SIFMA Seeks Targeted Branch Rule in Proposed FTC Regs
SIFMA Seeks Targeted Branch Rule in Proposed FTC Regs
- Institutional AuthorsSecurities Industry and Financial Markets Association
- Code Sections
- Subject Area/Tax Topics
- Jurisdictions
- Tax Analysts Document Number2020-3496
- Tax Analysts Electronic Citation2020 TNTF 20-332020 TNTI 20-192020 TNTG 20-22
January 16, 2020
Internal Revenue Service
CC:PA:LPD:PR (REG-105495-19)
Room 5203, Internal Revenue Service
PO Box 7604, Ben Franklin Station
Washington, DC 20044
Re: Allocation of interest expense to foreign branches of regulated financial institutions
Ladies and Gentlemen:
We commend the Treasury Department and the Internal Revenue Service for their efforts to provide comprehensive guidance regarding the application of the foreign tax credit rules in light of the Tax Cuts and Jobs Act.1 We intend to submit comments with respect to features of the proposed regulations that are relevant to our industry (for example, the definition of financial services income and the treatment of foreign tax redeterminations). The primary purpose of this letter is to draw your attention to a submission that we made prior to the issuance of the regulations.2 The submission discusses the need for a targeted rule for determining the amount of interest expense that is allocable to foreign branches of regulated financial institutions.
We were heartened to see that Treasury and the IRS recognize the importance of this issue, and are considering the adoption of such a targeted rule.3 We strongly support this endeavor. We have had the opportunity to discuss this topic with representatives of Treasury and the IRS on several occasions. In the course of those conversations, good and thoughtful questions were raised regarding the rationale for a targeted rule; what its scope should be; and how it would work in practice. We made an effort to address these questions in our paper. The paper describes a suggested methodology for a targeted branch rule, and includes draft regulatory language to put the rule into place. The proposed rule is tailored to take account of the preferences that were expressed in our conversations. We hope that we have accomplished that objective. We believe that the proposed rule would operate neutrally and fairly.
The preamble to the proposed regulations also requests comments regarding a broader range of expense allocation issues. The preamble notes that Treasury and the IRS continue to study the rules for allocating and apportioning interest deductions, and requests comments concerning whether further guidance should be provided in light of the changes made by the TCJA and the expected entry into force of section 864(f).
We would enthusiastically support such a broader reexamination of the rules, subject to the cautionary note described below. The rules governing the allocation and sourcing of items of income and expense have grown up over many decades, and are very imperfectly coordinated with each other. Some of the rules were developed for purposes that no longer apply, in the context of rules that no longer exist. Almost all of them predate the challenges to the tax system presented by the growth of the digital economy.
The rules would benefit from a comprehensive rethinking. We believe that a significant proportion of the changes required to update and rationalize them are within the scope of Treasury and the IRS's regulatory authority; others may need to be implemented by legislation.
But this is a big (and necessarily longer-term) project. We encourage Treasury and the IRS not to let it distract them from making remedial changes that are needed urgently, such as the adoption of a targeted branch rule.
* * * * *
We very much appreciate the opportunity to comment. Please do not hesitate to contact me at (202) 615-4732 orjwall@sifma.org if you have any questions or would like to discuss our comments in more detail.
Respectfully submitted,
Jamie Wall
Executive Vice President, Advocacy
SIFMA
cc:
L.G. “Chip” Harter
Deputy Assistant Secretary (International Tax Affairs)
Doug Poms
International Tax Counsel
Jason Yen
Office of Tax Policy
November 26, 2019
Internal Revenue Service
CC:PA:LPD:PR
Room 5203, Post Office Box 7604
Ben Franklin Station
Washington, DC 20044
Matching Branch Interest Expense to Branch Income
I. Introduction.
We are writing to follow up on our conversations regarding the appropriate methodology for determining the amount of interest expense that is allocable to foreign branch category income.1 Part II of the paper responds to your questions regarding the business case for a targeted branch rule. Part III discusses design issues (“moving parts”). Part IV provides suggested language.
II. The Business Case for a Targeted Branch Rule.
A. Overview.
We believe that there is a strong business case for a targeted branch rule. In today's interest rate environment, determining the interest expense allocable to a bank's foreign branches by reference to a formulaic methodology based on all of an affiliated group's assets and liabilities often will result in double taxation, and almost always will result in income in the branch basket that differs materially from the branches' “business profits” subject to foreign tax.2 The interest expense incurred by a bank's foreign branches (as reflected in their books and records) represents the best available measure of their actual borrowing costs.
You asked us to help you develop a more detailed understanding of the reasons why banks can borrow more cheaply than their non-bank affiliates, and why foreign branches sometimes can borrow more cheaply than their U.S. home office. Your framing of the questions required us to focus on broader bank-related aspects of the business case, as well as on branch-specific issues. We found this framing helpful, and have followed it in the discussion below.
Section B discusses the premises underlying the interest allocation rules. Section C discusses the characteristics that enable banks to raise funds at a lower cost than their affiliates. Section D provides an introduction to branch networks. Section E discusses the reasons why a bank's foreign branches sometimes can borrow money at rates significantly lower than its domestic operations. Section F builds on the preceding sections to distill the business case for a targeted branch rule.
B. Premises of the current interest allocation rules.
The core factual assumptions underlying the current interest allocation rules (often distilled into the mantra that money is fungible) are that (i) members of an affiliated group should be considered to have access to credit on the same terms, because borrowings by any member effectively are supported by all of the group's assets; and (ii) which member of the group faces the third-party lender should not be accorded tax significance, because the nominal borrower can freely transfer funds within the group.
Under the current rules, it is irrelevant whether these factual premises are met in a particular case. The regulations require an affiliated group to determine the source of interest expense on a combined basis, as if all of its assets and liabilities were held by a single corporation, with extremely limited exceptions.
The use of these conclusive presumptions may have represented a workable policy approach under prior law, when income from multiple disparate sources was swept into a single omnibus foreign tax credit basket. Even in cases where the factual premises didn't correspond to a taxpayer's actual circumstances, the methodology tended to produce rough justice.
C. Distinguishing characteristics of banks.
Banks occupy a special regulatory position. Their position gives them access to low-cost funding and a government safety net, and restricts their ability to extend credit to or take on liabilities for affiliates. As a result, none of the factual premises underlying the interest allocation rules will be met. Interest expense that is allocated between banks and their non-bank affiliates based on those premises will not correspond with a bank's actual funding costs from an economic, regulatory or foreign tax perspective.
