Treaty Override by Administrative Regulation: The Multiparty Financing Regulations

Abstract

Copyright (c) 1995 by Richard L. Doemberg.

Section 7701(), enacted as part of the Omnibus Budget Reconciliation Act of 1993, provides: "The Secretary of the Treasury may prescribe regulations recharacterizing any multiparty financing transaction as a transaction directly among any 2 or more of such parties where the Secretary determines that such recharacterization is appropriate to prevent avoidance of any tax imposed by this title." The provision originated out of a concern "that taxpayers were inappropriately avoiding U.S. tax by intricately structuring financial transactions which utilize multiple entities, where one or more of those entities serve as a conduit."
The Treasury issued regulations in response to this legislation in July of 1995. Under the regulations, various financing arrangements are recharacterized for U.S. tax purposes to disregard a conduit entity or entities. For example, suppose that if A, a foreign financing entity, made a loan to C, a U.S.-financed entity, interest paid by C to A would be subject to a 30% withholding tax in the United States. But suppose that pursuant to a financing arrangement, A instead makes a loan to B, a foreign intermediate entity, which in turn makes a loan to C, and suppose further that if the form of the transactions is respected, the interest paid by C to B will not be subject to a 30% U.S. tax, but rather will be subject to a reduced or zero rate of U.S. tax because of an exemption under U.S. law, such as the portfolio interest exemption of section 881(c), or as a result of the application of a tax treaty. The regulations set out circumstances under which such a financing arrangement may be recharacterized for U.S. tax purposes to disregard the intermediate entity, B, as a conduit and treat the interest as paid directly by C to A, thereby resulting in a 30% U.S. withholding tax.