Breaking the "Fairness Wall": Proposed Rules Restrict Probabilities of Minimizing US Withholding Tax

To print this article, all you need to do is be registered or log in to

  • The US Treasury Department has proposed

    Regulations (the proposed regulations) that would restrict foreign ones

    the ability of individuals to minimize US taxes through

    "Conduit" financing arrangements.
  • This Holland & Knight Warning provides a brief overview of

    the 30 percent withholding tax and the current one

    "Anti-Conduit" rules then describes the major changes that

    the proposed regulations would do.

The US Treasury Department issued proposed ordinances (the proposed

Regulations) on April 8, 2020 that would restrict foreign

the ability of individuals to minimize US taxes through

"Conduit" funding agreements.1 The

Proposed regulations may impact a number of types of

Structures used by foreign individuals to fund the United States

States, and therefore these structures should be reassessed.

The following discussion first gives a brief overview of the 30th

percentage withholding tax and the "anti-conduit"

Rules, then describes the main changes that the proposed regulations

would do.

The withholding tax of 30 percent

The U.S. federal income tax law imposes a tax of 30 percent on a

US source of a foreign person "fixed or determinable,

annual or periodic income "(such as interest, dividends,

Rents, royalties and similar types of income). This tax is levied

allowed on gross income, with no deductions. In general, this is tax

is collected by withholding, and so it is common

referred to as 30 percent "withholding tax". The 30th

percentage withholding tax can be reduced or eliminated through contracts

what the United States is a party.

Anti-conduit rules

The Congress became aware of numerous "conduit" structures

that foreign individuals used to minimize or eliminate the 30

Percent withholding tax. As an example, let's say a stranger

Person lives in a country that does not have an income tax treaty

with the United States. Hence, if that were a foreign person

Lend loans directly to a U.S. borrower called the foreigner

Interest income would be subject to withholding tax of 30 percent.

On the other hand, the foreign person could lend money to a company

that is: 1) a tax resident in a country that has an income tax

Treaty with the United States reducing or eliminating the 30

percentage withholding tax and 2) the entitlement to benefits under

this contract. 2 This contract country company could

Then loan the funds to the U.S. borrower (keeping a reasonable amount

Arm length). Structures like this were

raised by courts over the years, and in some cases have been


In 1993, Congress passed Section 7701 (l) of the Internal

Revenue Code (the code) that authorizes the Treasury to issue

Rules for characterizing a multi-party financing transaction

as a transaction directly between two or more parties

where such a re-characterization is appropriate to the

Avoidance of any taxes imposed by the Code. (Reference is made to these rules

referred to herein as "Anti-Conduit Rules".)

The provisions of Section 7701 (l) of the Code were the first

issued in 1995.3 and several have been modified

Times over the years. (These provisions are referred to here as

the "Current Anti-Conduit Regulations".)

Current anti-conduit regulations

Under current anti-conduit regulations, the IRS

re-characterize a number of legally separate financing transactions

as direct financing between the end provider and the

Final recipient of the funding. The IRS has that authority

where: 1) there are two or more "funding transactions"

connected by an "intermediate unit", 2) participation

of the intermediate company causes a reduction in the 30

Percent US withholding tax and 3) the participation of the

Intermediate companies are subject to tax avoidance


Financing according to the current anti-conduit regulations

Transaction involves a debt instrument, lease or

License.5 On the other hand, an instrument that is

Cannot be classified as equity for US tax purposes (with certain

Exceptions) represent financing

Transaction.6 The use of equity is therefore

sometimes referred to as the "wall of equity" because of it

excludes the application of the anti-conduit rules.

For example, a foreign person could advance money as an advance

a stake in a company domiciled in a country

that has an income tax treaty with the United States and that

qualifies for services from the contract. This creates the equity

Wall discussed above. That company could then provide a loan to an American.

Borrower. With a few limited exceptions, this arrangement is not

Currently under attack under the current anti-conduit


Proposed Anti-Conduit Regulations

The proposed regulations do not completely eliminate equity

Wall rule. However, they expand the definition of equity

Interests that are dealt with taking into account financial transactions

the tax treatment of the agreement under the Tax Act of

applicable abroad. The Treasury Department apparently believes if

The agreement enjoys favorable tax treatment in this foreign country

Country, then US tax breaks should not be allowed because the

Agreement "promotes the transmission of income through the

intermediary issuer in a functional manner like a

Intermediate company issues a debt instrument known as a

Financing transaction according to the applicable regulations. "

Accordingly, the proposed regulations provide for the following


  • The proposed regulations treat stocks or similar interests as

    Financing transaction if the issuer is permitted to withdraw or

    another tax benefit (e.g. an exemption, exclusion, credit, or a

    fictitious deduction in relation to the share or the like

    Interest) on amounts paid, accrued or distributed (as or

    otherwise) in relation to the share or similar interest

    according to the laws of the issuer's country of residence or a

    Country in which the issuer is liable for tax, e.g.

