US VIRGIN ISLANDS Law and Practice Contributed by: Marjorie (Jorie) Roberts, Duncan J.J. Kessler and Jessica McKenney, Marjorie Rawls Roberts PC
of the mirror Code) has adopted a somewhat differ - ent approach. It must be determined in each case whether a purported loan is in fact indebtedness or whether the loan represents an equity investment in the corporation. Concerning the classification of an investment in a corporation as either debt or equity, Code Section 385 sets out five factors that are to be considered, namely: • whether there is a written unconditional promise to pay on demand or on a specified date a sum cer - tain of money in return for an adequate considera - tion in money or money’s worth, and to pay a fixed rate of interest; • whether there is subordination to or preference over any indebtedness of the corporation; • the ratio of debt to equity of the corporation; • whether there is convertibility into the stock of the corporation; and • the relationship between holdings of stock in the corporation and holdings of the interest in ques - tion, ie, whether or not such holdings are propor - tional. The United States does not have a debt-to-equity ratio that can be used as a safe harbour to ensure debt treatment. Instead, the debt-to-equity ratio is merely one factor taken into account by the IRS and the courts, although it is generally believed that the IRS will not challenge a ratio of 3:1 or less on debt instruments that do not have equity features. IRS Notice 94-47 provides a list of the factors that it will consider in deciding the debt or equity character of an instrument. The characterisation of an instru - ment for federal income tax purposes depends on the terms of the instrument and all surrounding facts and circumstances. Among the factors that may be con - sidered in making this determination are: • whether there is an unconditional promise on the part of the issuer to pay a sum certain on demand or at a fixed maturity date that is in the reasonably foreseeable future; • whether holders of the instruments possess the right to enforce the payment of principal and inter - est;
• whether the rights of the holders of the instruments are subordinate to the rights of general creditors; • whether the instrument gives the holders the right to participate in the management of the issuer; • whether the issuer is thinly capitalised; • whether there is an identity between the holders of the instruments and stockholders of the issuer; • the label placed upon the instruments by the par - ties; and • whether the instruments are intended to be treated as debt or equity for non-tax purposes. No particular factor is conclusive in making the deter - mination of whether an instrument constitutes debt or equity. The weight given to any factor depends upon all the facts and circumstances, and the overall effect of an instrument’s debt and equity features must be taken into account. The IRS stated that certain categories of instruments will be closely examined on audit to determine whether debt treatment is appropriate. This includes financial instruments that are treated as equity for regulatory, rating agency or financial accounting purposes, but sought to be treated as debt for income tax purposes; instruments with unreasonably long maturities; and instruments with provision for payment of principal using stock of the issuer. 5.6 Transfer Pricing The US transfer pricing regime of Code Section 482 applies to the USVI by virtue of the mirror system. Code Section 482 provides that gross income, deduc - tions, credits and other allowances may be allocated among two or more organisations, trades or business - es under common ownership or control whenever it is determined that such action is necessary to prevent the evasion of taxes or to clearly reflect the income of the parties. True taxable income is determined by evaluating transactions between commonly controlled taxpay - ers against the standard of comparable transactions between unrelated persons dealing at arm’s length. If a taxpayer’s results differ from its true taxable income, the taxpayer may be subject to a realloca - tion of income, deductions, credits or any other item or element affecting taxable income. The permissible
1081 CHAMBERS.COM
Powered by FlippingBook