[Federal Register Volume 84, Number 213 (Monday, November 4, 2019)]
[Rules and Regulations]
[Pages 59297-59302]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-23817]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9880]
RIN 1545-BO02


Removal of Section 385 Documentation Regulations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document removes final regulations setting forth minimum 
documentation requirements that ordinarily must be satisfied in order 
for certain related-party interests in a corporation to be treated as 
indebtedness for Federal tax purposes. This document also adopts 
conforming amendments to other final regulations to reflect the removal 
of the documentation regulations. The final regulations removed or 
amended by this

[[Page 59298]]

document generally affect corporations that issue purported 
indebtedness to related corporations or partnerships.

DATES: These regulations are effective November 4, 2019.

FOR FURTHER INFORMATION CONTACT: Austin Diamond-Jones, (202) 317-5363 
(not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act (44 U.S.C. 3501-
3521), approval for the information collection included in these 
regulations had been requested under control number 1545-2267. Because 
of the removal of the final documentation regulations, the information 
burden has been removed and control number 1545-2267 is no longer 
needed.

Background

I. Overview

    Section 385(a) of the Internal Revenue Code (Code) authorizes the 
Secretary to ``prescribe such regulations as may be necessary or 
appropriate to determine whether an interest in a corporation is to be 
treated for purposes of [the Code] as stock or indebtedness (or as in 
part stock and in part indebtedness).'' Section 385(b) requires such 
regulations to ``set forth factors which are to be taken into account 
in determining with respect to a particular factual situation whether a 
debtor-creditor relationship exists or a corporation-shareholder 
relationship exists.'' Section 385(b) also enumerates a nonexclusive 
list of factors potentially to be included in those regulations.
    On October 21, 2016, the Department of the Treasury (Treasury 
Department) and the IRS published final and temporary regulations (T.D. 
9790) under section 385 in the Federal Register (81 FR 72858). The 
final and temporary regulations under section 385 (Section 385 
Regulations) include rules set forth in Sec.  1.385-2, which establish 
minimum documentation requirements that ordinarily must be satisfied in 
order for purported debt obligations among related parties to be 
treated as debt for Federal tax purposes (Documentation Regulations). 
The Section 385 Regulations also include Sec. Sec.  1.385-3, 1.385-3T, 
and 1.385-4T, which treat as stock certain debt that is issued by a 
corporation to a controlling shareholder in a distribution or in 
another related-party transaction that achieves an economically similar 
result (Distribution Regulations).
    The Documentation Regulations, as proposed, would have been 
applicable with respect to interests issued or deemed issued on or 
after the date of finalization. However, commenters expressed concern 
that, if the Documentation Regulations were to be applicable as of that 
date, taxpayers would lack adequate time to prepare for compliance with 
the requirements set forth in those regulations. To assist taxpayers in 
their preparation for the Documentation Regulations, the Treasury 
Department and the IRS made the regulations applicable with respect to 
interests issued or deemed issued after January 1, 2018. See Sec. Sec.  
1.385-1(f), 1.385-2(d)(2)(iii), and 1.385-2(i).

II. Executive Order 13789

    Executive Order 13789 (E.O. 13789), issued on April 21, 2017, 
instructed the Secretary to review all significant tax regulations 
issued on or after January 1, 2016, and to take concrete action to 
alleviate the burdens of regulations that (i) impose an undue financial 
burden on U.S. taxpayers; (ii) add undue complexity to the Federal tax 
laws; or (iii) exceed the statutory authority of the IRS. E.O. 13789 
further instructed the Secretary to submit to the President within 60 
days a report (First Report) that identifies regulations that meet 
these criteria. Notice 2017-38 (2017-30 I.R.B. 147 (July 24, 2017)) 
included the Section 385 Regulations in a list of eight regulations 
identified by the Secretary in the First Report as meeting at least one 
of the first two criteria specified in E.O. 13789. In addition, E.O. 
13789 instructed the Secretary to submit to the President a second 
report (Second Report) that recommended specific actions to mitigate 
the burden imposed by regulations identified in the First Report.

