This article is for a Controlled Foreign Corporation (CFC) that may have a limitation for business interest expense.
Abstract: The IRS recently issued final regs that provide guidance regarding the limitation on the deduction for business interest expense. They adopt most of proposed regs from 2020 with some revisions. This article explores the revisions, including calculation of adjusted taxable income and a safe harbor exempting certain controlled foreign corporations.
The IRS recently issued final regs that provide guidance regarding the limitation on the deduction for business interest expense. The regs address, among other things, the calculation of adjusted taxable income (ATI) and the application of the limitation to controlled foreign corporations (CFCs). They adopt most of proposed regs from 2020 with some notable revisions.
The final regs, like the 2020 proposed regs, provide that the lesser of two amounts must be subtracted from tentative taxable income to determine ATI. These amounts are:
• The amount of gain on the sale or other disposition of property, or
• The amount of depreciation deductions with respect to such property for the period of earnings before interest, taxes, depreciation and amortization (EBITDA).
These are sometimes referred to as negative adjustments. The ATI calculation also has additions to tentative taxable income for depreciation, amortization and depletion deductions during the EBITDA period. These are referred to as additions to tentative taxable income.
The final regs provide that a negative adjustment to tentative taxable income is reduced to the extent the taxpayer establishes that the additions to tentative taxable income in a previous tax year didn’t increase the amount allowed as a deduction for business interest expense for that year.
In addition, the final regs clarify that, for purposes of calculating ATI, the amount of gain taken into account by a consolidated group (that is, an affiliated group of corporations that can file a consolidated return) upon a “sale or other disposition” includes the net gain the group would take into account. This includes net gain resulting from intercompany transactions.
For example, assume that S would recognize $100 of gain upon the sale of property to a nonmember. However, rather than sell the property directly to a nonmember, S first might sell the property to member B and recognize $60 of gain. B could then sell the property to the nonmember and recognize an additional $40 of gain. In either case, the group would recognize a net gain of $100 in relation to the property, and that same $100 should be relevant in determining the amount of any negative adjustment to ATI.
CFCs and the No-Negative Rule
Proposed regs provided rules applicable to CFC group members. One of them provided that a single limitation is calculated for a specified period of a CFC group based on the sum of each group member’s:
- Current-year business interest expense,
- Disallowed business interest expense carryforwards,
- Business interest income,
- Floor plan financing interest expense, and
For this purpose, the ATI and other items of a CFC group member are generally calculated on a separate-entity basis.
Under a general rule, the ATI of a taxpayer cannot be less than zero. (This is referred to as the “no-negative ATI rule.”) The IRS agreed with commenters that the ATI of CFC group members should account for amounts less than zero for purposes of determining the ATI of a CFC group. Accordingly, the final regs provide that the no-negative ATI rule applies with respect to the ATI of a CFC group, but not to each CFC group member.
A proposed reg provided a safe harbor election that exempts certain applicable CFCs (that is, CFCs with one or more eligible U.S. shareholders) from application of Internal Revenue Code Section 163(j). The safe-harbor election is available for standalone applicable CFCs (in other words, an applicable CFC that’s not a specified group member of a specified group) and CFC group members.
The final regs expand this safe harbor. They provide that a safe-harbor election may be made with respect to a standalone applicable CFC or CFC group if its business interest expense doesn’t exceed either business interest income or 30% of the lesser of its “eligible amount.”
Generally, this eligible amount is the sum of the applicable CFC’s subpart F income and global intangible low-taxed income. Calculation of the eligible amount must account for only items properly allocable to a nonexcepted trade or business or its qualified tentative taxable income — that is, the applicable CFC’s tentative taxable income must be determined by accounting for only items properly allocable to a nonexcepted trade or business.
An anti-duplication rule exists to ensure that negative adjustments don’t apply if a subtraction for the same economic amount already has been required. The final regs clarify that the anti-duplication rule doesn’t apply to a whole-group acquisition.
The final regs apply to tax years beginning on or after March 20, 2021. For more information, contact your CPA.
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