Deposits represent a low-cost source of funding that is uniquely available to banks. The benefits of that funding inure to banks, and cannot effectively be shared with other members of a corporate group. Other financial services companies — even highly-regulated entities like broker-dealers — are not authorized to take deposits. Moreover, banks enjoy access to a government safety net in the form of deposit insurance and liquidity support from central banks. Finally, banks are subject to stringent limitations on their ability to make loans to, purchase assets from, and enter into other transactions with affiliates.
A methodology that attributes some of the benefits of deposit funding away from the bank that receives the deposits, to affiliates that are not themselves authorized to take deposits, will understate the bank's share of the group's net income. This had limited practical significance under prior law, because income derived by banks and their foreign branches was not required to be segregated from income derived by other members of the affiliated group. In the wake of the TCJA's creation of a separate limitation for foreign branch category income, it has become a serious concern. Unless remedial measures are taken, allocation on an affiliated group basis often will understate bank (and foreign branch category) income, and will thus create a further significant potential for double taxation. In summary,
1. The presumption that the assets of every member of an affiliated group are available to satisfy the obligations of every other member breaks down when one of the members is a bank. Regulatory capital and liquidity, risk management, resolution planning requirements, and credit and liability transfer restrictions separate a bank's assets those of its non-bank affiliates, and effectively make the bank's assets unavailable to satisfy claims against those affiliates.
2. The presumption that every member of the group has access to credit on the same terms isn't true where one member can take deposits and the others can't.
3. The presumption that the identity of the borrower doesn't matter, because funds can be freely transferred within the group, isn't true when the borrower is a bank. As indicated above, banks have privileged access to low-cost deposit funding and a government safety net, and are subject to stringent restrictions on their ability to make loans to, purchase assets from, and enter into other transactions with affiliates.
D. The benefits of branch networks.
In order to obtain access to local customers, and to be able to conduct a banking business in a foreign country, a bank generally must establish a formal presence — a branch — that is licensed and regulated in that country. Global banks maintain branches in the places where their most important customers are located, and in the financial centers where those customers wish to do business.
Branch networks offer significant advantages for banks and their customers. The use of such a network facilitates liquidity management and the flexible and efficient deployment of capital. A branch business model enables banks to transfer funds from the home office to foreign branches, from foreign branches to the home office, and from branch to branch. While a limited amount of resources may remain locally positioned in a branch to meet regulatory requirements, the process for moving money from place to place within a bank is dramatically simpler than the process required to transfer funds between separately incorporated members of a regulated financial services group.3 That's one of the principal benefits of conducting a banking business through a branch network.4
A branch network can make it easier for a bank to manage customer risk based on its net worldwide exposure to the customer, rather than on a transaction-by-transaction or location-by-location basis. A branch structure can also offer advantages to customers. Customers may prefer to do business with the licensed branches of a global bank, rather than dealing with separately-incorporated subsidiaries in each country. A customer that deposits funds in a bank's New York branch and enters into a swap with its London branch has a relationship with a single legal entity. All of the bank's assets, wherever held, support all of the bank's liabilities, wherever incurred.
Banks generally seek to ensure that their branches are self-funding (i.e., are able to raise funds in their home markets sufficient to support their activities in those markets).5 In many cases, foreign branches of U.S. banks are able to fund their activities almost entirely with deposits received from local customers. It is not uncommon for a branch to have access to more low-cost funding than it can efficiently redeploy in its local market. Such a branch normally will lend funds for which it has no immediate use to its U.S. home office or another branch on arm's length terms.
E. Why can banks sometimes raise funds more cheaply through foreign branches?
Deposit interest rates can vary significantly from branch to branch, and between a bank's foreign branches and its U.S. home office. It may seem counterintuitive, but a bank's foreign branches often are able to raise funds at rates that are significantly lower than the bank's cost of funds in the United States.
A branch's cost of funds will depend on market conditions (including the currency environment in which it operates) and on the products and services that it offers. Banks tailor deposit products to meet the needs of particular classes of customers: different products pay interest at different rates.
The differential between home office and foreign branch funding costs can be attributable in part to foreign currency considerations. For example, the Japanese market has been a very low rate, low return environment for many years. If the market interest rate for short-term debt denominated in Japanese yen is 0.1%, and the market rate for comparable debt denominated in U.S. dollars is 1.5%, then a Tokyo branch understandably will have a much lower cost of funds (and a correspondingly lower return on assets), than its U.S. home office. This fact pattern provides an easily accessible illustration, but it is important to note that foreign currency-related considerations are not the sole, and often are not the principal, reason why foreign branches can borrow at very low rates.
In some cases, foreign branches can realize even more substantial savings in respect of dollar-denominated funding. The dollar is the world's reserve currency. Transactions in oil and gas, minerals, commodities and basic materials routinely are priced in dollars, generally without regard to the identity of the parties or the location of the transaction. As a result, multinational businesses have very sizeable dollar cash flows outside the United States, and foreign branches of U.S. banks have access to billions of dollars of funding.
Other considerations that can affect the rate of interest that a branch is required to pay in order to attract funds include:
1. Supply and demand. Companies that have significant dollar cash flows in foreign countries can be in the position of sellers into a buyers' market. There are fewer safe investment alternatives for companies wishing to maintain ready access to dollars. This will tend to depress the rate of interest on foreign branch deposits.
2. Market characteristics. The market for corporate deposits is more competitive in the United States: customers have more bargaining power. As a result, deposit interest rates in Europe, Asia and Latin America are depressed to levels well below prevailing U.S. rates.
3. Ancillary services. Multinational businesses look to banks for assistance in managing complex cash flows from multiple sources to multiple destinations in multiple currencies. Customers in need of cash management services assign importance to efficiency and integration, and are willing to pay for those services by receiving a lower yield on deposits.
If a bank conducts a corporate cash management business through its London branch, that branch is likely pay interest at a lower rate than its New York branch, even if there is no differential between prevailing market rates in the two jurisdictions.
4. Legal and regulatory considerations. It is unlawful in some countries to pay interest on corporate deposits. (The United States had a similar prohibition until 15 or 20 years ago.) In such countries, banks compete for depositors based on the services that they provide.
F. The business case.
In the absence of a targeted branch rule, banks will be subject to an irreconcilable tension between regulatory and tax requirements, and a significant risk of double taxation. An unregulated business might be able to reconfigure its operations to conform to the presumptions reflected in a formulaic methodology. This kind of self-help is not realistically available to regulated financial services companies.6
The methodology that we are proposing would provide a measure of branch income that is more accurate from an economic perspective, and less likely to conflict with determinations made for regulatory and foreign tax purposes.
