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Global Business Group Presses for Changes to Interest Expense Regs

NOV. 2, 2020

Global Business Group Presses for Changes to Interest Expense Regs

DATED NOV. 2, 2020
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November 2, 2020

The Honorable Steven Mnuchin
Secretary of the Treasury
Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, DC 20220

The Honorable David Kautter
Assistant Secretary for Tax Policy
Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, DC 2022

Mr. L.G. "Chip" Harter
Deputy Assistant Secretary
International Tax Affairs
Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, DC 20220

Mr. Charles P. Rettig
Commissioner
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, DC 20224

Mr. Michael J. Desmond
Chief Counsel
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, DC 20224

Re: Comments on I.R.C. Section 163(j) Notice of Proposed Rulemaking (IRS REG-107911-18)

Dear Sirs:

The Global Business Alliance (“GBA”), formerly the Organization for International Investment (“OFII”), appreciates the opportunity to provide the following comments on the above referenced notice of proposed rulemaking (the “NPRM” or “Proposed Regulations”)1 issued under section 163(j) of the Code.2

GBA exclusively represents the U.S. subsidiaries of many of the world's leading international companies. International companies are invested in just about every industry and in every state across the United States, but they are especially concentrated in the manufacturing sector — responsible for employing 20 percent of America's manufacturing workforce. Moreover, international companies reinvest $100 billion annually back in their U.S. operations which adds to their ongoing presence and commitment to our economy.

Along with creating millions of high-paying U.S. jobs, these international companies operating in the United States produce over a quarter of U.S. goods exports, sending American-made goods to customers around the world. In short, international companies help broaden America's economy and open new markets.

GBA's mission is to ensure that policymakers at the federal, state and local level understand the critical role that foreign direct investment (“FDI”) plays in America's economy. GBA advocates for fair, non-discriminatory treatment of foreign-based companies and promotes policies that will encourage them to establish U.S. operations, which in turn increases American employment and U.S. economic growth.

GBA would like to again thank the Internal Revenue Service (the “IRS” or “Service”), and the U.S. Department of the Treasury (“Treasury”) for your work on the NPRM as well as the final regulations (the “Final Regulations”) issued simultaneously under section 163(j)3. On February 26, 2019, GBA submitted comments with respect to the then proposed regulations.4 We appreciate your consideration of those comments. GBA believes Treasury took the correct approach to several issues highlighted in that comment letter.

In particular, GBA believes Treasury took the correct approach in determining that depreciation subject to section 263A and included in cost of goods sold ("COGS") should not be excluded from the definition of depreciation and amortization for purposes of calculating ATI. GBA also believes that Treasury took the right approach in scaling back and refining the overly broad definition of interest in section 1.163(j)-1(b)(20).

These aspects of the Final Regulations make the complex rules more administrable and are consistent with Congressional intent. However, there are other aspects of the NPRM and the Final Regulations, that are concerning to the GBA membership and that GBA suggests be modified.

For instance, and as discussed in our previous comments, GBA continues to maintain that section 163(j) should not apply to controlled foreign corporations (“CFCs”) without a trade or business, and that such application is against Congressional intent and the general purpose of the statute. Further, the interest anti-avoidance rules5 in the Final Regulations are unclear and lack sufficient foundation in the previously published Proposed Regulations. While GBA continues to believe that these rules should be withdrawn, if Treasury chooses to finalize the rules described in the NPRM, GBA's requests and recommendations are as follows:

The CFC Group Election Should Be Available Each Year

The election provided in section 1.163(j)-7(b)(3) (the "Group Election") is revocable after five years and cannot be made again for five years after revocation. This policy does not reflect the difficulty that may arise for taxpayers attempting to forecast the impact of the Group Election over a five-year period. Unforeseen changes in both facts and law may render a previous Group Election unfavorable through no fault of the taxpayer.

Allowing a yearly Group Election would also be consistent with the safe harbor election provided for elsewhere in the NPRM as well as the remainder of the Code. GBA understands that Treasury and IRS may be concerned that a yearly election could allow for disfavored tax-planning, however Treasury has other mechanisms that it can implement to address those concerns.

The CFC Group Ownership Threshold Should Be Lowered

In order to make the CFC group election provided in Proposed Regulation § 1.861-7, the U.S. shareholder must own 80 percent of the value of a foreign corporation in order for the foreign corporation to be included in the CFC group for purposes of section 163(j). This requirement cross-references the ownership rules applicable to consolidated groups in section 1504(a).

GBA proposes lowering the CFC group ownership threshold to 50 percent, which would align with the requirement for a foreign corporation to be treated as a CFC. Both the Global Intangible Low-Taxed Income (“GILTI”) regime and subpart F regime use 50 percent ownership requirements, and consistency is important given that the subpart F rules are used as a justification to apply 163(j) to CFCs in the first place.

A 50 percent U.S. shareholder ownership requirement creates consistency across the Code, lowers administrative burdens and would allow true joint ventures to be included in the CFC group.

