For US multinational groups, the Tax Cuts and Jobs Act of 2017 introduced important changes to the US tax code, including new limits on the ability of US corporations to reduce their US tax liability by borrowing excessively from foreign subsidiaries.
The Act introduced a new Section 163(j) to the Internal Revenue Code. The provisions limit the deductibility of interest expenses that a business can deduct to the sum of; the taxpayer's business interest income, 30% of the taxpayer's adjusted taxable income, and the floor plan financing interest of the taxpayer.
Any business interest expense in excess of this threshold must be carried forward to the following year.
The limitation generally does not apply to small businesses (other than tax shelters), regulated public utilities, and electing farming or real property trades or businesses. Small businesses are those whose average annual gross receipts are USD25m or less for the three prior tax years. This amount will be adjusted annually for inflation starting this year.
The changes are intended to improve the efficacy of US tax provisions that seek to prevent US corporations from inappropriately reducing their liability to US tax by excessively borrowing from related parties situated in jurisdictions that have lower rates of tax; a practice known as "earnings stripping."
The adoption of the measure is the US's preferred approach in response to the recommendations of the OECD on tackling base erosion and profit shifting (BEPS). Specifically, the OECD proposed, in Action 4 of its BEPS project, that countries should cap an entity's net interest deductions to its level of economic activity at a percentage of its taxable earnings before interest income and expense, depreciation and amortisation (EBITDA).
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The US provisions apply to taxable years beginning after 31 December 2017.
In March 2019, the Joint Committee on Taxation provided an overview of the new provisions. This overview included sections on:
• the background to the interest deduction;
• prior law;
• present law;
• definitions of terms;
• rules for pass-through entities;
• the special carry-forward rule for partnerships;
• exceptions for small businesses, employees, utilities, and elections; and
• the effective date of the provisions.
Other Notable Developments
The US issued proposed regulations, REG–106089–18, on 26 November 2018. These confirmed that taxpayers should use new Form 8990, Limitation on Business Interest Expense Under Section 163(j), to calculate and report their deduction and the amount of disallowed business interest expense to carry forward to the next tax year.
Revenue Procedure 2018-59, effective 10 December 2018, thereafter provided a safe harbour that allows taxpayers to treat certain infrastructure trades or businesses as real property trades or businesses solely for purposes of qualifying as an electing real property trade or business. Qualifying entities fall outside the scope of the new interest deduction rules.