On July 28, 2020 the US Department of the Treasury and the IRS issued final and new proposed regulations for computing the business interest deduction limitation. These proposed regulations substantially revise a previous set of proposed regulations issued in 2018, including the interest capitalization rules for controlled foreign corporations (CFCs).
Taxpayers subject to the interest expense limitation should consider how the changes in these regulations could alter their chosen tax positions related to other areas of the Internal Revenue Code. An overview of key changes in the proposed regulations, as well as considerations for businesses, follows.
The proposed regulations accomplish the following:
- Provide relief for taxpayers impacted by COVID-19 with an increased 50% adjusted taxable income (ATI) threshold for the 2019 and 2020 tax years
- Allow taxpayers to use their 2019 CFC group ATI for the 2020 tax year
- Confirm that US shareholders must apply the interest-expense limitation in calculating the net income of CFCs
- Modify the calculation of the CFC group election and ATI
- Introduce an annual safe-harbor election for qualifying CFCs that allows US shareholders with a valid CFC group to ignore the interest expense limitation rule
The interest-expense limitation could result in a significant increase in taxable income when compared to financial net income. Taxpayers that lost money in previous years could potentially pay additional tax simply due to excess interest expenses paid on loans.
Taxpayers can benefit from modeling the modifications made by these regulations—especially with respect to CFCs—and evaluating whether elections such as the CFC group election or GILTI high tax exclusion could result in a lower tax burden.
CFC Group Election
These are the key changes within the proposed regulations that specifically impact a taxpayer’s CFC group election:
- Allow for a carryover of a CFC’s excess taxable income (ETI) to a future tax year
- Allow a standalone CFC to make a group election
- Apply the calculation of a CFC group’s ATI and interest expense on a consolidated basis
- Allow CFCs with effectively connected income (ECI) to be included in the CFC group
- Eliminate the tiering-up approach for calculating ATI and ETI of CFC group members
Calculation of US Shareholder ATI
The proposed regulations make the following modifications to the method of calculating a US shareholder’s ATI:
- Confirm the ATI of a US shareholder is computed without including deemed inclusions from CFCs—global intangible low-taxed income, Subpart F, and any associated Section 78 gross-up
- Allow a CFC group’s excess taxable income to increase a US shareholder’s ATI, to the extent that the US shareholder has a deemed inclusion under Subpart F or GILTI and has made a CFC group election
- Require the ATI of CFCs be calculated on an after-tax basis, although US corporations must still determine ATI on a pre-tax basis
The proposed regulations apply to tax years beginning on or after 60 days after the date the regulations are published as final. They may also be retroactively applied for tax years beginning after December 31, 2017, as long as a taxpayer applies both the 2020 final regulations and Proposed Regulation Section 1.163(j)-8.
The 2018 proposed regulations may still be applied for tax years beginning after December 31, 2017.
Although the 2020 proposed regulations may be applied retroactively, the new CFC group election and annual safe-harbor election must be made no later than the original due date of the return, including extensions.
Clarification is still needed on how to make these elections for tax years in which a US shareholder’s tax-return due date has already passed.
We’re Here to Help
For help navigating the proposed regulations, contact your Moss Adams professional.