International Aspects of 2021 Final Regulations on Deduction of Business Interest Expense
On January 5, 2021, Treasury and the IRS issued an early version of final regulations (the 2021 final regulations) that provide additional guidance regarding the limitation on the deduction for business interest expense under Section 163(j). Among many other items, these regulations address the application of the limitation with respect to controlled foreign corporations (CFCs). These regulations affect taxpayers that have business interest expense, including foreign corporations and their U.S. shareholders.
Application of Section 163(j) to Relevant Foreign Corporations and Their U.S. Shareholders
Section 163(j) generally limits the amount of business interest expense (BIE) that can be deducted in the current taxable year. On December 28, 2018, Treasury and the IRS published proposed regulations under Section 163(j) (REG-106089-18). On September 14, 2020, Treasury and the IRS published final regulations (85 FR 56686) (T.D. 9905) and additional proposed regulations (REG-107911-18) (the 2020 proposed regulations) under Section 163(j). The 2021 final regulations retain the same basic structure as the 2020 proposed regulations with certain revisions. Some of the key highlights with respect to the international aspects of the 2021 final regulations (Reg. §1.163(j)-7) are summarized below.
Treas Reg. §1.163(j)-7 provides rules for applying Section 163(j) to relevant foreign corporations and their U.S. shareholders. The IRS and Treasury note in the preamble to the 2021 final regulations that as they continue to study aspects of the 2020 proposed regulations related to foreign corporations and their U.S. shareholders, the final regulations reserve on the following issues:
- Treating a CFC group as a single C corporation for purposes of allocations to an excepted trade or business
- Treating a CFC group as a single taxpayer for purposes of treating amounts as interest
- The ordering rule for when a CFC group member has effectively connected income
- The computation of adjusted taxable income (ATI) of certain U.S. shareholders of applicable CFCs
- Related definitions in §1.163(j)-7(k)
These paragraphs of the 2020 proposed regulations are retained in proposed form and may be relied on to the extent provided in the regulations.
No-Negative ATI Rule
With respect to the no-negative ATI rule in §1.163(j)-1(b)(1)(vii), the 2021 final regulations provide that the rule applies with respect to the ATI of a CFC group, rather than a CFC group member.
The 2021 final regulations expand the anti-abuse rule in the 2020 proposed regulations so that it may apply not only to certain intragroup transactions that affect ATI but also to intragroup transactions entered into with a principal purpose of affecting a CFC group or a CFC group member’s Section 163(j) limitation by increasing the CFC group or a CFC group member’s business interest income (BII). This rule is intended to prevent taxpayers from artificially increasing the total amount of BII and BIE within a CFC group for a specified period in order to shift disallowed BIE from one CFC group member to another or change the timing of deductions of BIE.
In addition, the 2021 final regulations retain the limitation on the deduction of pre-group disallowed BIE carryforwards under the 2020 proposed regulations.
Rules for Determining a Specified Group and Specified Group Members
The 2021 final regulations make several clarifying changes to the rules for determining a specified group and specified group members. First, the definition of specified group is modified to clarify that a specified group may exist when a qualified U.S. person directly owns all of its applicable CFCs rather than owning one or more chains of applicable CFCs. Second, the definition of specified group member is modified to clarify that there must be at least two applicable CFCs in a specified group for any applicable CFC to be a specified group member and for a CFC group election to be available. Finally, the rule concerning when a specified group ceases to exist is modified to clarify that references to the common parent in certain subsections of §1.1502-75 are treated as references to the specified group parent. This is the case even if the specified group parent is a qualified U.S. person and therefore not included in the specified group.
The 2021 final regulations do not impose a 60-month waiting period on a specified group for which a CFC group election is not made for the first specified period in which a specified group exists (or the specified period beginning 60 days after the regulations are finalized). Consistent with the 2020 proposed regulations, the 2021 final regulations provide that the 60-month period begins after the last day of the specified period for which the election was made or revoked. Therefore, if an election is made or revoked with respect to a specified period, the 60-month period begins to run on the day after the end of that specified period.