1. More accurate.
A methodology that looks to a branch's actual funding costs unquestionably will provide a more accurate measure of the branch's economic income than a methodology based on the presumption that money is fungible. As discussed above, an interest allocation methodology that relies on sweeping factual assumptions may have represented an appropriate policy solution for a system in which income from multiple disparate sources was blended into a single omnibus foreign tax credit basket. In the context of such a fault-tolerant system, the fact that the assumptions did not always correspond to reality wasn't particularly troublesome.
This is no longer the case: the new foreign tax credit regime is not fault-tolerant. Foreign branch category income is a narrow band of income that can be (and, in the case of banks, typically is) subject to foreign tax at rates higher than the U.S. rate. The imperfections of the generally applicable rules will be exacerbated, and can produce unacceptable distortions, when applied to such a narrow category.
2. Less potential for conflict with business profits determined for regulatory and foreign tax purposes.
A methodology that takes account of a branch's actual borrowing costs will correspond more closely to the principles that apply for foreign regulatory and tax purposes, and will reduce the risk of double taxation.7
One of the core purposes of the international tax rules is to allocate taxing responsibility between countries, and thereby to avoid double taxation. The country in which a branch is located has the primary right to tax income derived from business activities conducted within its borders. Foreign tax systems generally determine branch net income by reference to a branch's actual cost of funds, as reflected in the terms of the liabilities on its books.8 If the United States uses a different methodology, there will be a built-in, systemic risk of double taxation.
III. DESIGN ISSUES.
A. Methodology.
1. Overview.
For the reasons discussed in Part II, a formulaic allocation methodology based on the assets and liabilities of an entire affiliated group inevitably will produce distortions if it is applied to determine foreign branch category interest expense.9 In order to avoid those distortions, it is necessary to take separate account of interest expense incurred by banks and other members of the affiliated group, and separate account of interest expense incurred by foreign branches and a bank's home office.
Once formulaic allocation has been rejected, how should the amount of interest expense that is allocable to foreign branch category income be determined? The possible methodologies fall along a spectrum between narrow tracing rules and broader matching rules. Foreign branches of U.S. banks conduct complex operating businesses. In the context of such businesses, we believe that matching provides a much better conceptual framework than tracing.
The approach that we recommend can be described as “matching, with adjustments”. All of the existing interest allocation rules provide for adjustments to achieve the desired result.
In the most restrictive version of a tracing rule, a borrowing that meets specified requirements may be allocated directly to the asset acquired with the proceeds of that borrowing. The source of interest expense on the borrowing then is determined by reference to the source of income derived from that asset, and the asset is not taken into account for other allocation purposes. Even a comparatively minor change in the facts can break the link between the borrowing and the asset (and the link is broken if the borrowing is refinanced, or the asset is sold and replaced with a different asset).10 A rule like this could not possibly be scaled up to make it a realistic option for complex operating businesses.
By contrast, a matching rule would attribute liabilities with specified characteristics to assets with specified characteristics, but would operate at the level of broad pools, and would not attempt to associate particular liabilities with particular assets.11
A matching rule also would make it easier to take account of equity funding. Neither of the existing tracing rules in Treasury regulations §1.861-10T deals appropriately with equity.
Example 1. Bank has total assets of 2,000 and liabilities of 1,900, for a 19:1 debt-equity ratio. Of these amounts, 1,900 of assets and 1,800 of liabilities are recorded on the books of Bank's home office; the remaining 100 of assets and 100 of liabilities are recorded on the books of Bank's sole foreign branch (“Branch”). From a legal and financial perspective, the fact that all of Bank's equity is recorded on the books of its U.S. home office does not affect the relative priority or credit quality of Bank's domestic and foreign debt. Branch's borrowings are supported by Bank's equity to the same extent as the home office borrowings, and without regard to whether any equity is shown on Branch's books.12 If Branch's liabilities are attributed to its assets without adjustment, then its cost of funds could be overstated.
Example 2. Bank has total assets of 2,000 and liabilities of 1,900, for a 19:1 debt-equity ratio. These totals include 100 of assets and 95 of liabilities on the books of Branch. All of the liabilities bear interest at a 1% rate. Under an allocation methodology, Branch would be considered to have incurred interest expense of 0.95 (19 of total interest [1% of 1,900 debt] x.05 [100 Branch assets ÷ 2,000 total assets]).
Would the result be the same under a tracing approach? If Branch's liabilities are allocated directly to a corresponding amount of Branch assets, then interest expense on 95 of debt, or 0.95, would be allocated to 95 of Branch assets. Branch would have 5 of residual assets. Would interest be required to be allocated to those residual assets?
Under the approach contemplated by Treasury regulations §§1.861-9 and 10T, the answer would appear to be yes. After tracing 95 of Branch liabilities to 95 of Branch assets, the interest expense allocable to Branch's remaining assets would be calculated as follows:
a. Percentage of residual branch category assets = 0.2625%, determined as follows: Residual branch category assets ÷ Bank assets (determined in each case net of assets subject to direct tracing) = 5/1905.
b. Interest expense subject to allocation = 18.05, determined as follows: interest expense at 1% on liabilities of 1,805 (1,900 total debt minus 95 subject to direct tracing).
c. Interest expense allocable to residual branch category assets = 0.047, determined as follows: 0.2625% x 18.05 (a x b).
On the facts of this example, Branch's interest expense for U.S. tax purposes would be greater than its borrowing costs from an economic perspective, and greater than the amounts that would have been allocated under the principles of Treasury regulations §1.861-9T. Relative to these two benchmarks, Branch's interest expense would be overstated by almost 5% (0.997 instead of 0.95).
B. Models.
The choice of a conceptual framework does not necessarily determine which, if any, of the existing regulatory provisions would represent an appropriate starting point in developing a targeted branch rule.13 The draft regulations in Part IV attempt to address branch-specific issues within the general framework of Treasury regulations §1.861-10T. The draft regulations are based on a matching approach, with adjustments to compensate for imbalances. Under this approach, foreign branch liabilities would first be attributed to foreign branch assets. Adjustments would then be made, if necessary, to take account of imbalances resulting from factors such as debt-financed capital and shareholder loans.14
C. Moving parts.
The general principle underlying the targeted branch rule might be stated as follows: In order to produce a fairer and more accurate measure of foreign branch category income, interest expense incurred by foreign branches of U.S. banks should be matched with income derived from the branches' assets.
The devil, as always, is in the details. Relevant questions include:
1. How should the targeted branch rule deal with cases in which an affiliated group includes more than one bank, or in which a bank has U.S. subsidiaries?