III. Additional Delay in Application of Documentation Regulations

    As noted in Part I of this Background section, the Treasury 
Department and the IRS had originally delayed the applicability date of 
the Documentation Regulations to help taxpayers prepare for compliance 
with those rules. Taxpayers, however, continued to express concern 
regarding the timing and potential application of the Documentation 
Regulations. Based on those continued concerns, and in light of the 
contemplated additional action regarding the Section 385 Regulations 
that resulted from E.O. 13789 review, the Treasury Department and the 
IRS determined that a further delay in the application of the 
Documentation Regulations would be appropriate. Accordingly, in Notice 
2017-36 (2017-33 I.R.B. 208 (August 14, 2017)), the Treasury Department 
and the IRS announced their intent to amend the Documentation 
Regulations to delay the applicability of the regulations for 12 
months, making the regulations applicable only to interests issued or 
deemed issued on or after January 1, 2019.

IV. Proposed Removal of Documentation Regulations

    The Second Report announced that the Treasury Department and the 
IRS were considering a proposal to revoke the finalized Documentation 
Regulations. See Executive Order 13789--Second Report to the President 
on Identifying and Reducing Tax Regulatory Burdens, 82 FR 48013, 48016 
(October 16, 2017). On September 24, 2018, the Treasury Department and 
the IRS published a notice of proposed rulemaking (REG-130244-17) in 
the Federal Register (83 FR 48265) that proposed removing the 
Documentation Regulations and adopting conforming amendments to other 
final regulations to reflect the removal of the Documentation 
Regulations (Proposed Regulations). The preamble to the Proposed 
Regulations provided that ``taxpayers may rely on these proposed 
regulations, in their entirety, until the date a Treasury decision 
adopting these regulations as final regulations is published in the 
Federal Register'' (Reliance Provision). Proposed Regulations, 83 FR at 
48267.

Summary of Comments

    The Treasury Department and the IRS received three written comments 
regarding the Proposed Regulations. Two of the comments supported 
removal of the Documentation Regulations, while one comment opposed 
removal. In connection with the Proposed Regulations, the Treasury 
Department and the IRS also received a written comment addressing 
solely the Distribution Regulations.
    The single commenter that opposed removal of the Documentation 
Regulations argued that the Proposed Regulations would hamper the 
ability of the IRS to counter earnings stripping, and result in 
significant decreases in Federal revenue. In addition, the commenter 
asserted that the removal likely would reduce the overall perceived 
legitimacy of the U.S. tax system, and consequently reduce voluntary 
compliance. The commenter further argued that removal of the 
Documentation Regulations would prove unnecessary because of (i) the 
delayed applicability date provided by Notice 2017-36 and (ii) 
substantial, taxpayer-favorable modifications included in the finalized 
Documentation Regulations.

[[Page 59299]]

    The two commenters that supported removal of the Documentation 
Regulations contended that the regulations fail to balance 
appropriately (i) the burdens imposed on taxpayers with (ii) the 
expected benefits to the Federal government described in the preceding 
paragraph. Both commenters expressed their appreciation for the 
Reliance Provision, and emphasized that application of the 
Documentation Regulations would have imposed onerous compliance burdens 
and costs on taxpayers. One commenter also asserted that the Reliance 
Provision appropriately reduced administrative burdens on the IRS.
    The Treasury Department and the IRS have considered each of the 
competing arguments and concerns set forth by the commenters and have 
determined that the burdens imposed on taxpayers by the Documentation 
Regulations outweigh the regulations' intended benefits. As a result, 
this document adopts the Proposed Regulations with no change as final 
regulations. The Treasury Department and the IRS, however, continue to 
consider the issues addressed by the Documentation Regulations.
    After this further review, the Treasury Department and the IRS may 
propose a modified version of the Documentation Regulations. In any 
modified version, the Treasury Department and the IRS would 
substantially simplify and streamline the proposal to minimize taxpayer 
burdens, while ensuring the collection of sufficient documentation and 
other information necessary for tax administration purposes. The 
Treasury Department and the IRS welcome comments regarding approaches 
that would most effectively achieve that balance. Any modified version 
of the Documentation Regulations would be proposed with a prospective 
effective date to allow sufficient lead-time for taxpayers to design 
and implement systems to comply with those regulations.

