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 Commercial Finance

Proposed Regulations Remove Tax Obstacles to Secure U.S. Domestic Corporate Borrowings

By David H. Saltzman, Elaine B. Murphy, and Sara Clevering, Ropes & Gray

On October 31, 2018, the Treasury Department released proposed regulations under Section 956 of the Internal Revenue Code of 1986, as amended, that generally exempt U.S. domestic corporations from recognizing deemed dividends if a controlled foreign corporation (or CFC) invests in U.S. property or provides credit support for a U.S. domestic corporation’s borrowing. The broad application of these rules has kept domestic borrowers from pledging more than 66 2/3 percent of CFC voting stock or from providing lenders with upstream guarantees or asset pledges. Significantly, while the proposed regulations relax the rules for domestic corporations, they do not change the deemed dividend rules that apply to individuals and other non-corporate borrowers, such as domestic operating partnerships owned by private investment funds.

Going forward, while domestic corporations are likely to pledge 100 percent of CFC equity, it may not be commercially feasible for a borrower to provide other forms of credit support from a foreign corporation. In this regard, there can be considerable financial and administrative costs to perfecting foreign security arrangements. Moreover, local law restrictions, such as financial assistance rules, may prevent a subsidiary from supporting a parent borrowing. Borrowers should review their credit agreements, which, in some cases, require borrowers to provide security from CFCs if changes in tax rules, like the proposed regulations, eliminate potential tax costs.

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