Highlights of the proposed earnings stripping regulations under Sec. 163(j); an admirable first effort in implementing a harsh statutory rule.
The Tax Adviser › Vol. 23 Nbr. 1, January 1992
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Summary
Sec. 163(j), meant to curtail 'earnings stripping' by foreign-owned U.S. corporations, and proposed regulations under it issued in June 1991 are discussed. Sec. 163(j) makes it more difficult for foreign corporations to claim interest deductions while claiming exemption from taxes on interest income. The proposed regulations regarding affiliated groups and the anti-abuse provisions are perhaps too complicated. However, the proposed regulations are a good first step.
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Highlights of the proposed earnings stripping regulations under Sec. 163(j); an admirable first effort in implementing a harsh statutory rule.
Congress and the IRS have become increasingly hostile towards foreign-owned U.S. corporations, based on their belief that these corporations are not paying their fair share of federal income taxes. In particular, Congress has been concerned with "earnings stripping," under which a U.S. corporation or branch of a foreign corporation obtains an interest deduction for its interest expense, but the payee is exempt from U.S. tax on the interest income. To prevent such interest deductions if the interest income is neither effectively connected with a U.S. trade or business nor subject to the full 30% withholding tax due to a tax treaty, Sec. 163(j) was enacted as part of the Revenue Reconciliation Act of 1989 (1989 RRA).
This article will examine Sec. 163(j) and analyze its proposed regulations, which were issued in June 1991. Sec. 163(j) Under Sec. 163(j), deductions for interest paid or accrued by a U.S. corporation or branch of a foreign corporation may be disallowed if the following three conditions are met. 1. The payor corporation's debt-to-equity ratio exceeds 1.5 to 1. 2. The payor corporation has "excess interest expense" for the tax year. 3. Interest is paid to a "related person" that is exempt from U.S. tax, in whole or in part, on the interest income. Sec. 163(j)(6)(C) requires that these calculations be made on an affiliated group basis. Interest paid to a related person may be disallowed to the extent of "excess interest expense," the amount by which "net interest expense" exceeds 50% of "adjusted taxable income" plus any "excess limitation carryforward." Disallowed interest may be carried forward indefinitely and is deductible in a carryforward year to the extent of excess limitat...See the full content of this document
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