Comments on capitalization of interest in the foreign context.

• Position: Comments submitted by Tax Executives Institute to the Department of the Treasury

Comments on Capitalization of Interest in the Foreign Context

On April 13, 1990, Tax Executives Institute submitted the following comments to the U.S. Department of the Treasury concerning the administrative and compliance burdens engendered by Notice 88-99 which deals with the capitalization of interest in the foreign context under section 263A(f) of the Internal Revenue Code. The Institute's submission, which followed up on the Institute's February 16 liaison meeting with Treasury officials, took the form of a letter from TEI President William M. Burk to Philip D. Morrison, the Treasury Department's International Tax Counsel. Preparation of the letter was coordinated by the Institute's International Tax Committee whose chair is Bernard J. Jerlstrom.

During the Institute's liaison meeting with the Office of Tax Policy on February 16, 1990, and during a follow-up meeting with Peter Barnes and you on March 6, 1990, we discussed the capitalization of interest in the foreign context under section 263A(f) of the Internal Revenue Code. This letter supplements those discussions.

Section 263A(f) provides that interest paid or incurred with respect to the production of certain property must be capitalized as part of the cost of such property. The statute authorizes the Treasury Department to issue regulations to prevent the use of related parties to avoid the application of section 263A. I.R.C. section 263A(i)(1). Notice 88-99, 1988-2 C.B. 422, extends the application of section 263A(f) to the interest expense of all parties related to the taxpayer, including foreign subsidiaries outside the consolidated group.

As we pointed out in our liaison meeting agenda, Notice 88-99 imposes extensive administrative and compliance burdens for U.S. companies, principally in the computation of indirect foreign tax credits under section 902 of the Code. In addition, we stated that the rules are fictive: they presume, for example, that a company has borrowed by (and secured by the assets of) a second, related company - even though the operations of the two companies (located in different countries, continents, or even hemisphere) are completely unrelated.

During our March 6 follow-up meeting, the suggestion was made that section 263A(f) generally benefits taxpayers by increasing their foreign-source income in the year of allocation (i.e., by increasing the amount of interest capitalized rather than deducted...