Foreign Trade Council Seeks Changes to Interest Expense Regs

November 2, 2020

The Honorable David J. Kautter
Assistant Secretary (Tax Policy)
Department of the Treasury
1500 Pennsylvania Ave., N.W.
Washington, D.C. 20220

The Honorable Charles Rettig
Commissioner
Internal Revenue Service
1111 Constitution Ave., N.W.
Washington, D.C. 20224

Re: The Proposed Limitation on Deduction for Business Interest Regulations [REG-107911-18]

Dear Assistant Secretary Kautter & Commissioner Rettig:

On behalf of the National Foreign Trade Council (“NFTC”), I would like to express our appreciation to the U.S. Department of the Treasury (“Treasury”) and the Internal Revenue Service (“Service”) for permitting us to comment on the proposed Section 163(j) limitation on deduction for business interest expense regulations (the “Proposed Regulations”).

The NFTC, organized in 1914, is an association of approximately 200 U.S. business enterprises engaged in all aspects of international trade and investment. Our membership covers the full spectrum of industrial, commercial, financial, and service activities and the NFTC therefore seeks to foster an environment in which global companies can be dynamic and effective competitors in the international business arena. The NFTC's emphasis is to encourage policies that will expand U.S. exports and enhance the competitiveness of multinational companies by eliminating major tax inequities in the treatment of U.S. companies operating abroad. To achieve this goal, American businesses must be able to participate fully in business activities throughout the world, through the export of goods, services, technology, and entertainment and through direct investment in facilities abroad. Foreign trade and foreign direct investment in the U.S. are fundamental to the economic growth of U.S. companies.

While the NFTC applauds the Treasury's and the Service's efforts in developing the Proposed Regulations after they were adopted as part of the CARES Act, there are a number of issues we would like to see addressed.

CFC Grouping Election (Prop. Reg. Sec. 1.163(j)-7(c))

Issue:

In most cases it seems likely that a CFC grouping election would be favorable, however, it is difficult (if not impossible) for taxpayers to forecast the impact of such an election over a five-year period, taking into account changes in facts/business and changes in U.S. federal income tax law.

Recommendation:

The NFTC's recommendation is to modify the five-year election (as described in Prop. Reg. Sec. 1.163(j)-7(e)(5)(ii)) to, instead, be an annual election. An annual election would be consistent with the Proposed Regulations' safe harbor election and with other elections made under the Code and Regulations, including the high-tax election for GILTI. In order to address apparent concerns regarding inappropriate tax planning that might be facilitated by allowing an annual CFC grouping election, restrictions could be placed on the ability to carry forward disallowed BIE if an election is made or revoked within 60 months of a previous revocation or election.

More specifically, the rationale for an annual election is as follows:

• GILTI high tax exclusion election: The CFC grouping election may have a negative impact due to its interaction with the GILTI high-tax exclusion election. If a GILTI high-tax exclusion election is made, making the section 163(j) CFC group election may affect the interest expense apportioned to the different tested units and may “flip” some from high-taxed into not high-taxed, and vice versa.

• QBAI for GILTI: The CFC grouping election might turn a tested income entity into a tested loss entity. QBAI of a tested loss entity is not included in the calculation of U.S. shareholder's NDTIR (therefore, potentially increasing the taxpayer's GILTI inclusion).¹

• Unintended increased limitation: If the CFC group is limited under section 163(j) because of a CFC group election, making the election could result in CFCs that would otherwise be able to deduct all of their interest expense (because they have plenty of ATI on a standalone basis) being limited under section 163(j). This could result in a net tax cost if, for instance, such as with a CFC that has low-tax subpart F income to which disallowed interest expense would have been apportioned without the election.

• Symmetry: Note that the safe harbor election provided under Prop. Reg. Section 1.163(j)-7(h)(1) provides for electivity for a CFC group. It is an annual election and, under Prop. Reg. Section 1.163(j)-7(j)(3)(ii), if the safe harbor election is made, the U.S. shareholder is not permitted to include any CFC inclusions in determining its ATI. The ability to annually elect into the safe harbor context provides support for making this the CFC group election available on an annual basis.

• Uncertainty as to Applicable Facts and Law: As noted above, a five-year election does not allow taxpayers the opportunity to take into consideration potential changes with respect to the underlying facts (such as acquisitions or dispositions) or changes in U.S. federal income tax law. To this point, the changes to remove depreciation and amortization from adjustments to ATI in 2022 may significantly change a CFC group profile, and it is difficult to predict implications of that specific change. The potential impact of future U.S federal income tax law changes may be even more significant.

If the five-year election is maintained, we recommend that the regulations clarify that if an election is made for a prior tax year, that the five-year begins with the first elected taxable year.

