The U.S. Treasury Department has issued its final rules altering debt-equity treatment of certain intercompany financing transactions meant to curb use of “corporate inversions” to escape income tax.

In April, Treasury issued proposed regulations to modify Section 385 of the U.S. Tax Code to target what it regarded as abusive measures to reduce U.S. income tax through finance transactions with overseas operations in low-tax jurisdictions. Swift and vocal feedback, including Congressional intervention, told Treasury the sweeping proposal would ensnare a number of common corporate treasury transactions, burdening companies with unfair added tax and compliance duties.

In its final regulations, Treasury says it has narrowed the rules to focus on cross-border transactions that generate interest payment deductions on related-party debt but do not finance new investment in the United States. The new rules do so by exempting cash pools and short-term loans, for example, and provide limited exemptions for certain entities where the risk of earnings stripping is regarded as low. That includes transactions between foreign subsidiaries of U.S. multinational corporations, S corporations, regulated financial companies, regulated insurance companies, among others.

Treasury says it also has expanded exceptions for ordinary business transactions, such as acquisitions of stock associated with employee compensation plans. Exceptions also were expanded for distributions, or payments made to affiliate companies, to generally include future earnings, allowing corporations to net distributions against capital contributions. That means distributions out of earnings and profits will not cause debt issued by a corporation to be re-characterized as equity, Treasury says.

Finally, Treasury says, the regulations ease the documentation requirements compared to those contained in the proposal, and the effective date is extended by one year to Jan. 1, 2018. In a statement accompanying the final regulations, Treasury Secretary Jacob Lew says the Obama administration is taking action to correct a problem -- companies relocating their corporate residency to lower-tax jurisdictions to escape U.S. tax -- that Congress has left unaddressed.

“In the absence of Congressional action, it is Treasury’s responsibility to use our authority to protect the tax base from continued erosion,” said Lew. “We have taken a series of actions to make it harder for large foreign multinational companies to avoid paying U.S. taxes and reduce the incentives for U.S. companies to shift income and operations overseas.”

The final rules represent an improvement over the proposal, but still contain some problematic features, says Ronald Dabrowski, a principal in the national tax practice at KPMG. “On the plus side, the documentation rule's applicability date of 1/1/18 and the exception—for the time being at least—for foreign issuers were responsive to comments and were absolutely necessary,” he said.

The various carve-outs also were welcome, said Dabrowski. “But the rules’ general response regarding cash pooling will still be highly burdensome where they apply, as will the retroactive application of the re-characterization rules. The focus will now shift to the states and how they will implement section 385.”