Updates on the Section 385 Regulations

August 30, 2017

This Memorandum provides updates on the regulations promulgated under Internal Revenue Code Section 385 (the “385 Regulations”), which were proposed and finalized in 2016. The intended effect of the 385 Regulations is to reduce or prevent inversion transactions and other tax practices that shift profits away from the United States or otherwise reduce a corporation’s taxable income. In an April 2017 memorandum titled “Recent Tax Developments that May Impact the Private Equity Industry,” we discussed how the 385 Regulations may affect investment structures utilized by private equity funds. In particular, we noted that (i) the 385 Regulations may impact the use of “levered blockers” but (ii) the ability to provide debt-financing to a portfolio company may not be impacted where a fund is merely a minority investor in the portfolio company. This Memorandum provides further commentary on these rules in light of a recent decision to delay the effective date of certain documentation rules imposed by the 385 Regulations.

1. The Internal Revenue Service announced1 that it would delay the effective date of the documentation requirements imposed by the 385 Regulations. These requirements do not establish that an interest in a U.S. corporation is debt or equity but rather provide the basis upon which such a determination can be made. If these requirements are not satisfied and an exception does not apply, an interest in a U.S. corporation will be treated as equity rather than debt. The documentation requirements previously applied to any interest issued by certain U.S. corporations on or after January 1, 2018. As a result of the delay, the documentation requirements of the 385 Regulations will apply to any interest issued by certain U.S. corporations on or after January 1, 2019.

2. Pursuant to an executive order signed by President Trump, the Treasury Department is reviewing “significant tax regulations” that were issued on or after January 1, 2016 and will make recommendations to mitigate the burden imposed by such regulations. The 385 Regulations and certain other regulations were identified as imposing undue financial burden, adding undue complexity or exceeding statutory authority. It is possible that the above-discussed delay of the effective date may be the only change to the 385 Regulations pursuant to this regulatory review, but it is also possible that the 385 Regulations will be revised or repealed, in whole or in part.

If you have any questions concerning the foregoing, please contact one of the attorneys listed below, or any other attorney in the Firm’s Private Equity Practice.


1 Notice 2017-36.