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ACLI Raises CFC Issues Under Business Interest Regs

FEB. 21, 2019

ACLI Raises CFC Issues Under Business Interest Regs

DATED FEB. 21, 2019
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February 21, 2019

Steven T. Mnuchin
Secretary
Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

David J. Kautter
Assistant Secretary for Tax Policy
Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

L.G. "Chip" Harter
Deputy Assistant Secretary
(International Tax)
Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

Marjorie Rollinson
Associate Chief Counsel, International
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, D.C. 20224

Re: Comments Regarding Proposed Regulations under section 163(j)1

Dear Messrs. Mnuchin, Kautter, Harter, and Ms. Rollinson:

On behalf of the American Council of Life Insurers (”ACLI”),2 we are writing with recommendations for implementation of section 163(j) of the Internal Revenue Code of 1986, as amended (the “Code”).3 Our recommendations offer reasons for why the Proposed Regulations implementing the business interest expense deduction limit, as defined in Code section 163(j), as amended by TCJA, should be modified to address issues of particular concern to the life insurance industry. Specifically, ACLI requests Treasury and IRS to confirm that (i) the election to use an alternative method provided by the Proposed Regulations would allow controlled foreign corporations (“CFCs”) that are related to a U.S. shareholder under Code section 954(d)(3) to be considered members of the same CFC group; (ii) such a CFC group would not exclude a financial services group as defined in the Proposed Regulations; and (iii) interest paid to a U.S. related party is not subject to Code section 163(j).

We thank you for soliciting feedback and providing the opportunity for dialogue and welcome the opportunity to discuss these items in further detail. We believe the following recommendations will assist you to issue guidance effectively and efficiently to implement Code section 163(j) after amendment by TCJA for the life insurance industry.

Background

Code section 163(j) generally limits the amount of business interest expense that can be deducted in the current taxable year. Under Code section 163(j)(1), the amount allowed as a deduction for business interest expense is limited to the sum of (1) the taxpayer's business interest income for the taxable year; (2) 30 percent of the taxpayer's adjusted taxable income (“ATI”) for the taxable year; and (3) the taxpayer's floor plan financing interest expense for the taxable year. We understand that Treasury and IRS considered whether Code section 163(j) should apply to CFCs and sought to make the section applicable to CFCs to address certain fact-patterns/situations. We do not think Code section 163(j) should be interpreted to apply to CFCs, but offer the following recommendations to address the life insurance industry's concerns should final regulations continue to make this section applicable to CFCs.

CFC groups should include all CFCs that are related under Code section 954(d)(3)

The Proposed Regulations provide that new Code section 163(j) applies to CFCs and certain partnerships in which an applicable CFC is a partner. In particular, Proposed Treasury Regulation sec. 1.163(j)-7 provides, in relevant part, that a CFC applies new Code section 163(j) to interest expense in computing Subpart F income under Code section 952, tested income for GILTI purposes under Code section 951A(c)(2)(A), and ECI.

The Proposed Regulations provide a group of related CFCs (“CFC groups”) the option to elect an alternative method (“Alternative Method”) for computing members' interest expense that would limit the amount of business interest expense of a CFC group member subject to the Code section 163(j) limitation by effectively not taking into account certain intragroup dealings. A CFC group means two or more CFCs, if at least 80 percent of the stock by value of each CFC is owned, within the meaning of Code section 958(a), by a single U.S. shareholder or, in aggregate, by related U.S. shareholders that own stock of each member in the same proportion (“80% vote/value test”).4 For purposes of identifying a CFC group, members of a consolidated group are treated as a single person. The election, which must be made by all members of the CFC group, is irrevocable once made.

The Preamble to the Proposed Regulations provide:

The Treasury Department and the IRS have determined that an approach that better reflects the reality of borrowings by related CFCs is one that takes into account the principle that money is fungible within a group of highly related CFCs (such a group, a “CFC group” and a CFC that is a member of the group, a “CFC group member”). Accordingly, these proposed regulations would provide for an election to apply an alternative method that would limit the amount of business interest expense of a CFC group member subject to the section 163(j) limitation to the amount of the CFC group member's allocable share of the CFC group's applicable net business interest expense. SEE Proposed Treas. Reg. § 1.163(j)-7(b)(3).

ACLI supports the election for an Alternative Method as it believes that CFCs related to the same U.S. shareholder should be grouped together for purposes of determining interest expense.

The Preamble to the Proposed Regulations provide:

The Treasury Department and the IRS determined that the alternative method is appropriately limited to situations in which a payor CFC and payee CFC have substantially identical ownership by United States shareholders because the alternative is based on the principle that money is fungible. The alternative is based on the principle that money is fungible, but fungibility should only apply in cases of close relationship where borrowings essentially support the entire group. Furthermore, the mismatch of a deduction and a payee income item is most significant when the payee and payor CFC have substantially identical ownership by United States shareholders.

In many instances, in the context of CFCs, the appropriate measure of relatedness and control is provided by Code section 954(d)(3).5 ACLI believes that the principles that underpin the Alternative Method may be well served where the CFCs are grouped by determining if they are related to a U.S. shareholder applying Code section 954(d)(3). The 80% vote/value test is too narrow to determine relatedness of CFCs, as it does not take into account the realities of investing in foreign insurance companies. For instance, the amount of U.S. ownership may be restricted under local law, and may not allow for a U.S. shareholder to meet the 80% vote/value test. While the concept of 80% relatedness may make sense in a domestic context for purposes of rules that relate to U.S. consolidated tax concepts, it is not an appropriate measure of control in the context of CFCs. Accordingly, ACLI requests that the 80% vote/value test be replaced with a relatedness and control test based on Code section 954(d)(3) with respect to a U.S. Shareholder or a higher tier foreign corporation.6

CFC groups should not carve out financial groups

Under the Proposed Regulations, if one or more CFC group members conduct a financial services business, the Alternative Method is applied by treating those entities as comprising a separate “financial services subgroup” (each member of the subgroup, a “financial services subgroup member”). For this purpose, an entity conducts a financial services business if it is an eligible CFC, as defined in Code section 954(h)(2)(A), is a qualified insurance company, as defined in Code section 953(e)(3), or is eligible for the dealer exception in computing foreign personal holding company income as described in Code section 954(c)(2)(C).

