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

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  • 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.


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