Energy Company Suggests Rules on Interest Deduction

May 30, 2018

The Honorable David J. Kautter
Assistant Secretary (Tax Policy)
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

The Honorable David J. Kautter
Acting Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

The Honorable William M. Paul
Principal Deputy Chief Counsel and Deputy Chief Counsel (Technical)
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Re: Section 163(j) Comments Submitted Pursuant to Notice 2018-28

Dear Messrs. Kautter and Paul:

NextEra Energy, Inc. (“NEE”) requests guidance from the United States Department of Treasury (the “Treasury”) with respect to the interest deduction rules under section 163(j) of the Internal Revenue Code (the “Code”),¹ as recently amended by The Tax Cuts and Jobs Act (P.L. 115-97) (the “TCJA”). The TCJA replaced section 163(j) with a more restrictive limitation on interest deductibility.² Under new section 163(j), the amount allowed by a taxpayer as a deduction for “business interest” in any taxable year cannot exceed 30 percent of the taxpayer's adjusted taxable income for that year.³ “Business interest” is defined as any interest paid or accrued on indebtedness “properly allocable” to a trade or business.⁴ For this purpose, the term “trade or business” does not include, inter alia, the trade or business of the furnishing or sale of utility services if the rates for such furnishing or sale are established or approved by a public service commission or other governmental entity.⁵ For purposes of this letter, a trade or business within the meaning of (and subject to) section 163(j) is referred to as an “included business,” and a trade or business that is not included within such meaning is referred to as an “excluded business.”

The TCJA did not define “properly allocable” or otherwise provide any insight into how to determine whether indebtedness is “properly allocable” to a trade or business. Thus, taxpayers with at least one included business and at least one excluded business currently have no guidance and must apply their own interpretation of “properly allocable.” On April 2, 2018, the Internal Revenue Service (IRS) issued Notice 2018-28,⁶ stating that the Treasury and the IRS intend to issue regulations addressing, inter alia, the application of section 163(j) to a consolidated group with one or more members that conduct an excluded businesses, or whose members hold an interest in a non-corporate entity such as a partnership that conducts such a business, and requesting comments on such regulations. Accordingly, NEE respectfully submits this letter suggesting rules for the regulations to be promulgated under section 163(j) that provide for the allocation of indebtedness between included and excluded businesses in a manner that will eliminate subjectivity, uncertainty, disparate treatment among similarly situated taxpayers, and protracted tax disputes.

I. Overview of NEE and the Policy for the Utility Exception

NEE is one of the largest electric power and energy infrastructure companies in North America and a leader in the renewable energy industry. NEE, which employed approximately 14,000 people as of December 31, 2017, was incorporated in 1984 under the laws of Florida. NEE has two primary businesses — a regulated utility business (an excluded business) and a non-regulated wholesale electric generation business (an included business) — that are conducted principally through its wholly-owned subsidiaries, Florida Power & Light Company (“FPL”) and NextEra Energy Resources, LLC (“NEER”), respectively, FPL is the largest electric utility in the State of Florida and one of the largest electric utilities in the U.S. NEER is the world's largest operator of wind and solar projects.

Investor-owned electric companies currently invest more than $100 billion annually to build energy infrastructure to meet our country's growing energy needs. Congress, in recognition of the importance of allowing utilities to retain their ability to deduct interest, excluded utilities from the limitation enacted in section 163(j). Guidance providing clear, fair, and administrable rules outlining how, for U.S. federal income tax purposes, to allocate indebtedness between included and excluded businesses is needed in order to fully implement and realize the policy objectives prescribed by Congress.⁷

II. Debt Should be Allocated Under a “Pure Apportionment” Approach with No Tracing

A. Pure Apportionment is the Most Simple, Equitable, and Administrable Approach

We believe that the regulations under section 163(j) should follow the apportionment approach set forth in the regulations promulgated under section 861 for purposes of determining what debt is “properly allocable” to a business, and should exclude for these purposes the specific nonrecourse debt tracing rules provided in those regulations. The section 861 regulations generally provide for the apportionment (rather than the direct allocation or “tracing”) of interest.⁸ The apportionment approach is simple, equitable, and administrable across all taxpayers. In addition, this approach would limit opportunities for taxpayer manipulation and protracted litigation based on factual disputes.

