Treasury Department Facing Challenges and Criticism to IRS 385 Rule

The Obama Administration has been one of the most aggressive regulatory administrations in history. In 2015, the annual cost of the regulatory regime hit a whopping $1.885 trillion, according to an analysis from the Competitive Enterprise Institute. President Obama and his administration have been responsible for issuing a record 600 new major regulations during his time in office so far, a record that has had an adverse effect on the economy.

One of the more recent regulatory proposals that the administration, specifically the Treasury Department, has proposed is what is known as the “Debt-Equity Rule” or Section 385 of the Internal Revenue Service Code. The new rule was first made public in April of this year, and many taxpayer advocates as well as business groups and key players in the financial services sector have all expressed concerns about the potential impact of the new rule.

What is the 385 rule? It stems from the continued fight that the Obama administration has waged against corporate inversions. Over the last few years the President has made it a point to criticize companies that have engaged in corporate inversions, which when “an American company reincorporates for tax purposes in a tax-friendlier country such as the U.K. or Ireland, typically while maintaining much of their operations in the U.S.A.”  The 385 rule, as proposed, would give the IRS more authority over businesses regarding how certain transactions are processed in terms of the restructuring that companies do, like inversions. Here is the full rule:

Would authorize the Commissioner to treat certain related-party interests in a corporation as indebtedness in part and stock in part for federal tax purposes, and establish threshold documentation requirements that must be satisfied in order for certain related-party interests in a corporation to be treated as indebtedness for federal tax purposes. The proposed regulations also would treat as stock certain related-party interests that otherwise would be treated as indebtedness for federal tax purposes. The proposed regulations generally affect corporations that issue purported indebtedness to related corporations or partnerships.

The challenges to the rule have come fast and furious. Back in May, the Business Roundtable sent a letter to Treasury Secretary Jack Lew expressing concerns about the potential impact the 385 rule could have on business. Those concerns included how the rule would affect cash management, double taxation, spin-offs, and debt issuances. The new regulation is so broad that businesses are right to worry.

Now, after months of mounting criticisms from a variety of stakeholders, the business groups are taking the fight to the next level. Earlier this month a lawsuit was filed against the Treasury Department over the 385 rule. David Ingram and David Morgan reported on the lawsuit for Reuters:

The U.S. Chamber of Commerce and the Texas Association of Business filed a lawsuit in Texas federal court that said a regulation from the U.S. Treasury Department in April exceeded what the law allows the department to do.

The problems with the rule are very clear and should be alarming to anyone who cares about providing businesses with a climate that encourages growth and investment.

The sheer complexity of the new rule adds yet another layer of unnecessary government red tape to an already bloated tax code.  This new rule also will force companies to waste precious time and limited resources. The cost of the new rule is estimated to be about $15 million per year (minimum) according the IRS.  This will be a direct drain on economic activity and growth all because of an increased burden of compliance and paperwork. Another problem is that while it was meant to go after so-called inversions, the new regulation will no doubt apply to companies that aren’t even engaging in an inversion.

This is regulation for the sake of regulation, and a case of creating more problems without presenting any real solutions. The key here is to have real tax reform for businesses. That starts by lowering the corporate tax rate, which remains the highest in the developed world at 40 percent. Next, instead of adding new rules and regulations, there needs to be a dismantling of the regulations that are strangling businesses and suffocating growth and investment.

TPA hopes that the 385 rule will be shelved, or at the very least defeated in the courts before it can wreak any havoc on the economy.