Removal of Sec. 163(j) limitation does not qualify as accounting method change.

• Author: Anderson, Kevin D.

The IRS concluded in Chief Counsel Advice (CCA) 201202021 that removing the Sec. 163(j) limitation on the deduction of interest paid on a loan from a related party does not qualify as an accounting method change under Sec. 446. For certain tax years, the taxpayer had limited its interest deduction on certain related party indebtedness by applying the provisions of Sec. 163(j). During an examination, the IRS determined that the Sec. 163(j) limitation did not apply because the affiliate that had loaned money to the taxpayer was not a related person under Sec. 163(j).

The taxpayer sought to have the favorable removal of the interest limitation treated as an accounting method change to benefit from a negative Sec. 481 adjustment in a single year, so that the taxpayer could have claimed the cumulative effect of missed deductions in tax years that were otherwise closed by statute. However, the Office of Chief Counsel advised that this treatment was not correct.

Facts

The taxpayer involved in the CCA was the parent corporation of a U.S. affiliated group that filed a consolidated federal income tax return. The affiliated group was jointly owned indirectly by various foreign entities. One foreign affiliate provided loans to the taxpayer and other members of the affiliated group for certain years. The taxpayer treated the loans from the foreign entity as loans from a related party for purposes of applying the Sec. 163(j) limitation. Sec. 163(j)(4) generally considers a related party as any person who is related within the meaning of Sec. 267(b) or Sec. 707(b)(1).

The taxpayer assumed the lender was a related party within the meaning of Sec. 267(b) or 707(b)(1). Therefore, the taxpayer limited its deduction for interest on the related-party indebtedness by applying the interest limitation provisions under Sec. 163(j). For each year, the taxpayer calculated the excess of the interest deduction that would have been allowed under Sec. 163(a) in the year without regard to Sec. 163(j) over the interest deduction it was permitted after taking into account that limitation. The excess amount was carried to the taxpayer's succeeding tax years.

Upon examination of the taxpayer, the IRS questioned whether the taxpayer and foreign affiliate that had provided the loans were in fact related parties under Sec. 163(j). The IRS determined that the taxpayer and its foreign affiliate were not related parties under Sec. 163(j) and, therefore, the Sec. 163(j) limitation...