to study the 
issues addressed by the Documentation

[[Page 48267]]

Regulations. When that study is complete, the Treasury Department and 
the IRS may propose a modified version of the Documentation 
Regulations. Any such regulations would be substantially simplified and 
streamlined to reduce the burden on U.S. corporations and yet would 
still require sufficient documentation and other information for tax 
administration purposes. Further, they would be proposed with a 
prospective effective date to allow sufficient lead-time for taxpayers 
to design and implement systems to comply with those regulations.

Proposed Effective/Applicability Date

    The proposed removal of Sec.  1.385-2 and conforming modifications 
are proposed to be applicable as of the date of publication in the 
Federal Register of a Treasury decision adopting these proposed 
regulations as final regulations. However, taxpayers may rely on these 
proposed regulations, in their entirety, until the date a Treasury 
decision adopting these regulations as final regulations is published 
in the Federal Register.

Statement of Availability of IRS Documents

    IRS Revenue Procedures, Revenue Rulings, Notices, and other 
guidance cited in this document are published in the Internal Revenue 
Bulletin (or Cumulative Bulletin) and are available from the 
Superintendent of Documents, U.S. Government Publishing Office, 
Washington, DC 20402, or by visiting the IRS website at https://www.irs.gov.

Special Analyses

I. Regulatory Planning and Review

    Executive Order 13777 directs agencies to alleviate unnecessary 
regulatory burdens placed on the American people by managing the costs 
associated with the governmental imposition of private expenditures 
required to comply with federal regulations. Executive Orders 13771, 
13563, and 12866 direct agencies to prudently manage the cost of 
planned regulations by assessing costs and benefits of available 
regulatory alternatives and, if regulation is necessary, to select 
regulatory approaches that maximize net benefits (including potential 
economic, environmental, public health and safety effects, distributive 
impacts, and equity). Executive Order 13563 emphasizes the importance 
of quantifying both costs and benefits, of reducing costs, of 
harmonizing rules, and of promoting flexibility.
    These proposed regulations have been designated as subject to 
review under Executive Order 12866 pursuant to the Memorandum of 
Agreement (April 11, 2018) (the ``Treasury-OMB MOA'') between the 
Treasury Department and the Office of Management and Budget regarding 
review of tax regulations. These proposed regulations have been 
designated a ``significant regulatory action'' by OIRA under section 
3(f) of Executive Order 12866 because they raise novel policy issues. 
This proposed rule, when final, is expected to be an Executive Order 
13771 deregulatory action.
    Pursuant to section 6(a)(3)(B) of Executive Order 12866, the 
following analysis discusses the anticipated economic effects of these 
proposed regulations. Although not required by that section, the 
Treasury Department and the IRS have generally provided monetized 
estimates in this analysis. These proposed regulations have been 
reviewed by the Office of Management and Budget.
A. Affected Population
    This analysis uses an expansive definition of the estimated 
affected population in order to minimize the risk that the analysis 
will not capture the effects on collateral groups.
1. Application to C Corporations
    As discussed in TD 9790, this regulatory action affects 
approximately 6,300 large C corporations out of 1.6 million C 
corporations and 5.8 million corporations of all types. This is because 
only C corporations that are part of expanded affiliated groups in 
which one or more members have sufficient assets ($100 million) or 
revenue ($50 million), or are publicly traded, would have been required 
to document the relevant transactions.
2. Documentation of Intercompany Loans and Compliance
    While there is variation across businesses, longer-term 
intercompany debt would typically be documented, in some form of 
agreement containing terms and rights, by corporations following good 
business practices. However, some information that would have been 
required by the Documentation Regulations, such as a debt capacity 
analysis, may not typically be prepared in some cases. If applicable, 
the Documentation Regulations would not have required that a specific 
type of credit analysis or documentation be prepared in order to 
establish a related-party debtor's creditworthiness and ability to 
repay, but merely would have imposed a standard intended to be closer 
to commercial practice. To the extent that information supporting such 
analysis is already prepared in accordance with a company's normal 
business practice, removal of the Documentation Regulations would have 
a relatively low compliance cost savings. However, where a business has 
not typically prepared and maintained written debt instruments, term 
sheets, cash flow, or debt capacity analyses for intercompany debt, 
compliance cost savings related to the removal of the Documentation 
Regulations would have been higher. While the level of documentation 
required is clearly evident in third-party lending, there is little 
available information on the extent to which related parties document 
their intercompany loans. Anecdotal evidence and comments received 
indicate that businesses vary in the extent to which related-party 
indebtedness is documented.
B. Description of the Documentation Regulations
1. In General
    If applicable, the Documentation Regulations would have prescribed 
the nature of the documentation necessary to substantiate the federal 
income tax treatment of related-party interests as indebtedness, 
including documentation of factors analogous to those found in third-
party loans. This generally means that taxpayers would have had to be 
able to provide such things as: Evidence of an unconditional and 
binding obligation to make interest and principal payments on certain 
fixed dates; that the holder of the loan has the rights of a creditor, 
including superior rights to shareholders in the case of dissolution; a 
reasonable expectation of the borrower's ability to repay the loan; and 
evidence of conduct consistent with a debtor-creditor relationship. The 
Documentation Regulations would have applied to relevant intercompany 
debt issued by U.S. borrowers beginning in 2019 and would have required 
that the taxpayer's documentation for a given tax year be prepared by 
the time the borrower's federal income tax return is filed.
    The Documentation Regulations would have applied only to related 
groups of corporations in which the stock of at least one member is 
publicly traded or the group's financial results report assets 
exceeding $100 million or annual revenue exceeding $50 million. Because 
there is no general definition of a small business under the Code, 
these asset and revenue limits were designed to exceed the maximum 
receipts

