The U.S. Treasury Department exceeded its authority by proposingwide-ranging regulations intended to curb corporations' abilityto shift their American earnings overseas, tax lawyers told agencyofficials during a hearing last week.

Their complaints added to a growing corporate backlash againstthe so-called earnings-stripping regulations, which broadly aim tocurb loans from foreign companies to their U.S. subsidiaries. Suchloans, which allow for moving U.S. income overseas viatax-deductible interest payments, represent a key tax-cuttingstrategy for U.S.-based companies that have moved their taxaddresses offshore.

But the rules are written so broadly that they also hit dailyinternal financing operations in global companies that aren'tavoiding taxes, according to several letters sent to the Treasuryas public comments on the proposal.

In essence, the regulations, which Treasury proposed in April,would allow the Internal Revenue Service to reclassify many ofthose debt transactions as equity transfers — erasing the taxbenefits. At Thursday's hearing, which was designed to gathercomment, some speakers said the proposals would give the IRS newauthority — without enough detail on how it would distinguish debtfrom equity.

“It's pretty obvious that the proposed regulations are probablyinvalid,” said Adam Halpern, an international tax lawyer withFenwick & West LLP. Halpern spoke in an interview after thehearing.

The proposal aims to expand on a 1969 regulation that gave theTreasury authority to write rules on how to tell debt from equityin related-party transactions. But that earlier regulation alsolays out conditions for new rule-making, Halpern said — Treasurymust describe in detail the economic, financial and other factorsthat would govern how to make distinctions.

Case law suggests that such factors would include the parties'creditworthiness, their earnings prospects and their debt-to-equityratios, Halpern said. None of those are present in the proposedregulations.

“Treasury has the authority to make guidelines, not bright-linerules” under the 1969 regulation, said Joseph Judkins, aninternational tax lawyer at Baker & McKenzie LLP, who alsospoke at the hearing. He spoke in an interview afterward.

Varied Objections

Banks, accounting firms, manufacturers and other multinationalsas well as major trade groups and tax lobbyists have objected thatthe proposed regulations go well beyond their intended target. Forexample, the rules would apply to companies that have always beenheadquartered outside the U.S. — not just recent tax emigres. BigFour accounting firm PriceWaterhouseCoopers has written in aresearch note that the proposed rules would “vitiate internal cashmanagement operations” that global companies use on a daily basisto fund their internal operations.

Treasury announced the rules in April as part of a group ofmeasures aimed at foiling “corporate inversions” — in which U.S.companies merge with offshore counterparts and shift the resultingcorporation's tax address overseas. But many companies havecomplained in letters to the Treasury Department that the ruleswould ensnare scores of ordinary business dealings among globalcompanies that haven't inverted.

Treasury officials have said the agency has the statutoryauthority to promulgate the proposed rules. The agency has received“a variety of comments” on them, “all of which we believe we canrespond to in the final regulations,” a department spokeswoman saidin an e-mailed statement.

It's unclear when the regulations might be final, however. “Itis important that we get these regulations right, and the exacttiming for finalization will depend on when we are satisfied thatwe have addressed any reasonable concerns,” the Treasuryspokeswoman said.

Samuel Thompson, who teaches tax law at Pennsylvania StateUniversity, said critics were reading the 1969 regulation toonarrowly and that Treasury does indeed have authority to write newrules that “may be necessary or appropriate.” But he also suggestedthat officials might want to get the views of the JusticeDepartment, which would represent the Treasury in any legalchallenge.

Pfizer's Deal

Treasury's related-party debt proposal was announced on the sameday that another measure — one aimed at preventing serialinversions — effectively killed a planned $160 billion mergerbetween Pfizer Inc. and Allergan Plc. That deal would have createda new company with a tax address in Ireland, where the corporatetax rate is 12.5 percent. The top U.S. corporate tax rate is 35percent.

Inversions have emerged as a hot-button topic in the 2016presidential race, with both Democratic and Republican candidatesvowing to crack down on them. More than 50 companies have undergonethem since 1982, almost half of them since 2012. President BarackObama's administration has issued a series of regulations aimed atthe practice.

But the proposed rules on related-party debt have drawn thelargest outcry. In Congress, members of the tax-writing House Waysand Means Committee wrote to Treasury Secretary Jacob J. Lew onJune 28 saying the regulations would “threaten jobs and economicgrowth.” The committee asked Treasury officials to “conduct athorough economic analysis to ensure they understand the fullimpact these regulations will have on the U.S. economy.”

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