Accordingly, we recommend adopting an approach under section 163(j) that requires taxpayers to aggregate their debt and then apportion that debt between their included and excluded businesses based on the amount of assets used in those businesses (using the metric described in Part II.B, infra). This approach is the simplest and most administrable, as it would not require taxpayers to trace debt proceeds to determine how and where those proceeds were used. It is also the most equitable approach because, unlike direct tracing (see Part II.C, infra), it is based on the longstanding principle underlying existing tax regulations that money is fungible and it is not subject to manipulation by taxpayers (i.e., debt is aggregated and apportioned in the same manner regardless of where it is located or how the debt proceeds are used).

Our recommendation is consistent with that of the Edison Electric Institute,⁹ which also submitted a letter suggesting a pure apportionment approach based on the principle that money is fungible.

B. Apportionment Should be Done Using Tax Basis

Apportioning debt based on assets seems most appropriate for capital-intensive businesses such as utilities, as the debt incurred by these businesses is largely used to fund the acquisition or construction of infrastructure. An asset-based apportionment should use a readily determinable metric. The use of U.S. tax basis would provide such a metric, and would be consistent with the section 861 regulations.¹⁰ If tax basis is used, we believe it should be recomputed without the bonus depreciation deduction under section 168(k) in order to eliminate distortions. Without this recomputation, businesses with assets that were not eligible for, or that elected out of, bonus depreciation would be apportioned a higher amount of debt than businesses that claimed bonus depreciation. This result docs not seem appropriate.

C. Direct Tracing of Debt is Subject to Manipulation and Should Not Be Permitted Except for Unique Industries Like Real Estate Where it May Be Appropriate

We do not believe that direct tracing should generally be available to allocate debt for purposes of section 163(j). Direct tracing is neither simple nor administrable. It would require taxpayers (and the IRS) to trace all debt proceeds to determine where and how those proceeds were used. The complexity involved would undoubtedly lead to a significant level of controversy between taxpayers and the IRS.

In addition, direct tracing is subject to manipulation by taxpayers. Specifically, taxpayers would be able to strategically locate debt and use the debt proceeds to fund or acquire excluded businesses (while using equity in the included businesses) in order to minimize the limitation on the interest deduction in contravention of the intent of section 163(j). Taxpayers would likely be able to structure the debt and their operations in a manner that allows them to choose whether to directly trace or apportion the debt depending on which approach gives them the best tax answer. While not allowing direct tracing would be a slight departure from the section 861 rules that permit direct tracing of "qualified nonrecourse indebtedness,”¹¹ we believe no direct tracing would result in a simpler, more equitable and administrable approach.

While we recognize that the real estate industry possesses unique characteristics that may warrant special rules permitting the direct tracing of debt (such as the tracing permitted for qualified nonrecourse indebtedness), we are not aware of any other industry warranting an equivalent exception. If it is determined that direct tracing should be permitted for the real estate industry, we believe any tracing rules adopted should be available only to that industry in order to ensure that the integrity of the pure apportionment approach is maintained to the greatest extent possible.

In the absence of unique industry considerations, we do not see any policy justification for allowing taxpayers to directly trace debt for purposes of section 163(j). In our view, any direct tracing would open the door for taxpayers to structure their debt and operations to avoid or minimize the limitation under section 163(j). Accordingly, we believe taxpayers should be required to allocate debt under the pure apportionment approach described above, and should not have an election or option to directly trace any debt.

III. A Deemed Step-Up in Inside Tax Basis Should be Computed for Acquisitions of Interests in Entities Without an Actual Step-Up Election

Distortive debt allocations could arise following an entity acquisition where there is no tax basis step-up election (e.g., pursuant to section 336, 338, or 754). To eliminate this distortion, we recommend that the Treasury adopt a mandatory, rather than elective, rule for entity acquisitions without a step-up election that effectively steps-up the inside asset tax basis of the acquired entity to fair market value. This deemed step-up could be accomplished under either (1) a notional goodwill method or (2) the section 338 method established under Notice 2003-65.¹² Under the notional goodwill method, the purchase price in excess of inside asset tax basis would be treated as an intangible asset amortized over 15 years. Under the section 338 method, the taxpayer would be deemed to make a section 338(h)(10) (or a section 754) election and depreciate/amortize the stepped-up tax basis in the assets using the applicable recovery period without bonus depreciation.¹³ The deemed step-up would apply solely for debt allocation purposes under section 163(j). For example, the step-up would not result in additional tax depreciation or amortization and would not impact gain or loss on a future disposition. Without a deemed step-up, taxpayers could structure an acquisition with or without a tax basis step-up election to achieve the most tax advantageous result, without changing a public utility regulator's approach to, or the ratemaking result associated with, a regulated acquisition.¹⁴