Adjusting ATI for Foreign Taxes (Prop. Reg. Section 1.163(j)-7(g)(3))

Issue:

The preamble to the Proposed Regulations requests comments regarding the adjustment of ATI for foreign taxes. In the case of CFCs, it is appropriate to adjust ATI for foreign taxes in order to ensure that CFCs are on a par with domestic corporations in determining the section 163(j) limitation. In addition, if foreign taxes reduce a CFC's ATI, CFCs in higher tax jurisdictions will be penalized relative to CFCs in lower tax jurisdictions. Accordingly, it is appropriate to add back foreign taxes to ATI to ensure that CFCs are also on par with CFCs in jurisdictions with lower tax rates.

As the preamble notes, that foreign taxes are generally a deduction for a U.S. taxpayer for purposes of calculating a CFC's earnings and profits (note that U.S. taxes also reduce a U.S. taxpayer's earnings and profits), deducting foreign taxes from a CFC's ATI is inconsistent with the general policy of treating a CFC as a domestic corporation — a policy that dates back to the 1960s under Treas. Reg. Sec. 1.952-2 (which provides that the principles of sections 61 and 63 and the regulations thereunder apply to computing a foreign corporation's gross income and taxable income, with certain narrow exceptions). While section 951A(c)(2)(A)(ii) (with its cross reference to section 954(b)(5)) details the required deductions to achieve the net foreign income inclusion, the aim of ATI is not to determine the ATI inclusion itself but to determine the level of BIE that is available to offset such inclusion. If a CFC's foreign taxes reduce its ATI, then CFCs are effectively subject to a greater than 30 percent limitation relative to domestic corporations.²

Recommendation:

To achieve parity with domestic corporations and among CFCs in jurisdictions with different tax rates, ATI should not be reduced for the CFC's national income taxes, i.e., income taxes imposed by the country in which the CFC is organized or tax resident.

Further, treating a foreign corporation as a domestic corporation should also mean treating that foreign corporation's foreign taxes (at least those taxes assessed by its country of tax residence) as taxes rather than expenses because a domestic corporation does not deduct its U.S. federal income tax prior to calculating its section 163(j) limitation.

If the recommendation to include foreign income taxes in a CFC's ATI is not accepted, in the alternative, we propose to include eligible foreign income taxes (from CFCs) in calculating a U.S. shareholder's ATI.

While we leave the methodology for determining the eligible foreign tax amounts to the Treasury, we note that analogous guidance may be found in the foreign tax credit context. Specifically, where a U.S. shareholder electing to claim foreign tax credits, it must include the foreign taxes associated with its sections 951 and 951A inclusions in income under section 78. Accordingly, §78 deems a dividend to a U.S. shareholder such that the amount of foreign taxes is not deducted from U.S. shareholder's taxable income. This allows for tax assessment on the full amount and to reduce the resulting U.S. tax liability by the foreign tax credit.

Not allowing foreign taxes to increase either CFC's ATI or the U.S. shareholder's ATI could create unintended consequences that either disincentivize taxpayers from loaning to high-tax jurisdictions and loaning to low-tax jurisdictions in order to avoid a reduction in ATI.

Adjusting ATI for Interest Expense

Issue:

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. Sec. 1.163(j)-7(j) deducts interest expense twice against the same earnings in calculating the U.S. shareholders' ATI — thus, artificially lowering its ATI. For example, consider a situation where USP, a domestic corporation, wholly owns CFC, a foreign corporation. 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% section 163(j) limitation). USP's inclusion is $400 before applying section 250, and $200 after applying section 250. Under Prop. Treas. Reg. Sec. 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 the $200 and again in CFC's ETI of only $300.

Recommendation:

There are several possible ways to avoid decreasing a U.S. shareholder's ATI twice for the same interest expense. One recommendation is to use the framework of the U.S. shareholder ATI calculation in the 2018 proposed Section 163(j) regulations, which allowed a U.S. shareholder to increase its ATI by the lower of (i) the shareholder's inclusion with respect to a CFC group, and (ii) the eligible ETI of such CFCs. The details of calculating the eligible ETI of a CFC group would, of course, need to be tweaked for the consolidated group approach of the Proposed Regulations for CFC groups. However, the general framework of the 2018 proposed regulations would avoid decreasing a U.S. shareholder's ATI twice for CFC interest expense deductions by not combining CFC ETI and U.S. shareholder inclusions in the same calculation. Such a solution would likely be the simplest way to avoid deducting CFC interest expense twice against the same earnings for calculating a U.S. shareholder's ATI.

Another possible solution would be to determine a U.S. shareholder's ATI increase by multiplying the ratio of CFC ETI over ATI by a number that does not include any CFC interest expense deductions, such as multiplying CFC ETI over ATI by (i) a modified calculation of the U.S. shareholder's CFC inclusion that adds back CFC interest expense deductions or (ii) instead of the U.S. shareholder's CFC inclusion, a modified version of CFC ATI that takes into account only deductions (like the section 250 deduction), that are not also made in calculating CFC inclusions.