Computations generally should be made at the level of a bank subgroup consisting of the members of an affiliated group that are banks or subsidiaries of banks.15
One of the core premises of the current regulations is that money is fungible, because corporate resources can be reallocated between the members of an affiliated group. This premise generally isn't correct with respect to funds moving from or to a bank.16
2. What characteristics should a branch possess in order to qualify for the targeted branch rule?
The rule is intended to be available to true (i.e., non-hybrid) foreign branches of U.S. banks.17
3. Should there be any limitations on the kinds of liabilities that are eligible for matching treatment?
No. We understand that you are considering whether a targeted branch rule should be made available only in respect of deposit funding, or funding provided in a currency other than the U.S. dollar, or funding provided in a currency that is not the branch's functional currency. None of these possible limitations on the scope of the rule is necessary or desirable.
a. Deposits. The ability to take deposits is the principal reason why banks are able to raise low-cost funding. A bank's liabilities, within and outside the United States, typically will consist primarily of deposits. Many or most differences between home office and foreign branch funding costs will be attributable to differences in deposit rates.
Nevertheless, it would be unnecessary and undesirable to limit the exception to deposit funding:
Unnecessary, because differences in deposit interest rates will also be reflected in the differential between the average interest rate on foreign branch liabilities and home office liabilities. An exception that is limited to deposits would be more work for no purpose; and
Undesirable, because banks have the ability, at least to some extent, to choose whether to denominate instruments as deposits or non-deposit obligations. Limiting the targeted branch rule to deposits could give banks the ability to elect into and out of the rule. Moreover, the borderline between deposit and non-deposit obligations can sometimes be difficult to discern. Limiting the targeted branch rule to deposits could require banks to make difficult and unnecessary judgments regarding the classification of some instruments.
b. Foreign currency. As indicated above, differences in market rates for different currencies represent only one of the reasons (and, in many cases, not the most important reason) why a foreign branch can have a lower cost of funds than its U.S. home office. There is no reason to assign special significance to foreign currency-related rate differentials.
A requirement to keep separate account of pools of assets and liabilities in different currencies would be burdensome, impractical, and unnecessary. Under a matching approach that provides for separate computations on a currency-by-currency basis, liabilities denominated in a particular currency presumably would be eligible for the targeted branch rule only to the extent of a branch's assets denominated in the same currency.
How would this work in practice?
Example 3. Bank's Tokyo branch has gross assets worth $100 billion and net assets of zero for Japanese regulatory and tax purposes: it has matching amounts of assets and liabilities in Japanese yen and U.S. dollars.18
As illustrated below, the amount and composition of the Tokyo branch's assets, determined for U.S. tax purposes, could differ significantly from the amount and composition of those assets for Japanese purposes.
A. Tokyo branch books:
¥ assets | ¥7.5 trillion |
¥ liabilities | (¥7.5 trillion) |
$ assets | $25 billion |
$ liabilities | ($25 billion) |
Total | 0 |
Assume that the yen-denominated assets reflected on the Tokyo branch's books for Japanese regulatory and tax purposes include $50 billion of dollar-denominated assets that have been swapped into yen pursuant to a currency swap with Bank's London branch, and that the dollar-denominated assets on the branch's books include a $20 billion loan to the Bank's New York branch. The swap and the loan are disregarded for U.S. tax purposes.
B. Interbranch loans and hedges:
Loan to New York branch | $20 billion |
¥/$ swap with London branch | ¥5 trillion/$50 billion notional amount |
C. Assets and liabilities for U.S. tax purposes:
| Third-party (regarded) | Related-party (disregarded) | Total |
|---|---|---|---|
¥ assets | ¥2.5 trillion | ¥5 trillion/$50 billion swap with London branch | ¥2.5 trillion |
¥ liabilities | ($7.5 trillion) |
| ($7.5 trillion) |
$ assets | $55 billion | $20 billion loan to New York branch | $55 billion |
$ liabilities | ($25 billion) |
| ($25 billion) |
From a U.S. tax perspective, Branch would have $80 billion worth of assets (¥2.5 trillion and $55 billion) and $100 billion worth of liabilities (¥7.5 trillion and $25 billion). Branch would continue to be fully matched from a Japanese regulatory and tax perspective.
What amounts would be eligible for matching on these facts?
c. Non-functional currency. Conditioning the availability of the targeted branch rule on whether a liability is denominated in a currency other than the branch's functional currency would create the potential for capricious differences between similarly situated banks.
Example 4. Bank A's London branch has a dollar functional currency; Bank B's London branch uses pounds sterling. Each branch has very substantial assets and liabilities denominated in dollars, pounds sterling, euros and kronor. Each branch has an average costs of funds that is significantly lower than its U.S. home office's cost of funds. On a separate currency basis, each branch can borrow in dollars and pounds sterling at rates that are significantly lower than its U.S. home office's cost of funds. Why should it make a difference whether a particular borrowing is denominated in a branch's functional currency?
4. Should any safety valves or guardrails be provided in order to prevent abuse, and to minimize the risk of unintended and unfair consequences?
Yes. Provisions for adjustments in appropriate circumstances will make the regulations fairer without making them significantly more complex.
None of the existing interest allocation rules is based on the mandatory application of a single governing principle to every fact pattern. All of them include special rules to address cases in which the general rule would produce inappropriate results.19
a. Under what circumstances, if any, should adjustments be made to take account of differences between the relative leverage of a bank's foreign branches and the bank or bank subgroup?
Example 5: Bank is the sole member of the Bank subgroup. It has $100 billion of assets subject to $80 billion of liabilities. Branch has $10 billion of assets. Assume alternatively that Branch has $5 billion, $10 billion and $15 billion of liabilities on its books. Under what circumstances, if any, should interest expense incurred outside Branch be allocated to Branch, or interest expense incurred by Branch be allocated away from Branch?
In cases where there is more than a de minimis difference in relative leverage, liabilities and interest expense should be allocated to or away from Branch to the extent required to eliminate the difference. This adjustment would produce more economic results, and would thereby reduce the risk of inappropriately overstated or understated branch interest expense.
If Branch has book liabilities that significantly exceed the amount of its assets, it would seem self-evident that a portion of the proceeds of its borrowings have been applied to provide funding to the home office.
If Branch's book liabilities are significantly lower than the amount implied by the Bank subgroup's leverage ratio, it would seem equally apparent that Branch has been funded in part with the proceeds of borrowings by the home office.
b. Under what circumstances, if any, should adjustments be made to take account of differences between the relative leverage of the bank subgroup and the affiliated group?
Our draft provision provides for a one-way adjustment in this case, to the bank subgroup but not away from it. See paragraph (g)(3)(A).