[[Page 48268]]

threshold used by the Small Business Administration in defining small 
businesses (U.S. Small Business Administration, Table of Small Business 
Size Standards, 2016). In addition, these thresholds exclude about 99 
percent of C corporation taxpayers while retaining 85 percent of 
economic activity as measured by total income. Approximately 1.5 
million out of 1.6 million C corporation tax filers are single entities 
and therefore have no affiliates with which to engage in tax arbitrage. 
The intent was to limit the Documentation Regulations to large 
businesses with highly-related affiliates, which are responsible for 
most corporate activity. For example, large foreign-controlled domestic 
C corporations (FCDCs) (those having assets over $100 million or total 
income over $50 million) make up 3 percent of FCDCs but report 90 
percent of FCDC interest deductions and 93 percent of FCDC total 
income. Similarly, the Documentation Regulations would have exempted 
most ordinary course transactions.
C. Assessment of the Documentation Regulations' Effects
    The Treasury Department and the IRS estimate that 6,300 or 0.4 
percent of C corporation taxpayers would have been affected by the 
Documentation Regulations, mainly because 95 percent of taxpayers do 
not have affiliated corporations, and the regulations would have 
affected only transactions between affiliates.
    While only a small fraction of corporate taxpayers will be affected 
by the removal of the Documentation Regulations, these 6,300 taxpayers 
tend to be the largest C corporation tax filers, claiming 65 percent of 
total interest deductions claimed by C corporations, 53 percent of 
total income claimed by C corporations, 81 percent of total income 
subject to tax claimed by C corporations, and 75 percent of total 
income tax after credits claimed by C corporations. Of these C 
corporations, approximately one-third are FCDCs that report about 20 
percent of the affected total income and 20 percent of the affected 
interest deductions.
1. Monetized Estimates
    The revenue and compliance burden effects are measured against a 
no-action baseline, which captures tax-related behavior in the absence 
of the proposed regulatory action and includes taxpayer behavior the 
Treasury Department and the IRS expect as a result of the enactment of 
Public Law 115-97 (TCJA). While this particular regulation does not 
implement TCJA requirements, it interacts with the TCJA. There are 
several provisions of the TCJA that reduced the tax advantages of 
Foreign Controlled Domestic Corporations (FCDCs) over domestically 
controlled companies (DCCs) and thus may affect the tax revenue and 
compliance burden consequences of the removal of the Documentation 
Regulations. First, for taxable years beginning after December 31, 
2017, the TCJA reduced the statutory corporate tax rate from 35 percent 
to 21 percent, which lowers the effective tax rate for DCCs more than 
for FCDCs. Second, the ability of FCDCs to strip earnings out of the 
United States using deductions for interest expense was significantly 
reduced by the TCJA through amendments to section 163(j) of the Code. 
Specifically, the section 163(j) statutory amendments (1) eliminated 
the debt-equity ratio safe harbor, (2) reduced the maximum net interest 
deductions' share of adjusted taxable income from 50 percent to 30 
percent, (3) limited all, rather than just related-party, interest 
deductions, and (4) eliminated the carryforward of excess limitation 
under pre-TCJA section 163(j). The TCJA's Base Erosion Anti-abuse Tax 
(BEAT) further reduces this ability. Thus, the benefits of the 
Documentation Regulations in reducing foreign acquisitions of U.S. 
assets and interest stripping were reduced by the TCJA.
    The vast majority of TCJA provisions are self-executing, which 
means that they are binding on taxpayers and the IRS without any 
regulatory action and therefore their applicability and potential 
taxpayers' responses to such applicability are assumed in the baseline. 
The Treasury Department and the IRS recognize, however, that the 
section 163(j) amendments and the BEAT, along with other TCJA 
provisions, while self-executing, provide interpretive latitude for 
taxpayers and the IRS and that, without further implementation 
guidance, those provisions could prompt a variety of potential taxpayer 
responses. Faced with ambiguous tax provisions that are susceptible to 
a range of reasonable interpretations, some taxpayers will take 
conservative filing positions, others will take aggressive filing 
