International Aspects of the 2020 Section 163(j) Proposed Regulations
Summary
On July 28, 2020, the Department of the Treasury and the Internal Revenue Service (collectively, Treasury) released final regulations under Section 163(j). On the same date, Treasury released proposed regulations under Section 163(j), which includes among many other items, guidance for how the business interest deduction limitation rules under Section 163(j) apply to U.S. shareholders, as defined in Section 951(b), of controlled foreign corporations (CFCs), as defined in Section 957(a), and to foreign persons with effectively connected income (ECI) in the United States.
Details
On December 28, 2018, Treasury published in the Federal Register proposed regulations under Section 163(j) (REG-106089-18). For a summary discussion of the international aspects to the 2018 proposed regulations, see our November 2018 tax alert. The final regulations largely reserve on the application of the Section 163(j) limitation to foreign corporations and U.S. shareholders and foreign persons with ECI.[1] Instead, the new proposed regulations include rules that substantially modify the 2018 proposed regulations with respect to foreign corporations and U.S. shareholders and foreign persons with ECI. This alert summarizes some of the key international items included in the proposed regulations.
1. Foreign Corporations and U.S. Shareholders
Section 163(j) and the Section 163(j) regulations apply to determine the deductibility of a relevant foreign corporation’s business interest expense for purposes of computing its taxable income for U.S. income tax purposes (if any) in the same manner as those provisions apply to determine the deductibility of a domestic C corporation’s business interest expense for purposes of computing its taxable income.[2] Proposed §1.163(j)-7 however, generally allows for an election to be made to apply Section 163(j) on a group basis with respect to applicable CFCs that are “specified group members” of a “specified group” where a single Section 163(j) limitation is computed for a CFC group.[3] For this purpose, the current-year business interest expense (BIE), disallowed BIE carryforwards, business interest income (BII), floor plan financing interest expense, and adjusted taxable income (ATI) of a CFC group are equal to the sums of the current-year amounts of such items for each CFC group member for its specified taxable year with respect to the specified period. A CFC group member’s current-year BIE, BII, floor plan financing interest expense, and ATI for a specified taxable year are generally determined on a separate-company basis before being included in the CFC group calculation. The extent to which a CFC group’s Section 163(j) limitation is allocated to a particular CFC group member’s current-year BIE and disallowed BIE carryforwards is determined using the rules that apply to consolidated groups under §1.163(j)-5(a)(2) and (b)(3)(ii) (consolidated BIE rules), subject to certain modifications.[4]
The disallowed BIE carryforwards of a CFC group member when it joins a CFC group (pre-group disallowed BIE carryforwards) are subject to the same CFC group Section 163(j) limitation and are deducted pro rata with other CFC group disallowed BIE carryforwards. However, pre-group disallowed BIE carryforwards are subject to additional limitations, similar to the limitations on deducting the disallowed BIE carryforwards of a consolidated group arising in a separate return limitation year (SRLY), as defined in §1.1502-1(f) or treated as arising in a SRLY under the principles of §1.1502-21(c) and (g).
In addition, the proposed regulations include rules for determining specified groups and specified group members along with rules for making or revoking a CFC group election. Also, the proposed regulations also include special rules for applying Section 163(j)(10) and the election under §1.163(j)-2(b)(3)(i) to CFC groups.
In response to comments, proposed §1.163(j)-7 does not provide for CFC financial services subgroups. Instead, applicable CFCs that otherwise qualify as CFC group members are treated as part of the same CFC group.
Proposed §1.163(j)-7 provides that an applicable CFC with ECI is not precluded from being a CFC group member. However, under proposed §1.163(j)-7(f), only the ATI, BII, BIE, and floor plan financing of the applicable CFC that are not attributable to ECI are included in the CFC group’s Section 163(j) calculations. The ECI items of the applicable CFC are not included in the CFC group calculations. Instead, the ECI of the applicable CFC is treated as income of a separate CFC, an “ECI deemed corporation,” that has the same taxable year and shareholders as the applicable CFC, but that is not a CFC group member. The ECI deemed corporation must do a separate Section 163(j) calculation for its ECI in accordance with proposed §1.163(j)-8.