IV. A Consolidated Group of Corporations Should be Viewed as a Single Taxpayer

We believe that debt held by all members of an affiliated group of corporations (within the meaning of section 1504(a)) that file a consolidated U.S. federal income tax return should be aggregated and then apportioned to the businesses of that group. Such a rule would be consistent with the legislative history, which provides that “[i]n the case of a group of affiliated corporations that file a consolidated return, the limitation applies at the consolidated tax return level."¹⁵ In addition, this rule is consistent with the approach adopted in Notice 2018-28.¹⁶ Without such a rule, consolidated groups could strategically place debt in order to avoid or minimize the application of section 163(j). For example, a member of a consolidated group with a favorable section 163(j) limitation could borrow and transfer (via contribution and/or distribution) the debt proceeds to member(s) with a less favorable limitation. In addition, consistent with Notice 2018-28, guidance should provide that intercompany obligations (and all Items arising therefrom) are disregarded for purposes of applying section 163(j).¹⁷

V. An Ordering and Look-Through Rule Should be Provided for Partnerships

Section 163(j)(4)(A)(i) provides that subsection (j) shall be applied at the partnership level. Thus, each partnership must determine the amount of its business interest, calculate the limitation on such interest, and allocate the allowable interest to its partners as part of its non-separately stated taxable income or loss.¹⁸ Partnerships with at least one included business and one excluded business will need to apportion their debt between those businesses.

Business interest that is not allowed as a deduction for a taxable year is treated as "excess business interest” and allocated to the partners in the same manner as the non-separately stated taxable income or loss of the partnership.¹⁹ Excess business interest is taken into account by such partners in future years only when the same partnership has “excess taxable income” allocated to the respective partners.²⁰ The partnership's excess taxable income represents the partnership's limitation for the taxable year over the amount of its net business interest for that year.²¹ The partners are able to increase their section 163(j) limitations by their share of the partnership's excess taxable income.²²

A partner must reduce its tax basis in a partnership both by the amount of allowed interest and the amount of excess business interest allocated to such partner in a taxable year.²³ That partner, to the extent it has at least one included business and one excluded business, wilt have to apportion its debt between those businesses. Part of the partner's debt could be apportioned to its interest in the partnership. Guidance would be helpful as to how this apportionment should occur, and how to determine whether (and to what extent) the debt apportioned to the partnership interest is “properly allocable” to an included or excluded business.

We recommend that guidance provide that part of the partner's debt be apportioned to its interest in the partnership based on the adjusted tax basis in this interest (adjusted to remove the impacts of bonus deprecation under section 168(k)). For this purpose, a partnership must apply section 163(j) prior to its partners, such that the partners must reduce their tax basis in the partnership prior to their application of section 163(j). This would prevent double counting tax basis in apportioning the debt of the partnership and the debt of the partnership's partners. The partners should also exclude their share of partnership debt (as determined under section 752) from the tax basis of their partnership interest for purposes of apportioning debt to that partnership interest.

Furthermore, we recommend that a partner be permitted to “look through” to the businesses of the partnership for purposes of determining whether debt apportioned to its partnership interest is “properly allocable” to an included or excluded business. This determination could be made by apportioning such debt based on the partnership's tax basis in the assets of the included businesses and excluded businesses, respectively. For this purpose, the partnership should first reduce the tax basis of its assets for the amount of its own debt apportioned to such businesses. We believe a look through approach is the most logical and would prevent debt effectively tied to an included (or excluded) business from being excluded from (or subject to) the application of section 1630). Moreover, this approach is consistent with fungibility of money principles and recognizes that partner-level borrowing indirectly (and sometimes directly) funds partnership activities. Consistent with the suggested approach for apportioning debt among the businesses of a consolidated group discussed in Part II, supra, the apportionment of partner-level debt to a partnership interest based on tax basis represents an administrable and equitable approach.

Thank you for considering these comments. Please do not hesitate to contact me at (561) 691-2437 or bruce.goldstein@nee.com if you have any questions or need further clarifications.

Sincerely,

Bruce Goldstein
NextEra Energy, Inc.
Juno Beach, FL

cc:
Thomas West, Esq., Tax Legislative Counsel
Christopher Call, Esq., Attorney-Advisor
Brett York, Esq., Attorney-Advisor