positions, and still others will simply forego business activity that 
implicates any uncertain provisions. Accordingly, the Treasury 
Department and the IRS have included in the baseline their best 
assessment of taxpayer behavior under current law and regulatory 
guidance; the baseline does not assume regulatory guidance that has not 
yet been issued. To the extent that taxpayer responses to any future 
legislation or rules regarding section 163(j) or the BEAT differ from 
this assessment, the revenue and compliance burden estimates with 
respect to the proposed removal of the Documentation Regulations would 
also be affected.
    The Treasury Department and the IRS solicit comments on the revenue 
and compliance burden estimates with respect to the proposed removal of 
the Documentation Regulations.
a. Revenue Effects of Proposed Regulations
    The Treasury Department and the IRS previously addressed revenue 
effects in the original regulatory impact analysis (RIA) published in 
the preamble to T.D. 9790 and have received comments that address the 
revenue effect of the Documentation Regulations. The removal of the 
Documentation Regulations may slightly increase the ability of some 
firms to strip earnings out of the United States and so reduce their 
tax payments. The Treasury Department and the IRS estimate that removal 
of the Documentation Regulations will reduce revenue by $407 million 
over the period 2019-2028, using standard revenue reporting conventions 
(undiscounted nominal total). The net present value of the revenue loss 
is $302 and $243 ($2018 millions) using real discount rates of 3 and 7 
percent, respectively. The annualized amounts are $35.4 and $34.5 
($2018 millions), again based on 3 percent and 7 percent real rates 
respectively. The revenue effects were estimated using the methodology 
described in the original RIA published in the preamble to T.D. 9790, 
although the estimate now covers 2019 to 2028 and includes factors that 
have changed as a result of TCJA as well as other technical 
adjustments.
    Annualized discounted revenue effects are shown in the following 
table.

[[Page 48269]]



------------------------------------------------------------------------
                                    Fiscal years 2019  Fiscal years 2019
                                     to 2028 (3% real   to 2028 (7% real
                                      discount rate)     discount rate)
------------------------------------------------------------------------
Estimated change in annual tax                 -$35.4             -$34.5
 revenue (annualized value, $2018
 millions)........................
------------------------------------------------------------------------

b. Compliance Burden Effects From Proposed Regulations
    The Treasury Department and the IRS estimate that removal of the 
Documentation Regulations will reduce compliance costs by $924 million 
over the period 2019-2028 (undiscounted nominal total). The net present 
value of the compliance cost savings is $773 and $685 ($2018 millions) 
using real discount rates of 3 and 7 percent respectively. These 
amounts are $90.6 million and $97.5 million on an annualized basis, 
again based on 3 percent and 7 percent real rates respectively. The 
methodology for estimating the compliance cost savings also followed 
the methodology described in the original RIA published in the preamble 
to T.D. 9790, with analogous adjustments due to the change in the 
period covered, the effects of TCJA, and other technical adjustments. 
The Treasury Department and the IRS view the proposed action (removal 
of Sec.  1.385-2) as reducing both tax revenues and compliance costs 
but they view the TCJA as primarily affecting the reduction in tax 
revenue from the action due mainly to reduced allowable interest 
deductions (163(j)) and to a lesser extent, taxation of certain base 
eroding payments to related parties (BEAT), including interest. The 
Treasury Department and the IRS do not expect a significant reduction 
in the number of relevant related party transactions, only a reduction 
in the dollar amounts, and therefore see a smaller effect of the TCJA 
on compliance cost savings than on revenue losses, relative to previous 
estimates.
    In addition, the analysis includes a sensitivity analysis in which 
the compliance costs were estimated for a 90 percent interval around 
the central estimate. Annualized discounted ongoing and start-up 
changes in compliance costs ($2018 millions) are shown in the following 
table.