A U.S. Shareholder Should Be Permitted to Include Its Section 78 Gross-Up When Calculating Its Adjusted Taxable Income (“ATI”)

GBA believes Treasury and IRS should follow longstanding principle and treat section 78 deemed dividends as income at the shareholder level. The Proposed Regulations states that because section 163(j) applies to CFCs, including CFC income inclusions at the U.S. shareholder level would create “an inappropriate double-counting of income.”6 However, not all income inclusions should be treated equally.

Unlike subpart F and GILTI inclusions, Section 78 deemed dividends do not implicate the preamble's concerns about double-counting income because Section 78 deemed dividends do not correspond to income already included in a CFC's ATI. Rather, under the Proposed Regulations, Section 78 deemed dividends correspond to deductions from a CFC's ATI. Accordingly, a U.S. shareholder should be permitted to include its Section 78 gross-up when calculating its ATI.

Foreign Taxes Should Not Be Deducted from a CFC's ATI.

The Proposed Regulations note that foreign taxes are generally a deduction for a U.S. taxpayer for purposes of calculating a CFC's earnings and profits; however, deducting foreign taxes from a CFC's ATI is inconsistent with the long-standing general policy of treating a CFC as a domestic corporation. When a domestic corporation claims foreign tax credits its foreign taxes are not treated as taxes and not an expense. Therefore, in order to treat a foreign corporation as a domestic corporation, Treasury should likewise treat that foreign corporation's foreign taxes as taxes.

GBA further notes that deducting foreign taxes from a CFC's ATI penalizes taxpayers with CFCs in high-tax jurisdictions. A taxpayer with a CFC in a high-tax jurisdiction will deduct a greater amount of foreign taxes from its CFC's ATI than a taxpayer with the same amount of income in a CFC in a lower-taxed jurisdiction. Not deducting foreign taxes from a CFC's ATI would remove this penalty effect of organizing a CFC in a higher tax jurisdiction.

A U.S. Shareholder's ATI Should Not Be Decreased Twice for the Same Interest Expense

Treasury and the IRS have repeatedly expressed concerns about double-counting income when allowing U.S. shareholders to include CFC ETI amounts in the shareholders' ATI. The corollary to not increasing ATI twice by the same income is not decreasing ATI twice for the same deductions. However, as drafted, Prop. Treas. Reg. § 1.163(j)-7(j) deducts interest expense twice against the same earnings in calculating U.S. shareholders' ATI increases from CFCs, leading to an artificially lower ATI for the U.S. shareholders.

For example, consider a situation where USP, a domestic corporation, wholly owns foreign corporation CFC. In 2020, CFC pays $100 of interest expense and earns $500 of gross income, such that USP takes into account $400 as GILTI. CFC therefore has $500 of ATI and $300 of ETI (calculated as ATI multiplied by the percentage of unused section 163(j) limitation, or $500 * ($250 - $100)/$250, assuming a 50 percent section 163(j) limitation). USP's inclusion is $400 before applying section 250, and $200 after applying section 250. Under Prop. Treas. Reg. § 1.163(j)-7(j), USP includes in ATI the product of $200 and $300/$500, or $120. Thus, CFC's interest expense is taken into account twice, first in USP's inclusion of $200 and then again in CFC's ETI of only $300.

There are several possible ways to avoid decreasing a U.S. shareholder's ATI twice for the same interest expense, including by using the framework of the U.S. shareholder ATI calculation in the 2018 proposed regulations. This framework allowed a U.S. shareholder to increase its ATI by the lower of the shareholder's inclusion with respect to a CFC group and the eligible ETI of such CFCs.

We commend Treasury and the IRS for their efforts to address numerous issues relating to Section 163(j). We hope that the above comments will be taken into account when new regulations are finalized.

In addition, GBA requests the opportunity to testify at the public hearing regarding the Proposed Regulations. The statements at the hearing will relate to the comments submitted in this letter, and other topics pertinent to the proposed regulations.

Sincerely,

Nancy McLernon
President and CEO
Global Business Alliance
Washington, DC

FOOTNOTES

1Limitation on Deduction for Business Interest Expense; Allocation of Interest Expense by Passthrough Entities; Dividends Paid by Regulated Investment Companies; Application of Limitation on Deduction for Business Interest Expense to United States Shareholders of Controlled Foreign Corporations and to Foreign Persons With Effectively Connected Income, 85 Fed. Reg. 56846 (published September 14, 2020) (to be codified at 26 C.F.R. pt. 1).

2Unless otherwise noted, all "Code," "section," and "I.R.C." references are to the United States Internal Revenue Code of 1986, as amended, and regulations issued pursuant thereto.

3Limitation on Deduction for Business Interest Expense, 85 Fed. Reg. 56686 (published September 14, 2020) (to be codified at 26. C.F.R. pt. 1).

4Limitation on Deduction of Business Interest Expense, 83 Fed. Reg. 67610 (proposed Dec. 28, 2018) (to be codified at 26 C.F.R. pt. 1).

685 FR at 56695 (Sept. 14, 2020).

END FOOTNOTES

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