If the bank subgroup is underleveraged relative to the rest of the affiliated group, it would seem appropriate to assume that the bank subgroup has been funded in part with the proceeds of third-party borrowings by members of the affiliated group that are not also members of the bank subgroup.
In the interest of avoiding unnecessary complexity, we have not provided a reciprocal adjustment to address cases in which the bank subgroup is overleveraged relative to the rest of the affiliated group.
c. If an adjustment has the effect of allocating additional interest expense to the bank subgroup, how should that expense be allocated between a bank's foreign branches and the rest of the bank subgroup?
The draft provides for allocation based on the relative leverage of the foreign branches and the rest of the bank subgroup, rather than by reference to their respective assets.
5. How should equity funding and related-party loans be taken into account?
Ø We believe that the adjustments described in paragraph 4.b above deal appropriately with equity provided to the bank subgroup and with related-party loans, except in cases where one of the parties to a related-party loan is a foreign branch. Accordingly, our draft generally does not take account of related-party loans, but provides a mechanism to deal with cases in which related-party funding transactions result in an overstatement or understatement of branch income. See paragraph (g)(3)(C).
This mechanism is designed to deal with funding transactions that are disregarded as well as transactions that are regarded for U.S. tax purposes. The policy issue is the same in each case. Related-party funding transactions involving foreign branches give rise to foreign tax costs and savings that are not appropriately taken into account under the current system.20 An adjustment should be provided without regard to whether the transactions are regarded or disregarded for other tax purposes.
6. Should computations be made with respect to all foreign branches in the aggregate, or a branch-by-branch basis?
Banks should be allowed to determine branch category income on an aggregate basis, and should not be required to prepare separate computations in respect of each branch.
IV. Proposed language.
Regulations §1.861-10. Special allocations of interest expense.
(g) Direct allocation of interest expense incurred by U.S. banks and their qualified foreign branches.
(1) General rules. Foreign branch interest expense shall be directly allocated to foreign branch assets, subject to the adjustments prescribed in paragraph (g)(3) of this section. Home office interest expense shall be directly allocated to home office assets, determined as if the bank subgroup were a separate affiliated group for purposes of §§1.861-9T-14T. Computations in respect of qualified foreign branches shall be made on an aggregate net basis, as if a single qualified foreign branch held all of the third-party assets, incurred all of the third-party liabilities, and entered into all of the related-party funding transactions, involving such qualified foreign branches.
(2) Definitions. The following definitions shall apply for purposes of this section:
(i) Bank means a bank, as defined by section 2(c) of the Bank Holding Company Act of 1956 (12 U.S.C. 1841(c)) without regard to subparagraphs (C) and (G) of paragraph (2) of such section), that is licensed or otherwise authorized to accept deposits, and accepts deposits in the ordinary course of business.
(ii) Bank subgroup consists of the members of a relevant affiliated group that are banks or subsidiaries of banks.
(iii) Foreign branch assets are third-party assets that are properly reflected as assets of the branch on a qualified foreign branch's separate set of books and records (as defined in §1.989(a)-1(d)(1) and (2)), and are taken into account for purposes of the regulations under section 861.
(iv) Foreign branch liabilities are third-party liabilities that are properly reflected as liabilities of the branch on a qualified foreign branch's separate books and records (as defined in §§1.989(a)(d)(1) and (2)), before taking account of the adjustments described in paragraph (g)(3).
(v) Foreign branch interest expense is the amount of interest paid or accrued on foreign branch liabilities, before taking account of the adjustments described in paragraph (g)(3).
(vi) Foreign branch means a foreign branch as defined in §1.904-4(f)(3)(iii)(A).
(vii) Home office assets are third-party assets held by a bank (or a member of a bank subgroup) that are not foreign branch assets.
(viii) Home office liabilities are third-party liabilities that are incurred by a bank (or a member of a bank subgroup) and are not foreign branch liabilities.
(ix) Home office interest expense means interest expense on Home office liabilities.
(x) Qualified foreign branch means a foreign branch of a bank that is not a separate legal entity, and is subject to foreign tax only on profits derived by the branch in one or more foreign countries.
(xi) Related-party funding transactions are borrowings and loans in which one party is a qualified foreign branch and the other party is a member of the relevant affiliated group. Such a transaction can be regarded or disregarded for U.S. tax purposes, depending on whether the borrower and lender are treated for U.S. tax purposes as separate corporations or as branches of a single corporation.
(xii) Relevant affiliated group is, with respect to a qualified foreign branch, the affiliated group that includes that branch.
(xiii) Third-party assets and liabilities. An asset held by a member of a relevant affiliated group shall be considered a third-party asset if it does not represent a claim against another member of that group. A liability incurred by a member of a relevant affiliated group shall be considered a third-party liability if it does not represent an obligation owed to another member of that group.
(3) Adjustments.
(A) Deemed funding by non-bank affiliates. The following adjustments shall be made in cases where the ratio of a bank subgroup's third-party liabilities to its third-party assets is less than the comparable ratio of the relevant affiliated group.
(i) An amount of relevant affiliated group liabilities sufficient to equalize the two ratios shall be considered to have been incurred to fund bank subgroup assets. Interest on those liabilities shall be directly allocated to those assets.
(ii) Liabilities described in subsection (i) shall be considered to have been incurred by qualified foreign branches if and to the extent required to equalize the ratio of the third-party liabilities to third-party assets of such branches with the comparable ratio of the home office.
(B) Deemed funding by and to qualified foreign branches. The following adjustments shall be made in cases where the ratio of foreign branch liabilities of all of the qualified foreign branches of a relevant affiliated group to foreign branch assets of such branches is greater or less than the ratio of home office liabilities to home office assets of that group.
(i) Branch ratio greater. An amount of foreign branch liabilities sufficient to equalize the two ratios shall be considered to have been incurred to fund home office assets. Interest on those liabilities shall be directly allocated to those assets.
(ii) Home office ratio greater. An amount of home office liabilities sufficient to equalize the two ratios shall be considered to have been incurred to fund foreign branch assets, and interest on those liabilities shall be directly allocated to those assets.
(C) Adjustment for related-party funding transactions. A relevant affiliated group shall determine whether an adjustment is required to take account of related-party funding transactions, and the amount of any such adjustment, pursuant to the following steps. The relevant affiliated group shall determine:
(i) The total amount of interest income that its qualified foreign branches derived in respect of related-party funding transactions in the relevant taxable year, determined as if the branches were separate entities for federal income tax purposes (“related-party income”).
(ii) The total amount of interest expense that its qualified foreign branches incurred in respect of related-party funding transactions in that year, determined as if the branches were separate entities for federal income tax purposes (“related-party expense”).