Effective Date

    The removal of Sec.  1.385-2 and the conforming modifications are 
effective as of November 4, 2019.

Statement of Availability of IRS Documents

    IRS Notices cited in this document are published in the Internal 
Revenue Bulletin and are available from the Superintendent of 
Documents, U.S. Government Publishing Office, Washington, DC 20402, or 
by visiting the IRS website at http://www.irs.gov.

Special Analyses

I. Regulatory Planning and Review--Economic Analysis

    Executive Order 13777 directs agencies to alleviate unnecessary 
regulatory burdens placed on the American people by managing the costs 
associated with the governmental imposition of private expenditures 
required to comply with Federal regulations. Executive Orders 13771, 
13563, and 12866 direct agencies to prudently manage the cost of 
planned regulations by assessing costs and benefits of available 
regulatory alternatives and, if regulation is necessary, to select 
regulatory approaches that maximize net benefits (including potential 
economic, environmental, public health and safety effects, distributive 
impacts, and equity). Executive Order 13563 emphasizes the importance 
of quantifying both costs and benefits, of reducing costs, of 
harmonizing rules, and of promoting flexibility.
    The final regulations have been designated as subject to review 
under Executive Order 12866 pursuant to the Memorandum of Agreement 
(April 11, 2018) between the Treasury Department and the Office of 
Management and Budget (OMB) regarding review of tax regulations. OMB 
has determined that the final regulations are not a significant 
regulatory action. This final rule is an Executive Order 13771 
deregulatory action.
A. Background
    On October 21, 2016, the Treasury Department and the IRS published 
final and temporary regulations (T.D. 9790) under section 385 in the 
Federal Register (81 FR 72858). The final and temporary regulations 
under section 385 include rules set forth in Sec.  1.385-2, which 
establish minimum documentation requirements that ordinarily must be 
satisfied in order for purported debt obligations among related parties 
to be treated as debt for Federal tax purposes (that is, the 
Documentation Regulations).
    These final regulations withdraw the Documentation Regulations, and 
thereby remove the requirements set forth in those regulations on 
taxpayers with respect to certain transactions related to debt 
issuance. If applicable, the Documentation Regulations would have 
prescribed the nature of the documentation necessary to substantiate 
the Federal income tax treatment of related-party interests as 
indebtedness, including documentation of factors analogous to those 
found in third-party loan agreements. In general, to comply with the 
Documentation Regulations, taxpayers would have needed to provide or 
otherwise establish the following: (1) Evidence of an unconditional and 
binding obligation to make interest and principal payments on certain 
fixed dates; (2) that the holder of the loan had the rights of a 
creditor, including rights superior to shareholders in the case of 
dissolution; (3) a reasonable expectation of the borrower's ability to 
repay the loan; and (4) evidence of conduct consistent with a debtor-
creditor relationship. The Documentation Regulations would have applied 
to relevant intercompany debt issued by U.S. borrowers beginning in 
2019, and would have required that the taxpayer's documentation for a 
given tax year be prepared by the time the borrower's Federal income 
tax return is filed.
    Since the issuance of the Documentation Regulations, Congress 
enacted the Tax Cuts and Jobs Act, Public Law 115-97, 131 Stat. 2054 
(2017) (TCJA). While the final regulations do not implement any 
provisions of the TCJA, the final regulations would interact with the 
TCJA. There are several provisions of the TCJA that reduced the tax 
advantages of conducting activity as part of a foreign controlled 
domestic corporation (FCDC) rather than in a domestically controlled 
company (DCC), and thus may affect the economic efficiency of the 
Documentation Regulations and, analogously, the removal of those 
regulations. First, for taxable years beginning after December 31, 
2017, the TCJA reduced the statutory corporate tax rate from 35 percent 
to 21 percent, which lowers the effective tax rate for DCCs more than 
for FCDCs. Second, the ability of FCDCs to strip earnings out of the 
United States through the use of deductions for interest expense was 
significantly reduced by the TCJA through amendments to section 163(j) 
of the Internal Revenue Code. See section 13301(a) of the TCJA, 131 
Stat. 2054, 2117-21. Specifically, the TCJA amendments to section 
163(j) (1) eliminated the debt-equity ratio safe harbor, (2) reduced 
the maximum net interest deductions' share of adjusted taxable income 
from 50 percent to 30 percent, (3) limited all, rather than just 
related-party, interest deductions, and (4) eliminated the carryforward 
of excess limitation under pre-TCJA section 163(j). The TCJA's Base 
Erosion Anti-abuse Tax (BEAT) further reduces the tax advantage to 
deducting interest expense. See section 14401(a) of the TCJA, 131 Stat. 
2054, 2226-32. Thus, the benefits of the Documentation