------------------------------------------------------------------------
    Estimated change in annual      Fiscal years 2019  Fiscal years 2019
   compliance costs (annualized      to 2028 (3% real   to 2028 (7% real
      value, $2018 millions)          discount rate)     discount rate)
------------------------------------------------------------------------
Central estimate..................             -$90.6             -$97.5
High estimate.....................             -113.3             -121.9
Low estimate......................              -68.0              -73.1
------------------------------------------------------------------------
Technical note: In this rulemaking, the Treasury Department made
  technical adjustments relative to the 2016 rulemaking in calculating
  the annualized compliance cost estimates. The cost stream in this
  rulemaking is in 2018 dollars, reflects a two-year delay in effective
  date (relative to the previous estimates), and applies real discount
  rates of 3 and 7 percent. Technical adjustments account for part of
  the difference in the estimates between the rulemakings.

2. Non-Monetized Effects
a. Reduced Tax Compliance
    By slightly increasing the ability of some taxpayers to strip 
earnings out of the United States through transactions with no 
meaningful economic or non-tax benefit, and so reducing their tax 
payments, removal of the Documentation Regulations is likely to 
slightly reduce the overall perceived legitimacy of the U.S. tax 
system, and hence reduce voluntary compliance.
b. Efficiency and Growth Effects
    By changing the treatment of certain transactions and activities, 
removal of the Documentation Regulations potentially affects economic 
efficiency and growth (output). While the removal of the Documentation 
Regulations may have multiple and to some extent offsetting effects, on 
net they are likely to slightly reduce economic efficiency. For 
example, the removal of the Documentation Regulations will likely 
increase the tax advantage foreign owners have over domestic owners of 
U.S. assets, and consequently will increase the propensity for foreign 
acquisitions and ownership of U.S. assets that are motivated by tax 
considerations rather than economic substance. While these effects will 
likely be small, they likely reduce efficiency and growth. By 
increasing the ability to undertake tax-motivated acquisitions or 
ownership structures, removal of the Documentation Regulations may 
slightly reduce the incentive for assets to be owned or managed by 
those most capable of putting the assets to their highest-valued use. 
Moreover, removal of the Documentation Regulations may put purely 
domestic U.S. firms on less even tax footing than their foreign-owned 
competitors operating in the United States. On the other hand, removal 
of the Documentation Regulations may slightly reduce the effective tax 
rate and compliance costs on U.S. inbound investment. While the 
magnitude of this reduction is small, to the extent that it increases 
new capital investment in the United States, its effects would be 
efficiency and growth enhancing. Most inbound investment is via 
acquisition of existing U.S. companies rather than greenfield (new) 
investment in the United States, however, and thus such investment 
changes the ownership of existing assets, without necessarily adding to 
the stock of capital employed in the United States. On balance, the 
likely effect of the removal of the Documentation Regulations is to 
reduce the efficiency of the corporate tax system slightly.
c. Higher Tax Administrative Costs for the IRS
    The reduced loan documentation required of large corporations as a 
result of the removal of the Documentation Regulations will reduce the 
ability of the IRS to more effectively administer the tax laws by 
making it harder for the IRS to evaluate whether purported debt 
transactions are legitimate loans. This will raise the cost of auditing 
and evaluating the tax returns of companies engaged in these 
transactions.