    Permanent establishment to which a payment on a financing

    Transaction is attributable. 7

Example: Foreign Corporation A owns 100

Percent of foreign company B. Foreign company B is

incorporated in country L. Foreign Corporation A makes a loan to a

US affiliate in exchange for a promissory note. Foreign

Company A then pays the promissory note to Foreign

Company B in exchange for convertible bonds with a term of 49 years

that is treated as a debt under the tax laws of country L, but as a

Equity for US federal income tax purposes. Without the suggested

Regulations there would be an "equity wall" that would do this

prevent current anti-conduit regulations from applying.

However, since the transaction is subject to deductions under the

L country tax laws, Foreign Corporation B shares are dealt with

as a financing transaction and the anti-conduit rules

apply. 8

  • The proposed regulations treat stocks or similar interests as

    Financing transaction when a person is linked to the issuer (generally

    A shareholder or other shareholder in a company is eligible

    a refund (including a credit) or similar tax benefit on taxes paid

    from the issuer to his country of residence, regardless of the

    Tax liability of the person in relation to the payment, provision or

    Distribution according to the laws of the issuer. 9

Example: Foreign Corporation A owns 100

Percent of foreign company B. Foreign company B is

established in country M. Foreign Corporation B lends $ 1 million

its US subsidiary. Country M has a tax system under

which Foreign Corporation A as the sole shareholder of Foreign

Company B will be granted a refund in respect of distributions from

Foreign Corporation B revenues equal to 90 percent of

the taxes of the country M paid by the foreign company B in relation to

these revenues.10 Without the proposed regulations,

there would be an "equity wall" that would prevent that

Current anti-conduit regulations do not apply. However, because

Foreign company A is entitled to a refund; financing is available

Transaction and anti-conduit rules apply.

Effective Date

It is suggested that these rules apply to payments made on or after

the date on which the final terms will be published

the federal register.


The proposed regulations, if and when they are finally adopted,

will create certain multi-party structures that will be used for lending,

Leasing or licensing into the United States is subject to Dec.

Percent US withholding tax. Additionally, under Section 267A of

the code issued under the Tax Reduction and Employment Act at

At the end of 2017, deductions may not be allowed for the US in some cases.

Borrowers in structures of this type. (This deduction

Non-admission rules are beyond the scope of this Holland &

Knight Alert.) Incoming funding structures should be reviewed

carefully in light of these developments.


1 REG-106013-19; 85 F.R. 19858-19873.

2 In practice has the ability to obtain contractual benefits

become more difficult over the years in the face of "limitation"

about benefits "and other contractual restrictions


3 TD 8611, 60 FR 40997 (August 11, 1995).

4 treasure. Reg. § 1.881-3 (a) (4) (i).

5 treasure. Reg. § 1.881-3 (a) (2) (ii) (A).

6 holdings in a

Company (or a similar interest in a partnership, trust or

other person) only constitutes a financing transaction if a

of the following conditions is met: 1) The issuer is required

the stock or similar interest at some point or the

The holder has the right to demand the redemption of the share from the issuer or

similar interest or other payment in relation to the

Shares or similar interest; 2) The issuer has the right to

Stocks or similar rates, but only if, based on all facts

and circumstances on the issue date, redemption accordingly

Right is more than likely not to occur; or 3) the owner of the

Shares or similar interests have the right to request a related person

to the issuer (or any other person acting under a plan

or agreement with the issuer) to acquire the share or similar

Make interest or payment in relation to the stock or the like

Interest. Treasure. Reg. § 1.881-3 (a) (2) (ii) (B) (1).

7 Prop. Treasure. Reg.

§ 1.881-3 (a) (2) (ii) (B) (1) (iv).

8 See Prop. Treas. Reg. §1.881-3 (e), example


9 Prop. Treasure. Reg.

§ 1.881-3 (a) (2) (ii) (B) (1) (v).

10 See Prop. Treas. Reg. §1.881-3 (e), example


The content of this article is intended to provide a general overview

Guide to the subject. Expert advice should be obtained

about your particular circumstances.


Guide to tax planning for the end of 2020

Duane Morris LLP

First and foremost, we hope that you, your family, and all of your loved ones stay safe and healthy during this incredibly difficult year that was challenging on many different levels.

Proposed changes to estate and gift tax laws

Paul Weiss Rifkind Wharton & Garrison

As 2020 comes to an end and the word "unprecedented" continues to thin, tax planning remains an increasingly important goal. Although the details of President-Elect Biden's gift and estate taxes …

Biden's tax plan

Cadwalader, Wickersham & Taft LLP

While quantitative analysis is bound to be fraught with considerable uncertainty, many commentators estimate that Biden's tax plan would increase federal revenue by $ 2 trillion to $ 2.5 trillion over the next decade.

FAQ not present/live