(iii) The “deemed cost of funds” in respect of related-party loans made by qualified foreign branches shall be equal to the amount of interest expense that would have been allocated to such loans if the loans had been treated as foreign branch assets subject to paragraph (g)(1).
(iv) Downward adjustment to branch category interest expense. If related-party income exceeds related-party expense, then the amount of interest expense that is allocable to foreign branch category income shall be reduced by the amount of that excess, minus the deemed cost of funds.
(v) Upward adjustment to branch category interest expense. If related-party expense exceeds related-party income, then the amount of interest expense that is allocable to foreign branch category income shall be increased by the amount of that excess, minus any adjustments made pursuant to subparagraphs (g)(3)(A) and (B).
(4) Examples.
(A) Common facts for all examples. Bank conducts a regulated banking business in the United States and through a qualified foreign branch in Country X ("Branch"). Bank applies the methodology described in section 1.861-10(g) to determine the amount of interest expense that must be allocated and apportioned to foreign branch category income. Bank is a member of a relevant affiliated group ("Group") headed by a bank or financial holding company ("Holding"). Bank is the only member of the bank subgroup: it does not have any U.S. subsidiaries, and there are no other banks in Group. Group conducts a diversified financial services business through U.S. and foreign subsidiaries. Bank derives foreign branch category income solely through Branch; no other member of Group has income in that category. Group has third-party assets of $100 million. Bank has third-party assets of $50 million (50% of the total). Branch has third-party assets of $10 million (representing 20% of Bank's assets, and 10% of Group's third-party assets). Branch's assets give rise solely to foreign branch category income. Group has third-party liabilities of $90 million. Bank has third-party liabilities of $45 million. The amount of Branch's liabilities, and the ratio of third-party debt to third-party assets, varies as described in the examples below. Branch pays interest on its debt at an average rate of 0.5%. Bank pays interest on Home office (i.e., non-Branch) debt at an average rate of 1%. Group pays interest on non-Bank debt at an average rate of 1.5%. Except as otherwise indicated, all determinations are made in accordance with the principles of section 1.861-9T-14T.
Unless otherwise indicated below, (i) totals are cumulative (i.e., assets, liabilities and interest expense listed under the Bank heading represent the sum of such amounts for Branch and Home office, and assets, liabilities and interest expense listed under the Group heading include such amounts for Bank; and (ii) the percentage cost of funds is not cumulative (i.e., Bank's cost of funds is based on Home office debt, and Group's cost of funds is based on non-Bank debt).
(B) Example (1). All leverage ratios equal but funding rates differ.
(i) Facts. Branch has third-party debt of $9 million. Bank has total interest expense of $405,000 ($45,000 [0.5% of $9 million] on Branch third-party debt and $360,000 [1% of $36 million] on Home office third-party debt). Group has total interest expense of $1.08 million ($405,000 on Bank third-party debt, and $675,000 [1.5% of $45 million] on non-bank third-party debt).
| Branch | Bank | Group |
|---|---|---|---|
Third-party assets | $10m | $50m | $100m |
Third-party liabilities | $9m | $45m | $90m |
Interest expense | $45,000 | $405,000 ($45,000 Branch + $360,000 Home office) | $1.08m ($405,000 Bank + $675,000 Group) |
Cost of funds | 0.5% | 1% | 1.5% |
(ii) Third-party debt-to-asset ratios of Bank and Group. Bank has $45 million of third-party debt and $50 million of third-party assets, for a ratio of 9:10. Group has $90 million of third-party debt and $100 million of third-party assets, for a ratio of 9:10. Since there is no difference between the two ratios, no adjustment is required under paragraph (g)(3)(A).
(iii) Third-party debt to asset ratios of Branch and Bank. Branch has third-party debt of $9 million and third-party assets of $10 million, for a ratio of 9:10. Bank has third-party debt of $45 million and third-party assets of $50 million, for a ratio of 9:10. Since there is no difference between the two ratios, no adjustment is required under paragraph (g)(3)(B).
(iv) Interest expense allocable to foreign branch category income. Since no adjustment is required under paragraph (g)(3)(A) or (B), and since Group does not have any other foreign branches, the amount of interest expense that is allocable to foreign branch category income is equal to the interest expense incurred by Branch, or $45,000.
(C) Example (2). Bank underleveraged compared to affiliated group as a whole..
(i) Facts. Branch, Bank and Group continue to borrow at the same rates as in Example 1, but have different third-party debt-to-asset ratios. Branch has third-party debt of $9 million and assets of $10 million. Bank has third-party debt of $35 million and assets of $50 million. Group has third-party debt of $90 million and assets of $100 million.
| Branch | Bank | Group |
|---|---|---|---|
Third-party assets | $10m | $50m | $100m |
Third-party liabilities | $9m | $35m | $90m |
(ii) Adjustment under paragraph (g)(3)(A). Bank's third-party debt to asset ratio of 7:10 is lower than Group's ratio of 9:10, so an adjustment is made pursuant to paragraph 3(A). In order to equalize the ratios, Bank is considered to have been funded with $10 million of Group's third-party debt. The mechanics and outcome of the adjustment are not affected by whether Bank actually receives funding from Group, or by the terms of such funding.
| Branch | Bank | Group |
|---|---|---|---|
Third-party assets | $10m | $50m | $100m |
Third-party liabilities | $9m | $35m | $90m |
Interest expense before adjustment | $45,000 | $305,000 ($45,000 Branch + $260,000 Home office) | $1.13m ($305,000 Bank + $825,000 Group) |
Adjustment to equalize ratios | 0 | $10m | ($10m) |
Interest expense after adjustment | $45,000 | $455,000 ($305,000 + $150,000 adjustment) | $1.13m ($455,000 Bank + $675,000 Group) |
(iii) Adjustment under paragraph (g)(3)(B). No adjustment is required under paragraph (3)(B), because Bank's third-party debt to asset ratio, after taking account of the adjustments pursuant to paragraph (3)(A), is the same as Branch's ratio.
(iv) Interest expense allocable to foreign branch category income. As in Example 1, the amount of interest expense that is allocable to foreign branch category income is determined solely by reference to Branch's actual funding costs of $45,000.
(D) Example (3). Foreign branch overleveraged compared to Bank as a whole.
