IRS issues final regulations on business interest expense deductions for controlled foreign corporations

On January 5, 2021 the Internal Revenue Service (“IRS”) published final regulations regarding the limitation on the deduction of business interest expense under section 163(j) (TD 9943). The final regulations clarify the application of section 163(j) to Controlled Foreign Corporations (“CFCs”) and harmonize the rules of this limitation with the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”).

Since the Tax Cuts and Jobs Act (“TCJA”) has been in effect, the limitation on the deductibility of business interest expense under IRC Section 163(j) is applicable to CFCs. In general, for tax years beginning after Dec. 31, 2017, business interest expense (“BIE”) deductions are limited to the sum of: (i) The taxpayer’s business interest income; (ii) 30% of the taxpayer’s adjusted taxable income (“ATI”); and (iii) The taxpayer’s floor plan financing interest expense.

The Cares Act allows taxpayers to use their ATI from 2019 in computing the 2020 limit. Also, taxpayers can elect to apply a 50% limitation on their ATI or the regular 30%-of-ATI limit under IRC Section 163(j)(10)(A)(i).

In 2018, the first set of proposed regulations was issued by Treasury and the IRS regarding the application of the “new” Section 163(j) included in the TCJA. These 2018 proposed regulations provided that the Section 163(j) limitation applies to CFCs on an individual basis and further provided an election to treat CFCs as a group. In 2020, Treasury finalized a substantial portion of the 2018 regulations, reaffirming the default CFC-by-CFC rule. However, in response to comments, the 2020 regulations reserved on all CFC group method issues.

In general, the final regulations mostly adopt the 2020 proposed regulations, but modify certain provisions. For instance, they provide a more favorable tax treatment than the proposed regulations in that the new rules allow taxpayers to make an initial CFC group election even if the 60-month period requirement is not satisfied when a specified group comes into existence.

The final regulations also have provisions that are intended to reduce administrative burdens, but in turn, they include a new disclosure requirement. Notably, the 2021 final regulations leave unresolved some relevant matters such as the appropriate method for determining the portion of the specified deemed inclusions of a US shareholder to increase its ATI.

In terms of applicability dates, the 2021 final regulations apply to tax years beginning on, or after, the date that is 60 days after publication in the Federal Register. It is important to note that President-Elect Joe Biden’s Treasury Department has announced its intention to scrutinize any regulation not published in the Federal Register when he comes into office.

Computation of Adjusted Taxable Income (“ATI”) for relevant foreign corporations

As a general rule, Section 163(j) applies to relevant foreign corporations in the same manner it applies to domestic corporations, including the computation of ATI. However, the 2020 Proposed Regulations provided that the calculation of tentative taxable income of a relevant foreign corporation should take into account the deduction related to foreign income taxes. Because domestic corporations are not required to deduct federal income taxes when computing their ATI, this rule created a disparity with respect to the tax treatment between domestic and foreign corporations. Consequently, the final regulations clarify that a deduction for foreign income taxes that are eligible to be claimed as a foreign tax credit should be disregarded when determining the ATI of a relevant foreign corporation.

Mazars’ Insight

The exclusion of foreign income taxes that are eligible to be claimed as a foreign tax credit from the calculation of the ATI of relevant foreign corporations balances the tax treatment between domestic and foreign corporations. The revision should result in higher ATI for the majority of foreign corporations.  

New rules for CFC groups

The final regulations provide a new set of rules that modify or complement the general rules for applying section 163(j) to CFC group members provided by the 2020 proposed regulations. New rules include an amendment to the “no-negative ATI rule,” changes to the CFC group election provision, the expansion of the CFC safe harbor election, and the establishment of a new disclosure requirement.

Under the 2020 proposed regulations, taxpayers were not allowed to have negative ATI. This is known as the “no-negative ATI rule.” However, it was unclear whether this rule should apply to the ATI of a CFC group or to each CFC group member. After the Treasury Department and the IRS analyzed the pertinence of applying this rule in these two contexts, the final regulations clarify that the scope of the no-negative ATI rule should involve the ATI of a CFC group rather than the ATI of each CFC group member.

With respect to the CFC group election, the 2020 proposed regulations provided that a CFC group election could be revoked with respect to any specified period of the specified group only after the 60-month period following the last day of the first specified period for which the election was made.

Similarly, the proposed regulations established a 60-month period to again make the CFC group election once revoked. Nevertheless, the 2020 proposed regulations did not take a position regarding the 60-month requirement for an initial election when a specified group does not make a CFC group election when it first comes into existence. Accordingly, the final regulations restate the provisions mentioned above, but clarify that the 60-month waiting period is not imposed on the initial CFC group election intended by a specified group when it first comes into existence.

Regarding the CFC safe harbor election provided by the 2020 proposed regulations to allow taxpayers to use subpart F income and GILTI items in lieu of ATI, the final regulations expand this rule by allowing stand-alone applicable CFCs or CFC groups with BIE that does not exceed BII to make such election without determining qualified tentative taxable income or “eligible amount.”

Lastly, the final regulations add a new disclosure requirement when a designated US person makes a CFC group election by attaching a statement to their federal income tax return. Under the 2020 proposed regulations, the attachment was only required for the taxable year for which an election is made. However, the final regulations expand the requirement to each taxable year for which a CFC group election is in effect.

Mazars’ Insight

In general, the final regulations can be seen as favorable to taxpayers with foreign operations structured in the form of CFCs. The CFC Group election has been overhauled since the original 2018 proposed regulations in a manner that should encourage its use both in terms of minimizing the disallowance potentially required by section 163(j) and easing the administrative burden of the rules. Additional benefits are in the form of the expanded safe harbor and initial election relief.

Please contact your Mazars LLP professional for additional information.

Published on January 15, 2021

The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.