[[Page 59300]]

Regulations in reducing foreign acquisitions of U.S. assets and 
interest stripping were reduced by the TCJA.
B. Need for the Final Regulations
    These final regulations implement the fifth deregulatory action 
identified for further consideration in the Second Report issued 
pursuant to E.O. 13789. Accordingly, the final regulations are needed 
to remove the Documentation Regulations.
C. Overview of the Final Regulations
    These final regulations remove the Documentation Regulations, which 
set forth minimum documentation requirements that ordinarily must be 
satisfied in order for certain related-party interests in a corporation 
to be treated as indebtedness for Federal tax purposes. In addition, 
the final regulations adopt conforming amendments to other final 
regulations to reflect the removal of the Documentation Regulations.
D. Economic Analysis
1. Baseline
    The Treasury Department and the IRS have assessed the benefits and 
costs of these final regulations compared to a no-action baseline that 
reflects anticipated Federal income tax-related behavior in the absence 
of these final regulations.
2. Summary of Economic Effects
    These final regulations provide compliance cost savings for some 
taxpayers by eliminating the need to document relevant transactions in 
a prescribed manner. The behavior of taxpayers that nevertheless 
continue to document such transactions would not be changed to any 
measurable degree. While the removal of the Documentation Regulations 
may lead to an increase in investment in the United States, this effect 
is likely to be small given that a body of other regulations continue 
to cover the terms of that investment. The final regulations may 
increase costs of the IRS in administering the Distribution Regulations 
and potentially lead to more noncompliance by some taxpayers.
    An analysis discussing the anticipated economic effects of these 
regulations was included in the preamble to the Proposed Regulations. 
See Proposed Regulations, 83 FR at 48267-69. The Treasury Department 
and the IRS received no substantive comments regarding that analysis in 
response to the Proposed Regulations. The analysis included herein 
presents the analysis set forth in those Proposed Regulations.
3. Number of Affected Taxpayers
    The Treasury Department and the IRS project that approximately 
6,300 large C corporations are likely to be affected by these 
regulations. This estimate is based on the number of corporations that 
have sufficient assets ($100 million) or revenue ($50 million) or are 
publicly traded such that they would have been required to document the 
relevant transactions.
4. Monetized Estimates of Compliance Burden Effects From Documentation 
Regulations
    The Treasury Department and the IRS estimate that removal of the 
Documentation Regulations will reduce taxpayer compliance costs by $924 
million over the period 2019-2028 (undiscounted nominal total). The net 
present value of the compliance cost savings is $773 million and $685 
million ($2018) using real discount rates of 3 percent and 7 percent, 
respectively. These amounts are $90.6 million and $97.5 million on an 
annualized basis, again based on 3 percent and 7 percent real rates, 
respectively. See below the ``Change in Annual Compliance Costs'' 
table.
    These estimates include an ongoing reduction in compliance costs 
and a reduction in the start-up cost equal to four times the annual 
ongoing compliance cost savings. In addition, the analysis includes a 
sensitivity analysis in which the compliance costs are estimated for a 
90-percent interval around our best estimate. First, the distributional 
characteristics of critical parameters used to produce the estimate are 
evaluated. Then, Monte Carlo simulations are used to vary the parameter 
values. Finally, alternative high and low estimates are computed based 
on parameter values at either end of the 90-percent range.

