Requirements under Section 385
Intending to deter corporate tax inversions, the U.S. Treasury Department issued proposed regulations under Internal Revenue Code section 385 in April 2016. The new rules determine whether an instrument is considered debt or equity, or a combination thereof. As there are negative implications to treating intercompany loans as equity, finance teams are looking for ways to treat intercompany loans as debt.
As section 385 imposes greater documentation requirements for intercompany financing, the proposed standard will have significant implications for treasury teams. Treasury systems can help automate the management and documentation of intercompany loans, decreasing manual work and aiding with 385 compliance.
Technology Support for Compliance
A recent Reval survey of about 100 finance professionals shows that 49% of treasuries use a treasury system to automate cash, liquidity and risk management workflows. Best practice treasury technology includes the following capabilities, helping finance professionals to comply with section 385:
- Intercompany Loan Management: Treasurers can capture intercompany loans in a system. Parameters include start date, maturity date, deal value and company-specific fields. Additionally, finance professionals need a market index to settle an arms-length agreement between the two entities. These documents can be attached in the system. Based on all this information, the software can generate a principal and interest schedule in order to demonstrate a reasonable expectation for repayment as required for classifying the intercompany loan as debt.
- Inception Documentation: When one entity requests funding from another entity, a treasury system’s documentation capabilities can help show that the intercompany loan can be treated as debt. Best practice technology can provide a term sheet giving an overview on the trade and a diagnostic review demonstrating the intercompany loan’s performance throughout its lifecycle. This justifies treatment of the intercompany loan as debt under regulation 385. As a company works to ensure intercompany loans meet the requirements for debt classification, they can ask regulatory experts from within treasury or other departments such as accounting, controlling or tax to oversee the process. These workflow controls such as trade approvals can also be managed in the treasury system.
- Ongoing Monitoring: Over the life of the loan, treasury needs to monitor the loan to ensure that it performs as documented. A treasury system can automate the reconciliation of the forecasted principal and interest cash flows against the bank statements. Integrated audit trails document all trade-related activity automatically. Besides monitoring the trade in real-time, technology can also help to ensure the trade is performing as desired. Trade limits can be implemented in the system, alerting finance professionals if repayments do not meet the required schedule for debt classification under 385.
- Post Trade Compliance: A post-trade report in the treasury system gives an overview on the performance of the intercompany loan, including actual principal and interest schedule, repayments attached to the loan and showing any binding obligation to pay. This is a final look back giving treasurers the confidence to show that the loan was following all regulatory requirements throughout its lifecycle in future audits and reviews.
Manual Processes under Pressure
As finance professionals prepare for regulation 385, they should make sure their treasury system can capture and monitor intercompany loans throughout their lifecycle as well as automate 385 compliance reporting. Since only half of treasuries use treasury technology, the other half depend heavily on manual operations. As more regulations, like 385, go into effect, these manual treasuries will face even greater operational pressure. Spreadsheets and manual processes are not enough to keep up with these growing regulatory requirements.