“Implicit support” comes charging out of the gates as an early candidate for Word or Phrase of the Year for 2024.
Before year’s end, the IRS Office of Chief Counsel dropped a new generic legal advice memorandum (“GLAM”), AM 2023-008, titled “Effect of Group Membership on Financial Transactions under Section 482 and Treas. Reg. § 1.482-2(a).” The GLAM visits some familiar territory, including the “realistic alternatives” principle, this time in the intracompany lending context.
Tax authorities and taxpayers, of course, each have incentives to police the arm’s length nature of interest paid (and deducted) to related parties. The section 482 regulations related to loans or advances say that in evaluating the interest rate, all relevant factors, “including…the credit standing of the borrower,” should be considered. Treas. Reg. § 1.482-2(a)(2)(i).
The GLAM describes what it asserts — without support — is the process by which credit rating agencies issue ratings, then concludes that the factors that inform the borrower’s rating include “the borrower’s role, level of integration within the group, and implicit support from affiliates” and therefore also inform the interest rate. For this purpose, the GLAM defines “implicit support” as the possibility that the borrower would obtain financial support from related parties even absent a legal obligation such as a written guarantee. GLAM at 2. Based on this review, the GLAM concludes that under Treas. Reg. § 1.482-2(a) it would not be appropriate to set an intracompany interest rate based exclusively on the credit rating of the borrower as an independent entity (i.e., without considering the group credit profile).
The GLAM also suggests that other areas of section 482 and its regulations further support the IRS’s position. First, it cites the realistic alternatives principle, which was codified in section 482 by the Tax Cuts and Jobs Act (Pub. L. No. 115-97), but which has been part of the section 482 regulations since 1993. See Treas. Reg. § 1.482-1(f)(2)(ii)(A); 58 Fed. Reg. 5253, 5266, 5275 (Jan. 21, 1993). In short, the realistic alternatives principle says that, unless the transaction as structured lacks economic substance, the IRS will not recast the transaction into a different form. It may, however, consider the alternatives realistically available to the taxpayer in evaluating whether the terms would be acceptable at arm’s length. Id. The GLAM says that in the financing context, the borrower’s financing options are informed by its credit rating, “which in turn may be affected by the entity’s standalone credit profile, the corporate group’s group credit profile, and implicit support available to the entity from the group.” GLAM at 4. The GLAM concludes that the borrower would never accept an interest rate greater than the rate it could borrow from in the market.
Second, the GLAM further asserts that transfer pricing regulations specifically for services transactions support its conclusion. In particular, Treas. Reg. § 1.482-9 says that no compensation is owed for any benefit arising solely from “passive association” in a corporate group. But the GLAM fails to explain whether implicit support is consistent with passive association or whether those regulations are even applicable to financial transactions. That said, the GLAM appears to conclude if a borrower gets some benefit from being part of a larger organization, then absent a written guarantee, it gets to keep the economic value of that benefit and should not have to pay it over to another group member in the form of a higher interest rate (or other imputed transaction).
IRS GLAMs, of course, are not binding authority and are not issued in a manner that complies with the Administrative Procedure Act. For the last couple years, however, the Transfer Pricing section of the IRS’s annual Priority Guidance Plan has mentioned “Regulations under §482 clarifying the effects of group membership (e.g., passive association) in determining arm’s length pricing, including specifically with respect to financial transaction.” Time will tell whether the positions taken in this new GLAM are echoed in these contemplated future regulatory efforts. In the meantime, we expect to see the IRS affirmatively use the GLAM against taxpayers, despite its flawed analysis and conclusions.