                Table--Change in Annual Compliance Costs
------------------------------------------------------------------------
                                           Fiscal years    Fiscal years
  Estimated change in annual compliance    2019 to 2028    2019 to 2028
 costs (annualized value, $2018 million)     (3% real        (7% real
                                          discount rate)  discount rate)
------------------------------------------------------------------------
Central estimate........................          -$90.6          -$97.5
High estimate...........................          -113.3          -121.9
Low estimate............................           -68.0           -73.1
------------------------------------------------------------------------
Technical note: In this rulemaking, the Treasury Department made
  technical adjustments relative to the Documentation Regulations in
  calculating the annualized compliance cost estimates. The cost stream
  in this rulemaking is in 2018 dollars, reflects a two-year delay in
  effective date (relative to the previous estimates), and applies real
  discount rates of 3 percent and 7 percent. Technical adjustments
  account for part of the difference in the estimates between the
  rulemakings.

5. Higher Tax Administrative Costs for the IRS
    The reduced loan documentation required of large corporations as a 
result of the removal of the Documentation Regulations will reduce the 
ability of the IRS to more effectively administer the tax laws by 
making it more difficult for the IRS to evaluate whether purported 
loans are properly treated as debt for Federal tax purposes. This will 
raise the cost of auditing and evaluating the tax returns of companies 
engaged in these transactions.
6. Other Economic Effects
a. Reduced Tax Compliance
    As a result of the final regulations, taxpayers will not be 
required to comply with the Documentation Regulations. Therefore, such 
taxpayers will not need to satisfy the documentation requirements with 
respect to relevant transactions formerly addressed by the 
Documentation Regulations. That lack of documentation likely will 
slightly reduce voluntary compliance by taxpayers to report accurately 
the Federal income tax consequences of such transactions. The resulting 
expected revenue reduction is $407 million over the period 2019 to 2028 
(undiscounted nominal total). The annualized value of the revenue 
reduction is $35.4 million and $34.5 million ($2018) using real 
discount rates of 3 percent and 7 percent, respectively. The revenue 
effects were estimated

[[Page 59301]]

using the methodology described in the preamble to the Section 385 
Regulations, although the estimate presented herein covers 2019 to 2028 
and reflects factors that changed as a result of the TCJA as well as 
other technical adjustments.
b. Efficiency and Growth Effects
    The removal of the Documentation Regulations will increase, to some 
extent, the tax advantage some foreign owners have over some domestic 
owners of U.S. assets, and consequently may increase the propensity for 
foreign acquisitions and ownership of U.S. assets that are motivated by 
tax considerations rather than economics. By increasing the ability to 
undertake tax-motivated acquisitions or ownership structures, removal 
of the Documentation Regulations may slightly reduce the incentive for 
assets to be owned or managed by those most capable of putting the 
assets to their highest-valued use. Moreover, removal of the 
Documentation Regulations may put purely domestic U.S. firms on less 
even tax footing than their foreign-owned competitors operating in the 
United States.
    On the other hand, removal of the Documentation Regulations may 
slightly reduce the effective tax rate and compliance costs on 
investment in the United States. While the magnitude of this reduction 
is small, to the extent that the reduction increases new capital 
investment in the United States its effects would be efficiency 
enhancing.