Proposed §1.163(j)-7 also provides an anti-abuse rule that increases ATI in certain circumstances. See proposed §1.163(j)-7(g)(4) for additional details.
Proposed §1.163(j)-7 provides a safe harbor election that exempts certain applicable CFCs from application of Section 163(j). The safe-harbor election is available for stand-alone applicable CFCs (which is an applicable CFC that is not a specified group member of a specified group) and CFC group members. The election is not available for an applicable CFC that is a specified group member but not a CFC group member because a CFC group election is not in effect. If the election is made, then no portion of any CFC excess taxable income is included in a U.S. shareholder’s ATI.[5]
In the case of a stand-alone applicable CFC, the safe-harbor election may be made for a taxable year of the stand-alone applicable CFC if its BIE does not exceed 30% of the lesser of (i) its tentative taxable income attributable to non-excepted trades or businesses (referred to as “qualified tentative taxable income”), and (ii) its “eligible amount” for the taxable year. In the case of a CFC group, the safe-harbor election may be made for the specified taxable years of each CFC group member with respect to a specified period if the CFC group’s BIE does not exceed 30% of the lesser of (i) the sum of the qualified tentative taxable income of each CFC group member, and (ii) the sum of the eligible amounts of each CFC group member. For taxable years of a stand-alone applicable CFC or specified periods of a CFC group beginning in 2019 or 2020, the 30% limitation is replaced with a 50% limitation, consistent with the change in the Section 163(j) limitation to take into account 50%, rather than 30%, of ATI for such taxable years or specified periods.
The “eligible amount” is a CFC-level determination. In general, the eligible amount is the sum of the applicable CFC’s Subpart F income plus the approximate amount of GILTI inclusions its U.S. shareholders would have were the applicable CFC wholly owned by domestic corporations that had no tested losses and that were not subject to the Section 250(a)(2) limitation on the Section 250(a)(1) deduction. Amounts used in the determination of the eligible amount are computed without regard to the application of Section 163(j) and the Section 163(j) regulations. While the eligible amount of an applicable CFC cannot be negative, qualified tentative taxable income can be negative. Thus, limiting the safe-harbor to 30% of qualified tentative taxable income ensures that losses of a stand-alone applicable CFC or a CFC group are taken into account in determining whether the stand-alone applicable CFC or the CFC group qualifies for the safe-harbor.
The safe-harbor election does not apply to EBIE, as described in §1.163(j)-6(f)(2), and EBIE is not taken into account for purposes of determining whether the safe-harbor election is available for a stand-alone applicable CFC or a CFC group, until such business interest expense is treated as paid or accrued by an applicable CFC in a succeeding year (that is, until the applicable CFC is allocated excess taxable income or excess business interest income from such partnership in accordance with §1.163(j)- 6(g)(2)(i)).
The proposed regulations provide that a safe-harbor election cannot be made for a CFC group that has pre-group disallowed BIE carryforward.
As a general matter, a U.S. shareholder does not include in its ATI any portion of its specified deemed inclusions. Specified deemed inclusions include the U.S. shareholder’s deemed income inclusions attributable to an applicable CFC and a non-excepted trade or business of the U.S. shareholder.[6] Proposed §1.163(j)-7 however, allows a U.S. shareholder of a stand-alone applicable CFC or a CFC group member of a CFC group to include a portion of its deemed income inclusions attributable to the applicable CFC in the U.S. shareholder’s ATI. This rule does not apply with respect to an applicable CFC that is a specified group member but not a CFC group member because a CFC group election is not in effect. If a safe-harbor election is in effect with respect to the taxable year of a stand-alone applicable CFC or the specified period of a CFC group, CFC excess taxable income is not calculated for the stand-alone applicable CFC or the CFC group members.
2. Foreign Persons with Effectively Connected Income
Proposed §1.163(j)-8(b)(1)-(5) provides that, for purposes of applying Section 163(j) and the Section 163(j) regulations to a specified foreign person, certain definitions (ATI, BIE, BII, and floor plan financing interest expense) are modified to take into account only ECI items. Additionally, proposed §1.163(j)-8(b)(6) provides that, for purposes of applying §1.163(j)-10(c) to a specified foreign person, only ECI items and assets that are U.S. assets are taken into account in determining the amount of interest income and interest expense allocable to a trade or business.