II. Regulatory Flexibility Act

    Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it 
is hereby certified that the proposed regulations will not have a 
significant economic

[[Page 48270]]

impact on a substantial number of small entities.
    As discussed earlier in this preamble, on October 21, 2016, the 
Treasury Department and the IRS published final and temporary 
regulations under section 385. The final and temporary regulations 
under section 385, among other things, established minimum 
documentation requirements that must be satisfied in order for 
purported debt obligations among related parties to be treated as debt 
for federal tax purposes. When finalized in October 2016, the 
Documentation Regulations were made applicable with respect to 
interests issued or deemed issued on or after January 1, 2018. In 
response to continued taxpayer concern with the application of the 
Documentation Regulations, the Treasury Department and the IRS, in 
Notice 2017-36, further delayed the applicability of the regulations by 
making the regulations applicable only to interests issued or deemed 
issued on or after January 1, 2019. This proposed rule, if finalized, 
would remove these Documentation Regulations that have not yet been 
made applicable to any interests issued by any taxpayer.
    Section 1.385-2, if applicable, would have provided documentation 
requirements to substantiate the treatment of certain related party 
instruments as indebtedness. Section 1.385-2 would have applied to 
large corporate groups (specifically, those that are publically traded, 
or have assets exceeding $100 million or annual total revenue exceeding 
$50 million in its expanded group), thus limiting the scope of small 
entities affected. Section 1.385-2 would have applied to financial 
institutions, which are considered small entities under the Regulatory 
Flexibility Act if they have less than $550 million in assets (13 CFR 
121). The Treasury Department and the IRS believe that Sec.  1.385-2 
would not affect a substantial number of small entities other than 
small financial institutions. Even if the regulations affected a 
substantial number of small entities in that sector, the economic 
impact of this rule would be minimal because the proposed regulations 
would remove the currently inapplicable documentation requirements in 
Sec.  1.385-2. Accordingly, a regulatory flexibility analysis is not 
required.
    Pursuant to section 7805(f), this notice of proposed rulemaking has 
been submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Unfunded Mandates Reform Act

    Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA) 
requires that agencies assess anticipated costs and benefits and take 
certain other actions before issuing a final rule that includes any 
federal mandate that may result in expenditures in any one year by a 
state, local, or tribal government, in the aggregate, or by the private 
sector, of $100 million in 1995 dollars, updated annually for 
inflation. In 2018, that threshold is approximately $150 million. This 
proposed rule does not include any mandate that may result in 
expenditures by state, local, or tribal governments, or by the private 
sector in excess of that threshold.

Executive Order 13132: Federalism

    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any rule that has federalism implications if the rule 
either imposes substantial, direct compliance costs on state and local 
governments, and is not required by statute, or preempts state law, 
unless the agency meets the consultation and funding requirements of 
section 6 of the Executive Order. This proposed rule does not have 
federalism implications and does not impose substantial direct 
compliance costs on state and local governments or preempt state law 
within the meaning of the Executive Order.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS as prescribed in this preamble under the ADDRESSES heading. 
All comments will be available at https://www.regulations.gov or upon 
request. A public hearing will be scheduled if requested in writing by 
any person that timely submits written comments. If a public hearing is 
scheduled, notice of the date, time, and place of the public hearing 
will be published in the Federal Register.

Drafting Information

    The principal author of this notice of proposed rulemaking is 
Austin Diamond-Jones of the Office of the Associate Chief Counsel 
(Corporate). However, other personnel from the Treasury Department and 
the IRS participated in its development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by removing 
the sectional authority for Sec.  1.385-2 to read, in part, as follows:

    Authority:  26 U.S.C. 7805 * * *
* * * * *
0
Par. 2. Section 1.385-1 is amended by revising paragraph (a), the last 
sentence of paragraphs (c) introductory text and (c)(4)(iv), paragraph 
(d)(1)(i), the first sentence of paragraph (d)(1)(ii), and paragraphs 
(d)(1)(iii) and (d)(1)(iv)(A), and removing and reserving paragraph 
(d)(2)(i).
    The revisions read as follows:


Sec.  1.385-1  General provisions.

