The TCJA U.S. Federal tax reform legislation enacted a business interest expense limitation applicable to U.S. taxpayers. The new rules generally limit the deductibility of business interest expense to business interest income plus 30% of the U.S. taxpayer’s adjusted taxable income (ATI). This provision is found in Section 163(j) of the U.S. federal tax law in the Internal Revenue Code. The CARES Act allows a temporary increase of the limitation to 50% of ATI for tax years beginning in 2019 or 2020. To implement the rules, the IRS released proposed regulations in 2018 (REG-106089-18), final regulations in 2020 (T.D. 9905), new proposed regulations in 2020 (REG-107911-18), and now final regulations in 2021 (T.D. 9943). The 2021 final regulations were published in the Federal Register on January 19, 2021.
The business interest expense limitation rules apply to controlled foreign corporations (CFCs) owned by U.S. shareholders. Certain elections including the CFC group election and the safe-harbor election are available for CFCs. The 2021 final regulations provide that it is possible to make a CFC group election or a safe-harbor election on a U.S. person’s amended U.S. Federal tax return for a tax year ending before November 13, 2020. However, such amended Federal tax return must be filed on or before the due date including extensions of the U.S. person’s Federal tax return for the first tax year ending on or after November 13, 2020. For a calendar year U.S. taxpayer, the first tax year ending on or after November 13, 2020, is the year 2020. Therefore, to make these elections effective for the prior calendar tax years 2018 and 2019, the amended Federal tax return must be filed on or before the due date including any extension of the 2020 Federal tax return. Otherwise, the elections must be made on the U.S. person’s original federal tax return filed on time by the original or extended due date.
The CFC group election is based on rules for business interest expense limitation applicable to a U.S. consolidated group. However, there are some specific modifications with respect to a CFC group. Intercompany obligations among CFC group members are regarded. Foreign taxes are not considered to be deductible in the CFC’s ATI calculation. An aggregated business interest expense limitation is determined for the CFC group and then allocated to each CFC group member. In determining the CFC group’s limitation, the business interest expense, business interest income, and ATI of each CFC group member are taken into account. A CFC group parent may include a U.S. corporation, a U.S. individual, or a CFC group member. The CFC group election is binding for a 60 month period.
The CFC safe-harbor election can be made on an annual basis. A CFC’s business interest expense is not limited if certain requirements for the election are satisfied. To qualify for the election, a CFC group’s business interest expense cannot exceed either of two thresholds. The first threshold is the CFC group’s business interest income. The second threshold is 30% of the lesser of the CFC group’s (1) Subpart F income and global intangible low-taxed income (GILTI), and (2) certain items of taxable income attributable to a non-excepted trade or business. The safe-harbor election may apply to standalone CFCs and CFC groups.
Subpart F income and GILTI are types of income from a CFC that require the U.S. shareholder to report and pay U.S. tax on the CFC’s undistributed earnings like a deemed dividend. If the safe-harbor election is made then the U.S. shareholder’s ATI for purposes of its own limitation is not increased by the CFC’s Subpart F income or GILTI. The 2021 final regulations do not provide rules to allow the inclusion of CFC Subpart F income or GILTI within the calculation of the U.S. shareholder’s ATI.
The 2021 final regulations bring significant technicality to the application of the business interest expense limitation rules to U.S. shareholders of CFCs. It is important to plan for the applicable filing due dates to make elections on time for 2018, 2019, 2020, and future tax years.
For more information, please contact Alison Dougherty.