Breaking the "Equity Wall": Proposed Regulations Limit Chances to Minimize U.S. Withholding Tax By Seth J. Entin
HIGHLIGHTS ď Ž The U.S. Department of the Treasury has issued proposed regulations (the Proposed Regulations) that would restrict foreign persons' ability to minimize U.S. tax through "conduit" financing arrangements. ď Ž This Holland & Knight article presents a brief overview of the 30 percent withholding tax and the current "anti-conduit" rules, then describes the key changes that the Proposed Regulations would make. __________________ The U.S. Department of the Treasury (Treasury) issued proposed regulations (the Proposed Regulations) on April 8, 2020, that would restrict foreign persons' ability to minimize U.S. tax through "conduit" financing arrangements.1 The Proposed Regulations potentially impact a number of types of structures used by foreign persons for financing into the United States, and therefore these structures should be reevaluated. The discussion below first presents a brief overview of the 30 percent withholding tax as well as the "anticonduit" rules, then describes the key changes that the Proposed Regulations would make.
THE 30 PERCENT WITHHOLDING TAX The U.S. federal income tax law imposes a 30 percent tax on a foreign person's U.S. source "fixed or determinable, annual or periodical income" (such as interest, dividends, rents, royalties and similar types of income). This tax is imposed on gross income, with no deductions allowed. In general, this tax is collected by means of withholding, and it is therefore commonly referred to as the 30 percent "withholding tax." The 30 percent withholding tax may be reduced or eliminated by treaties to which the United States is a party.
ANTI-CONDUIT RULES Congress became aware of numerous "conduit" structures that foreign persons were utilizing to minimize or eliminate the 30 percent withholding tax. As but one example, suppose that a foreign person resides in a country that does not have an income tax treaty with the United States. Therefore, if that foreign person were to lend funds directly to a U.S. borrower, the foreign person's interest income would be subject to the 30 percent withholding tax. On the other hand, the foreign person could loan funds to a company that is: 1) a tax resident in a country that has an income tax treaty with the United States that reduces or eliminates the 30 percent withholding tax and 2) that qualifies for benefits under that treaty.2 This treaty country company could then on-lend the funds to the U.S. borrower (retaining a reasonable arm's-length spread). Structures such as this have been addressed by courts over the years, and in some cases have been upheld. In 1993, Congress enacted Section 7701(l) of the Internal Revenue Code (the Code), which authorizes Treasury to issue regulations recharacterizing a multiple-party financing transaction as a transaction directly among any two or more of the parties where such recharacterization is appropriate to prevent the avoidance of any tax imposed by the Code. (These rules are referred to herein as the "Anti-Conduit Rules.")
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