(i) Facts. The facts are the same as in Example 1, except that Branch has assets of $15 million, and third-party debt of $13.5 million, on its books for regulatory and foreign tax purposes. The assets consist of $10 million of third-party assets and a $5 million loan to Bank. The loan to Bank is disregarded for U.S. tax purposes.
| Branch | Bank | Group |
|---|---|---|---|
Book assets | $15m | $50m | $100m |
Regarded assets | $10m | $50m | $100m |
Third-party liabilities | $13.5m | $45m | $90m |
Cost of funds | 0.5% | 1% | 1.5% |
(ii) Adjustment under paragraph (g)(3)(B). An adjustment is required under paragraph (3)(B) to equalize the third-party debt to asset ratios of Branch and Home office. In order to equalize the ratios, Home office is considered to have been funded with $4.5 million of Branch's third-party debt. After taking account of the adjustment, the amount of interest expense allocable to Branch's third-party assets is $45,000 (0.5% x $9 million [$13.5 million third-party debt - $4.5 million adjustment]).
| Branch | Home office | Bank | Group |
|---|---|---|---|---|
Third-party assets | $10m | $40m | $50m | $100m |
Third-party liabilities before adjustment | $13.5m | $31.5m | $45m | $90m |
Interest expense before adjustment | $67,500 | $315,000 | $382,500 ($67,500 Branch + $315,000 Home office) | $1.0575m ($382,500 Bank + $675,000 Group) |
Adjustment to equalize ratios | ($4.5 m) | $4.5m | — | -- |
Interest expense after adjustment | $45,000 ($67,500 - $22,500 adjustment) | $337,500 ($315,000 + $22,500 adjustment) | $382,500 ($45,000 Branch + $337,500 Home office) | $1.0575m ($382,500 Bank + $675,000 Group) |
(iii) Adjustment under paragraph (g)(3)(C). An adjustment in respect of related-party funding transactions may be required pursuant to paragraph (g)(3)(C). Branch has related-party income in excess of its related-party expense ($50,000 of income [1% of $5 million] minus zero of expense) so the amount of any required adjustment is determined pursuant to subparagraph (iv). The adjustment is equal to the amount by which related-party income exceeds related-party expense ($50,000), minus the deemed cost of funds ($22,500 [0.5% interest on deemed $4.5 million third-party borrowing]), or $27,500. The amount of interest expense allocable to Branch's third-party assets is adjusted downward by that amount, to $17,500 [$45,000 - $27,500].
(iv) Interest expense allocable to foreign branch category income. As a result of the adjustment, the amount of interest expense that is allocable to foreign branch category income is $17,500. If Branch derives a 1% return on its assets, Group will have foreign branch category income of $82,500.
| Branch |
|---|---|
Third-party assets | $10m |
Return on third-party assets at 1% | $100,000 |
Interest expense after (g)(3)(B) adjustment | $45,000 |
Adjustment for net related-party income | ($27,500) |
Interest expense after adjustment | $17,500 |
Foreign branch category income | $82,500 |
(E) Example (4). Foreign branch underleveraged compared to Bank as a whole.
(i) Facts. The facts are the same as in Example 1, except that Branch's liabilities include a $4 million loan from Bank's home office. The loan is taken into account for regulatory and foreign tax purposes, but is disregarded for U.S. tax purposes. On these facts, an adjustment normally will not be required under paragraph (g)(3)(C)(v), because the adjustment made pursuant to paragraph (g)(3)(B) will result in an appropriate allocation of interest expense to Branch.
| Branch | Home office | Bank |
|---|---|---|---|
Third-party assets | $10m | $40m | $50m |
Third-party liabilities | $5m | $40m | $45m |
Book liabilities (including related-party borrowings) | $9m | $40m | $45m |
Cost of funds | 0.5% | 1% |
|
(ii) Adjustment under paragraph (g)(3)(B). An adjustment is required under paragraph (3)(B) to equalize the third-party debt to asset ratios of Branch and Bank. In order to equalize the ratios, Branch is considered to have been funded with $4 million of Bank's third-party debt. After taking account of the adjustment, the amount of interest expense allocable to Branch's third-party assets is $65,000 (0.5% x $5 million plus 1% [Bank's cost of funds] x $4 million adjustment).
| Branch | Home office | Bank | Group |
|---|---|---|---|---|
Third-party assets | $10m | $40m | $50m | $100m |
Third-party liabilities before adjustment | $5m | $40m | $45m | $90m |
Interest expense before adjustment | $25,000 | $400,000 | $425,000 ($25,000 Branch + $400,000 (Home office) | $1.1m ($425,000 Bank + $675,000 Group) |
Adjustment to equalize ratios | $4m | ($4m) | -- | -- |
Interest expense after adjustment | $65,000 ($25,000 + $40,000 adjustment) | $360,000 ($400,000 - $40,000 adjustment) | $425,000 ($65,000 Branch + $360,000 Home office) | $1.1m ($425,000 Bank + $675,000 Group) |
(iii) Adjustment under paragraph (g)(3)(C). No adjustment is required under subparagraph (g)(3)(C)(v), because the amount by which related-party expense exceeds related-party income ($20,000 [0.5% of $4 million borrowing) is less than the adjustment made pursuant to paragraph (g)(3)(B) ($40,000).
* * * * *
We very much appreciate the opportunity to comment. Please do not hesitate to contact me at (202) 615-4732 or jwall@sifma.org if you have any questions or would like to discuss our comments in more detail.
Respectfully submitted,
Jamie Wall
Executive Vice President, Advocacy
SIFMA
cc:
L.G. “Chip” Harter
Deputy Assistant Secretary (International Tax Affairs)
Doug Poms
International Tax Counsel
Jason Yen
Office of Tax Policy
FOOTNOTES
1Guidance Related to the Allocation and Apportionment of Deductions and Foreign Taxes, Financial Services Income, Foreign Tax Redeterminations, Foreign Tax Credit Disallowance Under Section 965(g), and Consolidated Groups, 84 FR 69124 (the “proposed regulations”) and Foreign Tax Credit Guidance Related to the Tax Cuts and Jobs Act, Overall Foreign Loss Recapture, and Foreign Tax Redeterminations, 84 FR 69022 (the “final regulations”).
2“Matching Branch Interest Expense to Branch Income”, November 26, 2019. We have corrected a couple of typos in the version of that paper that accompanies this letter.
3Part III, B.4.iii of the summary to the final regulations discusses possible alternative methodologies for such a targeted rule. Part I.A.5 of the preamble to the proposed regulations requests comments concerning this issue.
1The rules governing the sourcing of items of income and expense would benefit from a comprehensive rethinking. The targeted fix discussed in this paper is urgently needed, is well within the scope of the Service's regulatory authority, and should not await the outcome of that longer-term project.