II. Regulatory Flexibility Act

    As described in more detail in this section, pursuant to the 
Regulatory Flexibility Act (5 U.S.C. chapter 6), the Treasury 
Department and the IRS hereby certify that these final regulations will 
not have a significant economic impact on a substantial number of small 
entities.
    The Documentation Regulations, as finalized, were made applicable 
with respect to interests issued or deemed issued on or after January 
1, 2018. See Background section, part I. In Notice 2017-36, the 
Treasury Department and the IRS further delayed the applicability of 
the Documentation Regulations by making the regulations applicable only 
to interests issued or deemed issued on or after January 1, 2019. See 
Background section, part III. Because of the Reliance Provision, the 
Documentation Regulations are not applicable to any interests issued by 
any taxpayer, unless such taxpayer chooses to apply the regulations 
despite the Reliance Provision. See Background section, part IV.
    The Documentation Regulations apply to large corporate groups 
(specifically, those that are publicly traded, or have assets exceeding 
$100 million or annual total revenue exceeding $50 million in its 
expanded group), thus limiting the scope of small entities affected. 
The Documentation Regulations apply to financial institutions, which 
are considered small entities under the Regulatory Flexibility Act if 
they have less than $550 million in assets. See 13 CFR 121.201. The 
Treasury Department and the IRS believe that the Documentation 
Regulations do not affect a substantial number of small entities other 
than small financial institutions. Even if the Documentation 
Regulations affected a substantial number of small entities in that 
sector, the economic impact of this rule would be minimal because the 
final regulations adopt the Proposed Regulations, which remove the 
Documentation Regulations and permit taxpayers not to apply such 
regulations until adoption of these final regulations. Accordingly, 
this final rule will not have a significant economic impact on a 
substantial number of small entities.
    Pursuant to section 7805(f), the proposed regulations preceding 
these final regulations were submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on their 
impact on small business and no comments were received.

III. Unfunded Mandates Reform Act

    Section 202 of the Unfunded Mandates Reform Act of 1995 requires 
that agencies assess anticipated costs and benefits and take certain 
other actions before issuing a final rule that includes any Federal 
mandate that may result in expenditures in any one year by a state, 
local, or tribal government, in the aggregate, or by the private 
sector, of $100 million in 1995 dollars, updated annually for 
inflation. In 2019, that threshold is approximately $164 million. This 
final rule does not include any mandate that may result in expenditures 
by state, local, or tribal governments, or by the private sector in 
excess of that threshold.

IV. Executive Order 13132: Federalism

    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any rule that has federalism implications if the rule 
either imposes substantial, direct compliance costs on state and local 
governments, and is not required by statute, or preempts state law, 
unless the agency meets the consultation and funding requirements of 
section 6 of the Executive Order. This final rule does not have 
federalism implications and does not impose substantial, direct 
compliance costs on state and local governments or preempt state law 
within the meaning of the Executive Order.

Drafting Information

    The principal author of the final regulations is Austin Diamond-
Jones, Office of the Associate Chief Counsel (Corporate). However, 
other personnel from the Treasury Department and the IRS participated 
in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by removing 
the sectional authority for Sec.  1.385-2 to read, in part, as follows:

    Authority:  26 U.S.C. 7805 * * *


0
Par. 2. Section 1.385-1 is amended by:
0
1. Revising paragraph (a), the last sentence of paragraph (c), the last 
sentence of paragraph (c)(4)(iv), paragraph (d)(1)(i), the first 
sentence of paragraph (d)(1)(ii), and paragraphs (d)(1)(iii) and 
(d)(1)(iv)(A); and
0
2. Removing and reserving paragraph (d)(2)(i).
    The revisions read as follows:


Sec.  1.385-1  General provisions.

    (a) Overview of section 385 regulations. This section and 
Sec. Sec.  1.385-3 through 1.385-4T (collectively, the section 385 
regulations) provide rules under section 385 to determine the treatment 
of an interest in a corporation as stock or indebtedness (or as in part 
stock and in part indebtedness) in particular factual situations. 
Paragraph (b) of this section provides the general rule for determining 
the treatment of an interest based on provisions of the Internal 
Revenue Code and on common law, including the factors prescribed under 
common law. Paragraphs (c), (d), and (e) of this section provide 
definitions and rules of general application for purposes of the 
section 385 regulations. Section 1.385-3 sets forth additional factors 
that, when present, control the determination of whether an interest in 
a corporation that is held by a member of the corporation's expanded 
group is treated (in whole or in part) as stock or indebtedness.
* * * * *

[[Page 59302]]

