The House tax bill would add a new Section 163(n) which limits interest deductions of a domestic corporation (or a U.S. affiliated group that files a consolidated return) that is a member of an “international financial reporting group” (“IFRG”).
- An IFRG is defined as a group which includes (i) (x) at least one foreign corporation engaged in a U.S. trade or business or (y) at least one domestic corporation and at least one foreign corporation, (ii) prepares consolidated financial statements and (iii) reports gross receipts annually over the past 3 years of at least $100 million.
The Limitation. In essence, a domestic corporation that is a member of an IFRG would be permitted to deduct interest expense only up to an amount equal to the member’s interest income plus 110% of its allocable share of IFRG net interest expense, which is its pro rata share of the net interest expense of the IFRG allocated based on EBITDA generated by each member.
Specifically, the provision caps a domestic corporation’s deduction for interest paid or accrued during the year at the “allowable percentage” of 110% of the domestic corporation’s net interest expense (if interest expense exceeds interest income) plus the domestic corporation’s interest income for the taxable year.
- The “allowable percentage” is defined as a ratio equal to the domestic corporation’s allocable share of the IFRG’s net interest expense (based on the corporation’s share of the IFRG’s EBITDA (determined without regard to intragroup distributions)) over the domestic corporation’s net interest expense on a stand-alone basis.
- Corporations that file a consolidated return for U.S. federal income tax purposes are treated as one corporation for purposes of the limitation.
- If the IFRG does not have net interest expense on a group-wide basis (i.e., the IFRG’s interest income exceeds the IFRG’s interest expense on a group-wide basis), the group’s domestic corporate members will not be permitted to deduct interest expense in excess of such domestic corporation’s interest income (even if the domestic corporation’s interest expense exceeds its interest income).
- For IFRGs with significant interest income on a group-wide basis (e.g. financial institutions and insurance companies), the effect of this provision may be a complete disallowance of net interest expense for domestic group members.
- This limitation applies in addition to the proposed Section 163(j), which would limit a domestic corporation’s net interest expense to no more than 30% of pre-tax earnings. Read more about the Section 163(j) limitation here and here.
Calculation of Interest Expense. The IFRG’s interest expense and interest income is based on the IFRG’s consolidated financial statements for the taxable year. The domestic corporation’s interest expense and interest income is based on amounts reported in the books and records of the IFRG which are used to prepare the IFRG’s consolidated financial statements.
Application to Partnerships and Foreign Corporations. The proposed Section 163(n) also limits interest deductions generated by a partnership (domestic or foreign) that is a member of an IFRG, as well as interest deductions generated by a foreign corporation that is engaged in a U.S. trade or business, subject to regulatory exceptions.
Carry Forward of Disallowed Deductions. Interest not allowed as a current deduction under the new limitation set forth in Section 163(n) (or the new limitation set forth in Section 163(j), which ever results in less allowable interest) could be carried forward to offset taxable income for the succeeding 5 years. However, the carry forward could be used to offset taxable income in future years only; absent taxable income, the carry forward would expire unused.
Interaction with Current Section 163(j). Unlike the current Section 163(j), this provision applies to third-party debt as well as intercompany debt, and applies without regard to the debt/equity ratios of the group members.