CFC Group Election Disclosure Requirements
To facilitate ongoing disclosure of the CFC group Section 163(j) limitation computation in subsequent taxable years, the 2021 final regulations provide that (in accordance with publications, forms, instructions, or other guidance) each designated U.S. person must attach a statement to its relevant federal income tax or information return for each of its taxable years that includes the last day of a specified period of a specified group for which a CFC group election is in effect. The CFC group election remains in effect even if the required statement is not filed.
Foreign Income Taxes and Relevant Foreign Corporation ATI
The 2021 final regulations also provide that no deduction for foreign income taxes (within the meaning of §1.960-1(b)) is taken into account for purposes of determining the ATI of a relevant foreign corporation. Thus, regardless of whether an election is made to claim a credit for these foreign income taxes, the foreign income taxes do not reduce ATI.
The 2021 final regulations provide that a safe-harbor election may be made with respect to a stand-alone applicable CFC or CFC group if its BIE does not exceed either (i) its BII, or (ii) 30% of the lesser of its eligible amount (in general, the sum of the applicable CFC’s Subpart F income and GILTI, taking into account only items properly allocable to a non-excepted trade or business) or its qualified tentative taxable income (that is, the applicable CFC’s tentative taxable income determined by taking into account only items properly allocable to a non-excepted trade or business). Thus, under the 2021 final regulations, if either a stand-alone applicable CFC or a CFC group has BII that is greater than or equal to its BIE, it is not necessary to determine its qualified tentative taxable income or eligible amount in order to make the safe-harbor election. However, consistent with the 2020 proposed regulations, the election may not be made for a CFC group that has pre-group disallowed BIE carryforwards. Rather than providing a formula for calculating each component of the eligible amount, the 2021 final regulations rely on existing rules under Sections 951, 951A, 245A (to the extent provided in Section 964(e)(4)) and 250 to determine the taxable income a domestic corporation would have had if it wholly owned the stand-alone applicable CFC or CFC group members and had no other assets or income.
Application of the Business Interest Expense Deduction Limitation with Respect to Foreign Persons with Effectively Connected Income
The 2021 final regulations continue to reserve on the application of the business interest deduction limitation to foreign persons with effectively connected income.
The 2021 final regulations apply to taxable years beginning on or after the date that is 60 days after the regulations are published in the Federal Register. Taxpayers and their related parties are permitted to retroactively apply the 2021 final regulations to a taxable year beginning after December 31, 2017 and before the 2021 final regulations are otherwise applicable, if the 2020 final regulations are also consistently applied to those taxable years.
It is mentioned in the preamble to the 2021 final regulations that the rules will take effect on the date the regulations are filed with the Office of the Federal Register for public inspection (instead of 60 days after the regulations are published in the Federal Register). The means that the effective dates of the final regulations will be 60 days earlier than the applicability dates. For the avoidance of doubt, the effective dates do not control when the rules are applied; instead, the applicability dates summarized herein control.
To the extent that a rule in the 2020 proposed regulations was not finalized under the 2021 final regulations, taxpayers and their related parties may rely on the rules in the 2020 proposed regulations for a taxable year beginning on or after the date that is 60 days after the date the 2021 final regulations are published in the Federal Register, provided they consistently follow all of the rules in the 2020 proposed regulations that are not finalized to that taxable year and each subsequent taxable year beginning on or before the date the Treasury decision adopting that rule as final is applicable or other guidance regarding continued reliance is issued. It is worth noting that when the 2020 proposed regulations were published, taxpayers and their related parties were generally permitted to rely on the 2020 proposed regulations retroactively to a taxable year beginning after December 31, 2017 as long as certain consistency reequipments are met.
The 2020 proposed regulations contain special effective date rules regarding certain proposed provisions. Taxpayers are recommended to look closely into such special effective date rules before retroactively adopting the 2020 proposed regulations.
The 2021 final regulations modify and clarify certain rules with respect to the application of §163(j) to CFCs and their U.S. shareholders. Please contact Amanda Mooney for additional information about the implications of these new regulations for international businesses.