    (c) * * * For additional definitions that apply for purposes of 
their respective sections, see Sec. Sec.  1.385-3(g) and 1.385-4T(e).
* * * * *
    (4) * * *
    (iv) * * * For purposes of the section 385 regulations, a 
corporation is a member of an expanded group if it is described in this 
paragraph (c)(4)(iv) immediately before the relevant time for 
determining membership (for example, immediately before the issuance of 
a debt instrument (as defined in Sec.  1.385-3(g)(4)) or immediately 
before a distribution or acquisition that may be subject to Sec.  
1.385-3(b)(2) or (3)).
* * * * *
    (d) * * *
    (1) * * *
    (i) In general. If a debt instrument (as defined in Sec.  1.385-
3(g)(4)) is deemed to be exchanged under the section 385 regulations, 
in whole or in part, for stock, the holder is treated for all Federal 
tax purposes as having realized an amount equal to the holder's 
adjusted basis in that portion of the debt instrument as of the date of 
the deemed exchange (and as having basis in the stock deemed to be 
received equal to that amount), and, except as provided in paragraph 
(d)(1)(iv)(B) of this section, the issuer is treated for all Federal 
tax purposes as having retired that portion of the debt instrument for 
an amount equal to its adjusted issue price as of the date of the 
deemed exchange. In addition, neither party accounts for any accrued 
but unpaid qualified stated interest on the debt instrument or any 
foreign exchange gain or loss with respect to that accrued but unpaid 
qualified stated interest (if any) as of the deemed exchange. This 
paragraph (d)(1)(i) does not affect any rules in Title 26 of the United 
States Code that otherwise apply to the debt instrument prior to the 
date of the deemed exchange (for example, this paragraph (d)(1)(i) does 
not affect the issuer's deduction of accrued but unpaid qualified 
stated interest otherwise deductible prior to the date of the deemed 
exchange). Moreover, the stock issued in the deemed exchange is not 
treated as a payment of accrued but unpaid original issue discount or 
qualified stated interest on the debt instrument for Federal tax 
purposes.
    (ii) * * * Notwithstanding the first sentence of paragraph 
(d)(1)(i) of this section, the rules of Sec.  1.988-2(b)(13) apply to 
require the holder and the issuer of a debt instrument that is deemed 
to be exchanged under the section 385 regulations, in whole or in part, 
for stock to recognize any exchange gain or loss, other than any 
exchange gain or loss with respect to accrued but unpaid qualified 
stated interest that is not taken into account under paragraph 
(d)(1)(i) of this section at the time of the deemed exchange. * * *
    (iii) Section 108(e)(8). For purposes of section 108(e)(8), if the 
issuer of a debt instrument is treated as having retired all or a 
portion of the debt instrument in exchange for stock under paragraph 
(d)(1)(i) of this section, the stock is treated as having a fair market 
value equal to the adjusted issue price of that portion of the debt 
instrument as of the date of the deemed exchange.
    (iv) * * *
    (A) A debt instrument that is issued by a disregarded entity is 
deemed to be exchanged for stock of the regarded owner under Sec.  
1.385-3T(d)(4);
* * * * *


Sec.  1.385-2   [Removed]

0
Par. 3. Section 1.385-2 is removed.

0
Par. 4. Section 1.385-3 is amended by revising paragraph (g)(4) to read 
as follows:


Sec.  1.385-3   Transactions in which debt proceeds are distributed or 
that have a similar effect.

* * * * *
    (g) * * *
    (4) Debt instrument. The term debt instrument means an interest 
that would, but for the application of this section, be treated as a 
debt instrument as defined in section 1275(a) and Sec.  1.1275-1(d).
* * * * *

0
Par. 5. Section 1.1275-1 is amended by revising the last sentence of 
paragraph (d) to read as follows:


Sec.  1.1275-1   Definitions.

* * * * *
    (d) * * * See Sec.  1.385-3 for rules that treat certain 
instruments that otherwise would be treated as indebtedness as stock 
for Federal tax purposes.
* * * * *

Sunita Lough,
Deputy Commissioner for Services and Enforcement.
    Approved: September 30, 2019.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2019-23817 Filed 10-31-19; 4:15 pm]
 BILLING CODE 4830-01-P