Finalized Section 385 Regulations Ease Burdens on Private Equity Industry
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- Scope of the Final Regulations Narrowed: On October 13, 2016, the Treasury Department and Internal Revenue Service issued final and temporary regulations recharacterizing certain debt instruments issued between related parties as stock for U.S. federal income tax purposes. While still adopting the general framework of the Proposed Regulations, the Final Regulations narrowed the scope and burden of the Proposed Regulations in ways beneficial to private equity funds.
- Final Regulations Do Not Apply to Blocker Loans: Blocker loans remain outside of the scope of the Final Regulations, except to the extent a blocker corporation is highly related to a direct or indirect corporate shareholder of a private equity fund.
- Final Regulations Turn Off Downward Attribution: The Final Regulations do not apply “downward” attribution from investors to private equity funds and reserve on attribution to corporations commonly controlled by a private equity fund. This is a welcome change from the Proposed Regulations, where the application of such rules could have resulted in “Expanded Groups” being found in unusual and surprising circumstances in the private equity funds context.
- “Per Se Rule” Still in Place; Foreign Issuers Exempted: The Final Regulations have retained the “Per Se Rule” that automatically treats debt as stock in certain circumstances, but added and expanded some key exceptions. The new rules are also only applicable to U.S. issuers of debt.