TEI Comments on Proposed Section 163(j) Regulations.

PositionTax Executives Institute

On February 26,2019, TEI submitted responsive comments and recommendations to the Internal Revenue Service concerning the proposed regulations under section 163(j) of the Internal Revenue Code (REG-106089-18). TEI's comments, which are reprinted below, were developed by a cross-industry working group of Tax Reform Task Force and Federal Tax Committee members under the stewardship of Watson M. McLeish, tax counsel for the Institute.

Tax Executives Institute ("TEI") welcomes this opportunity to comment on the new proposed regulations under section 163(j) of the Internal Revenue Code (the "Code"), (1) which were published in the Federal Register on December 28, 2018. (2) The proposed regulations would provide rules regarding the limitation on the deduction for business interest expense after the enactment of Public Law 115-97, colloquially known as the Tax Cuts and Jobs Act (the "Act"). (3)

TEI commends the Department of the Treasury ("Treasury") and the Internal Revenue Service (the "Service") for their laudable efforts to provide taxpayers with timely and comprehensive proposed guidance under section 163(j). The proposed regulations are helpful in addressing a wide range of issues pertaining to the new limitation on the deduction for business interest expense in section 163(j). There are, however, certain aspects of the proposed regulations that warrant clarifying or other changes to ensure successful implementation of the statute consistent with congressional intent. The following comments and recommendations address those aspects of the proposed regulations that are of greatest mutual concern to TEI members as they prepare to apply, and comply with, section 163(j).

About TEI

TEI is the preeminent association of in-house tax professionals worldwide, with over 7,000 members representing 2,800 of the leading companies in North and South America, Europe, and Asia. TEI represents a cross-section of the business community, and is dedicated to the development of sound tax policy, uniform and equitable enforcement of tax laws, and minimization of administration and compliance costs to the mutual benefit of government and taxpayers. As a professional association, TEI is committed to fostering a tax system that works--one that is administrate and with which taxpayers can comply in a cost-efficient manner.

TEI members are responsible for administering the tax affairs of their companies and must contend daily with provisions of the tax law relating to the operation of business enterprises, including the new limitation on the deduction for business interest expense in section 163(j). We believe that the diversity and professional experience of our members enable TEI to bring a balanced and practical perspective to the issues raised by the proposed regulations, and we are eager to assist Treasury and the Service in their important, collective efforts to implement the Act.

Background

Section 163(j) was added to the Code by the Omnibus Budget Reconciliation Act of 1989, (4) through which Congress intended to prevent erosion of the U.S. tax base by means of excessive deductions for interest paid by a taxable corporation to a tax exempt (or partially tax exempt) related person. (5) Prior to its amendment by the Act, section 163(j) disallowed a deduction for "disqualified interest" paid or accrued by a corporation in a taxable year if (i) the corporation's debt-to-equity ratio exceeded 1.5 to 1.0 and (ii) the corporation's net interest expense exceeded 50 percent of its adjusted taxable income. (6) To that end, "disqualified interest" included interest paid or accrued to (A) related persons if no U.S. federal income tax was imposed on the interest, (B) unrelated persons in certain instances where a related person guaranteed the debt, and (C) a real estate investment trust ("REIT") by a taxable REIT subsidiary thereof. (7)

Effective for taxable years beginning after December 31, 2017, the Act amended section 163(j) to generally limit a taxpayer's annual deduction for business interest expense to 30 percent of the taxpayer's adjusted taxable income for the taxable year. (8) Pursuant to section 163(j)(1), as amended by the Act:

The amount allowed as a deduction under [Chapter 1 of the Code] for any taxable year for business interest shall not exceed the sum of-- (A) the business interest income of such taxpayer for such taxable year, (B) 30 percent of the adjusted taxable income of such taxpayer for such taxable year, plus (C) the floor plan financing interest of such taxpayer for such taxable year. The amount determined under subparagraph (B) shall not be less than zero. (9) This new, expanded limitation on the deduction for business interest expense applies to all taxpayers, except for certain small businesses that meet the gross receipts test of section 448(c). (10) The amount of any business interest not allowed as a deduction for any taxable year by reason of section 163(j)(1) is carried forward and treated as business interest paid or accrued in the next taxable year. (11)

The proposed regulations would withdraw proposed Treasury regulations sections 1.163(j)-1 through -10, which were issued under prior law, (12) and provide wide-ranging guidance regarding the new limitation on the deduction for business interest expense in section 163(j). Central to that guidance are the proposed definitions of "adjusted taxable income" and "interest," which are the subject of TEI's comments below.

Discussion

  1. Adjusted Taxable Income

    As previewed above, the new limitation on the deduction for business interest expense in section 163(j) is principally based on a percentage of the taxpayer's adjusted taxable income. For purposes of section 163(j), the statute defines the term "adjusted taxable income" to mean the taxable income of the taxpayer computed without regard to:

    (i) any item of income, gain, deduction, or loss which is not properly allocable to a trade or business,

    (ii) any business interest or business interest income,

    (iii) the amount of any net operating loss deduction under section 172,

    (iv) the amount of any deduction allowed under section 199A, and

    (v) in the case of taxable years beginning before January 1, 2022, any deduction allowable for depreciation, amortization, or depletion. (13)

    This measure of income is referred to as "EBITDA," for earnings before interest, taxes, depreciation, and amortization. (14) For taxable years beginning after December 31, 2021, however, the limitation under section 163(j) becomes more restrictive; adjusted taxable income will be similar to earnings before interest and taxes (or "EBIT"), as it will no longer exclude depreciation, amortization, or depletion deductions. (15)

    For taxable years beginning before...

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