We also recommend modifying the Proposed Regulations to state that ATI is not reduced by taxes imposed on the net income of the CFC by the jurisdiction in which it is incorporated or in which it is otherwise tax resident.

Definition of interest (Prop. Reg. Sec. 1.163(j)-1(b)(22))

Issue:

Under Prop. Reg. Sec. 1.163(j)-1(b)(22)(iii)(F), taxpayers can treat certain amounts from regulated investment companies (“RICs”) as interest income for section 163(j) purposes. The rationale given in the preamble to the Proposed Regulations hinges on the ability of a RIC to look through to its underlying investments. To the extent the underlying earnings of a RIC is interest, the U.S. taxpayer, may similarly treat their earnings from that RIC as interest. This provision should be extended to include foreign regulated investment and money market funds (“Investment Funds”), where a taxpayer can obtain support that the income earned from such a fund is attributable to interest income earned by the fund. This will ensure consistent treatment for investments in domestic and foreign regulated funds with respect to the application of section 163(j).

RICs are defined as domestic corporations³ that are registered under the Investment Company Act of 1940.⁴ Foreign corporations are excluded from the definition a RIC and, therefore, the look-through treatment (described above) was not extended to non-RIC holdings, such that foreign dividends cannot be considered section 163(j) “interest dividends.”

Recommendation:

In order to bring uniformity to investments in RICs with investments in other Investment Funds, we propose the following:

Additionally, we suggest that “interest dividend” look-through treatment be permitted for taxpayers that invest in domestic or foreign regulated funds that invest all but a de minimis portion of their assets in interest bearing securities.

Depreciation, Depletion and Amortization — Prop. Reg. Sec. 1.163(j)-1(b)(iv)(E) as Applied to Final Reg. Sec. 1.163(j)-1(b)(ii)(C)-(E)

Issue:

The Proposed Regulations require a recapture of depreciation, depletion, and amortization (“DD&A”) when property (including partnership interest and stock sales) is subsequently sold.

As currently drafted, Prop. Regs. Sec. 1.163(j)-1(b)(iv)(E)(1) requires that ATI be adjusted for DD&A (in 2018-2022) when properties are sold, even if the DD&A addback does not increase the amount of business interest expense allowed by section 163(j).

Without a revision, a taxpayer who did not benefit from the DD&A addback would be negatively impacted in future property sales by a forced claw-back of the perceived benefit.

This is inequitable and seems to be counter to Congress' intent of allowing taxpayers to increase ATI by DD&A from the beginning. Congress did not intend to adversely affect the taxpayer by providing the DD&A sunset provision.

Recommendation:

We recommend a recapture of DDA previously added-back to Sec. 163(j) adjusted taxable income (“ATI”) for property sold (including partnership interests and stock sales) only to the extent that a Sec. 163(j) benefit was recognized as a result of the previous addback.

Basis Adjustments Required on Non-liquidating Partnership Distributions

Issue:

Treasury and the IRS requested comments on whether or not the basis adjustments (inside and outside) for disallowed business interest expense carryforwards should be required on non-liquidating distributions. Requiring such adjustments should not economically impact the taxable income of either the partner or the partnership in the year of the distribution. However, in future years, these adjustments could be detrimental. For example: a carryforward deduction due to excess ATI may occur years before a partnership sells the capital property to which the inside basis adjustment was made.

Recommendation:

The NFTC recommends that there be no basis adjustments for non-liquidating distributions.

Use of CFC ETI in U.S. Group — Prop. Reg. Sec. 1.163(j)-7(j)(2)(iii)

Issue:

The Proposed Regulations describe the mechanics of the ETI roll-up computation with non-standard terminology, with multiple cross-references, and without an example. For instance, in Prop. Reg. Sec. 1.163(j)-7(j)(2)(iii), words such as “over” and “bear to” may be misinterpreted and appear to rely on context versus a stand-alone meaning to explain the formula.

Recommendation:

The NFTC requests that the IRS and Treasury provide examples concerning the operation of the rules concerning the U.S. shareholders use of a CFC's excess taxable income to ensure interpretative consistency.

* * * * *

Again, thank you very much for the opportunity to provide these comments. Please do not hesitate to contact me should you have any questions on the above. We would be glad to meet with you to discuss these comments more fully and hereby formally request a public hearing to present our oral comments on the Proposed Regulations.

Sincerely,

Catherine G. Schultz
Vice President for Tax Policy
cschultz@nftc.org
202-887-0278 ext. 104
National Foreign Trade Council
Washington, DC 20006