Proposed §1.163(j)-8(c) includes rules to determine the portion of a specified foreign partner’s allocable share of ETI, EBIE, and EBII (as determined under §1.163(j)-6) that is treated as ECI and the portion that is not treated as ECI. Proposed §1.163(j)-8(d) includes rules to determine the portion of deductible and disallowed BIE of a relevant foreign corporation (as defined in §1.163(j)-1(b)(33)) that is characterized as ECI or not ECI. Proposed §1.163(j)-8(e) provides rules regarding disallowed BIE. Proposed §1.163(j)-8(f) provides rules coordinating the application of Section 163(j) with §1.882-5 and similar rules and with the branch profits tax.
3. Applicability Dates
Final §1.163(j)-7 applies to taxable years beginning on or after November 13, 2020.[7] However, taxpayers and their related parties, within the meaning of Sections 267(b) and 707(b)(1), may choose to apply the rules of final §1.163(j)-7 to a taxable year beginning after December 31, 2017, so long as the taxpayers and their related parties consistently apply the rules of the Section 163(j) regulations, and, if applicable, §§1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of §§1.382-2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to that taxable year.
The proposed regulations are proposed to apply to taxable years beginning on or after 60 days after the date the Treasury Decision adopting these rules as final regulations is published in the Federal Register.
Taxpayers and their related parties, within the meaning of Sections 267(b) and 707(b)(1), who apply the final regulations to a taxable year beginning after December 31, 2017, and before November 13, 2020, may rely on proposed §§1.163(j)-7 and 1.163(j)-8 for that taxable year, provided the taxpayers and their related parties also rely on proposed §§1.163(j)-7 and 1.163(j)-8 and apply the final regulations for each subsequent year. Taxpayers who choose not to apply the final regulations to a taxable year beginning after December 31, 2017, and before November 13, 2020, may not rely on either proposed §1.163(j)-7 or 1.163(j)-8 for that taxable year. For any taxable year beginning on or after November 13, 2020, and before 60 days after the date the Treasury Decision adopting the proposed regulations as final regulations is published in the Federal Register, taxpayers and their related parties, within the meaning of Sections 267(b) and 707(b)(1), may rely on proposed §§1.163(j)-7 and 1.163(j)-8 provided they consistently follow all of the rules of §§1.163(j)-7 and 1.163(j)-8 for such taxable year and for each subsequent taxable year beginning before 60 days after the final version of these proposed regulations is published in the Federal Register.[8]
Taxpayers and their related parties who rely on proposed §1.163(j)-7 for any taxable year ending before November 13, 2020, can make a CFC group election or a safe-harbor election even if the deadline provided in proposed §1.163(j)-7(e)(5)(iii) or (h)(5)(i) has passed. Such taxpayers and their related parties are permitted to make the election on an amended federal income tax return filed on or before the due date (taking into account extensions, if any) of the original federal income tax return for the first taxable year ending after November 13, 2020.
Alternatively, taxpayers and their related parties, within the meaning of Sections 267(b) and 707(b)(1), may rely on proposed §§1.163(j)-1 through 1.163(j)-11, which were issued in a notice of proposed rulemaking (REG-106089-18) and published on December 28, 2018, in the Federal Register (83 FR 67490), in their entirety, for a taxable year beginning after December 31, 2017, and before November 13, 2020, so long as the taxpayers and their related parties consistently apply proposed §§1.163(j)-1 through -11 of the 2018 proposed regulations, and, if applicable, proposed §§1.263A-9, 1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9, 1.469-11, 1.882-5, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of §§1.382-2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to that taxable year. Notwithstanding the preceding sentence, taxpayers applying the provisions in the notice of proposed rulemaking may apply §1.163(j)-1(b)(1)(iii) in these final regulations for taxable years beginning after December 31, 2017.
For additional applicability dates and details including items not discussed in this summary, see the final and proposed regulations.
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