This post is based on a Sullivan & Cromwell LLP publication authored by David P. Hariton.
[On April 4, 2016], the U.S. Treasury Department issued a notice of proposed rulemaking that could significantly affect the debt capitalization of U.S. subsidiary groups owned by foreign corporations (and of foreign subsidiaries owned by U.S. corporations).
The proposed regulations would, among other things, effectively turn debt issued by a U.S. subsidiary group and held by a related foreign parent corporation into preferred equity for U.S. tax purposes, unless the debt was issued for cash that served to increase the capital of the U.S. subsidiary group, after taking any related transactions into account. For example, $1 billion of debt issued by the U.S. group to the foreign parent in exchange for $1 billion of cash would be respected as debt for tax purposes. However, such debt would not be respected as debt if (i) $1 billion of debt was simply distributed by the U.S. group to the foreign parent, (ii) $1 billion of debt was issued by the U.S. group to the foreign parent for cash, but the $1 billion of cash was later (or earlier) distributed to the foreign parent, (iii) the foreign parent sold one U.S. subsidiary to another U.S. subsidiary in exchange for $1 billion of debt in the acquirer, (iv) the foreign parent merged one U.S. subsidiary into another U.S. subsidiary in exchange for stock plus $1 billion of debt, or (v) one foreign affiliate lent $1 billion to a U.S. subsidiary and the U.S. subsidiary distributed the cash to a different foreign affiliate. The proposed regulations are broadly drafted in an effort to cover similar transactions perceived as end-runs or loopholes. These rules would likewise apply to the debt capitalization of foreign subsidiaries by U.S. parent corporations.