2It is important to note that our proposed rule is intended to operate neutrally. The objective is to produce a more accurate measure of a branch's business profits, and thereby to further the policy objectives of the foreign tax credit rules. A more accurate measure will not always work in taxpayers' favor. It is easy to imagine circumstances, particularly following a change in market conditions, in which the distortions produced by a formulaic methodology would produce a better outcome for taxpayers.
3Banks have financial, regulatory and foreign tax incentives to ensure that their foreign branches operate on a matched-book basis, and do not incur mismatches between the duration, currency or other terms of their assets and liabilities. This doesn't mean that the proceeds of particular borrowings can be traced to particular assets. Moreover, positions that are matched for financial, regulatory and foreign tax purposes will not necessarily be matched for U.S. tax purposes.
4Financial services groups conduct banking businesses through foreign subsidiaries when necessary (for example, some countries, including China, do not allow U.S. banks to open local branches), or for historical reasons (for example, in cases where a U.S. group has acquired an existing foreign bank).
5Retail customers will make deposits in home-country institutions (local banks, and local branches of foreign banks). A broader range of considerations will determine the locations where multinational businesses and other institutional customers keep their money. Relevant considerations can include: (i) the location that provides the best access to desired products and services (e.g., custody, cash management and notional pooling); (ii) the source and expected use of funds (maintaining deposits in the country or regional financial hub closest to the funds flows can create efficiencies); (iii) a foreign currency's natural home (maintaining deposits in the country of issue, or the place where the relevant central bank is located [e.g., Yen in Japan and Euro in Frankfurt] can streamline processing, and reduce transaction costs); and (iv) time zones (all other things being equal, customers will prefer to deal with branches that are open during their business hours [e.g., London for European and Middle Eastern customers, and Hong Kong for Asian customers]).
6Banks do business through branch networks for reasons unrelated to U.S. taxes. Regulatory and foreign tax constraints restrict their ability to reconfigure activities conducted through foreign branches. A bank cannot simply decide to shift assets and activities from a foreign branch to the U.S. home office, or to a different foreign branch. Funding provided in one location cannot simply be replaced with funding provided on the same terms in a different location.
7In a significant number of countries, income for regulatory purposes determines income for tax purposes.
8A number of countries have adopted the OECD methodology under which equity capital must be allocated between a bank's home office and its foreign branches. Our proposed rule is consistent with this approach.
9In the current interest and exchange rate environment, these distortions often will result in an understatement of foreign branch category income, and thereby will make it more difficult for banks to make effective use of foreign tax credits. However, it is easy to imagine circumstances in which the distortions could have the opposite effect, and overstate foreign branch category income. This could enable banks to claim credits for foreign taxes imposed at rates in excess of the U.S. rate. Our proposed rule is intended to operate neutrally, and to reduce the potential for foreign branch category income to be inappropriately overstated or understated.
10The special exceptions for qualified nonrecourse borrowings and integrated financial transactions in Treasury regulations §1.861-10T are narrowly restrictive tracing rules. Those exceptions are so narrowly delimited — both in terms of the circumstances in which taxpayers may rely on them, and the conditions that must be satisfied in order for them to apply — that they almost never apply.
11Treasury regulations §1.882-5 is a matching rule. As discussed below, that provision was designed to apply in a different factual context, and we have not used it as a starting point.
12Countries that follow the OECD model impute equity to foreign branches.
13We had initially thought that the §1.882-5 regulations would represent a good starting point, because those regulations are designed specifically for branches; they represent the most recent, and the most highly developed, attempt by the U.S. tax authorities to prescribe rules for measuring branch income; and they address many of the issues that will arise in the context of foreign as well as U.S. branches. These regulations were designed to address inbound businesses conducted by foreign banks through U.S. branches. Those businesses present technical, practical and tax policy considerations that differ in significant respects from the considerations relevant to outbound businesses conducted by foreign branches of U.S. banks. The §1.882-5 regulations include features that were developed to address the circumstances of foreign banks doing business in the United States. Those features would need to be modified or eliminated to make the regulations suitable for use in outbound fact patterns. You expressed concern about the need to identify and consider the suitability of provisions that were originally designed for use in a very different factual context, and about the potential for unintended consequences. We weren't as concerned about this as you were — we thought our proposed language did the job — but we understand the basis for your concern, and have attempted to address it by not using §1.882-5 as a starting point for our proposed rule.
14An ordering and anti-double counting rule should be provided to deal with the (presumably very rare) cases in which an amount otherwise would be subject to more than one special rule. For example, if a transaction is subject to the special exception for assets funded with qualified nonrecourse indebtedness provided in Treasury regulations §1.861-10T(b), then the relevant asset, liability and interest expense should not be taken into account again for purposes of the targeted branch rule.
15Our proposed bank subgroup rule is not based on an existing model. We concluded that it would be easier and safer to draft a new rule rather than attempting to fix what's wrong with Treasury regulations §1.861-11T, which provides for separate computations with respect to specified financial institutions. Those regulations are overbroad and confusing. They are not in common use. Although the regulations have been on the books for more than 30 years, many taxpayers appear to have almost forgotten that they exist. Significant effort would be required to make them workable.
16The regulatory and practical constraints on intercompany transfers in which one party is a bank apply to a significantly lesser extent if the other party is also a bank, or a subsidiary of a bank
17The considerations that support the application of a targeted rule to foreign branches also apply to the bank's U.S. home office. We have tried to take account of this, without introducing undue complexity, by providing for the direct allocation of “home office expenses” to “home office assets”.
18For convenience, this example assumes an exchange rate of ¥100:$1.
19For example, Treasury regulations §1.882-5, which prescribes rules for determining the amount of interest expense that is allocable to the U.S. branch of a foreign bank, is a matching rule that provides for several significant adjustments. Under those regulations, the amount of branch interest expense is determined initially by reference to the terms of liabilities on the branch's books. Funding costs incurred outside the branch are taken into account only to the extent those liabilities are not at least equal to the liabilities attributed to the branch for purposes of the regulations. The amount of such liabilities that are so attributed is determined using a formula based on the bank's overall leverage. This can produce an amount that is more or less than the debt shown on the branch's books.
20If the related-party funding transaction is regarded for U.S. tax purposes, then the consolidated return intercompany transaction rules will provide for the matched sourcing of interest income and expense on the transaction. If the transaction is disregarded for U.S. tax purposes, then interest income and expense normally will not be taken into account.
END FOOTNOTES
- Institutional AuthorsSecurities Industry and Financial Markets Association
- Code Sections
- Subject Area/Tax Topics
- Jurisdictions
- Tax Analysts Document Number2020-3496
- Tax Analysts Electronic Citation2020 TNTF 20-332020 TNTI 20-192020 TNTG 20-22