    (a) Overview of section 385 regulations. This section and 
Sec. Sec.  1.385-3 through 1.385-4T (collectively, the section 385 
regulations) provide rules under section 385 to determine the treatment 
of an interest in a corporation as stock or indebtedness (or as in part 
stock and in part indebtedness) in particular factual situations. 
Paragraph (b) of this section provides the general rule for determining 
the treatment of an interest based on provisions of the Internal 
Revenue Code and on common law, including the factors prescribed under 
common law. Paragraphs (c), (d), and (e) of this section provide 
definitions and rules of general application for purposes of the 
section 385 regulations. Section 1.385-3 sets forth additional factors 
that, when present, control the determination of whether an interest in 
a corporation that is held by a member of the corporation's expanded 
group is treated (in whole or in part) as stock or indebtedness. * * * 
* *
    (c) * * * For additional definitions that apply for purposes of 
their respective sections, see Sec. Sec.  1.385-3(g) and 1.385-4T(e).
* * * * *
    (4) * * *
    (iv) * * * For purposes of the section 385 regulations, a 
corporation is a member of an expanded group if it is described in this 
paragraph (c)(4)(iv) of this section immediately before the relevant 
time for determining membership (for example, immediately before the 
issuance of a debt instrument (as defined in Sec.  1.385-3(g)(4)) or 
immediately before a distribution or

[[Page 48271]]

acquisition that may be subject to Sec.  1.385-3(b)(2) or (3)).
* * * * *
    (d) * * *
    (1) * * *
    (i) In general. If a debt instrument (as defined in Sec.  1.385-
3(g)(4)) is deemed to be exchanged under the section 385 regulations, 
in whole or in part, for stock, the holder is treated for all federal 
tax purposes as having realized an amount equal to the holder's 
adjusted basis in that portion of the debt instrument as of the date of 
the deemed exchange (and as having basis in the stock deemed to be 
received equal to that amount), and, except as provided in paragraph 
(d)(1)(iv)(B) of this section, the issuer is treated for all federal 
tax purposes as having retired that portion of the debt instrument for 
an amount equal to its adjusted issue price as of the date of the 
deemed exchange. In addition, neither party accounts for any accrued 
but unpaid qualified stated interest on the debt instrument or any 
foreign exchange gain or loss with respect to that accrued but unpaid 
qualified stated interest (if any) as of the deemed exchange. This 
paragraph (d)(1)(i) does not affect the rules that otherwise apply to 
the debt instrument prior to the date of the deemed exchange (for 
example, this paragraph (d)(1)(i) does not affect the issuer's 
deduction of accrued but unpaid qualified stated interest otherwise 
deductible prior to the date of the deemed exchange). Moreover, the 
stock issued in the deemed exchange is not treated as a payment of 
accrued but unpaid original issue discount or qualified stated interest 
on the debt instrument for federal tax purposes.
    (ii) Section 988. Notwithstanding the first sentence of paragraph 
(d)(1)(i) of this section, the rules of Sec.  1.988-2(b)(13) apply to 
require the holder and the issuer of a debt instrument that is deemed 
to be exchanged under the section 385 regulations, in whole or in part, 
for stock to recognize any exchange gain or loss, other than any 
exchange gain or loss with respect to accrued but unpaid qualified 
stated interest that is not taken into account under paragraph 
(d)(1)(i) of this section at the time of the deemed exchange. * * *
    (iii) Section 108(e)(8). For purposes of section 108(e)(8), if the 
issuer of a debt instrument is treated as having retired all or a 
portion of the debt instrument in exchange for stock under paragraph 
(d)(1)(i) of this section, the stock is treated as having a fair market 
value equal to the adjusted issue price of that portion of the debt 
instrument as of the date of the deemed exchange.
    (iv) * * *
    (A) A debt instrument that is issued by a disregarded entity is 
deemed to be exchanged for stock of the regarded owner under Sec.  
1.385-3T(d)(4); * * *
* * * * *


Sec.  1.385-2   [Removed]

0
Par. 3. Section 1.385-2 is removed.
0
Par. 4. Section 1.385-3 is amended by revising paragraph (g)(4) to read 
as follows:


Sec.  1.385-3  Transaction in which debt proceeds are distributed or 
that have a similar effect.

* * * * *
    (g) * * *
    (4) Debt instrument. The term debt instrument means an interest 
that would, but for the application of this section, be treated as a 
debt instrument as defined in section 1275(a) and Sec.  1.1275-1(d).
* * * * *
0
Par. 5. Section 1.1275-1 is amended by revising the last sentence of 
paragraph (d) to read as follows:


Sec.  1.1275-1  Definitions.

* * * * *
    (d) * * * See Sec.  1.385-3 for rules that treat certain 
instruments that otherwise would be treated as indebtedness as stock 
for federal tax purposes.
* * * * *

Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2018-20652 Filed 9-21-18; 8:45 am]
 BILLING CODE 4830-01-P