The Preamble to the Proposed Regulations provides this rationale for the financial services subgroup approach:

The Treasury Department and the IRS determined that it is appropriate to apply the alternative method separately for entities that conduct financial services businesses, because those businesses are typically highly leveraged with significant amounts of business interest income and business interest expense and could reasonably be expected to cause distortion if included in the alternative method with other, non-financial services business CFC group members.

A multinational insurance group may own both insurance and non-insurance CFCs. For instance, it is common for insurance companies that are CFCs to be held under an offshore holding company that is also a CFC. In addition, insurance companies may own non-insurance companies that are CFCs, such as service companies, asset managers, etc., that are closely aligned with its insurance business. In addition, because of the strict rules of Code section 953(e)(3), not all operating insurance company CFCs are qualified insurance companies under that section. For example, an insurance company that derives 50% or more of its aggregate net written premiums from the issuance of non-home country insurance contracts is not a qualified insurance company under Code section 953(e)(3).

While the Preamble may accurately describe the leverage of non-insurance financial service companies, insurance companies are often not highly leveraged. Leverage in an insurance group is often not at the insurance company operating level, but at a holding company, and is not as high as may be found at other financial service companies. The holding company of an insurance company is not a qualified insurance company under Code section 953(e)(3).

A financial services subgroup carve-out that includes insurance companies within that carve-out ignores the manner in which multinational insurance companies operate and forces them to deal with Code section 163(j) in a piecemeal fashion based on arbitrary line drawing. ACLI recommends that the Alternative Method not be limited by a financial services subgroup rule.

CFC Interest Payments to Related U.S. Person

Interest paid by a CFC to a related U.S. person is subject to U.S. tax. While Code section 163(j) does not allow for CFCs and the U.S. related affiliates to be a part of one Code section 163(j) group, so that related party interest paid by a CFC to a U.S. affiliate will not be subject to Code section 163(j), such interest that is subject to U.S. tax should not be subject to the Code section 163(j) limitation. Clearly, no tax avoidance exists when a CFC pays interest that is subject to U.S. tax, when the CFC interest expense offsets the CFC income that is either exempt from U.S. tax pursuant to Code section 245A, has Code section 951A GILTI income subject to U.S. tax at a rate of 10.5% (less foreign tax credits), or has Subpart F income subject to U.S. income tax at 21% (less foreign tax credits). Therefore, interest paid by a CFC to a U.S. shareholder or U.S. affiliate of a U.S. shareholder should not be subject to Code section 163(j).

* * *

We thank you for considering our comments to the Proposed Regulations and welcome the opportunity to discuss our recommendations.

Sincerely,

Regina Rose

Mandana Parsazad

American Council of Life Insurers
Washington, DC

CC:
Douglas Poms
International Tax Counsel
Department of Treasury

Angela J. Walitt
Attorney-Advisor
Department of Treasury

Brett York
Attorney-Advisor
Department of Treasury

FOOTNOTES

1REG-106089-18. On November 26, 2018, Treasury and the IRS released the Proposed Regulations, the first guidance relating to business interest expense deduction limit under section 163(j) (the “Proposed Regulations”). The preamble that accompanied the Proposed Regulations will be referred to hereinafter as the “Preamble to the Proposed Regulations.”

2The American Council of Life Insurers (ACLI) advocates on behalf of 280 member companies dedicated to providing products and services that promote consumers' financial and retirement security. 90 million American families depend on our members for life insurance, annuities, retirement plans, long-term care insurance, disability income insurance, reinsurance, dental and vision and other supplemental benefits. ACLI represents member companies in state, federal and international forums for public policy that supports the industry marketplace and the families that rely on life insurers' products for peace of mind. ACLI members represent 95 percent of industry assets in the United States. Learn more at www.acli.com

3The Code was last amended by “an Act to Provide for Reconciliation pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018,” P.L. 115-97 (more commonly referred to as the Tax Cuts and Jobs Act, or “TCJA”).

4See Proposed Treas. Reg. § 1.163(j)-7(f)(6).

5Related person defined — For purposes of this section, a person is a related person with respect to a controlled foreign corporation, if —

(A) Such person is an individual, corporation, partnership, trust, or estate which controls, or is controlled by, the controlled foreign corporation, or

(B) such person is a corporation, partnership, trust, or estate which is controlled by the same person or persons which control the controlled foreign corporation.

For purposes of the preceding sentence, control means, with respect to a corporation, the ownership, directly or indirectly, of stock possessing more than 50 percent of the total voting power of all classes of stock entitled to vote or of the total value of stock of such corporation. In the case of a partnership, trust, or estate, control means the ownership, directly or indirectly, of more than 50 percent (by value) of the beneficial interests in such partnership, trust, or estate. For purposes of this paragraph, rules similar to the rules of section 958 shall apply. Code section 954(d)(3)

6Another approach, which we outlined in our February 7, 2019 follow-up comments regarding Proposed Regulations under Code section 951A, may be to group qualified CFCs engaged in the active conduct of a banking, financing, or insurance business that are part of a financial services group as defined in Section 904(d)(2)(C)(ii) with respect to a U.S. shareholder as comprising the CFC group under the Alternative Method.

END FOOTNOTES

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