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Three of the largest U.S. banks, in a joint appeal to the Treasury Department, warned that proposed tax rules on internal corporate debt could make their industry "more fragile in times of financial stress" and end up "creating risk to the financial stability of the United States."

Citigroup Inc., J.P. Morgan Chase & Co., and Bank of America Corp. want industry-specific exceptions to the tax rules, which the government wrote to prevent tax-motivated transactions known as "earnings stripping."

The banks say their internal loans don't stem from tax avoidance, but from legitimate needs to move their inventory—money—around the world efficiently. In some cases, they say, internal loans are driven by other government regulations.

"Making intercompany loans is fundamental to the ordinary course of a global financial services business," the banks' letter says. Under the rules, "a financial services group would face the choice between, on the one hand, staggering administrative complexities and a tax burden disproportionate to its true economic profit, and on the other hand, the imposition of crippling constraints on its ordinary business activities."

Those warnings follow concerns from dozens of businesses and trade groups that say the rules would transform their finances in punitive, cascading and unpredictable ways. In its waning days, the Obama administration is facing tough, organized resistance to one of its most consequential tax regulations, and not just from foreign companies with the most to gain from earnings stripping.

The big four global accounting firms asked the Treasury to withdraw the rules and replace them with a more targeted effort, citing "consequences that are severe and far-reaching in nature." Exxon Mobil Corp. wrote that the regulations would disadvantage the company against foreign competitors and require $30 million in upfront compliance costs and $100 million annually. Verizon Communications Inc. wrote that the rules would "unfairly penalize" it for routine transactions.

Supporters include left-leaning nonprofit groups, a collection of law professors and Sen. Bernie Sanders of Vermont, who wrote that the rules "focus only on the most blatant abuses."

The government says it is listening, but the Treasury rebuffed requests from lawmakers and trade associations seeking more time to study the rules. The Internal Revenue Service will hold a public hearing Thursday, one week after the comment deadline.

The Treasury says it will issue final rules "swiftly," with the decision coming after officials are "satisfied that we have addressed any reasonable concerns," the department said in a statement Tuesday that didn't directly address the banks' issues.

"Thus far," the statement said, "these comments generally fall into a few categories of feedback, all of which we believe we can respond to in the final regulations."

The rules under section 385 of the tax code are part of the government's effort to halt corporate inversions, in which companies cut their tax bills by putting their addresses outside the U.S. Companies based abroad, inverted or not, can load U.S. subsidiaries with debt payable to the parent company. They can deduct interest against the 35% U.S. tax rate, shifting profits to a lower-taxed jurisdiction. The rules attack earnings stripping by reclassifying those debt instruments as equity investments, making payments nondeductible.

Banking trade groups, including the Securities Industries and Financial Markets Association and the American Bankers Association, filed their own letters seeking industry-specific exemptions. Sifma, which said the rules could have "potentially catastrophic" effects, has met with the Treasury. Payson Peabody, the group's tax counsel, said Treasury officials are aware of the concerns and understand them. It isn't clear yet what Treasury will do.

"The existing 385 regulations will create undue hardship on the banks. I don't think that a complete exclusion of them from 385 is the answer," said Bret Wells, a University of Houston law professor who added the government should focus on companies with excessive leverage in the U.S.

Citigroup, J.P. Morgan and Bank of America—three of the four largest U.S. banks by assets—wrote to emphasize their particular concerns apart from the larger trade groups that often speak for them but also represent other financial-services companies with different interests. The banks' 24-page letter proposes specific changes that would treat banks and broker-dealers differently from other companies. Other Treasury rules already recognize those differences, the banks write, and the reasons here are "especially compelling."

The three banks submitted a joint comment on a different international tax policy regulation last year. They repeated that teamwork this time because they share a similar business footprint and scale, said three people involved in developing the banks' response.

According to the banks, existing regulations limit their ability to erode the U.S. tax base. And, they write, regulators require or encourage banks to have intercompany debt that can be moved around the company to provide flexibility during financial stress.

The banks say their subsidiaries and branches make hundreds of intercompany deposits daily. They may, for example, use debt to move money from a Hong Kong subsidiary to New York and back to meet customer demand. Internal loans also help banks manage interest-rate risks, according to the letter.

Samuel Thompson, a tax-law professor at Penn State University who supports the rules, said the banks make a good case for an exception and that the government should consider adopting some but not all of their recommendations.

Mr. Thompson said the government should exempt banks' ordinary financial transactions from some rules but let the government recharacterize other transactions as equity.

"They are a brilliant set of rules," Mr. Thompson said. "And they need to tinker with them to make sure they don't become overly onerous on non-tax-avoidance transactions."

Write to Richard Rubin at richard.rubin@wsj.com

(END) Dow Jones Newswires

July 13, 2016 13:05 ET (17:05 GMT)

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