Association Says Business Interest Regs Harmful to Manufacturers

February 25, 2019

The Honorable David J. Kautter
Assistant Secretary
Department of Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

The Honorable Charles Rettig
Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

The Honorable William M. Paul
Acting Chief Counsel
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

RE: Proposed Regulations on Section 163(j) — Computation of Adjusted Taxable Income and Applicability to Controlled Foreign Corporations

Dear Assistant Secretary Kautter, Commissioner Rettig and Acting Chief Paul:

The American Forest and Paper (AF&PA) serves to advance a sustainable U.S pulp, paper, packaging, tissue, and wood products manufacturing industry through fact-based public policy and marketplace advocacy. AF&PA member companies make products essential for everyday life from renewable and recyclable resources and are committed to continuous improvement through the industry's sustainability initiative — Better Practices, Better Planet 2020. AF&PA commends the Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) for their excellent work to-date in issuing guidance to implement Public Law 115-97 (2017), the “Tax Cuts and Jobs Act” (“TCJA”).

Section 163(j), as amended by TCJA, generally limits the deduction for business interest expense to the sum of business interest income, 30 percent of adjusted taxable income (“ATI”), and floor plan financing interest. For years prior to 2022, ATI is generally computed as earnings before income taxes, plus depreciation, amortization and depletion. On November 26, 2018, Treasury and IRS released proposed regulations implementing the TCJA amendments to section 163(j) (the “Proposed Regulations”). Under the Proposed Regulations, depreciation, amortization, and depletion that reduce gross income as separate line-item deductions are added back in computing pre-2022 ATI, but depreciation, amortization, and depletion that reduce gross income via costs of goods sold are not. As a result, the Proposed Regulations require capital intensive businesses that manufacture or produce inventory to compute ATI without the benefit of adding back a substantial amount of their depreciation, amortization and depletion, as those items are often capitalized as inventory under Section 263A ('UNICAP'). This effectively subjects these companies to an artificially lower interest limitation threshold relative to other businesses.

When finalized, the Proposed Regulations should be modified to provide that the pre-2022 ATI additions for depreciation, amortization and depletion include amounts that are capitalized to inventory under section 263A and included in cost of goods sold. This will fulfill Congressional intent to provide equal treatment to all taxpayers subject to section 163(j) and prevent unintended harm to those in the business of manufacturing or producing goods for sale to customers.

There is no evidence that Congress intended an overly literal reading of the word “deduction” in section 163(j)(8)(A)(v) for purposes of ATI addbacks related to depreciation, amortization and depletion. Amounts incurred for cost recovery but capitalized to inventory and included in cost of goods sold are not literally “deductions” but rather are reductions to gross receipts. It is acknowledged that, in general, the term “deduction” usually refers to items that reduce taxable income by reducing gross income; and cost of goods sold reduces a manufacturer's gross receipts to arrive at gross income. However, if Congress intended to limit the addback to deductions allowed under sections 167 or 168 (to the exclusion of amounts incurred that are included in cost of goods sold), it could have done so with that specific language, as Congress did for the section 199A deduction addback, which provides for the addback of “any deduction allowed under section 199A.”

In addition, the congressional intent of TCJA was not to treat specific industries of domestic companies unfairly. UNICAP generally requires manufacturers to capitalize significant amounts of depreciation, amortization and depletion related to domestic investments in equipment and facilities. These amounts are capitalized to inventory and reduce taxable income through cost of goods sold. Manufacturers invest in depreciable equipment to produce goods. Limiting the base for the 30 percent calculation to EBIT, before it is statutorily required, would harm manufacturers by failing to account for the depreciation that is associated with capital equipment purchases. Congress could not have intended for section 163(j) to apply unevenly and in a way that harms manufacturers by turning pre-2022 EBITDA into EBIT only for manufacturers, as the Proposed Regulations appear to do. Congress statutorily makes this change for tax years beginning after January 1, 2022, ensuring a consistent threshold across industries. If Treasury does not change its position on this addback to section 163(j), Congress would be putting manufacturing companies in a significantly less competitive position.

Please see addendum attached to this letter for a more detailed discussion of the industry's recommendation to include amounts that are capitalized to inventory under the UNICAP rules and deducted as cost of goods sold in the ATI additions for depreciation and amortization.

Further, we hereby submit the following comment on Proposed Regulation section 1.163(j)-7(b)(2), which provides a general rule that section 163(j) applies to an applicable controlled foreign corporation (“CFC”). We believe that this is the incorrect application of the provisions. Section 163(j) only applies to “taxpayers,” as written in the conference report and explained in various associated explanatory documents. A CFC that is not engaged in a trade or business is not considered a US taxpayer. By disregarding this statutory language, we believe Treasury has misinterpreted Congressional intent, while adding tremendous complexity and administrative burden onto taxpayers as well as potential double taxation in situations involving cross border loans where interest expense deduction is limited at the CFC level under 163(j) but corresponding interest income included in the taxable income of the US Shareholder.

Directly related to the above, we request that Treasury modify Proposed Regulation sections 1.163(j)-7(d)(1)(i) and (ii) that provide a US shareholder's adjusted taxable income does not include global intangible low-taxed income ('GILTI') or Subpart F inclusions, or any associated section 78 gross-ups (less any associated section 250 deduction). Treasury has stated that the rationale behind this regulation was to prevent 'double counting' of taxable income of a CFC that was already taken into account at the CFC level to determine the CFC's section 163(j) limitation. Should Treasury take into account AF&PA's recommendation above, the concern with double counting will be eliminated, as section 163(j) will no longer apply to CFCs and therefore the income will not be taken into account at the CFC level.

We appreciate your consideration of our requests. If you have any questions or concerns regarding the comments above, we would be happy to meet with you to discuss.

Sincerely,

Elizabeth Bartheld
Vice President, Government and Industry Affairs
American Forest & Paper Association